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Executives

Dominic Paschel - Vice President of Corporate Finance and Investor Relations

Joe Kennedy - Chairman and Chief Executive Officer

Mike Herring - Chief Financial Officer

Analysts

Heath Terry - Goldman Sachs

Scott Devitt - Morgan Stanley

Nat Schindler - Bank of America

Douglas Anmuth – JPMorgan

Jordan Rohan - Stifel Nicolaus

Mark Mahaney - RBC

Laura Martin - Needham & Co

Sameet Sinha - B. Riley & Co

Martin Pyykkonen - Wedge Partners

Peter Stabler - Wells Fargo Securities

John Blackledge - Cowen and Company

Ralph Schackart - William Blair

Barton Crocket - Lazard Capital

Brian Nowak - Susquehanna

Jim Goss - Barrington Research

Corey Barrett - Pacific Crest Securities

Pandora Media, Inc. (P) F2Q 2014 Earnings Conference Call August 22, 2013 5:00 PM ET

Operator

Welcome to Pandora’s Second Quarter and Fiscal 2014 Financial Results Conference Call. All lines have been placed on mute. There will be a question-and-answer session at the end of the conference. (Operator Instructions) Opening today’s call is Dominic Paschel, Vice President, Pandora. Sir, you may begin.

Dominic Paschel

Thanks Angela. Good afternoon, and welcome to Pandora’s second quarter fiscal year 2014 financial results call for the quarter ended July 31, 2013. Some of our discussions will contain forward-looking statements which may include projected financial results or operating metrics, business strategies, anticipated future products or services, anticipated market demand or opportunities and other forward-looking topics. These statements are subject to risks, uncertainties and assumptions. Accordingly, actual results could differ materially. For a discussion of the risks that could cause our results to differ from today’s discussion, please refer to the documents we filed with the Securities and Exchange Commission.

Also, I would like to remind you that during the course of this conference call, we will discuss non-GAAP measures of our performance. Reconciliations to the most directly comparable GAAP financial measures are provided in the tables in the press release and Form 8-K filed earlier this afternoon with the SEC. For your convenience, supplemental information has been included in today’s press release and detailed financials regarding RPM metrics that are available on the investor relation site. Today’s call available via webcast and replay available for two weeks following the conclusion of the call. To access the press release, supplemental financial information or the webcast replay, please consult the IR section of Pandora.com.

With that, let me turn the call over to Joe Kennedy, Pandora's Chairman and CEO.

Joe Kennedy

Thanks Tom. We believe Pandora’s second fiscal quarter was an important inflection point in Pandora’s history. Strong momentum in our mobile business with total non-GAAP mobile revenue growing 92% year-over-year to a 116 million clearly demonstrates the leverage in Pandora’s business model. To drive future growth we’re accelerating investment in new technologies, channels and capabilities that maximize the value that Pandora delivers.

We’re proud to release Pandora’s second quarter results which were remarkable across many financial metrics, we closed the second quarter with record non-GAAP revenue of a 162 million an increase of 58% over a 102.6 million in the same period last year and 26% higher than any quarter on record. Again mobile drove the quarter with total non-GAAP mobile revenue exceeding a 100 million for the first time or 92% year-over-year to a 116 million and a record total mobile RPM of $37.59 on a non-GAAP basis, 58% higher than the same period last year demonstrating our continued leadership as one of the largest mobile media advertising platforms in the world.

Our ability to manage our business cost and gain leverage in our model is also improving, cost of content decreased dramatically as a percentage of non-GAAP revenue from 59% in the second quarter last year to 51% this year. Strong top-line execution driven by a long term solid focus on implementing our growth strategies drove profitability upside achieving non-GAAP earnings per share of $0.04 for the second quarter.

As we look to the second half of the year we plan to accelerate our investment in operating capacity with the focus on product innovation, market penetration and top-line growth rather than profitability reflecting our conviction that we’re still at an early stage of a huge market opportunity. In the second quarter our strategy was to balance growth and cost, our limit on mobile users listening hours had the outcome we intended with growth in content cost tightly controlled while having very low impact on listeners or our ability to grow revenue. Total listener hours grew to 3.88 billion for the quarter up 18% compared to the year ago quarter.

More recently we announced our share of U.S. radio listening increased from 6.02% in July of 2012 to 7.08% in July of 2013. At the same time active listeners grew from 54.9 million last year to 71.2 million an increase of 30%. The bottom-line is that we significantly improved our monetization levels while continuing to grow our audience.

The foundation of our long term growth and our position as category leader and innovator is our audience and the focus we bring to their experience. From the time Pandora was conceived almost a decade ago we have dedicated ourselves to delivering the best personalized radio experience in the world.

Since that time our users have created over 5 billion stations and given over 30 billion thumbs up and thumbs down an average of almost a 150 per registered listener and we have used every single one of them to make each station better for each listener in real time.

We continue to invest more heavily than ever in our personalization intellectual property to expand our leadership and delight our listeners every single day. It's no surprise that consumers are increasingly accessing the internet and applications on a variety of connected devices from the connected home to the connected car and Pandora is leading the next way of innovation in the internet of things. What is surprising is that at such an early stage in consumer adoption already more than 13% of our usage comes from a connected device other than a smartphone or PC. We’re thrilled that Pandora scaled so well across so many connected devices and believe our focus on our products is the right strategy for long-term growth.

