TPI Composites, Inc. (NASDAQ:TPIC) Q2 2023 Earnings Call Transcript

TPI Composites, Inc. (NASDAQ:TPIC) Q2 2023 Earnings Call Transcript August 3, 2023

TPI Composites, Inc. misses on earnings expectations. Reported EPS is $-1.9 EPS, expectations were $0.73.

Operator: Hello, and welcome to the TPI Composites 2Q 2023 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to hand the conference over to your first speaker today, Mr. Jason Wegmann, Investor Relations. Please go ahead.

Jason Wegmann: Thank you, operator. I would like to welcome everyone to TPI Composites second quarter 2023 earnings call. We will be making forward-looking statements during this call that are subject to risks and uncertainties, which could cause actual results to differ materially. A detailed discussion of applicable risks is included in our latest reports and filings with the Securities and Exchange Commission, which can be found on our website, tpicomposites.com. Today’s presentation will include references to non-GAAP financial measures. You should refer to the information contained in the slides accompanying today’s presentation for definitional information and reconciliations of historical non-GAAP measures to the comparable GAAP financial measures. With that, let me turn the call over to Bill Siwek, TPI Composites’ President and CEO.

Bill Siwek: Thanks, Jason, and good afternoon, everyone. Thank you for joining our call. In addition to Jason, I’m here with Ryan Miller, our CFO. Jason is our new VP of Investor Relations and Sustainability and is replacing Christian Edin, who has recently moved to Europe and is now part of our customer-facing commercial team. I want to thank Christian for progressing our Investor Relations program over the last four plus years and for his passion and leadership in advancing TPI sustainability initiatives. Jason brings with him a wealth of experience in numerous financial leadership roles at a multinational aerospace and defense company. I want to welcome Jason to the team, and Ryan and I look forward to introducing him to all of you in the coming days and weeks.

With that, let’s get to it. Please turn to Slide 5. To put it simply, it’s been a tough quarter. Q2 has been challenging from both an industry and TPI perspective, and I can boil it down to two key issues: quality and volume. Both of which I will discuss in a minute, but first, some good news. I’m pleased to announce that TPI and GE have reached an agreement in principle to amend our existing supply agreement in Mexico to add four new lines to produce blades for GE’s Workhorse turbine in Juarez, with an initial term through 2025. TPI and GE expect to finalize this agreement in the third quarter. Quality has been broadly discussed industry-wide over the past several quarters and quality issues have had a pronounced impact on performance, and we have not been immune to these issues.

While the accelerated pace of new product introductions within the industry over the last five years, and the push to get larger wind turbines to the market faster has significantly reduced the cost of wind energy. It is also a contributing factor to the wind turbine and blade manufacturing quality issues that have surfaced. As we reported last week, our financial results for the quarter were impacted by a warranty provision for the inspection and repair of blades, primarily related to one blade type in one factory. We have responded to the evolving quality challenges with the following actions. We had a third-party complete an in-depth assessment of our existing quality system and are implementing improvement initiatives. We have and continue to engage with our customers more deeply and earlier in the design phase to minimize quality risks in the product design and manufacturing process.

The good news is that our customers have significantly slowed the pace of new product introduction and recognize the benefits of standardization and industrialization. We hired Neil Jones as our Chief Quality Officer effective August 1, 2023. In this newly created position, Neil will oversee all quality processes, systems and controls relating to TPI’s wind business, and will report directly to me. Neil brings over 25 years of experience in quality and engineering positions in the wind and automotive industry. Neil spent more than 13 years with Vestas and a variety of quality leadership roles with the last five years as Senior Vice President, Quality, Health, Safety and Environment. Before joining Vestas, Neil spent over 20 years in the automotive industry, including engineering and quality leadership roles with TRW Automotive and a senior quality leadership role with Eaton Automotive.

And finally, we are replacing certain members of our senior team to improve our operational leadership given the performance and quality challenges the company has experienced during the past year. We are confident that the steps we’ve taken will significantly reduce our warranty claim exposure going forward. Now let’s discuss volume. As we discussed on our first quarter earnings call, we are still working on a handful of volume changes with our customers that will likely net out to lower sales for the year. Given the extended time it is taking to get clear guidance on the Inflation Reduction Act and the complexity of its implementation, ongoing challenges in the EU and the changing economics of certain markets our customers continue to lease on a market-by-market basis while considering existing inventory levels.

All of which have resulted in volume changes from three of our four blade customers in 2023. In addition, there is no doubt that permitting, transmission, transmission queues, the ability of the broader winds, industry supply chain to ramp volume, inflation and the cost and the availability of capital are further factors impacting the timing of recovery which we believe has likely pushed to 2025 as our customers continue to move transitions and new line start-ups to the right. Notwithstanding, we stand by our mid- to long-term sales and adjusted EBITDA targets we had introduced in our 2022 year-end earnings call in February and are focused on positioning ourselves to deliver on those targets as volumes return and then accelerate to more robust levels the industry expects.

