TPI COMPOSITES, INC - Quarter Report: 2018 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2018

OR

Commission File Number 001-37839

TPI Composites, Inc.

(Exact name of registrant as specified in its charter)

8501 N. Scottsdale Rd.

Gainey Center II, Suite 100

Scottsdale, AZ 85253

(480) 305-8910

(Address, including zip code, and telephone number,

including area code, of registrant’s principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of October 31, 2018, there were 34,510,890 shares of common stock outstanding.

TPI COMPOSITES, INC. AND SUBSIDIARIES

INDEX

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities law. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. In many cases, you can identify forward-looking statements by terms such as “may,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

These forward-looking statements are only predictions. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other important factors that may cause our actual results, levels of activity, performance or achievements to materially differ from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. We have described in the “Risk Factors” section of our Annual Report on Form 10-K filed with the United States Securities and Exchange Commission (SEC) on March 8, 2018 (the Annual Report on Form 10-K) the principal risks and uncertainties that we believe could cause actual results to differ from these forward-looking statements. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely on these forward-looking statements as guarantees of future events.

The forward-looking statements in this Quarterly Report on Form 10-Q represent our views as of the date of this Quarterly Report. We anticipate that subsequent events and developments will cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we undertake no obligation to update any forward-looking statement to reflect events or developments after the date on which the statement is made or to reflect the occurrence of unanticipated events except to the extent required by applicable law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date after the date of this Quarterly Report. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.

PART I—FINANCIAL INFORMATION

ITEM l. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

TPI COMPOSITES, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(In thousands, except par value data)

See accompanying notes to unaudited condensed consolidated financial statements.

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TPI COMPOSITES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

See accompanying notes to unaudited condensed consolidated financial statements.

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TPI COMPOSITES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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TPI COMPOSITES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(In thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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TPI COMPOSITES, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

Note 1. Summary of Operations and Significant Accounting Policies

Description of Business

TPI Composites, Inc. is the holding company that conducts substantially all of its business operations through its direct and indirect subsidiaries (collectively, the Company). The Company was founded in 1968 and has been producing composite wind blades since 2001. The Company’s knowledge and experience of composite materials and manufacturing originates with its predecessor company, Tillotson Pearson Inc., a leading manufacturer of high-performance sail and powerboats along with a wide range of composite structures used in other industrial applications. Following the separation from the boat building business in 2004, the Company reorganized in Delaware as LCSI Holding, Inc. and then changed its corporate name to TPI Composites, Inc. in 2008. The Company is currently headquartered in Scottsdale, Arizona and has expanded its global footprint to include domestic facilities in Newton, Iowa; Fall River, Massachusetts; Warren, Rhode Island and Santa Teresa, New Mexico and international facilities in Dafeng, China; Taicang Port, China; Taicang City, China; Yangzhou, China; Juárez, Mexico; Matamoros, Mexico; Izmir, Turkey and Kolding, Denmark.

References to TPI Composites, Inc, the “Company,” “we,” “us” or “our” in these notes refer to TPI Composites, Inc. and its consolidated subsidiaries.

Public Offerings and Stock Split

In July 2016, we completed an initial public offering (IPO) of 7,187,500 shares of our common stock at a price of $11.00 per share, which included 937,500 shares issued pursuant to the underwriters’ over-allotment option. Certain of our existing shareholders, a non-employee director and executive officers purchased an aggregate of 1,250,000 shares of our common stock in the IPO included in the total issuance above. The net proceeds from the IPO were $67.2 million after deducting underwriting discounts and offering expenses. Immediately prior to the closing of the IPO, all shares of the then-outstanding redeemable preferred shares converted into an aggregate of 21,110,204 shares of our common stock and the redeemable preferred share warrants converted on a net issuance basis into 120,923 shares of our common stock. In addition, concurrent with the closing of the IPO, certain subordinated convertible promissory notes in the aggregate principal and interest amount of $11.9 million were converted into 1,079,749 shares of our common stock at the public offering price of $11.00 per share.

Prior to the IPO, in July 2016 we amended our amended and restated certificate of incorporation to effect a 360-for-1 forward stock split of our common stock. As a result of the stock split, we have adjusted the share amounts authorized and issuable under the share-based compensation plans. All share and per share common stock information (including the share-based compensation plans) referenced throughout the unaudited condensed consolidated financial statements and notes thereto have been retroactively adjusted to reflect this stock split. The stock split did not cause an adjustment to the par value of the authorized shares of our common stock.

