Qihoo 360 (UNKNOWN:QIHU.DL) reported its third-quarter earnings results last week, beating analysts' expectations on both the top and bottom lines. Management also guided for higher-than-expected fourth-quarter revenue while showing improvement in its operating and net margins.
CEO Hongyi Zhou and CFO Alex Zuoli Xu spoke with analysts on Tuesday morning to provide a few extra insights into the quarter and answer any questions. Here are five key takeaways from that conference call.
Most important growth drivers
We continue to believe that search and mobile monetization are two most important drivers of our overall growth over the next few years.
-- Hongyi Zhou, CEO
In mobile, the company announced that its 360 Mobile Assistant surpassed 600 million users this quarter with over 160 million daily app downloads. That's good enough for management to proclaim itself the market-leader in third-party app stores.
Qihoo monetizes its app store with advertising and games. Last quarter it accounted for over 20% of total revenue.
With search, Qihoo 360 is still in the very early stages of monetization. The company reached its 30% market share goal last quarter, and started ramping up efforts to sell advertising on its so.com.
Meanwhile, Qihoo's mobile search products remain in growth mode with very little monetization. Mobile currently accounts for just 25% of Qihoo's search traffic, but 50% of China's total search traffic comes from mobile. The company will continue to grow mobile until its ratio matches the market.
What's causing the operating margin decline
The year-over-year and sequential increase [in operating expenses] were mainly driven by ... personnel-related costs as we expand our sales and marketing efforts to support our search monetization and mobile Internet penetration.
-- Alex Zuoli Xu, CFO
Qihoo 360's greatest growth driver is also what's causing the company to see its margins decline. The good news is that the pain seems temporary. While, the company may not return to its high margins, it ought to keep improving from the last two quarters.
Considering it's still in the early stages of selling ads, Qihoo ought to be able to find leverage in its sales team, increasing sales per salesperson. Meanwhile, growth in mobile Internet is reaching the top of the S-curve, which means Qihoo will slow down spending on mobile Internet penetration.
Leveraging its current market presence
Given that we control the largest Android distribution platform ... the app store can be used to distribute the browser and the search app.
-- Alex Zuoli Xu
Qihoo is in a position where it doesn't have to spend heavily on marketing or preinstall agreements with OEMs to gain share of mobile search. Instead, it can leverage its position with 360 Mobile Assistant to grow its mobile search products.
This is similar to how it grew its desktop Web browser, mobile security app, and mobile app store in the first place -- by leveraging its existing market position in each category first.
Given the company's plans to slow down the growth in spending on things like preinstalls and the like, it opens up opportunities for the company to spend on continued search monetization efforts as well as mergers and acquisitions.
Potential M&A targets
There are ... basically two areas that clearly we will ... need to do some M&A, big or small. First of all, it's really the enterprise security. ... The other general area is really the broad definition of mobile Internet.
-- Alex Zuoli Xu
Enterprise is still in the early stages, but represents a big opportunity for Qihoo 360. There's currently no revenue coming from its enterprise business, but the company plans to launch a couple of new products in the early part of next year. A few small acquisitions in the area could boost its portfolio while consolidating the market.
Management sees enterprise security potentially becoming a meaningful part of revenue by the end of next year.
With the mobile Internet, it would make sense for acquisitions to stay small. As mentioned, Qihoo is already in a strong position to leverage its existing presence on mobile to grow its mobile Internet products. Acquisitions will likely help Qihoo monetize its mobile services like the MediaV acquisition helped it monetize So.com.
We don't believe the business model we're running today in China is transferable outside China just because, as you know, we started from security and then using security to get the app store and the browser as very important mid-layer kind of applications to direct users' traffic. Then we monetize [that] traffic.
-- Alex Zuoli Xu
Qihoo 360 already has an international app to provide its mobile security features on Android phones outside of China. However, it's forced to use the Google Play store to distribute the app, and it's had very low adoption thus far. Likewise, its presence in the PC security and browser market outside of China is practically nonexistent.
So, why does Qihoo 360 bother with international markets? Because it actually helps the company increase adoption in China. It provides a certain cachet with Chinese consumers that Qihoo 360 is an international company.
Investors shouldn't expect Qihoo to try to scale its international efforts or ever monetize those efforts. Its international efforts are just for show, but not for naught.
Qihoo 360 looks strong going forward
With mobile gaming continuing to grow rapidly in China, Qihoo's gaming segment should continue to drive growth going forward along with improved monetization and penetration of its search products. Meanwhile, the company's efforts in enterprise security provide another growth driver down the line, as the company will be able to leverage its existing PC and mobile security position to attract enterprise customers once it builds its product portfolio.
As these products ramp, the pressure on margins will likely ease. As a result, profits and cash flow ought to grow more in line with revenue growth. Management may look to funnel that cash into mergers and acquisitions or its search products, but it doesn't look to have grand spending plans for international growth. That's quite all right, though. There are 1.5 billion people in China to monetize first.
Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Google (A shares) and Google (C shares). The Motley Fool owns shares of Google (A shares) and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.