Our focus on automotive technology integrations is a good example of how our early focus we imagining the in-car radio experience, has begun to payoff. The automobile has traditionally been the primary home of radio, where almost half of our radio listening occurs. So, we strategically focused on this market as a way to increase active users, listener hours, and ultimately market share. During the second quarter, we announced the following in-car milestones that demonstrate our continued growth and momentum in this category.

Since launching our first OEM integration in 2010, Pandora’s automotive specific integrations have been activated more than 2.5 million times across 23 major automotive brands and 8 aftermarket manufacturers. Pandora is now seamlessly integrated in over 100 car models with the native in-dash entertainment system. And we estimate that probably one-third of all new cars sold in 2013, in the U.S., we will have this Pandora capability. Also as part of our mission to make Pandora available anytime and anywhere users want, we have created a partnership with Google and we will soon be launching on their new Chromecast device. These technology developments are making our vision of providing Pandora personalized radio anytime and anywhere consumers want closer to reality. Given the monetization potential that we have demonstrated, we believe the long-term value of the company is maximized by maximizing our long-term audience and market share of radio listening. So, we believe this customer-centered focus is the right approach for its long-term sustainable growth.

In summary, Pandora continues to execute successfully across our growth strategies, particularly in mobile and across connected devices. We remain excited about our future and believe that we have just scratched the surface of our potential.

With that, I hand the call over to Mike Herring, our Chief Financial Officer.

Mike Herring

Thank you, Joe. I will now walk through our second quarter financials, discuss our business strategy and finish with some thoughts regarding guidance for the remainder of the year. Starting with revenue, we ended the quarter with record total non-GAAP revenue of $152 million, representing 58% growth from the year ago quarter above the high end of our guidance range. GAAP revenue was $157.4 million for the quarter.

As a remainder from our Q1 call, Pandora has presented a temporary non-GAAP adjustment to revenue to reflect management’s estimate on subscription returns in order to better illustrate the period’s activity. Because we have had limited operating history with in-app subscription returns, we are required to reserve 100% of the revenue associated with the subscription increase until that return rate expires despite all the cost associated with delivering those services, transaction fees and content fees being incurred in the period. As we expect to have sufficient history to estimate a reserve in January of 2014, some accumulation of these adjustments will be reversed at that time.

Non-GAAP revenue was 26% higher than in any quarter previously. This was driven by mobile with total mobile revenue exceeding $100 million for the first time, up 92% year-over-year to $116 million with total mobile RPM reaching a record high of $37.59 on a non-GAAP basis. Advertising sales has increased momentum aided by significant progress made across our technology integrations with major media buying platforms. Across the country, advertising agencies are adding Pandora to broadcast media avails on a regular basis, and we are getting orders from new agencies and advertisers as a result. Importantly, we have eased the friction associated with buying Pandora by integrating with the technology systems and processes broadcast and radio buyers use most often allowing advertisers to buy Pandora using metrics and measurement of radio or digital whichever meets their needs. To close the loop on the entire media planning, buying, and transacting process, transactions can now be completed electronically.

On both STRATA and Mediaocean, we are now transacting with many agencies from proposal to invoice. On Triton Digital, we increased measurement to all 275 metro areas starting with April data. That means we have nationwide coverage. On Mediaocean, we have also released functionality to calculate reach and frequency based on Triton Data as of July nearing similar functionality that had earlier been released on STRATA. During this process, we have developed a proprietary order management system called Slingshot, which allows us to take a transaction from proposal to invoice using the buying methodology that works best for the advertiser. We are also in discussions with STRATA and Mediaocean regarding importing orders directly in (inaudible). Our progress with our technology integration has undoubtedly increased our advertising momentum and I look forward to seeing the momentum build as we welcome new advertisers and agencies to the platform. We are also building momentum in audio and local advertising, during the second quarter audio ads exceeded 60% of ad revenue for the first time with local generating four times the revenue in the second quarter this year compared to the same period last year.

In fact Q2’s local revenue was nearly equal to the total local revenue recorded for the entire fiscal year 2013. Audio ad units are native to Pandora and is an existing $15 billion. They have further differentiate Pandora as unique advertising platform among our competition. Our native ad units combined with targeting and attribution capabilities and the scale of our platform are key to our success. Additionally we’re adjustments to optimize our ad load; our research indicates that listeners prefer longer periods of uninterrupted music who we’re gradually rolling out a back to back audio ad format. This new format provides listeners with longer music suites (ph) and fewer total music interruptions while increasing advertising inventory.

We began rolling this out to a very small segment of our listener community last week. This change is consistent with this strategy; we have had in place for the last several years, very gradually increasing the amount of audio ad inventory on Pandora as our sales capacity grows while staying focused on delivering the best personalized radio experience to the listener.

For those listeners that prefer not to receive ads we have offered a subscription alternative called Pandora One and more recently the ability to purchase a Pandora One subscription through in-app functionality. Subscription revenue was 21% of total non-GAAP revenue for the quarter and we have reached 3 million subscribers in total.