Now let’s cover our overall Q2 results. Sales for the second quarter were $381 million and were negatively impacted by delivery delays of blades from increased inspection and repair activities. We also had lower automotive sales due primarily to lower bus body deliveries and field service sales were down as we had our field service technicians working on warranty-related efforts. Adjusted EBITDA was a loss of $38.9 million in the second quarter. As we discussed on our first quarter earnings call, we expect the second quarter to be the low watermark for profitability for the year, primarily due to annual wage increases kicking in while incremental productivity benefits will be phased in over the second half of the year to offset those increases.

However, at that time, we didn’t expect the quality challenges I discussed a few minutes ago, which by far had the biggest impact on our adjusted EBITDA for the quarter. In addition to the warranty charge of $32.7 million we recorded, our adjusted EBITDA was also impacted by lower volume than expected, inflation and higher cost of inspection and repair activities. Now I’ll give you a quick update on the rest of our global operations, including service and automotive. Please turn to Slide 6. Notwithstanding the challenges we faced in Mexico during the quarter, our blade facilities in India and Türkiye performed exceptionally well. Globally, we produced 661 sets and achieved a utilization rate of 85%. In global service, sales were down year-over-year due to a reduction in technicians deployed to revenue-generating projects.

For the full year, we expect revenue to be down by about 30% year-over-year. Things continue to progress nicely in our automotive business. However, we now anticipate automotive’s 2023 full year revenue to be down from 2022, primarily due to lower bus body sales. We are also experiencing lower than expected sales and other automotive products due to our customer supply chain constraints and customer delays and transitions of new product launches. In the second half of this year, we are planning to launch three new automotive production programs. These programs include large structural panels for a commercial truck, a full battery enclosure also for a commercial truck and high-voltage battery packed thermal barriers for a light-duty truck. Our customer diversification initiative is paying dividends as these three launches are each with a different customer with two of them being new to TPI.

In addition, the products being launched through our investment in innovation and new manufacturing technologies are aligned with the needs of the automotive market. To support additional near-term growth, we have and are making additional capital investments in the light resin transfer molding, pultrusion and assembly processes. We expect our Rhode Island and Juarez automotive plants to be vertically integrated for these technologies by year-end, which will enable the scaling of our capacity and significant growth next year. We continue to explore strategic alternatives for the automotive business to enable us to scale faster and are encouraged by the initial discussions and expect to have more information to share by the end of Q3. As it relates to our supply chain, the situation is significantly better than during the past 2 years.

We continue to expect the overall cost of raw materials to trend down compared to 2022 while logistics costs have returned to pre-pandemic levels, both of which provide us some tailwinds for the back half of the year. Over the last couple of quarters we’ve suggested that 2023 would be a transition year while the industry digests and/or waits for formal implementation guidance related to key components of the IRA in the U.S. and clarity around more robust policies in the EU. More and more, however, it’s starting to look like the expected increase in volume related to the IRA and initiatives in the EU may not materialize broadly until closer to 2025. Last month, the EU finally signed off on its renewable energy directive after months of negotiations.

The emergency measures on permitting agreed last year will now become permanent. That means enforcing the principle that the expansion of wind is in the overriding public interest, applying a binding two-year deadline to all permits and a population-based approach to biodiversity protection and requiring all EU countries to digitalize their permitting procedures. These new rules are an important step forward and will help unlock the 80 gigawatts of wind farms currently in the permitting pipeline across Europe. EU countries have until the middle of 2024 to implement them. Some are already doing so, for instance, Germany. And there it has led to an increase in permitting rate for onshore wind to winning appeals against permits that were previously lost.

Here in the U.S., although guidance on many of the key provisions under the IRA have been issued, interpreting and getting clarification of the guidance will take some time. As you might expect, with legislation as broad as the IRA clarity around implementation will take some time. Just last week, the Federal Energy Regulatory Commission, or FERC, issued a long-awaited final rule on interconnecting generation and storage resources to the grid. Based on initial FERC statements, the final rule will implement among other reforms first ready first-serve cluster study, providing much needed relief for nearly 2 terawatts of renewables and storage that are currently waiting to interconnect. While we recognize the challenges the wind industry continues to face in the near-term, with a continued focus on energy security and independence globally, we remain confident that demand for wind energy will strengthen once the current regulatory complexity is deciphered and global economies begin to stabilize.

