Twitter (NYSE:TWTR) posted a strong quarter in terms of user growth and profitability, but the company has some work to do when it comes to monetization. For example, the U.S. saw the strongest increase in engagement but the biggest decline in ad revenue.

In this segment of Industry Focus: Tech, Motley Fool analyst Dylan Lewis and contributor Evan Niu, CFA, discuss Twitter's ad business.

A full transcript follows the video.

This video was recorded on April 28, 2017.

Dylan Lewis: Beyond the user side, switching over to the ad side of their business, I think on first glance, one of the things that was a "yikes" moment in the results was, even with all these positive trends -- more daily actives outstripping the monthly active growth, and general positive growth trends in monthly actives -- cost per ad engagement was down 60% year over year, and that's on the back of a 50% decline a year ago. Generally, in the past, the company has been able to make up for those declines based on the volume of ad engagements. Even with ad engagements up 140% year over year in this most recent quarter, they still posted the revenue decline, because that price is coming down and down. This is something that you have to be a little bit concerned about. At the end of the day, the user growth is only so good as long as they can monetize those users.

Evan Niu: Yeah, exactly. I think that's exactly the challenges they face now. Jack Dorsey has certainly always been a more product-focused CEO. The product improvements are helping the user numbers, but as far as financials go. For example, they mentioned that engagement had the biggest gains in the U.S., in part because of the political stuff we mentioned. They're seeing the biggest gains and engagement in the U.S. But ad revenue declined the most in the U.S. So, there's a big disconnect there between these things. These things are diverging. Growth is down, engagement is up. How do you reconcile those two things? That's what they're trying to focus on next. "Once we stabilize the user number, then we focus on the ads." And they're trying to streamline their ad products, because I think they had a little bit too much going on. They're trying to be more efficient and targeted with how they're approaching the ad business. It's definitely what they need to hit next. Right now, there's a big discrepancy between engagement and ad sales. So, whether or not they could do that, that's a pretty big, open-ended question, in terms of results going forward.

Lewis: To a certain extent, I think that's just the dynamics of the ad business. In the quarterly call, CFO Anthony Noto tried to explain what was going on here by saying, "Current revenue trends we are reporting reflect budget decisions based on trends in audience and pricing of 6-12 months ago, and we're not seeing significant acceleration in user growth." Really, what he's getting at here is, ad budgets are planned out, so any increase in ad spend or anything that would impact the rates that people are paying on Twitter or the number of impressions, anything like that, it's going to be a reflection of what user growth looks like six months prior, basically. In the company's PR, in their guidance, they said Twitter continues to expect advertising revenue growth to continue to meaningfully lag that of audience growth in 2017. Including into the second quarter. So, if you're looking for a period where we might start to see these metrics sync up a little bit more, and start seeing what people are paying for ads on Twitter reflect what's going on with the audience growth they're experiencing, it probably happens sometime in the fall of 2017. That's the mark-your-calendar period for investors if you're watching these two metrics.

Niu: Yeah, I definitely agree with that. There's a little bit of a lag time there. But, hopefully they can actually start executing better on the ad side. But even beyond that, the cost bit is pretty important. I think they've been a little too generous with things like stock-based compensation, for example. They're expecting stock-based compensation in 2017 to be down about 20% to 25% versus 2016 levels, which I think is an encouraging sign. That's certainly one of their largest expenses. It's a non-cash expense, but it's still one of the biggest expenses on a GAAP basis, and they're still trying to hit GAAP profitability. They're still putting non-GAAP net income, but of course, investors prefer GAAP profits.

Lewis: Absolutely.

Niu: They have a lot of pieces of the puzzle to work on at the same time. And they're making progress on the user side and the product side and on the cost side. But they do need to be doing better on the ad side, on the revenue side.

Dylan Lewis has no position in any stocks mentioned. Evan Niu, CFA has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Twitter. The Motley Fool has a disclosure policy.