Moving from revenue to EPS GAAP basis and diluted loss per share was $0.04, non-GAAP with earnings per share was $0.04 including approximately 10.5 million in stock based compensation and including approximately 4.7 million in revenue related to our subscription return reserve. Non-GAAP EPS of $0.04 exceeded the high end of our guidance range. GAAP basic and diluted EPS were based on 175.3 million weighted average shares outstanding.

Non-GAAP basic and diluted EPS were based on 196.7 million weighted average shares outstanding.

As we have mentioned before leverage within the Pandora business model is driven by a central financial dynamic, the ability to drive RPM in excess of LPMs or licensing cost per thousand hours.

LPMs are largely fixed with annual increases and thus as RPMs expand we’re able to commensurately expand our gross margin. This quarter’s results reflect this dynamic with non-GAAP growth margin improving approximately 900 basis points from 34% in the second quarter last year to 43% this year. A cornerstone of our future success is continued total mobile RPM growth including advertising and subscription revenue and that is whether we’re so pleased with our recent performance in this area. Second quarter 2014 total RPM based on non-GAAP revenue increased to $41.73 from $31.09 in the same period last year. This was driven by mobile with non-GAAP mobile RPMs reaching an all-time high of $37.59, compared to $23.81 last year.

Web RPM based on non-GAAP revenue also increased to $57.75 this quarter from $55.19 in the second quarter of fiscal 2013. LPM for the quarter increased to $21.09 from $18.33 in the same period last year due to the annual increase in the licensing rates that went into effect in January 2013 and the higher mix of subscription hours we’re now seeing.

However because monetization outpaced this increase dramatically as a percentage of revenue content acquisition cost represented 51% of non-GAAP revenue for the second quarter this year down from 64% last quarter and 59% in the second quarter of last year.

Our investment in advertising and description implementing smart leverage such as reducing song skipping and limited mobile listening has helped us drive monetization and manage content cost. As reflected by the increase in RPM and decrease in content cost as a percentage of revenue. When we introduced the 40-hour mobile listening limits, we were confident that our scale over 7% of total radio listening and Pandora’s number one ranking in most major markets would allow us to take this action without impacting our key monetization initiatives in driving the disruption of radio advertising market and driving our mobile advertising leadership.

As our results have shown, the continued strong growth in our advertising revenue allowed us to cover the increased royalty cost with dollars left over to invest back into the business. With these tools in hand and insight into how they work, we are resetting our levers in September. Notably, Pandora plans to eliminate the blanket 40-hour-per-month limit on free mobile listening effective September 1. In the six months, since we first implemented the free mobile listening limitation, we have gained critical insight into the user population that has given us greater control of our business. Because of these insights, Pandora has implemented both other surgical levers to control content cost and new features that will allow for greater product usage. With these tools in place, we are well-positioned to continue to both optimize the cost structure of the business and further monetization progress.

Fundamentally, we see no difference in the monetization potential between the desktop and mobile platforms that now constitute the majority of our usage and listening to mobile listening limits reinforces our belief in the potential of mobile monetization. As a consequence of removing the listening hour limit, we do not anticipate dramatic growth in net new subscribers for the rest of the year. To help from a modeling perspective, we expect subscription revenue to be approximately 20% of total revenue for the year.

Pandora ended the second quarter with $68.9 million in cash, cash equivalents, and short-term investments compared to $75.4 million at the end of the prior quarter. For the first time, we also drew on our line of credit taking a draw of $10 million. The decrease in the draw were related to the $8 million acquisition of a broad patent portfolio from Yahoo! which includes several fundamental internet radio patents dating to the late 90s. These patents invite innovation developed at Launch Media, which ran the Launchcast service and Musicmatch and was distributed the MusicMatch Jukebox and will enable Pandora to further reinforce our intellectual property strategy around internet delivered music content.

Cash used in operating activities was $2.3 million for the second quarter of fiscal 2014 compared to $2.8 million generated in the year ago quarter of fiscal 2013. We increased headcount 64% year-over-year to 964 employees in the second quarter of fiscal 2014 from 589 employees in the same period last year. Overall, our sales and marketing expense represented 28% of non-GAAP revenue in the second quarter and increased 95% compared to the year ago from $23.5 million to $45.8 million as we invest to take advantage of this market opportunity. Our product development expense represented 5% of non-GAAP revenue in the second quarter and increased 77% compared to the year ago quarter from $4.5 million to $7.9 million. Our G&A expense represented 11% in non-GAAP revenue in the second quarter and increased 73% compared to the year ago quarter from $10.6 million to $18.4 million. Pandora will continue investing to scale our operation to support our top line growth objectives.

At this point, I also want to make our intentions known that we will file a Form 8-K tomorrow morning with the SEC noting Pandora’s transition from a January 31st based fiscal year to December 31st based fiscal year end during the fourth quarter of this calendar year. As such, we will report earnings according to our normal fiscal cadence for the quarter ended October 31, 2013 followed by a two-month stub period for November and December 2013 to achieve this transition. The purpose of this change is simple to align Pandora’s business calendar with that of the advertising industry’s normal cycle. We plan to have calendar financials posted on our website prior to our next quarterly earnings call. And on that call, we will begin providing forward guidance consistent with our new reporting cadence. And at the same time for one quarter, how it would have also been viewed on the prior fiscal calendar to help you with the transition and to facilitate the understanding of our performance going forward.