In May 2017, we completed a secondary public offering of 5,075,000 shares of our common stock at a price of $16.35 per share, which included 575,000 shares issued pursuant to the underwriters’ option to purchase additional shares. All of the shares were sold by existing shareholders and certain of our executive officers. The selling shareholders received all of the net proceeds of $78.8 million from the secondary public offering. We did not sell any shares and did not receive any of the proceeds from the offering and the costs paid by us in connection with the offering of $0.8 million were recorded in general and administrative costs in the accompanying condensed consolidated statement of operations.  

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TPI COMPOSITES, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

Basis of Presentation

We divide our business operations into four geographic operating segments—the United States (U.S.), Asia, Mexico and Europe, the Middle East and Africa (EMEA) as follows:

The accompanying condensed consolidated financial statements include the accounts of TPI Composites, Inc. and of our majority owned subsidiaries. All significant intercompany transactions and balances have been eliminated.

The condensed consolidated financial statements included herein have been prepared by us without audit, pursuant to the rules and regulations of the SEC and should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2017 included in our Annual Report on Form 10-K. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been condensed or omitted, as permitted by the SEC, although we believe the disclosures that are made are adequate to make the information presented herein not misleading. The accompanying condensed consolidated financial statements reflect, in the opinion of our management, all normal recurring adjustments necessary to present fairly our financial position at September 30, 2018, and the results of our operations, comprehensive income and cash flows for the periods presented. We restated our December 31, 2017 condensed consolidated balance sheet and the September 30, 2017 condensed consolidated statement of operations and cash flow for the effect of the adoption of Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, (Topic 606), see Note 13, Adjustments to Previously Reported Financial Statements from the Adoption of an Accounting Pronouncement. Interim results for the three and nine months ended September 30, 2018 and 2017 are not necessarily indicative of the results to be expected for the full years.

As previously announced, effective January 1, 2018, we adopted the requirements of Topic 606 using the full retrospective method as further described in Recently Issued Accounting Pronouncements - Revenue from Contracts with Customers and Note 2, Revenue from Contracts with Customers. All amounts and disclosures set forth in this Quarterly Report on Form 10-Q reflect the adoption of Topic 606 and differ from amounts previously reported for prior periods. See Note 13, Adjustments to Previously Reported Financial Statements from the Adoption of an Accounting Pronouncement, for further discussion of the adoption of Topic 606, including the impact on our previously reported financial statements.

Revenue Recognition

The majority of our revenue is generated from long-term contracts associated with manufacturing of wind blades and related services.  We account for a long-term contract when it has the approval from both parties, the rights of the parties are identified, payment terms are established, the contract has commercial substance and the collectability of consideration is probable.

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TPI COMPOSITES, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

To determine the proper revenue recognition method for each long-term contract, we evaluate whether the original contract should be accounted for as one or more performance obligations. This evaluation requires judgment and the decisions reached could change the amount of revenue and gross profit recorded in a given period. As most of our contracts contain multiple performance obligations, we allocate the total transaction price to each performance obligation based on the estimated relative standalone selling prices of the promised goods or services underlying each performance obligation. Our manufacturing services are customer specific and involve production of items that cannot be sold to other customers due to the customers’ protected intellectual property; therefore, we allocate the total transaction price under our contracts with multiple performance obligations using the contractually stated prices, as these prices represent the relative standalone selling price based on an expected cost plus margin model.  

Revenue is primarily recognized over time as we have an enforceable right to payment upon termination and we may not use or sell the product to fulfill other customers’ contracts.  In addition, the customer does not have return or refund rights for items produced that conform to the specifications included in the contract. Because control transfers over time, revenue is recognized based on the extent of progress towards the completion of the performance obligation. We use the cost-to-cost input measure of progress for our contracts as this method provides the best representation of the production progress towards satisfaction of the performance obligation as the materials are distinct to the product being manufactured because of customer specifications provided for in the contract, the costs incurred are proportional to the progress towards completion of the product, and the products do not involve significant pre-fabricated component parts. Under the cost-to-cost method, progress and the related revenue recognition is determined by a ratio of direct costs incurred to date in fulfillment of the contract to the total estimated direct costs required to complete the performance obligation.

Determining the revenue to be recognized for services performed under our manufacturing contracts involves significant judgments and estimates relating to the total consideration to be received and the expected total costs to complete the performance obligation.  The judgments and estimates relating to the total consideration to be received include the amount of variable consideration as our contracts typically provide the customer with a range of production output options from guaranteed minimum volume obligations to the production capacity of the facility, and customers will provide periodic non-cancellable commitments for the number of wind blades to be produced over the term of the agreement.  We use historical experience, customer commitments and forecasted future production based on the capacity of the plant to estimate the total revenue to be received to complete the performance obligation.  In addition, the amount of revenue per unit produced may vary based on the costs of production of the wind blades as we may be able to change the price per unit based on changes in the cost of production.  Further, some of our contracts provide opportunities for us to share in labor and material cost savings as well as absorb some additional costs as an incentive for more efficient production, both of which impact the margin realized on the contract and ultimately the total amount of revenue to be recognized.  Additionally, certain of our customer contracts provide for concessions by us for missed production deadlines.  

