Trina Solar , one of China’s largest solar panel manufacturers, reported its Q2 2014 earnings on August 26. The company’s quarterly revenues grew by around 16.7% sequentially to $519 million driven by significantly higher panel shipments, although net income fell by around 60% sequentially to $10.7 million due to slightly higher polysilicon costs, lower average selling prices and lower contribution from the company’s high-margin downstream business. The company’s panel shipments grew by about 68% sequentially to 943 megawatts. For Q3, the company expects to ship roughly 1.06 to 1.12 gigawatts of panels and expects gross margins to be in the low to mid-teens. Here is a brief look at the key factors that drove the company’s Q2 earnings.

Gross Margins Fall on Lower ASPs

Trina Solar’s gross margins fell from 20.6% during Q1 2014 to 15.4%. This was largely due to lower average selling prices that resulted from higher sales to markets such as China, where panel prices are lower than other markets. During Q2, about 34% of the company’s shipments were directed towards China while just about 18% shipments were made to the lucrative Japanese market. In contrast, during Q1, about 30% of the shipments were made to Japan while just about 12% of shipments were made to the Chinese market. We expect the trend of weak ASPs to continue into Q3 as well, since the company is guiding that China will account for as much as 35% of its shipments.

Higher Polysilicon Costs

Much of the manufacturing cost reductions that Trina Solar has been able to make over the past two years have come from lower raw material costs and a tighter control of the company’s supply chain. These cost reductions were enabled by the oversupply in the global solar markets. However, it is unlikely that the company will be able to replicate these cost reductions going forward, given that the solar industry has been swiftly transitioning out of the oversupply phase and demand for raw materials such as polysilicon has been increasing. For this quarter, Trina saw its polysilicon costs (which account for about 20% of total manufacturing costs) rise from around $0.10 per watt to around $0.11 per watt for panels.

Lower Projects Revenues, But Constructions on Track

The results of Trina Solar’s downstream business can sometimes be volatile, since they are dependent on achieving certain revenue recognition criteria for projects. For this quarter, although the company shipped over 148 MW of panels to its downstream projects, the revenue and earnings contribution from the downstream business were not very meaningful. However, the company’s progress in project execution was relatively encouraging. For instance, the company began construction of a 90 MW solar power plant in Xinjiang province and is also working on a 120 MW utility scale solar project in Jiangsu province in China. Both projects are expected to be completed this year. The company has a total project pipeline of about 682 MW, out of which around 400 MW to 500 MW is expected to be completed this year. Downstream projects generally offer better margins, since they involve the supply of panels as well as value added services such as design and construction.

United States Tariffs

In July, the United States closed a loophole that allowed Chinese solar companies to circumvent previously imposed duties on their solar panels by moving cell manufacturing to Taiwan. Trina Solar now faces duties of around 23% on its products in the U.S., which is lower than the industry average. Despite the duties, the company indicated that demand for its panels remains strong in the U.S. market, noting that its U.S. business remains profitable. Given that the U.S is one of its largest markets (accounting for about 38% of shipments for Q2), Trina has been looking for ways to work around the tariffs. For instance, the company has noted that it is seeking new sites for manufacturing overseas so that it can support its growth in the U.S. market.