Now, I will wrap up with thoughts regarding our guidance for our current fiscal 2014. First, at a high level, we are at an exciting moment in time for Pandora, where we have the opportunity to truly redefine radio for millions of music listeners. We have made significant progress disrupting the traditional radio market in a very short period of time and we’re just getting started. Pandora’s profitability trajectory in previous quarter’s and in particular of this quarter demonstrates we can drive significant leverage in our financial model, investment to-date however only begins to address the huge opportunity of the future of connected device. Given this opportunity we will continue to maximize our investment in the business and we expect EPS growth to trail revenue growth as we work to realize our full market potential.

Starting with the full year fiscal 2014 we are now estimating non-GAAP total revenues to be in the range of 640 million to 655 million, or year-over-year growth at the mid-point of 50%, we’re also targeting profitability for the full year on a non-GAAP basis with fiscal 2014 non-GAAP EPS to be between break even and earning of $0.05. We have tightened the range for full year non-GAAP EPS guidance and lowered the upper end of the range to reflect our intentions to invest aggressively for growth.

Fiscal 2014 non-GAAP EPS includes revenue related to our subscription return reserve excludes stock based compensation expense and amortization of intangible assumes minimal tax expense given operating loss addition and is based on a 197 million diluted shares outstanding for fiscal 2014.

For the third quarter of fiscal 2014 we currently expect total non-GAAP revenue to be in the range of a 174 million to a 179 million, or year-over-year growth at the mid-point of more than 46%. Non-GAAP diluted EPS is expected to be between $0.03 and $0.06 for the third fiscal quarter.

Non-GAAP EPS includes revenue related to our subscription, return reserve excludes stock based compensation expense and amortization of intangibles assumes a minimal tax expense given our net operating loss position and it's based on a 198 million diluted shares outstanding for the third quarter of fiscal 2014.

By any measure Pandora is the undisputed leader in internet radio today. We’re highly confident in the strength of our business and our ability to thrive in an evolving business environment. We have a well-established track record of innovating it's scale and we’re no stranger to intense competition past or present. Pandora’s strength and resilience is based on the unique consumer value of the best product and unparalleled ubiquity boasted by our singular focus and more than 10 years of expertise creating this category and building a powerful brand that resonates deeply with listeners.

Importantly our scale is a critical advantage with more than 200 million registered users and more than 70 million active listeners; Pandora has a dominant 70% share of the U.S. internet radio market today. Pandora listeners are highly engaged creating more than 5 billion stations and 30 billion pieces of feedbacks since we launched eight years ago.

In July 2013 our listeners logged more than 1.28 billion listening hours which translates to nearly 17 hours of listening per month for the average user.

When compared with the terrestrial radio industry we’re effectively the number one radio station in most major markets across the country with more than 7% national market share. The disruption of terrestrial radio is just starting.

Bottom-line the combination of our scale, our mobile monetization momentum and our operating leverage make me highly confident on what’s ahead for Pandora. And with that we’re ready to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions). First question comes from Heath Terry with Goldman Sachs.

Heath Terry - Goldman Sachs

You mentioned that local was up 4 year-over-year can you give us a sense of where the mix sits now between local, national and I guess remnant and to the degree that you can sort of quantify for us where RPMs in each of those four category even if it's just on a relative basis stand.

Joe Kennedy

So local is in the fastest growing piece of advertising revenue for us and certainly has been a driver of the growth of audio revenue that now is 60% of total revenue across our advertising base. We still have very strong digital revenue and we’re still selling quite a bit of advertising through the digital channels as well as the broadcast channels, it's just the tip of the spear in terms of driving growth in 2013 so far. As in terms of general pricing and RPMs, we don’t breakout RPMs on a per channel basis. The CPMs however tend to go from low to mid single-digits on a national account when you are talking audio up to the high-teens on a local basis. So, we have pursued the local advertising dollars not just because it is such a wide open market opportunity for our native ad products, but because the pricing power in those local markets is very attractive.

Operator

Your next question comes from Scott Devitt with Morgan Stanley.

Scott Devitt - Morgan Stanley

Hi, thanks. I was just wondering if the introduction of the skip limit is replacing the need for the cast, or you are approaching a mobile RPM level that’s making you more comfortable listening in, because we have noticed recently that you have become the number one grossing app on iPhone and you have also moved up the chart on iPad and Android. And wondering now what this cast removal will do to subscription growth and should we assume that the removal is financially accretive from the outset or there are other reasons for doing it? Thanks a lot.

Joe Kennedy

Thanks for the question Scott. So, the mobile listening limit was a blunt tool that we implemented six months ago. And in that timeframe, we have because of that limit and because of ongoing trajectory of the business, we have learned a lot about how users consume our product and have implemented a variety of more surgical techniques to not just improve listening experience, but also control costs that were otherwise being controlled by the mobile listening limit. And you correctly identified the skip limit as one of those surgical efforts in order to better control the cost issue while not changing the listening experience. So, that’s one of many things that changed in that timeframe, but the other big reason to remove it at this point is related to the second side of that, which is the monetization of those additional hours greater than 40 has increased significantly in the six months that have to do with both the growth of subscription revenue that is being applied to our heaviest listeners as well as our advertising capacity from the investment in sales people and in infrastructure that allows us to monetize those hours from 41 onward at a much higher rate and thus we are willing to take those on as part of our overall business. Thanks for the question.