We estimate variable consideration at the most likely amount to which we expect to be entitled. We include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information available to us at the time of the estimate and may materially change as additional information becomes known.

Our contracts may be modified to account for changes in specifications of products and changing requirements. If the contract modifications are for goods or services that are not distinct from the existing contract, they are accounted for as if they were part of the original contract. The effect of a contract modification on the transaction price and the measure of progress for the performance obligation to which it relates is recognized as an adjustment to revenue on a cumulative catch-up basis. If contract modifications are for goods and services that are distinct from the existing contract and increases the amount of consideration reflecting the standalone sale price of the additional goods or services, then the contract modification is accounted for as a separate contract and is evaluated for one or more performance obligations.  

Each reporting period, we evaluate the progress towards satisfaction of each performance obligation based on any contract modifications that have occurred, cost incurred to date, and an estimate of the expected future revenue and costs to be incurred to complete the performance obligation. Based on this analysis, any changes in estimates of revenue, cost of sales, contract assets and liabilities and the related impact to operating income are recognized on a cumulative catch-up basis, which recognizes in the current period the cumulative effect of the changes on current and prior periods based on the percentage of completion of the performance obligation.

Wind blade pricing is based on annual commitments of volume as established in our customer’s contract and orders less than committed volume may result in a higher price per wind blade to our customers. Orders in excess of annual commitments may result

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TPI COMPOSITES, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

in discounts to our customers from the contracted price for the committed volume. Our customers typically provide periodic purchase orders with the price per wind blade given the current cost of the bill of materials, labor requirements and volume desired.  We record an allowance for expected utilization of early payment discounts which are reported as a reduction of the related revenue.

Precision molding and assembly systems included in a customer’s contract are based upon the specific engineering requirements and design determined by the customer and are specific to the wind blade design and function desired. From the customer’s engineering specifications, a job cost estimate is developed along with a production plan, and the desired margin is applied based on the location the work is to be performed and complexity of the customer’s design. Precision molding and assembly systems are generally built to produce wind blades which may be manufactured by us in production runs specified in the customer contract.

Contract assets primarily relate to our rights to consideration for work completed but not billed at the reporting date on manufacturing services contracts.  The contract assets are transferred to accounts receivable when the rights become unconditional, which generally occurs when customers are invoiced upon the determination that a product conforms to the contract specifications and invoices are due based on each customers negotiated payment terms, which range from 15 to 65 days.  We apply the practical expedient that allows us to exclude payment terms under one year from the transfer of a promised good or service from consideration of a significant financing component in its contracts. With regards to the production of precision molding and assembly systems, our contracts generally call for progress payments to be made in advance of production. Generally, payment is made at certain percentage of completion milestones with the final payment due upon delivery to the manufacturing facility. These progress payments are recorded within contract liabilities as current liabilities in the condensed consolidated balance sheets and are reduced as we record revenue over time.  

Our customers may request, in situations where they do not have space available to receive products or do not want to take possession of products immediately for other reasons, that their finished products be stored by us in one of our facilities. Most of our contracts provide for a limited number of wind blades to be stored during the period of the contract with any additional wind blades stored subject to additional storage fees, which are included in the wind blade performance obligation revenue.  

Revenue related to non-recurring engineering and freight services provided under our customer contracts is recognized at a point in time following the transfer of control of the promised services to the customer. Customers usually pay the carrier directly for the cost of shipping associated with items produced.  When we pay the shipping costs, we apply the practical expedient that allows us to account for shipping and handling as a fulfillment costs and include the revenue in the associated performance obligation and the costs are included in cost of goods sold.

Taxes assessed by a governmental authority that are both imposed on and concurrent with specific revenue-producing transactions, that are collected by us from a customer, are excluded from revenue.

Warranty Expense

We provide a limited warranty for our mold and wind blade products, including parts and labor, with terms and conditions that vary depending on the product sold, generally for periods that range from two to five years. Warranty expense is recorded based upon estimates of future repairs using a probability-based methodology that considers previous warranty claims, identified quality issues and industry practices. Once the warranty period has expired, any remaining unused warranty accrual for the specific products is reversed against the current year warranty expense amount.

