Last week, Facebook Inc (NASDAQ:FB) reported strong earnings results, beating EPS estimates by $0.18 and revenue estimates by $200 million – posting total revenues of $8.03 billion, a staggering 49.3% YoY increase from the first quarter of last year.

Despite great numbers, the market is still nervous about Facebook’s stock – and the share price reacted negatively to earnings.

Part of the negativity is due to changes in Facebook’s accounting standards. But more importantly, many fear Facebook’s advertising revenue growth will slow. The company’s expenses are also expected to increase as it hires moderators to police the site for violent and disturbing content.

Looking Deeper into the Numbers

In terms of monthly active users (MAUs), Facebook now has 1.94 billion – up from 1.86 billion last quarter. Daily active users (DAU) has also grown significantly to 1.28 billion – 18% YoY increase from the previous quarter.

In other operational highlights, Facebook’s revenue is increasingly dominated by mobile. Approximately 85% of all ad revenue now comes from smartphones, tablets, and other mobile devices compared to 82% in the first quarter of 2016. There is also good news on the balance sheet. Facebook’s cash pile is now a staggering $32.31 billion.

So, What’s the Problem?

First off, Facebook has changed the way it reports its earning and will no longer report certain non-GAAP metrics. In addition, management has decided to adopt something it calls “Accounting Standards Update No. 2016-09” which relates to the accounting treatment of stock-based compensation.

Stock-based compensation represents stock options and awards given to employees. It isn’t a cash outflow, but it represents an opportunity cost (and dilution to existing shareholders). GAAP requires stock-based compensation be treated as a real expense, but many tech companies remove it from their non-GAAP financial statements.

Facebook’s reported results will be negatively impacted by the inclusion of stock-based compensation. But this move makes sense for the sake of transparency.

On top of the changes to accounting standards (which was actually decided late last year), Facebook’s management has given a grave warning to investors regarding the future outlook of the company’s advertising growth rate. Facebook expects its advertising growth rate to slow down by the middle of this year because the company is reaching the upper limits of how many adds can be stuffed on the Facebook feed without turning off its users.

Worse still, Facebook’s costs are expected to increase – perhaps as much as 50% – due to an increased focus on hiring. Facebook needs more moderators to clean up the site’s material after a string of high-profile suicides and other acts of violence streamed on its live video service.

Conclusion

Facebook’s first quarter results are great. The company continues to report breakneck, analyst-beating, top line growth and profitability. But the market is still concerned about several challenges coming up in the future.

Facebook’s top line will come under pressure from a slowdown in ad revenue expected this year. The bottom line will be negatively impacted by increasing employee costs as moderators are hired to monitor and clean up the site’s content. But all that being said, Facebook’s stock is still fairly priced. And if the company can successfully navigate its near-term challenges, it will continue delivering the excellent returns investors love.

 

The author has no position or business relationship in any stock or company mentioned in this article, and he has no plans to initiate. The author is not receiving compensation for this article expect from Smarter Analyst. This article is intended for informational and entertainment use only, and should not be construed as an investment advice.