Pandora Inc. ((P - Snapshot Report)) reported loss of a penny in the third quarter of 2014, almost in line with the Zacks Consensus Estimate. Shares fell 8% ($1.85) during extended hours of trading due to slowing listener growth on a monthly basis.

Quarter Details

Non-GAAP revenues jumped approximately 40% year over year to $240 million narrowly beating the Zacks Consensus Estimate.

The year-over-year increase was on account of higher advertising revenues (81% of revenues), which increased 44% from the year-ago quarter to $194.3 million. Subscription service and other revenues (19% of revenues) improved almost 32% year over year to $45.3 million.

Active users increased 5.2% year over year from 72.7 million to 76.5 million in the third quarter of 2014. Total listener hours grew 25% on a year-over-year basis to 4.99 billion from 3.99 billion in the year-ago period.  

Pandora’s share of the total U.S. radio listening market increased from 7.77% a year ago to 9.06% at the end of September.

Total revenue per thousand listener hours reached $48 in the third quarter, up 12% from $42.98 in the year-ago quarter. Advertising revenues per thousand listener hours (Ad RPMs) from mobile and other connected devices increased 12% from the year-ago quarter to $44.35 in the reported quarter.

Mobile advertising RPMs were $40.82 in the third quarter, increasing 16% from $35.31 in the year-ago quarter, despite intensifying competition from Google (GOOGL - Analyst Report), Apple (AAPL - Analyst Report) and Sirius XM (SIRI - Analyst Report).

Currently, mobile advertising accounts for 78% of total ad revenue. Mobile ad revenues surged 56% year over year to $151.7 million. The investments in local advertisements seem to have paid off as local revenues surged 118% on a year-over-year basis.

Margins

Gross margin expanded 300 basis points (bps) to 47.1%, primarily due to lower content acquisition cost in the third quarter.

Pandora paid more than $100 million in content royalties to rights holders. However, music licensing represented 46% of revenues in the third quarter — lowest in its history as a publicly traded company — due to improving monetization.    

Operating expenses (including stock-based compensation), as a percentage of revenues, surged 260 bps to approximately 48% in the quarter. The significant year-over-year increase was primarily due to higher sales & marketing (up 270 bps) and product development expenses (up 30 bps), slightly offset by a lower general and administrative expense (down 30 bps) in the quarter.

Pandora reported GAAP operating loss of $2 million compared with a loss of $4 million in the year-ago quarter.

Net loss (including stock-based compensation) was $1.8 million compared with net loss of almost $2 million in the year-ago quarter.

Balance Sheet & Cash Flow

Pandora exited the quarter with $316.4 million in cash and investments compared with $437.9 million in the prior quarter. In the quarter, cash flow from operating activities was $5.1 million as compared to cash outflow of $7.1 million in the year-ago quarter.

Outlook

Pandora expects continued subscription revenue growth as a result of the price increase ($4.99 per month for all new subscribers), as new subscribers paying the higher rate represent a larger percentage of the total Pandora One subscriber base.

For the fourth quarter of 2014, revenues are expected in the range of $273 to $278 million. The company expects to report earnings in the range of 17 to 19 cents per share.

For 2014, revenues are now expected in the range of $912 to $917 million, up from the prior range of $895 to $915 million. Earnings are expected in the range of 19–21 cents per share for the full year, up from the prior guidance of 16–19 cents.

Management continues to believe that Pandora’s monthly active user base will surpass 100 million over the long term. However, monthly growth is expected to decline due to growing competition.

Pandora expects gross margin to increase further to 60% over the long term.

Our Take  

Pandora reported not-so-encouraging third-quarter results. Slowing monthly subscriber base remains a major headwind amid growing competition, in our view. Moreover, rising costs related to licensing will remain a headwind in the near term. Additionally, higher operating expenses are expected to hurt profitability in the near term.

Nevertheless, improving monetization and strong mobile growth are the positives. We believe that Pandora will benefit from the growing listening hours, market share gains and introduction of the new music recommendation units called Promoted Stations.

We believe that improving listening hours is necessary for subscriber base growth, which is the primary revenue source for Pandora. The company's plan to launch service in cars is a positive move in this regard as it has ample room to grow in this market. Its partnerships with Ford, Holden and Mazda in Australia expand its service in the region, which will boost ad revenues, going forward.

Currently, Pandora has a Zacks Rank #3 (Hold).