Warranty accrual at September 30 consisted of the following:

Treasury Stock

Common stock purchased for treasury is recorded at historical cost. Transactions in treasury shares relate to share-based compensation plans and are recorded at weighted-average cost.

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TPI COMPOSITES, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

Net Income Per Common Share Calculation

The basic net income per common share is computed by dividing the net income by the weighted-average number of common shares outstanding during a period. Diluted net income per common share is computed by dividing the net income by the weighted-average number of common shares outstanding plus potentially dilutive securities using the treasury stock method. The table below reflects the calculation of the weighted-average number of common shares outstanding, using the treasury stock method, used in computing basic and diluted earnings per common share:

Share-based compensation awards of 7,000 shares and 63,000 shares were excluded from the computation of diluted net income per share for the three and nine months ended September 30, 2018, respectively, because their effect would be anti-dilutive. We did not have any potential dilutive securities which were excluded from the computation of diluted net income per share for the three and nine months ended September 30, 2017.

Financial Instruments

Interest Rate Swap

We use interest rate swap contracts to mitigate our exposure to interest rate fluctuations associated with our new credit agreement (the Credit Agreement) that we entered into in April 2018. We do not use such swap contracts for speculative or trading purposes.

To offset the variability of future interest payments on the Credit Agreement arising from changes in the London Interbank Offered Rate (LIBOR), in April 2018, we entered into an interest rate swap agreement with a financial institution for a notional amount of $75.0 million with an expiration date of April 2023. This interest rate swap effectively hedges $75.0 million of the $75.4 million of the then outstanding future variable rate LIBOR interest expense to a fixed rate interest expense. The derivative instrument qualified for accounting as a cash flow hedge in accordance with Financial Accounting Standards Board (FASB) Accounting Standard Codification (ASC) Topic 815, Derivatives and Hedging, and we designated it as such.

The settlement value of the interest rate swap is $0.7 million as of September 30, 2018 and is included in other noncurrent assets in the condensed consolidated balance sheet.  The unrealized gain on the swap of $0.6 million, net of tax, is included in the condensed consolidated statement of other comprehensive income (loss).

Forward Contract

We use forward contracts to mitigate our exposure associated with fluctuations in foreign currency exchange rates. We do not use such forward contracts for speculative or trading purposes.

In August 2018, we provided a Turkish Lira denominated intercompany loan to an EMEA subsidiary in the amount of $15.0 million converted at the spot rate on the transaction date to 96.6 million Turkish Lira to fund their working capital requirements. We entered into a forward contract, with the same expiration as that of the intercompany loan’s maturity in October 2018, for a notional amount of 101.5 million Turkish Lira to reduce our exposure to currency fluctuations from the settlement of this Turkish Lira denominated intercompany loan of 96.6 million Turkish Lira and accrued interest of 4.9 million Turkish Lira. The derivative instrument qualifies for accounting as a cash flow hedge in accordance with FASB ASC Topic 815, Derivatives and Hedging, and we designated it as such at inception.

The settlement liability of the forward contract is $1.2 million as of September 30, 2018 and is included in accounts payable and accrued expenses in the condensed consolidated balance sheet. 

For the three and nine months ended September 30, 2018, a loss of $1.1 million has been included in realized loss on foreign currency remeasurement in the condensed consolidated statements of operations offsetting the remeasurement of the Turkish Lira denominated

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Notes to Unaudited Condensed Consolidated Financial Statements

intercompany loan receivable. An additional $0.1 million unrealized loss on the forward contract, net of tax, is included in the condensed consolidated statement of other comprehensive income (loss).

Use of Estimates

The preparation of these condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Recently Issued Accounting Pronouncements

Accounting Pronouncements Adopted in 2018

Revenue from Contracts with Customers

In May 2014, the FASB issued Topic 606, which provides new recognition and disclosure requirements for revenue from contracts with customers that supersedes the existing revenue recognition guidance. The new recognition requirements focus on when the customer obtains control of the goods or services, rather than the current risks and rewards model of recognition. The core principle of the new standard is that an entity will recognize revenue when it transfers goods or services to its customers in an amount that reflects the consideration an entity expects to be entitled to for those goods or services. The new disclosure requirements included in these financial statements contain information intended to communicate the nature, amount, timing and any uncertainty of revenue and cash flows from the applicable contracts, including any significant judgments and changes in judgments and assets recognized from the costs to obtain or fulfill a contract.

We adopted Topic 606 as of January 1, 2018 with retrospective application to January 1, 2016 through December 31, 2017.  See Note 2, Revenue from Contracts with Customers and Note 13, Adjustments to Previously Reported Financial Statements from the Adoption of an Accounting Pronouncement, for further discussion of the adoption of this standard, including the impact on our previously reported financial statements.

