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Qihoo 360 (QIHU - Snapshot Report) reported first-quarter 2014 earnings per ADS of 40 cents, exceeding the Zacks Consensus Estimate of 34 cents.

Revenues

Qihoo’s total revenue was $265.1 million, up 19.6% sequentially and 141.3% year over year. Reported revenues were above management’s expected range of $117.8 to $228.0 million. The increase was due to continued momentum in both online advertising and Internet value-added services, driven by strong user traffic growth and further penetration of performance-based advertising on 360 Personal Start-up Pages. Additionally, better-than-expected ramp-up in search and mobile monetization aided revenue growth.

Online advertising revenues were $140.0 million, flat sequentially but up 120.9% from the year-ago quarter. The increase was driven by increased monetization of user activities on 360 Personalized Start-up Pages and strong contribution from search and mobile advertising.

Internet value-added service revenues were $124.8 million, up 58.2% sequentially and 172.2% year over year. The increase was driven by strong ramp-up in mobile games and healthy performance in PC game operations.           

Margins

Reported gross margin for the quarter was 81.0%, down 540 basis points (bps) sequentially and 640 bps from the year-ago quarter.

Qihoo reported operating expenses of $175.1 million, which were 96.4% higher than $89.2 million reported in the year-ago quarter. As a percentage of sales, general & administrative and product development expenses decreased from the year-ago quarter, while selling & marketing (S&M) expenses increased. The net result was an operating margin of 14.9%, up from 6.2% in the year-ago quarter.

Non-GAAP net income attributable to Qihoo 360 was $53.40 million or 40 cents per ADS, compared with $21.01 million or 16 cents in the prior quarter. Non-GAAP net income excludes the interest expense of convertible senior notes but includes share-based compensation expense.

Balance Sheet

Qihoo exited the quarter with cash and cash equivalents of $901.6 million versus $1,013.5 million in the prior quarter. Accounts receivables were $74.5 million, up from $54.6 million in the prior quarter.

Net cash generated from operations was $100.5 million, compared with $76.8 million in the prior quarter. Cash capital expenditures were $69.5 million versus $18.8 million in the prior quarter.

Guidance

For the first quarter of 2014, Qihoo expects revenues between $300 million and $305 million, representing an increase of 98–101% year over year and 13–15% sequentially.

Recommendation

We believe Qihoo posted decent first-quarter results with revenues registering strong growth, both on a year-over-year as well as sequential basis.

Moreover, the company continues to solidify its position as the undisputed leader in the Chinese Internet market with its PC security products covering nearly 95% of Chinese PC Internet users and the mobile security solutions covering approximately 70% of Chinese smartphone users.

Qihu expects to make investments in product development and technology innovation as well as to expand its coverage of PC and mobile Internet, going forward. Its consistent focus on Internet and product innovation has been the cornerstone of its success.

However, with intensifying competition, Qihu’s prospects might be affected if it fails to expand and innovate its products keeping in mind the changing tastes and preferences of consumers.

Currently, Qihu has a Zacks Rank #3 (Hold). Other stocks that can be considered as attractive investment options this season are Digital River Inc (DRIV - Snapshot Report), Applied Micro Circuits Corporation (AMCC - Analyst Report) and Exar Corp. (EXAR - Snapshot Report). All these stocks sport a Zacks Rank #1 (Strong Buy).

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