Facebook Inc. (FB) reported earnings of 12 cents in the third quarter of 2012. However, including stock-based compensation, payroll taxes and income tax adjustment, Facebook reported 6 cents per share, which missed the Zacks Consensus Estimate by a penny.

Quarter Details

Facebook’s revenue (excluding foreign exchange effect) jumped 38% year over year to $1.31 billion, much ahead of the Zacks Consensus Estimate of $1.23 billion. The year-over-year growth was driven by strong advertising revenue (87% of the total revenue) that climbed 43% year over year to $1.4 billion. Approximately 14% of the ad revenue came from mobile.

Facebook generated the rest of the revenue from payments & other fees, which increased 13% year over year to $176.0 million.

The strong upside in advertising revenues was primarily driven by a 27% increase in the number of ads delivered. Strong increase in ad inventory due to new product launches fully offset lower ads per user (due to continuing shift to mobile) in the quarter.

Average price per ad increased 7.0% year over year, primarily aided by a 20% increase in CPMs in the US due to the sponsored stories in news feed. Price per ad growth was also strong in Asia and rest of the world, which fully offset a decline in Europe.

Monthly Active Users (MAU) improved 26% year over year to 1.01 billion at the end of September 30, 2012. Mobile MAUs surged 61.0% year over year to 604 million at the end of quarter. During the same period, Daily Active Users (DAU) increased 28.0% year over year to 584 million.

Average revenue per user (ARPU) increased 4% annually, with approximately 20% growth in North America and rest of the world.

However, this healthy growth in revenue and user base was partially offset by higher costs and operating expense in the quarter, particularly due to stock-based compensation, which totaled $148 million in the quarter. Operating expenses shot up 64.0% year over year to $885.0 million, driven by headcount growth and costs incurred related to infrastructure development.

Facebook’s operating income decreased 9.0% year over year to $377.0 million. Operating margin was 30% compared with 43% reported in the year-ago quarter.

Net loss (including stock based compensation and payroll tax expense) was $59.0 million or 2 cents per share compared with net profit of $227.0 million or 10 cents per share in the year- ago quarter.

Facebook ended the quarter with cash & cash equivalents of $10.45 billion compared with $10.19 billion reported in the year-ago quarter. The company generated $250.0 million as cash flow from operations in the quarter compared with $242.0 million in the year-ago quarter.

Outlook

Facebook expects fiscal 2012 capital expenditure to remain at the low end of the previously guided range of $1.6 billion to $1.8 billion.

Our Take

We believe that Facebook has significant growth opportunities from increasing online advertising spending on mobile devices as compared to traditional formats. Facebook’s massive user base and its ability to track personal details over time make it a formidable force in the online ad market. Facebook can use this massive database to help advertisers target relevant ads going forward.

Facebook is facing significant competition in the display advertising market from Google ( GOOG - Analyst Report ) . Rising concerns over the effectiveness of Facebook ads as compared to Google’s AdSense has been a headwind lately. As per eMarketer, Google is set to grab the #1 position in the display ad market by the end of 2013. We believe that Google’s increasing popularity has the potential to limit Facebook’s ad revenue growth going forward.

Apart from increasing competition, lack of visibility around mobile monetization remains a concern. Although Facebook launched several new products in the last quarter, we believe that the mobile platform will take some time to generate significant revenue. Moreover, continued investments to expand mobile offerings are expected to hurt margins in the near term.

We remain Neutral on the stock over the long term (6-12 months). Currently, Facebook has a Zacks #3 Rank, which implies a Hold rating in the near term.