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Originally published Monday, 25 August 2014.

Qihoo 360 Technology (QIHU, profile) released Q2 FY2014 results which included revenue of 317.9 million USD (exceeding management's earlier guidance) and net income of 37.0 million USD. The Q2 results beat the consensus revenue estimate of about 309 million USD and also beat on earnings (non-GAAP EPADS of 0.50 USD vs. 0.46 consensus). In addition to Q2 results, the company offered a strong Q3 outlook. Management's Q3 FY2014 revenue guidance was for about 363 million USD (higher than the 357 million USD consensus), reflecting growth of about +93% YoY and +14% QoQ.

Along with a quarter of strong top-line growth, management continued investing in future growth. Although fixed expenses (Selling and promotion, Product development) were at levels similar to earlier quarters (percentage of revenue), higher costs of revenues meant further operating margin compression YoY and QoQ. It seems worth noting that some of the recent initiatives (mobile, search monetization) could bring more long-term results, so focusing on the near-term might paint an incomplete picture.

Recent Quarterly Performance FY2014
(000) USD, Except Per Share AmountsQ2Q3Q4Q1Q2
Revenue151,666187,928221,617265,142317,914
Gross profit133,820162,022191,437214,752251,288
Operating profit36,57450,8028,91739,61043,859
Net income33,21343,92415,15047,92236,975
Earnings per share (GAAP, fully diluted per ADS)0.260.340.130.370.30
Comparison YoY
Revenue108%124%115%141%110%
Gross profit102%113%107%124%88%
Operating profit269%316%-27%482%20%
Net income373%245%20%762%11%
Earnings per share352%219%23%749%14%
Comparison QoQ
Revenue38%24%18%20%20%
Gross profit39%21%18%12%17%
Operating profit437%39%-82%344%11%
Net income497%32%-66%216%-23%
Earnings per share488%31%-63%195%-21%
Margin analysis
GPM88%86%86%81%79%
OPM24%27%4%15%14%
NPM22%23%7%18%12%
EBITDA32%35%19%29%24%

Along with encouraging financial results, Qihoo 360's operating metrics were also positive. Unique visitors to the company's Personal Start-Up page grew to nearly 128 million during Q2, reversing a declining trend from the previous two quarters. Despite increased traffic, however, the number of daily clicks was lower QoQ, reaching nearly 750 million during the quarter vs. 772 in Q1. Qihoo 360's efforts in mobile showed continued progress, with the number of 360 Mobile Safe users reaching 641 million during Q2, up about 90% YoY and 20% QoQ.

In prepared remarks, the company emphasized progress in mobile, highlighting growth in the number of 360 Mobile Safe users (reaching 641 million during Q2, about +90% YoY), and other mobile initiatives. Management also noted that it had achieved its full-year target for a 30% share of search based on a news story circulated shortly before the Q2 release. When noting its progress in search, management suggested that it would step up its efforts in mobile, so higher R&D spending might be around the corner.

The company generated about 57.7 million USD of operating cash flow during the quarter, down from the 100.5 million USD generated in Q1 and 86.4 million USD in Q2 last year.

The company's Q3 FY2014 outlook included the following:

  • Revenue: 360 to 365 million USD (+92%-94% YoY, +13%-15% QoQ)

Operating Metrics

Financial Performance

Qihoo 360 Technology Income Statement FY2014
(000) USDQ2Q3Q4Q1Q2
Revenues
Internet services151,666187,928221,617265,142317,914
Total revenues151,666187,928221,617265,142317,914
YoY108%124%115%141%110%
Costs of revenues
Internet services-17,846-25,906-30,180-50,390-66,626
Total costs of revenues-17,846-25,906-30,180-50,390-66,626
Gross profit133,820162,022191,437214,752251,288
YoY102%113%107%124%88%
Gross profit margin88%86%86%81%79%
Subsidy income022,3440920
Operating expenses
Selling and marketing-23,997-28,057-30,988-68,733-84,907
General and administrative-12,918-14,707-76,680-21,766-22,511
Product development-60,331-68,458-76,248-84,643-100,931
Impairment loss on intangibles00-94800
Operating profit36,57450,8028,91739,61043,859
YoY269%316%-27%482%20%
Operating profit margin24%27%4%15%14%
Interest income, net1,778969642605537
Other income (expense)1,3457523,781-12,038811
Impairment loss on long-term investments-1,3010-3,7030-1,956
Gain on disposal of a subsidiary, long-term investments0-14514,80827,6528,445
Pretax income38,39652,37824,44555,82951,696
Income tax expense-4,278-7,798-9,130-5,889-10,991
Loss on equity method investments-905-656-165-2,018-3,730
Net income33,21343,92415,15047,92236,975
YoY373%245%20%762%11%
Net profit margin22%23%7%18%12%
Income/loss attributable to noncontrolling interest-2165321,4981,1992,149
Net income attributable to Qihoo 36032,99744,45616,64849,12139,124

Revenue higher both YoY and QoQ due to the combined strength in the company's online advertising and Internet value-added services businesses. Online advertising revenues grew 89% YoY (22% QoQ), driven by growth in the search and mobile advertising business, as well as increased monetization for the 360 Personalized Start-Up page. Internet value-added services grew about 140% YoY (17% QoQ), driven higher by additional PC and mobile games on the company's game platform.

Cost of revenues increased significantly both YoY and QoQ, outpacing revenue growth, resulting in gross margin compression vs. last quarter and a year ago. Some of the company's direct costs include bandwidth and traffic acquisition costs, and it seems that increases in traffic could drive both higher. Noting that the company has seen its search share increasing, it seems reasonable to conclude that other competitors may be responding with increased traffic acquisition spending, which could be driving up overall price levels.

Fixed costs rose during Q2, driven by increased spending on the key areas of Selling and marketing and Product development. Selling and marketing rose to 27% of total revenue during Q2, a relative high vs. recent quarters. Product development expenses rose to slightly over 100 million USD, the fifth consecutive quarterly increase, as the company has been investing in R&D to support its search monetization and mobile efforts. Higher overall revenue levels meant that although the cost item was higher, the impact on operating margin was limited (product development was 32% of total revenue vs. 32% last quarter and 40% in Q2 FY2013).

On aggregate, fixed expenses were 66% of total revenue, flat vs. Q2, so a the decrease in gross margin was the main factor behind the lower operating a margin vs. Q1.

Qihoo 360 recognized minimal non-operating items, unlike the boost provided from a disposal of long-term investments in Q1, so net income was largely driven by results at the operating level.

Disclosure: none.

Source: Parsing Qihoo 360's Q2 FY2014 Results