With our current facility capacity of nearly 15 gigawatts and we expect our wind revenue to eclipse $2 billion, yielding a high single-digit adjusted EBITDA and a free cash flow percentage in the mid-single digits over the next couple of years. Today, we are operating 37 lines, including 4 lines for Nordex in Mexico. With transitions to larger blades, the startup of new lines and the completion of the Nordex contract in Mexico in mid-2024, we plan to exit 2024 with 39 lines. These 39 lines will enable us to produce approximately 3,200 sets per year or 15 gigawatts. In IEA’s updated net 0 by 2050 scenario, wind needs to reach over 400 gigawatts of installations per year with approximately 80% onshore and 20% offshore. Therefore, the market would have to be almost 5x larger than it was in 2022.

15 gigawatts of capacity will not be sufficient to meet the long-term needs of our customers. So strategically growing our global capacity and footprint over the next few years is a discussion we are engaging today with all of our customers as we are in a unique position to capitalize on the growth in the wind industry. With that, let me turn the call over to Ryan to review our financial results.

Ryan Miller: Thanks, Bill. Please turn to Slide 8. All comparisons discussed today will be on a year-over-year basis for continuing operations compared to the same period in 2022. Please note, our prior year financial information has been restated to exclude the discontinued operations from our Asia reporting segment as we shut down operations in China at the end of 2022. The second quarter of 2023 net sale sales were $381 million compared to $392.5 million for the same period in 2022, a decrease of 2.9%. Net sales of wind blades, tooling and other wind related sales, which are after all referred to as just wind sales decreased by $4.9 million in the second quarter of 2023 or 1.3% compared to the same period in 2022. The decrease in net sales of wind during the second quarter was primarily due to a 2% decrease in the number of wind blades produced due to lower customer demand and delivery delays from increased inspection and repair activities, a decrease in other wind related sales for mold decommissioning services, and lower average sales prices due to the impact of raw material and logistic cost reductions on our blade prices.

These decreases were partially offset by favorable foreign currency fluctuations and an increase in tooling sales. Additionally, our utilization in the second quarter of 2023 was 85% compared to utilization of 88% in the second quarter of last year. Field service sales decreased by $2.9 million in the second quarter compared to the same period in 2022. The decrease was due to a reduction in technicians deployed on revenue-generating projects due to an increase in time spent on non-revenue-generating inspection and repair. Automotive sales decreased by $3.4 million in the second quarter compared to the same period in 2022. The decrease was primarily due to a reduction in the number of composite bus bodies produced and a decrease in sales of other automotive products due to our customers’ supply chain constraints and customer delays and transitions of new product launches, partially offset by an increase in fees associated with minimum volume commitments.

Net loss attributable to common stockholders from continuing operations was $80.8 million in the second quarter of 2023 compared to a net loss of $25.3 million in the same period in 2022. Adjusted EBITDA for the second quarter of 2023 was a loss of $38.9 million compared to adjusted EBITDA of $5.6 million during the same period in 2022. The decrease in adjusted EBITDA during the second quarter ended June 30, 2023, was primarily due to increased warranty costs, higher production costs for additional quality control measures implemented at certain manufacturing facilities and increased labor costs in Türkiye and Mexico partially offset by foreign currency fluctuations, cost saving initiatives and lower start-up and transition costs. Moving to Slide 9.

We ended the quarter with $170 million of unrestricted cash and cash equivalents and $195 million of debt. We had positive free cash flow of $6.2 million in the second quarter of 2023 compared to $19.4 million in the same period in 2022. In light of a challenging quarter, we placed a significant focus on preserving cash, ensuring we efficiently deployed our working capital to make sure we can comfortably execute key initiatives as we move forward. We do expect a modest level of cash burn during the second half of the year as we satisfy our warranty commitments and continue to implement quality improvement initiatives. Note that most of this cash burn is expected to occur in the third quarter. I know many of you want to understand how we are thinking about our cash position beyond 2023 and as we enter a period of time in 2024, when we expect to be starting up idle lines and transition to longer blades.

The bottom line is we continue to be confident in our liquidity position. To shed a little color on the moving pieces, in 2024, we expect positive EBITDA and working capital initiatives to be our primary sources of cash. We are expecting EBITDA to significantly improve in 2024 compared to 2023 as we get the cost of quality issues behind us, and we effectively set the losses from our Nordex Matamoros plant. We also expect to get some advances from our customers to support the ramp of idle lines. Offsetting these sources of cash will be CapEx, primarily related to the transitions and start-up of idle lines, interest and taxes as well as cash payments to Oaktree for the preferred dividends. Our first dividend payment to Oaktree will be in January 2024.

In total, we expect to make about $40 million in payments for preferred dividends to Oaktree in 2024. End of the day, we believe our balance sheet, our projected liquidity position and our operating results will enable us to navigate the short-term challenges and invest in our business to achieve our mid- to long-term growth targets of $2 billion plus in wind sales, and high single-digit adjusted EBITDA margins. Moving on to Slide 10. As a result of the quality and volume changes Bill discussed, we are updating our financial guidance for the year. Sales are now expected to be down by about $100 million at the midpoint of the ranges from our initial guidance. Approximately half of the reduction relates to lower customer demand for blades and delays for inspection and repair activity about a quarter of the reduction relates to lower field service sales as technicians have been diverted to non-revenue-generating work.

