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Facebook Inc. (FB - Analyst Report) reported strong first-quarter 2014 results, which reflected its growing dominance in the mobile advertising market. Earnings of 25 cents per share were much better than the Zacks Consensus Estimate of 18 cents. Revenues also comfortably beat the Zacks Consensus Estimate of $2.36 billion.

Following the results, Facebook announced the resignation of David Ebersman from the position of Chief Finance Officer (CFO) and will be replaced by Dave Wehner.

Quarter Details

Revenues (excluding the foreign exchange effect) surged 72.2% from the year-ago quarter to $2.51 billion. The strong revenue performance was aided by robust advertising revenues that jumped 82.7% from the year-ago quarter.

Advertising revenues were driven by increasing mobile engagement, higher number of marketers, continuing investment in new products and robust performance of its newsfeed ads.

Mobile ad revenues were $1.3 billion, which accounted for 59.0% of ad revenues, up from 53.0% in the previous quarter. Ad revenues from desktop increased 8.0% on a year-over-year basis.

Mobile-only Monthly Active Users (MAU) was 341 million at the end of the first quarter compared with 189 million in the year-ago quarter and 296 million in the previous quarter. Messenger and Instagram both achieved 200 million MAUs during the last quarter.

In the last quarter, Facebook achieved strong growth from advertisers across mobile gaming, e-Commerce and consumer-packaged goods verticals.

As of Mar 31, 2014, Facebook’s MAU improved 15.0% year over year to 1.28 billion. Mobile MAUs surged 34.0% year over year to 1.01 billion. Daily Active Users (DAU) increased 21.0% year over year to 802 million.

Ad impressions declined 17.0% on a year-over-year basis, primarily due to lower ad volumes on mobile devices. However, average effective price per ad soared 118.0% from the year-ago quarter driven by favorable mix shift toward high-priced newsfeed ads. Average revenue per user (ARPU) increased 48.1% year over year to $2.00.

Payments and other fees increased 11.0% year over year to $237.0 million in the reported quarter. Payments revenues from games grew approximately 1.0% on a year-over-year basis.

Total cost and expenses as percentage of revenues plunged to 57.0% from 74.4% reported in the year-ago quarter. Research & development, marketing & sales and general & administrative expenses decreased 190 bps, 100 bps and 460 bps, respectively.

The lower-than-expected increase in operating expenses drove operating margin, which surged from 25.6% in the year-ago quarter to 43.8% in the first quarter. Net income was $639.0 million or 25 cents per share compared with $217.0 million or 9 cents in the year-ago quarter.

Facebook exited the quarter with cash & cash equivalents and marketable securities of $12.63 billion compared with $11.45 billion in the previous quarter. The company generated $1.29 billion of cash flow from operating activities compared with $1.23 billion in the previous quarter. Free cash flow was $922.0 million compared with $748.0 million in the last quarter.

Guidance

Facebook expects to carry on with its investments for improving the quality, engagement and value of its ads and products, which will further boost advertisers’ demand over the long term.

Management expects that year-over-year advertising revenue growth rate will decline due to tough comparisons. Total expenses (including cost of revenues but excluding stock-based compensation) are expected to increase approximately 40.0% to 45.0% for 2014. Capital expenditure is likely to be in the range of $2.0 to $2.5 billion for 2014.

Our Take

Facebook has gained significant traction in its mobile ad business within a very short span of time. This combined with the massive user base and its ability to track personal details over time makes it a formidable force in the online ad market.

We believe that Instagram’s growing popularity and the new initiatives such as Internet.org will continue to boost Facebook’s user base, going forward. We expect the company’s international revenue per user to increase at a faster rate, going forward.  

Moreover, the new products will help the company to face intensifying competition from the likes of Yahoo! (YHOO - Analyst Report), Twitter (TWTR - Analyst Report) and Google (GOOGL - Analyst Report).

However, overdependence on advertising revenues for growth will be a headwind, going forward. We note that Facebook’s recent acquisition of WhatsApp and Oculus are long-term growth opportunities. The Internet.org initiative is also long-term focused. Hence, lack of revenue diversification remains a major concern in the near term.

Currently, Facebook has a Zacks Rank #2 (Buy).

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