Cash Flow Presentation

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, that clarifies how certain cash receipts and cash payments are presented and classified in the condensed consolidated statements of cash flows.  In addition, in November 2016, the FASB issued ASU 2016-18, Restricted Cash, that requires restricted cash and cash equivalents to be included with the amount of cash and cash equivalents that are reconciled on the condensed consolidated statements of cash flows. We adopted these ASUs as of January 1, 2018 with retrospective application to each period presented.

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets which total the same such amounts in the condensed consolidated statements of cash flows:

See Note 13, Adjustments to Previously Reported Financial Statements from the Adoption of an Accounting Pronouncement, for further discussion of the adoption of these standards, including the impact on our previously reported financial statements.  

Income Taxes

In December 2017, the SEC staff issued Staff Accounting Bulletin 118 (SAB 118), which provides relief for companies that have not completed their accounting for the effects of The Tax Cuts and Jobs Act (Tax Reform Act) but can determine a reasonable estimate of

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Notes to Unaudited Condensed Consolidated Financial Statements

those effects to allow them to include a provisional amount based on their reasonable estimate in their financial statements. The guidance in SAB 118 also allows companies to adjust the provisional amounts during a one-year “measurement period” which is similar to the measurement period used when accounting for business combinations. In the accompanying consolidated financial statements, we have not yet completed our accounting for all the tax effects associated with the enactment of the Tax Reform Act. However, we have, in certain cases made a reasonable estimate of the effects on our existing carryforward attributes and the one-time transition tax. See Note 9, Income Taxes, for further discussion.

Accounting Pronouncements Not Yet Adopted

Leases

In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 is a comprehensive new recognition model for leases requiring a lessee to recognize the asset and liability that arise from leases. For public companies, this new standard is effective for financial statements issued for annual periods beginning after December 16, 2018. Entities may elect to early adopt the lease standard in 2016. In adopting ASU 2016-02, entities are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. In July 2018, the FASB issued ASU 2018-11, Leases: Targeted Improvements, that provides an alternative transition method of adoption, permitting the recognition of a cumulative-effect adjustment to retained earnings on the date of adoption.

We will adopt this new standard on the effective date using the alternative transition method provided by ASU 2018-11 and we are currently evaluating the potential changes from ASU 2018-11 to our future financial reporting and disclosures and designing and implementing related processes and controls.  We expect that the standard will have a material impact on our total assets and liabilities for the addition of right-of-use assets and lease liabilities, but we do not expect it to have a material impact on our results of operations or liquidity.  

Note 2. Revenue From Contracts with Customers

The following tables represents the disaggregation of our net sales revenue by contract type for each of our reportable segments (in thousands):

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Notes to Unaudited Condensed Consolidated Financial Statements

In addition, most of our net sales are made directly to our customers, primarily wind turbine manufacturers, under our long-term contracts which are typically five years in length.

Contract Assets and Liabilities

Contract assets consist of unbilled amounts typically resulting from revenue recognized over time for products in production and the revenue recognized exceeds the amount billed to the customer. The contract assets are recorded as current assets in the condensed consolidated balance sheets. Contract liabilities consist of advance payments in excess of costs incurred. These amounts were historically recorded as customer deposits which primarily related to progress payments received as precision molding and assembly systems were being manufactured. The contract liabilities are recorded as current liabilities in the condensed consolidated balance sheets and are reduced as we record revenue over time.  

These contract assets and liabilities are reported on the condensed consolidated balance sheets net on a contract-by-contract basis at the end of each reporting period, as demonstrated in the table below.

Contract assets and contract liabilities consisted of the following:

Contracts assets increased by $16.6 million from December 31, 2017 to September 30, 2018 due to incremental unbilled production during the nine months ended September 30, 2018. Contracts liabilities increased by $5.6 million from December 31, 2017 to September 30, 2018 due to the amounts billed to customers exceeding the progress billings received primarily related to precision molding and assembly systems being produced in the nine months ended September 30, 2018.

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Notes to Unaudited Condensed Consolidated Financial Statements

The time it takes to produce a single blade is typically between 24 to 36 hours. The time it takes to produce a mold is typically between 3 to 6 months.

For the three months ended September 30, 2018, we recognized no revenue, and for the nine months ended September 30, 2018, we recognized $2.8 million of revenue, in each case, that was included in the corresponding contract liability balance at the beginning of the period.

Performance Obligations

Remaining performance obligations represent the transaction price of firm orders for which work has not been performed and excludes any unexercised contract options.