Operator

Your next question comes from Nat Schindler with Bank of America.

Nat Schindler - Bank of America

Yes, hi. I am just going to go back a couple of years to your IPO and you were talking about a long-term model concept, where you would get to roughly 40% contact acquisition costs and everything being the same dropping down to about 20% operating margin on a long-term model. At the time though, you were virtually 100% national campaigns, now you have gone at least a good step towards local as a driver, is there going to be any incremental cost in sales and marketing that you wouldn’t have thought of them due to that growth in local advertising? Is that a lower margin inherently, because of more sales people required for the same amount of revenue?

Mike Herring

That’s a great question. So, it is true that the local sales dollars are more expensive to acquire and it takes more investment both in people and in time. And so in general on a per sales rep basis, you overall would have lower quotas and achieve a lower total dollars than a national sales rep, but because of the CPM difference that we talked about earlier, where their local CPM is going to be 3 or 4 times that of a national account, the leverage that comes from pricing more than makes up for the cost of sales increase on that revenue. So, when we talk about moving that revenue, that RPM up driving that RPM higher with higher CPMs coming from a local sale is actually more accretive to sort of a bottom line than driving that RPM through selling more national revenue. Now, go back to that original IPO target model that really hasn’t changed much, that 40% cost of content percent of revenue target is really at that $50 to $55 RPM level and we’re seeing that happen now we’re going from $30 RPMs all across the board to $41.73 this last quarter we have seen a direct impact on our percent of revenue for cost of content down to 51% this quarter as we get back RPM from the $41 to the $50 – $55 level is it will have a direct impact on driving cost to content down closer that 40% and as growth slows we would get be able to drive higher earnings and target that 20% operating margin. But if we’re still growing at 40% - 50% or greater or we see opportunities to do that then we will continue to invest aggressively at the margin and you know be optimizing for top-line growth rather than that operating margin.

Operator

Your next question comes from Douglas Anmuth with JPMorgan.

Douglas Anmuth – JPMorgan

So I want to ask two things first on the second half earnings guide, can you just talk more about the major areas investment and in particular how you’re thinking about the sales force expanding perhaps the number of markets you could be in as you look out over a couple of quarters into ’14 or ’15 rather and then also can you give us the ad revenue split between mobile and computer for the quarter? Thanks.

Mike Herring

As we look forward couple of things happened in the back half of the year, content cost actually will increase because hours will tend to drive upward as we head into not just the fall but into the holiday season. So the additional leverage on that is harder to get it's harder to drive because we’re talking about an increased hours and it's about selling out, continuing to sell out inventory at higher levels, so you combine that beginning to invest for next year’s sales environment and in the fourth quarter where we transition from a very strong advertising market in the sort of September, December time frame to a resetting of that market in January and so there is it's a confluence of an investment period for Pandora to get ready for the next year and the next advertising cycle and you know the revenue fluctuating from an advertising opportunity perspective so that’s a main thing that’s driving you know the step up in revenue along with sort of a less aggressive EPS target.

And the split between Desktop and mobile revenue, ad revenue in the second quarter you know total mobile ad revenue was around 90 million and web ad revenue would be about 40 million or so, 38 million.

Operator

Your next question comes from Jordan Rohan with Stifel Nicolaus.

Jordan Rohan - Stifel Nicolaus

There was some commentary offered when you announced the elimination of the 40 hour limit on free mobile listening about the effect on the subscription business, I was hoping you could repeat that because obviously it's quite material something about a 20% number I don’t remember what period of time that was over and also something about is it number of subscribers not increasing any more or can you repeat that and secondly should we assume a pretty significant spike in hours as you go from September, October month whenever it really hits and the unlimited mobile listening returns or should we assume that the other message of controlling listening effectively made that 40 hour per month limit relatively ineffective or didn’t come to effect very often. How do we think about the content hour streamed and therefore the cost line in this quarter as the mobile caps removed?

Joe Kennedy

We don’t expect a big spike in hours, for hours to grow but when we implemented the mobile cap as a blunt (ph) instrument we thought about estimated 10% decrease in hours judged from limiting mobile free listening at 40 hours. We don’t expect that to then step back up again, because exactly like you surmised that skip limits and other measures that we have implemented will actually manage the listening patterns a lot more closely and we have been rolling those out through several iterations of our products over the last six months. So, although we will see longer listening periods from our heaviest free listeners, the total impact to hours won’t be as dramatic as the reduction was. And I did mention that we don’t expect that subscriber number to continue to grow as it has been. I mean, if you think back over the last two quarters, we have grown from 1.8 million subscribers at the beginning of this year to over 3 million subscribers two quarters later.

We estimate a large percentage of that – a majority percentage of those subscriber additions were related to heavy listeners that reached the mobile listening limit for free listeners. As we move to the next few quarters that motivation for subscribing won’t be there anymore, because we will still have – will allow listening in excess of those 40 hours. There will be other reasons and other motivations to drive subscription. We still think that will be a strong business, but it just won’t be making the step functions of growth that we have seen over the last two quarters. That’s why estimated just from building the model out that revenue for the year we expect will even out at about 20% of revenue on subscription revenue and 80% of revenue on advertising.