The remainder of the reduction relates primarily to lower ASPs from supply chain reductions and lower automotive sales than expected. We do continue to expect to achieve low single-digit adjusted EBITDA margins over the second half of the year, which is consistent with our initial adjusted EBITDA guidance for the full year. However, with the loss from the second quarter, we now expect our adjusted EBITDA for the full year to be a slight loss of less than 1% of sales. With the reduction in sales volumes, we now expect utilization to be in the low to mid-80s versus our initial guidance in the mid- to upper 80s. With that, I’ll turn the call back over to Bill.

Bill Siwek: Thanks, Ryan. Please turn to Slide 12. We remain very bullish on the energy transition and believe we will continue to play a vital role in the pace and ultimate success of the transition. We remain focused on managing our business through the short-term challenges in the industry and are excited about how we are positioned to capitalize on the significant growth the industry expects in the coming years. I want to thank all of our TPI associates once again for their commitment, dedication and loyalty to TPI. I will now turn it back to the operator to open the call for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from Julien Dumoulin-Smith from Bank of America. Please go ahead.

Julien Dumoulin-Smith: Sorry, guys, can you hear me? I was on mute.

Bill Siwek: Yes. Got you, Julian. Good to talk to you.

Julien Dumoulin-Smith: Hey likewise thanks for the time. Really appreciate it. Hey guys, just a couple of different things here. So look, I know the backdrop has been challenging here of late, but can we talk about the quality-related matters in a little bit more detail, right? So you disclosed here A issue with A customer at a given site under warranty. But you also discussed a third-party independent evaluators come through reviewed our operations, et cetera. Can you discuss what the third-party review found? And have you needed to pursue quality changes at other sites and/or for other customers thus far, if we can kind of get into some of the other permutations here, if you don’t mind?

Bill Siwek: Sure. Yes. We brought in – actually, we brought in the third-party quality review or that was our choice. Our customers didn’t know we were doing it, quite frankly, at the time. I commissioned that a couple of months ago. and it was more just to make sure that as – again, we were seeing more issues within the industry, and we had a little bit of a of an increase in what we would call non-conformances and some of the blades we were producing. So, wanted to get a very objective third-party view of our quality management systems, what we were doing well, what we needed to improve on. So I would tell you, it’s not – I mean, in virtually all of our plants, we’re in actually really good shape. We just had a couple of facilities that were not where we would like them to be today.

So that’s kind of the genesis of the findings. There’s improvements we can always make and we’re making those, but overall, there was nothing that was a major concern. It was just improvement on what we had already done. So I think that’s about the third-party reviewer. But again, we have – just so you guys know, I mean, blades are incredibly, right? I mean it’s anywhere from 1,500 to 3,000 or 3,500 direct labor hours per blade. Hundreds of layers of glass laid up by hand. Infusion that is somewhat automated, but still relatively manual as well as laying core down, et cetera, et cetera. So there’s a lot of manual processes that go into it. Every 1 of our customers’ blades is different and each of our customers’ blade models are different.

So, it’s not like it’s a highly automated process, which then leads to more room for non-conformances when you’re building a blade. That can be 80 meters long, 30,000-plus pounds, right? And so the whole industry has work to do, especially as we move from relatively moderate-sized blades to very large blades very quickly. The challenge is getting up to serial production. Once you get to serial production, the quality is obviously much better. But when you’re switching blade models as quick as you are, you never really get there. So the good news is, is with NPI slowing down, I think our and – any improvements we’re making from a quality standpoint, I think the instance of quality issues going forward will moderate back to levels that we used to see, which were very low.

Julien Dumoulin-Smith: Got it. And just to clarify this, you said there was a couple of sites with issues. Just can you elaborate a little bit on what’s been done to remediate and it seems like you didn’t elect to pursue a warranty claim on that second site if you can elaborate.

Bill Siwek: So, Julien, we evaluate our potential warranty claims continuously. There are some other small warranty claims out there. I mean we’ve got a fairly sizable reserve now. So, we feel very comfortable that what we’ve got is covered. I mean, the other – what have we done to protect them, we have firewalls that we put in place. And again, remember, we have – our customers are in our plants with us. And so not only are we inspecting them, but generally, our customers are inspecting them as well before they get shipped. We have increased the level of inspection. We’ve increased the numbers of inspection during the production process, not just at the end of the process. And in some cases, we’ve invited third parties into our plants to validate the inspection work that we’ve done.