For the three and nine months ended September 30, 2018, net revenue recognized from our performance obligations satisfied in previous periods decreased by $3.9 million and $7.9 million, respectively. This primarily relates to changes in certain of our estimated total contract values and related percentage of completion estimates.

As of September 30, 2018, the aggregate amount of the transaction price allocated to the remaining performance obligations was  approximately $5.6 billion. We estimate that we will recognize the remaining performance obligations as revenue as follows: 5 percent in the remainder of 2018, 27 percent in 2019, 27 percent in 2020, 17 percent in 2021, 14 percent in 2022 and the remaining 10 percent in 2023.

Pre-Production Investments

We recognize an asset from the costs incurred to fulfill a contract when those costs meet all of the following criteria:  (a) the costs relate directly to a contract or to an anticipated contract that we can specifically identify; (b) the costs generate or enhance our resources that will be used in satisfying performance obligations in the future; and, (c) the costs are expected to be recovered. We capitalize the costs related to training our workforce to execute the manufacturing services and other facility set-up costs related to preparing for production.  We factor these costs into our estimated cost analysis for the overall contract.  Costs capitalized are amortized over the number of units produced during the contract term. As of September 30, 2018, the cost and accumulated amortization of such assets totaled $4.8 million and $1.7 million, respectively. As of December 31, 2017, the cost and accumulated amortization of such assets totaled $2.4 million and $1.4 million, respectively. These amounts are included in other noncurrent assets in the condensed consolidated balance sheet.

In applying the practical expedient as permitted under Topic 606, we recognize the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the asset that we otherwise would have recognized is one year or less.  These costs are included in cost of goods sold.

Note 3. Significant Risks and Uncertainties

Our revenues and receivables are from a small number of customers. As such, our production levels are dependent on these customers’ orders. See Note 11, Concentration of Customers.

We maintain our U.S. cash in bank deposit accounts that, at times, exceed U.S. federally insured limits. U.S. bank accounts are guaranteed by the Federal Deposit Insurance Corporation (FDIC) in an amount up to $250,000 during 2018 and 2017. At September 30, 2018 and December 31, 2017, we had $70.6 million and $98.9 million, respectively, of cash in deposit accounts in U.S. banks, which was in excess of FDIC limits. We have not experienced losses in any such accounts.

We also maintain cash in bank deposit accounts outside the U.S. with no insurance. At September 30, 2018, this includes $29.6 million in China, $8.6 million in Turkey and $2.0 million in Mexico. We have not experienced losses in these accounts. In addition, at September 30, 2018, we have short-term deposits in interest bearing accounts of $2.8 million in China, which are reported as restricted cash in our condensed consolidated balance sheets. At September 30, 2018, we also have long-term deposits in interest bearing accounts of $0.5 million in Iowa which are reported as restricted cash within the caption other noncurrent assets in our condensed consolidated balance sheets.

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Notes to Unaudited Condensed Consolidated Financial Statements

Note 4. Related-Party Transactions

Related party transactions include transactions between us and certain of our affiliates. The following transactions were in the normal course of operations and were measured at the exchange amount, which is the amount of consideration established and agreed to by the parties.

We have entered into several agreements with subsidiaries of General Electric Company and its consolidated affiliates (GE) relating to the operation of its business. As a result of these agreements, GE has been a debtor, creditor and holder of both preferred and common shares. During the second quarter of 2017, GE reduced its holdings of our common shares to less than five percent of the total shares then outstanding and completely divested of our common shares during the third quarter of 2017.

We have entered into five separate supply agreements with GE to manufacture wind blades in Newton, Iowa; Taicang Port, China; Juárez, Mexico (2) and Izmir, Turkey. The supply agreements in Taicang Port, China and Izmir, Turkey expired on December 31, 2017 and GE did not renew or extend these two contracts. For the six months ended June 30, 2017, we recorded related-party sales with GE of $198.6 million.

Certain of our existing stockholders, consisting of entities associated with Element Partners, Angeleno Group and Landmark Partners, each of which is an affiliate of a member of the board of directors, as well as certain executive officers and a director, purchased an aggregate of 1,250,000 shares of our common stock in the IPO. In addition, all outstanding obligations and accrued interest under our subordinated convertible promissory notes held by certain existing stockholders, including Element Partners, Angeleno Group and Landmark Partners, were converted into an aggregate of 1,079,749 shares of our common stock concurrent with the closing of the IPO at the public offering price of $11.00 per share.  

In connection with our secondary offering in May 2017, certain entities associated with Element Partners, Angeleno Group, Landmark Partners and NGP Energy Technology Partners, L.P, as well as certain of our executive officers sold an aggregate of 5,075,000 shares of our common stock at the public offering price of $16.35 per share.

