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Qihoo 360 (QIHU - Snapshot Report) reported second-quarter 2014 earnings per ADS of 30 cents, missing the Zacks Consensus Estimate of 33 cents due to higher operating expenses. Earnings per ADS include the interest expense of convertible senior notes and share-based compensation expenses.

Revenues

Qihoo’s total revenue was $317.9 million, up 19.9% sequentially and 109.6% year over year. Reported revenues were above management’s expected range of $300 to $305 million and beat the Zacks Consensus Estimate of $295 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 $171.3 million, up 22.3% sequentially and 89% 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 $146.2 million, up 17.2% sequentially and a significant 140% 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 79%, down 20 basis points (bps) sequentially and 930 bps from the year-ago quarter.

Qihoo reported operating expenses of $208.3 million, which were 114.2% higher than $97.2 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 expenses increased. The net result was an operating margin of 13.8%, down from 24.1% in the year-ago quarter.

Non-GAAP net income attributable to Qihoo 360 was $43.45 million or 30 cents per ADS, compared with $49.1 million or 37 cents in the prior quarter.

Balance Sheet

Qihoo exited the quarter with cash and cash equivalents of $807.4 million versus $901.6 million in the prior quarter. Accounts receivables were $93.1 million, up from $74.5 million in the prior quarter.

Net cash generated from operations was $57.7 million, compared with $100.5 million in the prior quarter. Cash capital expenditures were $41.4 million versus $69.5 million in the prior quarter.

Guidance

For the third quarter of 2014, Qihoo expects revenues between $360 million and $365 million, representing an increase of 92–94% year over year and 13–15% sequentially.

Recommendation

We believe Qihoo posted decent second-quarter results with revenues registering strong growth, both on a year-over-year as well as sequential basis. However, earnings missed the Zacks Consensus Estimate on higher-than-expected expenses.

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.

Qihoo plans to invest in product development and technology innovation as well as expansion of PC and mobile Internet coverage, going forward. Its consistent focus on Internet and product innovation has been the cornerstone of its success.

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

Currently, Qihoo has a Zacks Rank #2 (Buy). Other stocks that have been performing well and are worth a look include Sabre Corporation (SABR - Snapshot Report), Digital River Inc. (DRIV - Snapshot Report) and RingCentral, Inc.(RNG - Snapshot Report). All these stocks carry the same Zacks Rank as Qihoo.

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