Operator

Your next quest comes from Mark Mahaney with RBC.

Mark Mahaney - RBC

Good afternoon. I have two questions please. First, any color commentary all on international markets? And then secondly as you mix shift your expenses away from those with a structural royalty cost with the kind of the offensive investments, could you may be prioritize what you would like to do with those incremental dollars, particularly in sales and marketing and product development? Could you get little more granular about what the kind of the freeness of the OpEx budget in the way I will ask you to do? Thank you.

Mike Herring

First, I will start the second one and I will let Joe talk about international markets here in a second. The expense as we free up revenue dollars or the percentage of revenue away from content costs, we are still going to be paying significant content costs, but just we will have more dollars to spend as percentage of our revenue. We have two ways we primarily want to invest that. One is in sales and marketing, we are seeing tremendous return on the sales and marketing investments that we made year-to-date. And I think our revenue growth and our increased guidance over time is reflecting that return we are seeing. And we think that, that will continue for quite some time with 7% of total listening and a fraction of that as a percentage of the 15 billion in radio market that we actually are currently garnering. We think there is a lot of room for our sales team to really penetrate that advertising market.

And then the other piece would be investing in product development. Our target model had 7% of revenue in product development. And currently, we are sitting at 5%. We have been achieving amazing things in terms of product quality and innovation at that level of spend. We think that the future is just going to expand in terms of the areas you want to take that product and then take the investment to do that. And so as we drive leverage on those content costs line, we expect to invest aggressively back in product development in order to give us more options for the future.

Joe Kennedy

And Mark, this is Joe. On your first question on the international, there is two things with respect to the markets we opened officially and with full force in December of last year, Australia, New Zealand were really pleased with the progress there. We continued to grow exponentially just by word of mouth on a population adjusted basis were much further along there than we were in the U.S. at our comparable period in time, so, just really reinforcing our thesis of the global appeal of Pandora. We continued to be both patient and opportunistic in terms of our position with other markets and continue to have exploration there but there is nothing to share or update on at this point in time.

Operator

Your next question comes from Laura Martin with Needham.

Laura Martin - Needham & Co

Okay so two questions one is on the local ad revenue, (inaudible) on local ad revenue it sounds like the tech is really working now. My recollection is that last quarter you kind of said your local ad sales was in tech you are growing to go what, does this make you want to grow it faster given that over-delivery and pricing power you’re getting in local ad-markets and then secondly Joe could you give us an update on what’s going on with the content post negotiations with DC, we haven't heard about that in a while what’s happening with your content cost renegotiations?

Mike Herring

On the first part quickly Laura thanks for the question, it's exactly why we are stepping up investment is we’re seeing a return to you global as an example you know really starting to achieve our expectations, those sales people are executing extremely well, the advertising dollars are starting to follow freely back to Pandora driven from these integrations in the Mediaocean and STRATA it's really enabling that go to market strategy and once we have kind of got that down it's expanding existing markets they were in already, they are viewing on local markets and playing it to the next level of local markets, the expansion in Trident to 275 markets is about really pushing Pandora in nationwide scale to cover either with people on the street or internally much larger swaps of the United States in terms of local advertising and Joe you want to talk about it?

Joe Kennedy

Laura in terms of your other question really nothing new to report there, we’re getting closer 2014 is the start of the next CRB process we’re certainly intensify our preparations that have been underway for some time and we’re much looking forward to that rate arbitration and we continue to set expectations that this will come down to a decision by the judges that would be published late in 2015.

Operator

Your next question comes from Sameet Sinha with B. Riley.

Sameet Sinha - B. Riley & Co

One question about this pattern portfolio I do remember the time when it was launched was actually a public company but have you accessed the enforceability of this patent portfolio obviously the patent go back many years in light of the fact that competitive environment is getting tougher and new guys are entering if you could comment on that I would appreciate. Thank you.

Joe Kennedy

So in doing our diligence we definitely did assess the patents from many angels and you know our assessment was that it bought applicability to internet radio generally and specifically reinforced our already existing IP protection and portfolio and so it's a very prudent investment on behalf of Pandora to be the buyer of those patents.

Operator

Your next question comes from Martin Pyykkonen with Wedge Partners.

Martin Pyykkonen - Wedge Partners

Two questions on the sales force it sounds like again Q3 fiscal that you would be stepping up and the reasons are pretty clear and I think you mentioned in previous call it's been more of a Q4 and Q1 just based on kind of bonus paid so it sounds like a little more spread out of course around that is when you hire and probably it's more to local sales people from radio stations and companies (inaudible) on others, is that typically a non-compete in any way because doesn’t seem like it in terms of the numbers and how you’re scaling and you’re getting your return but it's brought up and sometimes it's fairly typical a six month or so, non-compete and then just second quick question it sounds like you’re saying this but within the Q3 guidance you are assuming an internal model and I know you would put a number to it if there are some reacceleration on listener hours total listener hours that’s compared to for summer and going back early in the year what it has been decelerating that there are some reacceleration on that listener hour number for the rest of the year? Thanks.

Mike Herring

On the listener hours seasonally that’s always had strong hours growth as you exit the summer and go back to school, back from summer vacations into the office with a lot of our listening does occur in those environments. And we tend to see hours grow in the fall. Also listening on the holidays with holiday music and such drives pretty significant hour growth generally. We also with the removal of the listening limit, we don’t expect that to swing back, because we have other measures in place, but we do think there will be a measurable impact from removing the limit in terms of average hours per user.

And then on the first question around sales non-competes, yeah, they are common for sales people in this industry, and we are very careful about making sure that we respect those agreements. We expect others in our industry to respect ours. So, we are careful about it, but it doesn’t keep us from hiring people who are subject to those agreements. We just make sure that there is (garden) associated or they are not involved in activities that violate those agreements in anyway. I think that’s pretty standard practice of anybody in this industry and/or doesn’t do anything differently.

Operator

Your next question comes from Peter Stabler with Wells Fargo Securities.

Peter Stabler - Wells Fargo Securities

Thank you. I want to go back to the pricing question for a second. Radio buyers we stick with, acknowledge that Pandora has got a superior ad product as a low clutter, minimal switch away, real demo in geo-targeting versus terrestrial, which really doesn’t. Yet really what people are telling us is that you are not really demanding a CPM premium at this point that you are “pricing to market” or “bringing buys” that buyers are allowed to bring buys in without paying you guys the premium. So, I guess my questions are two. If this is true and you are not taking the price premium relative to the top, let’s say 10 terrestrial stations, do you think in the future that your dominant orient position would allow you to do that? And secondly what kind of timing might be associated with that if you have any color? Thank you.

Joe Kennedy

So, Peter thank you for the question. So, the question about whether we can drive our premium pricing or not, I think the short answer is we think our service does provide a much better experience and a higher return for our advertisers and deserves the premium. And we are definitely not discounting for sure and holding to our pricing structures because of that. We are still in major market expansion mode. And so it’s much easier for us to drive revenue and this is profitable revenue in a price match situation against competitors and improve that our ROI is higher. So, that has been our strategy to-date. We do drive additional revenue though outside of that kind of standard CPM through other things like the addition of calls to action or specific digital revenue that pairs with the audio that allows us up-sell the advertisers into more immersive experience or higher engagement experience with the consumer. So, although pricing may not be – being driven at premium, overall deal size is driven at premium, because we are able to offer things that terrestrial radio just has never and never will be able to put out there. Over time, I think we do have some pricing power from that perspective, but I believe that we will earn that pricing power through higher ROI not through size or breadth in the marketplace. Operator?

Operator

And your next question is from John Blackledge of Cowen and Company.

John Blackledge - Cowen and Company

Thanks. Two questions. First, I think you mentioned listing the audio spot loads if you are running back-to-back audio spots, and in turn driving longer uninterrupted our songs, can you just talk about the average number of audio spots now and where that can go over the next several years? And then other question on the content cost, it’s being reported at Apple’s iTunes radio on the content side they are not paying for song skips in the first 20 seconds, they are benefiting from Payola. They are not paying a higher per track license fee for their subscription business versus their ad supported business offset to some degree with the ad revenue split. Can you just talk about those reported differences versus what Pandora is paying for and how that deal might impact the next round of content cost negotiations if at all? Thanks.

Mike Herring

Sure. I will just add a little question and then let Joe speak to iTunes radio. So, you know we have always stuck to a strategy over the last few years of increasing ad load gradually on our service as both were able to sell through the advertising associated with that ad load and in fact great and bouncing that with the listening experience. Adding back to back ads is absolutely in-line with that strategy on where we have done a lot of testing, the beauty of having connected radios, we can test many different combinations of the way we deliver advertising to consumers and we definitely see a positive response from grouping them together and giving the longer listening swap of music to listeners and at the same time we can increase that ad load potential within an hour so current, up before we launch this you know we were at a maximum of 3.5 to 4 audio ads per hour sub-2 minute, we think that this will increase that somewhat and will give us a potential to take that up you know materially maybe as many as you know five ads per hour or something so we get in the 2 to 2.5 maybe even three minute level, where that goes eventually depends a lot on where we think the best way to monetize their services and we do a lot of different things from advertising to performance based revenue to paid listening options and as we find the right curve of opportunities I think there will be different levels but we think so far we haven’t seen any sort of, any negative reaction to the increases of ad load that we have implemented and we believe that can be done you know much more extensively than where we’re today without dramatic impact on our listener ship and Joe you want to pick up the second half?

Joe Kennedy

Yes John to your second question about the apple contracts we have seen it's posted on the internet what I think everyone believes is the contract they have with the independent labels and we have done analysis of that, I’ve seen I think pretty good analysis by independent third party, there is a guy named David Touve who wrote about it on blog called Rockonomics pretty good analysis that highlights the points you make that there is numerous exclusions in that contract that in our analysis mean that the Apple content cost is probably somewhat below what our current content cost is. In terms of impact on the next CRB it's yet to be seen it's a potential benchmark, I think that will take some time to sort out.

Operator

Your next question comes from Ralph Schackart with William Blair.

Ralph Schackart - William Blair

You had talked about high teen CPMs and local versus low single digits, low to mid-single digits I think for national, how should we think about that as the business mix shift continues to move towards sort of Mediaocean and STRATA which is more a sort of a spot environment, how should we think about those CPMs overtime and then second can you give us a sense and if not quantification maybe subjectively how we should think about what percent of revenue is local within the fiscal year guide this year. Thank you.

Mike Herring

The integration with Mediaocean and STRATA definitely do facilitates this spot markets and the spot is a step function CPMs over that low end of the range that I gave you they are sort of in-between because there is national spot as well as regional and local spot so it's kind of a graduated scale from the $4 to $6 CPMs to the high teen CPMs. So those investments are actually all about accessing dollars that are more targeted in this higher CPM and local whether you think of it as regional or you think of it as smaller local markets or even micro-local opportunities is growing quickly. It has been a big part of the growth of the 60% of our revenue that came from audio. We’re not disclosing that specifically however because it's close to their strategy as a business. So thanks for the question though.

Operator

Your next question comes from Barton Crocket with Lazard Capital.

Barton Crocket - Lazard Capital

I wanted to follow-up a little bit on John Blackledge’s question earlier about the Apple deal and in particular you know if the Apple deal has actually cost less than what you guys are paying for content. Why wouldn’t you go up to the labels and say, hey give us that deal, we will sign on to that, why push it so that we have to have a judge decide and go through all that uncertainty, is that the labels are not offering that to you and the judge needs to mandate it, little bit of color there would be helpful? And then related to Apple is it ramping up to launch here in September, are that bringing new advertisers into the market, is that kind of splash expanding the category?

Mike Herring

Hey, Barton. Joe, I will take at least the first part of that since we launched eight years ago we have taken advantage of the federal statutory license and continue to do so today. We have complete flexibility in terms of whether we continue with that strategy or use some degree of direct licensing strategy. At this point, we haven’t done anything in the latter category, but we have full flexibility there and really are ultimately focused in terms of making sure we get inappropriate long-term across the content.

Joe Kennedy

Yes. And we made this comment publicly, but we think that this market is going to continue to grow pretty dramatically as the shift from broadcast to connected radio and the advertising dollars is going to be a big one. And Apple’s entrant highlights the advantages of it. It highlights the future of connected radio as a primary advertising vehicle, and we believe we are going to play an important part of that for a long time to come. And so that to the extent it expands that, it will help our opportunity.

Operator

Your next question comes from Brian Nowak with Susquehanna.

Brian Nowak - Susquehanna

Thanks. I have a couple. So, just going back to the local sales force, I was wondering if you could give us an update on how many local sales people you have now, I think you had 72 at the end of last quarter, how many are you at now? And then going back to the non-compete clauses in the local sales force, can you just help us a little bit to better understand typically how long is restrictive non-compete clauses are for the local sales people to not go after their old books of business. Just to give an idea of when they could potentially become even more productive for you guys? Thanks.

Mike Herring

Sure. So, quickly on the latter point, they are all over the map. I mean, six months is typical, given much longer than that they are hard to enforce. So, that’s generally kind of how that lays out. Usually, it will take some time off, spend some time getting trained up, you just can’t touch their old account books during that timeframe. And then the first question about how many local sales people, we have added a handful of sales people in the second quarter. The majority of our hires in second quarter are really around other functions and product development in particular. The sales team has really hired mostly the end of Q4 and the beginning and through Q1.

Operator

Your next question comes from Jim Goss with Barrington Research.

Jim Goss - Barrington Research

Thanks. I have noticed more and more articles attempting to define the dollar value of the overall mobile market and the rate of growth. And thinking in terms of how internet over about 10 or 15 years emerged as a major category, what is the shape of that curve as that you are seeing in terms of timing and magnitude how fast will this happen? And then one clarification, that the revenue guidance you gave for the full year, is that the 11-month or 12-month revenue guidance?

Mike Herring

Yes, thanks for clarifying question. It’s the 12 months ended January 31, 2014 is the annual guidance. So, it’s directly – it’s same revenue guidance for the year that we have been giving year-to-date. So, the mobile advertising role is early in its days just like advertising was for the Internet world 15 years ago, and it took some time for that curve although it’s been reasonably steep to get up into meaningful dollars that rose all boats, and there is always early benefactors and some of those early benefactors become very large businesses. The mobile world we believe is going to be a lot steeper and a lot bigger, just because the sheer number of users in the United States and globally will be so much larger on the mobile side than the Internet side. And that, that curve because of what we have learned through the Internet phase of things will be a lot of steeper. And I think we are already seeing that with the handful of companies that are being successful are finding that they can be successful very quickly and drive pretty nice growth rates.

Operator

And your final question comes from Corey Barrett with Pacific Crest Securities.

Corey Barrett - Pacific Crest Securities

Hi, thanks for taking my question. You have mentioned several times new investments in feature functionality and product development broadly speaking. Is there any color you can provide on what you’re working on there or what you might aspire to develop in terms of new functionalities.

Mike Herring

No nothing specifically, you know we have spent a lot of time making sure that we are improving the listener experience and driving the ubiquity of our service across multiple platforms and channels and we endeavor to do both those things at a world class pace over the next few years and that’s all we say about that so.

Joe Kennedy

Great. Operator with that we will have to conclude today’s conference call. We look forward to seeing you guys out on the road in the coming months. Take us back to Pandora please.

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