Note 5. Accounts Receivable

Accounts receivable consisted of the following:

Note 6. Property, Plant and Equipment, Net

Property, plant and equipment, net consisted of the following:

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Notes to Unaudited Condensed Consolidated Financial Statements

Total depreciation expense for the three months ended September 30, 2018 and 2017 was $5.8 million and $5.1 million, respectively, and $18.6 million and $13.5 million for the nine months ended September 30, 2018 and 2017, respectively.

Note 7. Long-Term Debt, Net of Debt Issuance Costs and Current Maturities

Long-term debt, net of debt issuance costs and current maturities, consisted of the following:

In April 2018, we entered into a new credit agreement (the Credit Agreement) with four lenders consisting of a multi-currency, revolving credit facility in an aggregate principal amount of $150.0 million, including a $25.0 million letter of credit sub-facility. We drew down $75.4 million on the revolving credit facility in connection with the closing of the transactions contemplated by the Credit Agreement and used the proceeds to pay all outstanding amounts due and payable under our senior secured credit facility, various fees and expenses and related accrued interest. All borrowings and amounts outstanding under the Credit Agreement are scheduled to mature in April 2023.

Interest accrues at a variable rate equal to LIBOR plus an initial margin of 1.5% (3.7% as of September 30, 2018), which may vary based on our total net leverage ratio as defined in the Credit Agreement. Interest is paid monthly and we are not obligated to make any principal repayments prior to the maturity date so long as we are not in default under the Credit Agreement. We may prepay borrowings without penalty under the Credit Agreement.

In April 2018, we also entered into an interest rate swap arrangement to fix a notional amount of $75.0 million under the Credit Agreement at an effective interest rate of 4.2% for a period of five years.

In August 2018, we borrowed an additional $15.0 million under the Credit Agreement in order to fund the working capital requirements of one of our EMEA subsidiaries.

Note 8. Share-Based Compensation Plans

Our Amended and Restated 2015 Stock Option and Incentive Plan (the 2015 Plan) provides for the issuance of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock units, restricted stock awards, unrestricted stock awards, cash-based awards, performance share awards and dividend equivalent rights to certain employees, non-employee directors and consultants. Under the 2015 Plan, we have granted awards of stock options, restricted stock units (RSUs) and performance-based restricted stock units (PSUs) to certain employees and non-employee directors.

During the nine months ended September 30, 2018, we issued to certain employees and non-employee directors an aggregate of 149,012 timed-based RSUs, 121,836 PSUs that vest upon achievement of a cumulative, three-year Adjusted EBITDA target measured from January 1, 2018 through December 31, 2020, and 170,712 PSUs that vest upon achievement of certain stock price hurdles for the period of the grant date through December 31, 2020. 100% of the time-based RSUs vest on the third anniversary date of the grant date.

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Notes to Unaudited Condensed Consolidated Financial Statements

Each of the time-based and performance-based awards are subject to the recipient’s continued service with us, the terms and conditions of the 2015 Plan and the applicable award agreement.

The share-based compensation expense recognized in the condensed consolidated statements of operations was as follows:

The share-based compensation expense recognized by award type was as follows:

As of September 30, 2018, the unamortized cost of the outstanding RSUs and PSUs was $4.8 million and $3.9 million, respectively, which we expect to recognize in the condensed consolidated financial statements over weighted-average periods of approximately 1.7 years and 2.5 years, respectively. Additionally, the total unrecognized cost related to non-vested stock option awards was $2.3 million, which we expect to recognize in the condensed consolidated financial statements over a weighted-average period of approximately 1.5 years.    

The summary of activity under our incentive plans is as follows:

The fair value of RSUs which vested during the nine months ended September 30, 2018 was $3.9 million.  In addition, during the nine months ended September 30, 2018, we repurchased 100,891 shares for $2.9 million related to tax withholding requirements on vested RSU awards.

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TPI COMPOSITES, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

The following table summarizes the outstanding and exercisable stock option awards as of September 30, 2018:

Note 9. Income Taxes

Income taxes for the three and nine months ended September 30, 2018 were lower than for the three and nine months ended September 30, 2017 primarily due to the reversal of our valuation allowances related to our U.S. federal deferred tax assets in the three months ended September 30, 2018 totaling $10.9 million. This valuation allowance release was the result of our decision during the three months ended September 30, 2018 to account for the impact of the global intangible low-taxed income (GILTI) as a current period item. With this election and our adoption of ASC 606, we ceased to be in a cumulative loss position in the U.S. and we have positive evidence that our U.S. tax attributes will be fully realized in the future.

We will continue to refine our provisional estimates of our computations of the GILTI, the deduction for foreign-derived intangible income (FDII) and other parts of the Tax Reform Act, which may result in changes to the expected impact for 2018. We also continue to not record a deferred tax liability related to unremitted foreign earnings as we maintain our assertion to permanently reinvest our unremitted foreign earnings. 

An ownership change under Sections 382 and 383 of the Internal Revenue Code was deemed to occur in June 2018. In general, a Section 382 and 383 ownership change occurs if there is a cumulative change in our ownership by “5% shareholders” (as defined in the Internal Revenue Code of 1986, as amended) that exceeds 50 percentage points over a rolling three-year period. Based on the analysis performed, however, we do not believe that the Section 382 and 383 annual limitation will materially impact our ability to utilize the tax attributes that existed as of the date of the ownership. Additional ownership changes in the future could result in additional limitations on our net operating loss carryforwards and credits.

Income taxes for the three and nine months ended September 30, 2018 have also been adjusted to reflect China’s retroactive increase in the deduction for research and development expenses. No other changes in tax law during the quarter have had a material impact on our income tax provision.

Note 10. Commitments and Contingencies

Legal Proceedings

From time to time, we may be involved in disputes or litigation relating to claims arising out of our operations.

In March 2015, a complaint was filed against us in the Superior Court of the State of Arizona (Maricopa County) by a former employee, alleging that we had agreed to make certain cash payments to such employee upon any future sale of the Company. We filed a motion to dismiss the complaint in April 2015, which was denied. We subsequently filed an answer to the complaint in July 2015 denying the substantive allegations of the complaint. The parties completed court-ordered mediation in December 2015 but were not able to reach a settlement. We filed a motion for summary judgment to dismiss the complaint in April 2016 and the court denied the motion in August 2016. The court recently postponed the trial date from August 2018 until June 2019. We continue to deny the substantive allegations of the complaint and intend to vigorously defend this lawsuit; however, we are currently unable to determine the ultimate outcome of this case.

In August 2015, we entered into a transition agreement with our former Senior Vice President – Asia, pursuant to which that individual transitioned out of this role at the end of 2015 and was to serve in a consulting capacity in 2016 and 2017. In January 2016, following our discovery that the individual had materially violated the terms of the transition agreement, we terminated the

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TPI COMPOSITES, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

consultancy for cause. In April 2016, an arbitration claim was filed in China by the individual with the Taicang Labor and Personnel Dispute Arbitration Committee alleging that we improperly terminated the transition agreement. The individual is demanding that we honor the terms of the transition agreement and pay compensation and fees under the transition agreement, which in the aggregate totals approximately $2.6 million. In addition, the individual is also challenging the validity of our termination of an option to purchase 164,880 shares of our common stock and 77,760 restricted stock units awarded under the 2015 Plan, which were canceled in January 2016 when the consultancy was terminated. The Taicang Labor and Personnel Dispute Arbitration Committee awarded damages to the individual of approximately $1.2 million but rejected the claims regarding the termination of the stock option and restricted stock unit awards. We subsequently appealed the arbitration award in favor of the individual to the Taicang Municipal People’s Court, which affirmed the arbitration award in June 2018. We have appealed this judgment to an appellate level court in the Jiangsu Province and the appeal remains pending. We previously established a reserve for these matters and do not believe the award, if upheld on appeal, will have a material impact on our operating results or financial condition.

In June 2018, Iowa OSHA, a division of the Iowa Department of Labor, issued a citation and notification of penalty to us alleging that certain of our workplace practices and conditions at our Newton, Iowa wind blade manufacturing facility had violated the Iowa Occupational Safety and Health Act. Specifically, the citation cited us for multiple alleged violations and proposed that we pay an aggregate penalty of $0.2 million. In June 2018, we notified Iowa OSHA that we were contesting all of the alleged violations and proposed penalties. In June 2018, the Labor Commissioner of the Iowa Department of Labor subsequently filed a complaint with the State of Iowa Employment Appeal Board, petitioning the appeal board to affirm the citation and notification of penalty that Iowa OSHA issued to us. In July 2018, we then filed a response with the appeal board denying the substantive allegations of the complaint. A hearing date has been set for June 2019 and the matter remains pending.

From time to time, we are party to various lawsuits, claims, and other legal proceedings that arise in the ordinary course of business, some of which are covered by insurance. Upon resolution of any pending legal matters, we may incur charges in excess of presently established reserves. Our management does not believe that any such charges would, individually or in the aggregate, have a material adverse effect on our financial condition, results of operations or cash flows.  

Note 11. Concentration of Customers

Revenues from certain customers in excess of 10 percent of our total consolidated revenues are as follows: