Pandora Media (NYSE:P)
Q4 2013 Earnings Call
February 5, 2014, 6:00 p.m. ET
Brian McAndrews - Chairman and CEO
Mike Herring - CFO
Dominic Paschel - VP, Corporate Finance and Investor Relations
Heath Terry - Goldman Sachs
Douglas Anmuth - JPMorgan
Scott Devitt - Morgan Stanley
Nat Schindler - Bank of America Merrill Lynch
Mark Mahaney - RBC Capital Markets
James Marsh - Piper Jaffray
Jordan Rohan - Stifel Nicolaus
Rich Greenfield - BTIG
Laura Martin - Needham Capital Partners
Jason Helfstein - Oppenheimer & Co.
Michael Graham - Canaccord Genuity
Peter Stabler - Wells Fargo Securities
Welcome to Pandora's November and December 2013 subperiod and calendar Q4 2013 period ending December 31, 2013 financial results conference call. [Operator instructions.] Opening today's call is Dominic Paschel, Vice President, Pandora.
Thanks, operator. Good afternoon, and welcome to Pandora's year-end financial results call for 2013. We will provide financial results for the two-month, November, December subperiod and the 11 months ended December 31, 2013 as we conclude our transition from a fiscal to a calendar year financial reporting convention. We will focus our remarks primarily on the 3- and 12-month calendar months ended December 31, 2013, as that is more relevant for investors to evaluate on a going forward basis.
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 direct 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 are available on the Investor Relations site. Today's call is available via webcast, and a replay will be 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 Brian McAndrews, Pandora's Chairman, CEO, and President.
Thanks, Dom. Thank you all for being on the call. We had a tremendous year in 2013, achieving many financial and nonfinancial milestones which we’ll share with you today. We also made significant progress in product innovation, which continues to drive the network effects of our business. We enter 2014 with strong momentum, executing well on many fronts and enjoying first mover advantage enabled by our Pandora Everywhere investment made over the last several years.
I’m excited to share more details of all of our accomplishments in 2013, and my thoughts heading into 2014. While Mike will walk you through the detail on the transitional subperiod we’ll report in the 10-K, as Dom noted, I want to focus on our financial highlights for the calendar year and quarter, as it is much more relevant thinking about our going forward reporting and guidance.
Let me start with a few highlights from calendar year 2013. Pandora ended the year with $647.5 million in non-GAAP revenue, an increase of 56% over $414.4 million in the  calendar year ended December 31. 2013 was Pandora’s first profitable year as a public company on a non-GAAP basis, with $11.5 million non-GAAP net income, and earnings per share of $0.06 compared to a non-GAAP net loss of $6.5 million for 2012.
Pandora also closed a record fourth quarter, surpassing the $200 million total revenue mark for the first time in a three-month period with a total non-GAAP revenue of $200.8 million, an increase of 51% over $132.9 million in the same period of 2012.
The fourth calendar quarter was also profitable for Pandora on both a GAAP and non-GAAP basis, with GAAP net income of $9 million and non-GAAP net income of $23 million, compared to GAAP net income of $1.6 million and non-GAAP net income of $9.7 million in the fourth quarter of 2012.
These strong financial results were driven by our increased hours and our continued focus on monetization. Total non-GAAP RPMs reached a record $44.23 in the fourth quarter, and $38.77 for the year. Advertising RPMs also reached record highs for the fourth quarter on both traditional desktop and mobile at $61.92 and $36.20 respectively.
Given that the majority of Pandora’s listening hours occur on mobile, we’ve been particularly focused on mobile monetization. Mobile advertising RPMs reached a record $36.20 in the fourth quarter of 2013, increasing 42% from $25.52 in the same quarter last year.
At the same time, listener hours grew 16% to 4.54 billion in Q4 2013, from 3.91 billion in Q4 2012, and active users increased 13% to over $76 million from $67.1 million in the fourth quarter of 2012. And, according to our estimates, which include third-party data, our share of total U.S. radio listening increased to 8.6% at the end of 2013, from 7.6% a year earlier.
We will release our January metrics later today, but let me preview a few key points. In line with our traditional seasonality following the strong Q4 holiday listening season, active users declined to 73.4 million in January from 76.2 million in December, and are up 12% from 65.6 million last year.
Pandora’s market share essentially stayed the same in January at 8.57%, and is up from approximately 7.7% last year. January listener hours were flat at 1.6 billion in December, and are up 13% from approximately 1.4 billion last January. In short, given the usual seasonality patterns, January is off to a strong start.
We are executing well on many fronts, and much of our continuing growth can be credited to the strength of our product. We continue to invest in innovations to enhance and improve the product for our users and make Pandora available everywhere consumers what to listen to personalized radio and to optimize the platform for our business and advertisers.
To improve the listening experience for users, we made significant investments in our playlist technology, analyzing dozens of pieces of metadata and user interaction. In addition to deciding which songs to play and when, our refined playlist technology measures other variables such as repetitiveness, song duration, and new music discovery to make the Pandora listening experience truly unique and provide a huge competitive advantage.
Ongoing investments in Pandora’s proprietary playlist technology have resulted in millions of tracks for more than 100,000 artists, resulting in more than 600 billion total spins, with more than 5 billion stations created, over 35 billion thumbs up and down registered, and now more than 50 algorithms that build on the Music Genome Project to continually enhance the listener experience.
In addition to improving our playlist technology, we made many product enhancements over the year. We added alarm clock and sleep timer features, created a station email recommendation system, and added an Android in-app subscription capability for Pandora One.
One of our key goals was to make Pandora accessible everywhere consumers want to listen to their personalized radio: at home, in the office, in the car, or on any connected device. And in 2013, we came closer to seeing this goal become a reality.
Pandora expanded its reach with the launch of the Pandora app on the Windows 8 phone and Android tablets, integration with Facebook Timeline, a redesign of the iPad app, and integration with Google’s new Chromecast product and TV.Pandora.
Pandora is now available in 9 out of 10 of the best-selling passenger vehicles and more than 4 million unique users have activated Pandora through a native integration across 25 major automotive brands and eight aftermarket manufacturers that we partner with. Throughout 2013, we expanded our automotive partnerships with GM, Chrysler, Mazda, Hyundai, Toyota, Nissan, and Honda.
Most recently, at the Consumer Electronics Show, we announced that we will begin rolling out in-car advertising solutions incorporating Pandora into the native environment of the car. Major national brands, including BP, Ford Motor Company, State Farm, and Taco Bell are already on board with advertising sponsorships.
Clearly the network effects of our business are taking hold and increasing our momentum. As we make Pandora accessible anywhere users want to listen to their personalized radio, our listener hours increased, driving our market share and attracting more advertisers and more partners to our platform.
While we were innovating and improving Pandora for consumers throughout the year, we were also busy optimizing the product for our advertising partners, including creating and refining multiple monetization levers and integrating with major broadcast media buying and planning platforms such as STRATA and Mediaocean, and our results reflect these improvements.
We are very pleased with our financial performance and our product innovation throughout 2013. Despite some very high profile competitive pressure, we have maintained our market leadership position, highlighted by the release of Trident’s December rankings that show Pandora’s market share of internet radio out of the top 20 U.S. properties at a still-dominant 77%, unchanged from the year before.
Our growth strategies are working and our business is resilient. We’ve closed our first non-GAAP profitable year as a public company, with market share and monetization at record highs and with our reputation enhanced as the leading innovator in the space. We are proud of our accomplishments and we enter 2014 with tremendous momentum focused on three strategic priorities.
First, we are focused on continuing to grow our active listeners and listening hours. We are increasing our investments in the product to optimize the listener experience by having the best playlist experience on the market and adding innovative new features. We will continue to invest in our Pandora Everywhere strategy, including being part of the first connected cars rolling out this year, and we will significantly increase our marketing spend to ensure our listeners are well informed of all these new developments.
Secondly, we plan to continue our progress in improving monetization. We will continue our investment in sales expansion and new and innovative advertising products, including better ad targeting in ways that only the internet and our breadth of user data allow us to do. And we will continue to work with the industry to ensure that we are integrated into the advertising infrastructure in ways that help advertisers better understand our value.
Finally, we will continue to focus on managing our cost of content. We will increase our engagement with people across the music and radio industry, including artists, labels, and competitors, to ensure that we are building a relationship and staying abreast of all key developments in this rapidly changing royalty environment.
We may not always agree with others in the ecosystem, but it’s important that we understand each other’s objectives and work to find common ground where we can. We end 2013 with a continually innovating product, a growing number of listeners and listener hours, and significantly increased monetization. This is an incredible platform to continue to build off of in 2014. I am really looking forward to the year and the years ahead.
And now I’d like to turn the call over to Mike Herring, our chief financial officer, for more detail regarding our financials.
Thank you, Brian. I’ll walk through our two-month November/December subperiod and 11 months ended December 31, 2013, followed with our calendar year financials for the fourth quarter and full calendar year ended December 31, 2013. I’ll also discuss our business strategy and share some thoughts regarding guidance for the first quarter and for the full year 2014.
As you know, we are transitioning from a fiscal-based year ending January 31 to a calendar based fiscal year ending December 31. For this transitional reporting period, we are providing unaudited financials for the fourth quarter and full year on a calendar basis. We are also providing financials for the two-month November and December subperiod and the 11 months ended December 31, 2013, both today on our call and in our form 10-K.
Following this reporting period, we will only report standard calendar quarters. For purposes of helping you model our business, and comparing year over year periods, we have provided unaudited quarterly and annual historical financials on a calendar year basis on our investor relations website.
First, I will walk you through the two-month November/December subperiod and the 11-month period ending December 31, 2013, and then focus the remainder of my remarks on the calendar quarter and year.
For the two-month November and December subperiod, GAAP revenue was $137 million, representing 57% growth from the same period in 2012. Non-GAAP revenue was $137.2 million, above the high end of our guidance range.
As a reminder, Pandora 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 a 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 [right] expires, despite all the costs associated with delivering the services, transaction, and content fees being incurred in the period. As we expect to have sufficient history to estimate a reserve in January of 2014, the accumulation of these adjustments will be reversed in the first quarter.
For the subperiod, GAAP basic EPS was $0.06, and GAAP diluted EPS was $0.05. Non-GAAP basic EPS was $0.11 and non-GAAP diluted EPS was $0.10, also above the high end of our guidance range.
Non-GAAP EPS excludes approximately $9.5 million in stock based compensation and includes approximately $0.2 million in revenue related to our subscription return reserve. GAAP and non-GAAP basic EPS are based on 194.6 million shares outstanding. GAAP and non-GAAP diluted EPS are based on 218.8 million shares outstanding.
For the 11-month period ending December 31, 2013, GAAP revenue was $600.2 million, representing 54% growth from the same period in 2012. Non-GAAP revenue was $609.4 million, above the high end of our guidance range. GAAP basic and diluted share loss per share was $0.15. Non-GAAP basic EPS was $0.12, and non-GAAP diluted EPS was $0.11, also above the high end of our guidance range.
Non-GAAP EPS excludes approximately $40 million in stock based compensation and includes approximately $9.1 million in revenue related to our subscription return reserve. GAAP and non-GAAP basic EPS is based on 181 million shares outstanding. Non-GAAP diluted EPS is based on 203 million shares outstanding.
Now, I’ll focus the remainder of my comments on our calendar quarter and year-end results, starting with revenue. We ended the fourth quarter of 2013 with a record non-GAAP total revenue of $200.8 million, representing 51% growth from the year ago quarter and above the high end of our guidance range.
For the 12 months ended December 31, 2013, total non-GAAP revenue was $647.5 million, representing 56% growth over $414.4 million in total non-GAAP revenue for the 2012 calendar year.
Advertising revenue increased 39% in the fourth quarter of 2013 to $162 million, compared to $116.1 million in the same quarter last year. Ad revenue is driven by mobile execution and for the fourth quarter, mobile ad revenue was $116.8 million, an increase of 60% over $73.2 million for the same quarter last year. Mobile ad RPMs reached a record high of $36.20 for the fourth quarter of 2013, an increase of 42% over the prior year.
For the calendar year 2013, advertising revenue increased 45% to $521.2 million, compared to $360.7 million in calendar year 2012. Mobile ad revenue was $366.3 million, an increase of 69% over $216.5 million for the 2012 calendar year. Mobile ad RPMs reached a record high for the year of $30.93, an increase of 40% from the same period last year.
Turning to subscriptions, for the fourth quarter, non-GAAP subscription and other revenue was $38.8 million, an increase of 132% over $16.7 million in the same period in 2012. For the year ended December 31, 2013, non-GAAP subscription and other revenue increased 135% to $126.3 million, from $53.7 million from the same period in 2012. And we finished the year with a total of 3.3 million subscribers.
We experienced a step function increase in subscriptions when we applied the free mobile listening hour limits early in the year. When we removed the free mobile limit on September 1, subscription growth moderated, ending the year at approximately 20% of total non-GAAP revenue for the year, roughly as we expected.
Fourth quarter GAAP basic and diluted earnings per share were $0.05 and $0.04 respectively. Basic and diluted non-GAAP earnings per share were $0.12 and $0.11 respectively, excluding approximately $13.4 million in stock based compensation and including approximately $0.4 million in revenue related to our subscription return reserve.
GAAP and non-GAAP basic EPS were based on 194.4 million weighted average shares outstanding. GAAP and non-GAAP diluted EPS were based on 218.5 million weighted average shares outstanding.
For the 12 months ended December 31, 2013, GAAP, basic, and diluted net loss per share was $0.23. Non-GAAP basic and diluted earnings per share were $0.06, reflecting our first full year as a profitable public company on a non-GAAP basis.
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 LPM, or licensing cost per thousand hours. LPMs are largely fixed as annual increases, and thus as RPMs expand, we are able to commensurately expand our gross margin. This quarter’s results reflect this dynamic.
For the fourth quarter, non-GAAP gross margin expanded 700 basis points from the same period last year, from 40% to 47%. Non-GAAP gross profit for the quarter of $95.1 million was up 81% from the fourth quarter of 2012.
For the calendar year, non-GAAP gross margin also improved approximately 700 basis points, from 33% in 2012 to 40% this year. Non-GAAP gross profit of $261.6 million was up 92% from 2012. You’ll note in our press release financial statement that we have added gross margin to our financial statement presentation to facilitate the understanding of our financial model.
Continued total RPM growth, including advertising and subscription [unintelligible], is a cornerstone of our future success, and that is why we are so pleased with our 2013 full year performance in this area. Across all dimensions of our business - web advertising, web subscription, mobile advertising, and mobile subscription - annual RPMs increased. This is the first time RPMs have increased across the board since Pandora has been a public company.
Specifically, when measured on a non-GAAP basis, total RPMs for calendar year 2013 grew 27% to $38.77, compared to $30.55 for 2012. Total mobile RPMs for calendar year 2013 increased 45% to a record $34.57, compared to $23.76 for 2012. And total web RPMs for calendar 2013 increased 6% to $55.37 from $52.15 in 2012.
LPMs for the year increased to $20.53 from $18.31, due to the blended annual increase of roughly 8% in licensing rates that goes into effect on January 1 of each year, and the higher mix of subscription hours in the year.
However, monetization outpaced this increase in content acquisition costs in the year, and thus content acquisition cost, as a percentage of revenue, decreased 700 basis points from 60% of non-GAAP revenue for the calendar year 2012 to 53% this year. In fact, in the fourth quarter, content costs as a percentage of revenue dropped to an all-time low of 47%.
The landscape around content licensing is complex, and we are addressing that in a variety of ways. In the last month, Pandora signed an agreement with the Universal Music Publishing Group, as they disclosed during the quarter, rather than pulling impacted UMPG songs from service. So while the agreement marginally increases cost, it does not impact our ability to continue to drive leverage in our business and achieve our target financial model. The specific terms of this deal are confidential.
The continued strong growth in our advertising revenue has allowed us to cover royalty costs and leverage our incremental gross profit to reinvest back into the business. Our investments through 2013 and the fourth quarter only begin to address the huge opportunity in the future of connected devices.
We will continue to make investments in our products to provide our users access to Pandora in whatever context they choose to listen, and we will continue to support our existing loyal users a product updates and innovations to provide them with the high quality personalized radio experience they have come to expect.
We will also continue to invest in sales and sales support, as we did last year. Typically, the majority of our hiring in sales and sales support occurs in the first quarter of the year, and those sales hires ramp over the second and third quarters. Our goal is to have those sales teams fully ramped by the fourth quarter, much like we have historically, and certainly in 2013.
We know the model works, and have demonstrated we can drive significant leverage. Given our substantial market opportunity, our bias continues to be revenue and market share growth over profitability.
Turning to the balance sheet, Pandora ended the fourth quarter with $450.1 million in cash and investments, compared to $443.3 million at the end of September. Cash provided by operating activity was $12.3 million for the fourth quarter of calendar year 2013, compared to $9.6 million generated in the year ago quarter.
We increased headcount 53% year over year, to 1,069 employees in the fourth quarter of calendar year 2013, from 698 employees in the same period last year, consistent with our staffing plans. Our increase in headcount over the year included adding 101 sales people for the year and 77 engineers.
As noted previously, we generally hire the majority of our new sales people in the first quarter of the year, and plan to do that again in 2014. We also plan to aggressively hire engineers as we invest in products and innovation.
For the fourth quarter of 2013, non-GAAP sales and marketing expense represented 23% of total non-GAAP revenue, an increase of 70% and $27.7 million in the fourth quarter of 2012, to $46.9 million in the fourth quarter of 2013.
For the calendar year ended December 31, 2013, our non-GAAP sales and marketing expense represented 25% of non-GAAP revenue, and increased 80% compared to the 2012 calendar year, from $89.7 million to $161.5 million, as we continue to invest to take advantage of the market opportunity.
For the fourth quarter of 2013, non-GAAP product development expense represented 3% of non-GAAP revenue, and increased 84% compared to the fourth quarter of 2012, from $3.5 million to $6.5 million. Our non-GAAP prior development expense represented 4% of non-GAAP revenue for the calendar year 2013, and increased 73% compared to 2012, from $13.1 million to $22.7 million.
For the fourth quarter of 2013, non-GAAP G&A expense represented 9% of non-GAAP revenue, and increased 60% compared to the fourth quarter of 2012, from $11.6 million to $18.5 million. Our non-GAAP G&A expense represented 10% of non-GAAP revenue for the calendar year 2013, and increased 64% compared to the calendar year 2012, from $39.7 million to $65.2 million.
Now, I’ll wrap up with thoughts around our guidance for the calendar year 2014, and the first quarter of 2014. Starting with the full year 2014, we estimate non-GAAP total revenues in the range of $870 million to $890 million, or year over year growth at the midpoint of 36%. We expect non-GAAP diluted EPS between $0.13 and $0.17.
Full year 2014 EPS excludes revenue related to our subscription return reserve, excludes the stock based compensation expense and amortization of intangibles, assumes minimal tax expense given our net operating loss position, and is based on 225 million diluted shares outstanding.
For the first quarter of 2014, ended March 31, 2014, we estimate non-GAAP total revenue in the range of $170 million to $176 million, or a year over year growth at the midpoint of 48%. As a reminder, as we shift from a fiscal to a calendar year, the first quarter [unintelligible] January, which has historically reflected the typical modest advertising seasonality that follows the holidays.
We estimate first quarter 2014 non-GAAP basic and diluted loss per share to be between $0.16 and $0.14. First quarter 2014 non-GAAP EPS excludes revenue related to our subscription return reserve, excludes stock based compensation expense and amortization of intangibles, assumes minimal tax expense given our net operating loss position, and is based on 200 million basic shares outstanding.
As we’ve noted throughout this call, our growth strategies are working. Q1 is generally an investment quarter, where we hire aggressively, primarily in sales and engineering, and those investments set us up for the remainder of the year.
Also, as expected, content costs increased 8% during the first quarter. We are optimistic that we will see the business build over the course of the year as we have historically, and we’ll continue to execute on our plans and be the disruptive force in redefining radio.
In summary, Pandora has had an outstanding and profitable year, with new highs in ad revenue, RPMs, and gross margin, driven by the success in mobile monetization. We are realizing operating leverage in our financial model, with content costs decreasing as a percentage of revenue. We are leading innovators in this space, and we continue to attract new users and engage our existing users through the best personalized radio experience possible, anytime, anywhere users want to engage.
Our world-class product and Pandora Everywhere strategy has resulted in a strong growth in market share of all radio listening, and we continue to grow and prosper in an evolving business market with many competitive threats thanks to the network effects of our business and the loyalty of our listeners.
We’re proud of what we have accomplished in 2013, but we’re just getting started. We enter the year with tremendous momentum, and look forward to 2014. And with that, we’re ready to take some questions.
[Operator instructions.] The first question comes from Heath Terry from Goldman Sachs.
Heath Terry - Goldman Sachs
Brian, can you give us a sense, when you look at the opportunity at Pandora and particularly when you were coming on, looking at the opportunity in Pandora, how did you think about where Pandora’s advertising technology sat, how much of an opportunity that represented, and what your initial priorities were in terms of leveraging the data there?
And with the January audience metrics out, I guess just your perspective on the 13% growth in listener hours, and to what extent you’re beginning to become capacity constrained or inventory constrained, whether it’s just in some markets or overall, given the rate of growth in listener hours.
Let me answer the first, and I’ll touch on the second, and then Mike can jump in on that as well. You know, I think that we’ve been growing very rapidly, obviously, in terms of our sales force and investing a lot in people who certainly have done investments in technology as well, and have begun to see some of the benefits of that.
I do think there is certainly upside there in terms of efficiency, in terms of investing in more types of native advertising for us in the space, and so I don’t know what I don’t know in terms of how the market’s evolving, but certainly we see that as a priority, and I think as we’ve expanded our engineering team significantly, we have different folks working on different things. And certainly there’s a team dedicated to investing and working on developing better technology for the advertising side as distinct from the consumer side.
And I think leveraging data, we’re beginning to do that already. We target in over 100 different ways, different combinations of variables that we have. And we have an advantage over a lot of places because of the consistent login across devices and the information we get up front. But again, it’s a space that’s evolving and we want to continue to evolve with it.
Right now, with zipcode, we have great location data, but over time, companies will look more at geolocation, and that’s an area we can look at over time. We want to invest in programmatic and take a bigger part in that, part of the ecosystem, as that evolves in display and ultimately video, and maybe ultimately in audio.
So I think there’s a lot of headroom there. These things take a while, but again, we’ve been making investments and continue to make investments to take advantage of those kinds of things.
You know, I would say on the January metrics, there’s a law of large numbers at some point, and we are very large, and so we’re going to obviously see some declines in growth. But on the other hand, we still feel very good about that growth and as I mentioned in my remarks, one of our key strategies is to make sure we’re continuing to invest in that growth.
I think historically, we have invested primarily in the playlist technology and what you might call the back end of our technology, what’s not seen by the listener. But obviously, it has a big impact, and we’re very proud of the fact that despite some real competitive companies, most notably, of course, iTunes radio coming out this year, while it certainly has an impact on us, we continue to grow. But we feel very good about that, and we attribute a lot of that to the fact that we just have the best product out there from a playlist standpoint.
On the other hand, we haven’t invested as much on the front end, if you will, in the consumer interface, and you’re starting to see some of that with, as I mentioned, the alarm clock, the sleep timer, the station recommendations. We feel there’s a lot more headroom there, and when we do those things, a lot of them increase the listener hours, increase listener engagement.
So we haven’t historically done a lot in marketing. We’ve been fortunate we haven’t had to. We now see an opportunity to do more, so it’s doing more on the front end for more engagement, and then also spending more in marketing to make sure people are aware of that.
From a monetization perspective, we’re not close to capacity constrained. We’ve made tremendous progress to date, and we did increase our total maximum ad load from an audio perspective twice in 2013. But we still have lots of room from a sell through perspective and lots of opportunity, even optimizing the sell through we have, through targeting, that allows us to drive revenue for some time without worrying about ad load or worrying about hours constraints from a revenue capacity perspective. So that’s not a big concern for this coming year.
Your next question comes from Douglas Anmuth from JPMorgan.
Douglas Anmuth - JPMorgan
I just wanted to follow up on the ad product side. And I was hoping you could just help us prioritize sort of the initiatives in terms of ad products. It just seems like there’s a lot of things to do here in terms of audience segmentation and programmatic and self-serve, and perhaps other things. Could you just sort of lay out the top three that you’re thinking about that will drive mobile RPM over the next year or two?
And then just following up on the January metrics, how do you get completely comfortable that it is just sort of seasonality as you might normally see it, and not any kind of competitive thing?
I would say in terms of prioritization, there’s a lot that we can do. I think one thing is we put a high priority on trying to make sure that we’re part of the overall infrastructure in the ad market. We talked about STRATA and Mediaocean integration. That’s been important. That continues to be an initiative.
We talked about measurements and making sure that we’re doing what we can, and working toward getting common currency and a measurement technology that goes across all of radio. We think that will help us, and there’s things that we can do, there are initiatives we can do there.
Clearly we see ourselves as a leader in audio advertising and digital, so ways to create new types of ads in both digital and other ways to engage with our advertisers. I’d say those are kind of the things that we need to do, just ongoing in our business.
And I think the bigger initiatives, programmatic is probably one of the larger ones that we’re talking about in terms of things that are beyond just efficiency and effectiveness, but also big, new initiatives. That’s probably, I would say, the highest priority.
I would say self-serve is a lower priority. I think that’s something that can make sense over time, but isn’t something we’re putting a high priority on right now. That’s not been the history of the way radio has been sold. We’ve been very effective with our sales force and we think there’s probably a lot more opportunity in the current model before we divert too many resources toward that.
I’d say that’s exactly right. And to touch on the seasonality, we monitor our usage both from a user perspective and a returning user perspective, and total hours listening perspective, to make sure that we understand what’s happening in our user base.
And frankly, the trends we’ve seen into January look pretty identical to prior years. Last year hours were essentially flat from December to January, and it’s almost exactly the same this year. We see a little bit of user drop-off as the holiday music listening season is behind us, but the engagement of existing users tends to pick up as we move to the new year, and that’s exactly what happened.
So we feel really good about where we sit right now. Honestly, other than the modest impact that we saw after the iTunes launch a few months ago, we really don’t see, at our scale, any measureable impact from other competitors out there.
Your next question comes from Scott Devitt from Morgan Stanley.
Scott Devitt - Morgan Stanley
You started off ’14 growing listener hours around 13%, and we were wondering how we should think about listener growth throughout ’14 and given the March through September period has you comping the 40 hour mobile cap.
And then as it relates to also the disclosure recently with the 4 million unique vehicle activations, John and I are just wondering how we should think about auto listening starting to have a more material impact on listener hours.
And then secondly, again an auto question, you talked a bit about monetization in the vehicle, and we were wondering how advertisers are going to be able to target in the vehicle. Are they going to be able to target just in-car listeners? And will there be some sort of premium to pay if so?
To touch on those themes, it’s going to be an interesting year, because we are comparing a product today that doesn’t have any limits to where we had limits from February through August last year on free listening limit in mobile.
So when we compare January year over year, for example, we had a lot of unfettered listening in January last year that is still moderated this year through the time out functionality and [unintelligible] functionality and more surgical methods that we put in place to really make sure that the listening that’s occurring, that we’re paying for, is real music listening as a way of controlling costs but also making sure that the advertising that’s served in that environment has the best chance to be effective. And we’ve seen that having a really positive impact.
So as we look through this year, as we move, I think we’re going to see a dissimilar pattern as we did last year, and more towards a general pattern that we might have seen in prior years, in 2012 for example, but just at a higher level. That’s how we’re modeling it today.
And then when you talk about auto listening, impact on listener hours, you know, auto listening is still a pretty small percentage of our hours. We’re talking about low single digit percentages overall of total listening hours of 4.5 billion hours last quarter.
Now, it doesn’t mean it’s immaterial, and clearly it isn’t. Advertisers have been excited to be a part of that, and we have enough capacity to bring on more than a few large, national advertisers. I think we’re up to half a dozen now, that are buying specifically in-car listening inventory.
There’s the idea that these advertisers have traditionally valued in-car listening, a situation where you know someone is actually, for sure, listening and hearing the ad, in a relatively captive environment. And that has driven premium in the traditional radio market through selling drive-time timeslots and such.
Right now, since we’re rolling this out, we haven’t focused as much on the pre-selling, any premium from that perspective, but more from selling it as a form of targeting. So it’s the same targeting we have otherwise, in terms of gender and age and location from a [unintelligible] perspective, but now we can also add a variable into that, which is that we know that the type of listening going on is in-car listening, just like we know whether it’s a desktop or a mobile device in a more traditional sense, and that adds to the attractiveness to the advertiser. So there’s definitely component there from a targeting perspective that gets reflected in the sales process.
Our next question comes from Nat Schindler with Bank of America Merrill Lynch.
Nat Schindler - Bank of America Merrill Lynch
Can you remind us how much impact you saw from political ad spend in Q4 of last year, and how that would have affected your monetization rates, particularly in mobile ad supported RPM that year?
And secondly, I know when you turned on the mobile listening cap, you basically cut the legs out of some of your highest listeners, most active listeners. You’ve said in the past that some of those people left and didn’t come back. Is there any way to quantify that number, to understand, as we come and lap your mobile monetization cap, what impact that would have to your listening hours growth numbers?
Political spending is really more of a Q3 dynamic. Now, especially under our former structure, where we had our third quarter ended October 31, there was $6 million in the October 31, 2012 quarter ending that came from political ads, and obviously that was much less this last year. So in terms of looking at Q4, you would have had one month of that $6 million that would have impacted it, but I don’t think it’s material in terms of comparing RPMs or ad revenue from Q4 to Q4, when we’re just talking about comparing ad revenues in those periods.
On the mobile listening cap, it definitely, obviously, it was targeted at people who listen the most, greater than 40 hours in a month. And that was mitigated in a few different ways. If there were multiple people using the same account, our customer service department worked to help them split those accounts up, so that we could avoid that problem.
But there were certainly people who were our most heavy listeners who hit that cap and had to wait until the following month to start again. And we saw people return in actually surprising numbers. You focus on the group that didn’t come back, but we saw that people actually returned in the area of 90% of the time, the people who hit the cap, who then would return the following month.
So I actually look at it a little bit glass half full, in that we don’t really feel we’ve lost that many people who hit that cap. We did get a decent number of them to convert into being a paying subscriber where there was no limit. Keep in mind we added 1.2 million net subscribers in the first two quarters of last year, and a large percentage of those was driven by hitting the mobile cap. The nice thing is we didn’t see a lot of them churn afterward.
And then as far as whether that’s going to affect our hours, because I think most of those listeners stayed with us this year, and either converted into subscribers or just started listening again in the following month and then have stayed with us since that timeframe, I don’t expect that people who have left will materially impact our numbers.
Your next question comes from Mark Mahaney from RBC Capital Markets.
Mark Mahaney - RBC Capital Markets
Just a quick question for Brian. Brian, can you talk briefly about how you think about Pandora’s international markets opportunity? You’ve been there for a little bit of time. You’ve had a lot of experience in international markets before. What do you see as the ease of the opportunity, the size of the opportunity, or the challenges given a lot of specific issues [unintelligible]?
I would say I see it as a near term challenge and a long term opportunity. And then I would say there’s also some gray in there as well. And what I mean by that there are certainly challenges in terms of the royalty issue. Each country is different, or [unintelligible] of countries are different. And it takes investing energy and time to figure out what the difference regimes or structures and then figuring out how we might fit into that, and to some degree trying to influence that in different ways.
And so part of it’s an investment in time and energy on our part to figure that out. We’ve certainly done some of that, but we haven’t done a lot of that. And part of that is just a time constraint and a priority thing, where we see such a big opportunity in the U.S., that’s appropriately where the focus has been.
Having said that, we are trying to divert some more energy and some investment in 2014 towards learning more about those markets. Having said that, it’s understanding how complicated the royalty world is in different countries, and certainly as you’ve all seen in the U.S., I think it’s a longer term opportunity. And I don’t know how to define that.
Certainly part of my hope and plan is to invest more energy in it this year and figuring it out more, so by the end of this year we have a better sense of that. But I would say that you shouldn’t expect a lot of big announcements in 2014.
Your next question comes from James Marsh with Piper Jaffray.
James Marsh - Piper Jaffray
Just had a quick question on the sales investment. I think you mentioned you hired just over 100 sales people last year. Can you give us a sense for how many sales people you have today? How many do you plan to deploy this year? And then just kind of where we are in that cycle. How big do you see this sales force being over time?
We’ll talk a lot more about this in the Q1 call, in the quarter, as we talk about the investment we’re making this year. We’re in the approximately 270 or so sales people. Most of those people were hired in the first half of last year and we’re now adding a lot of new people and getting them ramped up for this coming year.
We’re going to be focusing on opening new local markets, but not as many as we opened last year, and doubling down on a lot of the local markets that we had one, two, or three people in in this last year, and really putting the next layer of sales in there to take advantage of the opportunity.
So I think there’s a lot in front of us that we’re still executing on, and we don’t want to give too much information out there to our competition as to what our plans are from that perspective. I would say that, some of our competitors have 1,300 sales people in 80 markets. I think we’re likely to put a decent number of sales people, maybe double where we are today, across 40 to 50 markets, and cover the rest through inside sales and technological solutions.
Not necessarily self-serve down to an individual business, technical solutions that allow people in smaller markets that want to target those markets through the segmentation capabilities that we have, since we are able to measure that in 275 local markets today, through Triton. We can carve that up into all 275 markets, and we want to be able to provide that targeting segmentation capability to people interested in reaching those markets. I think that will be mostly addressed with technical solutions or inside sales. It’s currently, right now, primarily inside sales.
Your next question comes from Jordan Rohan with Stifel Nicolaus.
Jordan Rohan - Stifel Nicolaus
I actually have a couple of questions. For those like me that were a little surprised at the mention of a direct deal with Universal Music Publishing Group, can you go over exactly how that came to be? It seems somewhat [unintelligible] in nature, and has something to do with the inclusion of their music rights in the BMI organization.
Secondly, I noticed personally that you guys are serving back to back ads now. I don’t know how long this has been going on. This is the first time I’ve noticed it. Is that new to the platform? Is there a way to therefore increase yield without increasing specific number of times that our music experience is interrupted? And what could that do over time to overall revenue per thousand hours?
The first one, UMPG was related to its publishing deal, part of the publishing side, of our royalty structure. And it is related to the BMI case, where UMPG indicated that they were withdrawing from BMI and the judge in the case acknowledged that they could, and they had to withdraw altogether, related to the songs that they owned the publishing rights for.
So we signed a deal with them to ensure that we’re still licensed to play those songs. They’ve since announced that they’ve gone back into BMI, and so we could have stayed in, theoretically, and licensed through BMI, but there are different pieces to that story.
When you talk about back to back, that’s something that we rolled out in August. It took our maximum ad load from four ads per hour to six ads per hour. But instead of four ads per hour, one every 15 minutes, we did two ads every 20 minutes - and these are approximations - per hour. That allowed us to increase ad load while actually also increasing the [swath] of listening that occurs between ad breaks.
In testing and now in practice we’ve seen not only does it increase our potential revenue per hour, particularly in high value demos, but it actually improved the listening experience, at least as measured by listener behavior, from a technical perspective. So we think that was a great move, and we don’t expect that we’ll need to do additional increases to ad load in the short term, because of the capacity that gave us.
Your next question comes from Rich Greenfield with BTIG.
Rich Greenfield - BTIG
Wanted to follow up on Jordan’s question. When you look at other music publishers, there’s been a lot of rumblings about more people using that ruling to pull out of BMI or potentially even out of ASCAP. And just wondering, as you go forward over the next couple of years, what is the situation? You have a compulsory license, I believe, where you have the access to all that content, but only if that rights body has access to the underlying songwriter’s content. And just wondering how you plan to deal with that over the next couple of years.
As I said in my comments in the call earlier, it’s very complex. And it’s an ongoing, changing landscape. It’s different today than it was a month ago today, than it was six months ago today, and certainly a year ago today. So the good news is we have a group of experts who work here at Pandora who are on top of it. We’re developing the relationships with the people who are the content creators and the content owners, the rights owners, to see if we can find the right outcome over time.
With ASCAP, it’s less of an issue in the short term. It’s more that there’s two years left in the relationship, and the publishers have been deemed not able to withdraw that kind of going forward basis, at least through the end of that timeframe. BMI is left clear along the way, but right now I think the short term noise has kind of occurred and it’s really going to be a series of these things that we’ll have to deal with on a one-off basis, because the industry’s trying to solve the right way to manage rights in this environment. And every day kind of presents a new challenge from that perspective.
The next question comes from Laura Martin with Needham.
Laura Martin - Needham Capital Partners
Brian, first for you, you said you’re trying to get a common currency, and you’re mentioning STRATA and Mediaocean. Arbitron and Nielsen have said they’re going to rate you now. Could you give us any sense of timing, because that would be the fastest way to bring new advertisers to Pandora who in the past have not been willing to advertise.
And then for you, Mike, I guess I’m wondering about marketing costs for the year, because if you’re going to double the salesmen and add another 101, we had the negative comp last year. So it just feels like marketing expenses, which were up 80% for the year, should be up less, because it sounds like we already have it in the current numbers, that [hellish] first quarter, and we’re just going to replicate that year. So could you talk about what you think marketing in sales expense growth will be for ’14?
The short answer is it’s really a question for Nielsen. Obviously we want to work with them to make it happen as quickly as it can. You’ve heard their public comments that they want to make it happen. It makes sense for their business to do it. But like anything, it’s a technological change that probably takes some time. So we certainly want to work with them, and it will be really up to their timeline. In the meantime, we have Triton as a great partner for us, and there are other ways that the currency is being measured. We want to be measured by as many ways as make sense in the industry.
I just want to add to that before getting to your question about marketing and sales growth. We made huge strides here with Triton as a partner to date. And I think we expect to continue to see that relationship continue to develop and bear fruit over time. It’s going to be really helpful. So we’re working closely with the players in the space, and we think that we’ll get the right outcome, essentially.
From a marketing and sales growth perspective, we make a step function investment in the first quarter. That’s mostly around sales people specifically. And then we build kind of momentum, and through the year, in terms of as they are selling and developing accounts, the support pieces that go with those accounts. But the majority of the capacity for the year in terms of sales dollars, advertising dollars, is going to be built up in the first part.
One thing that we have started to do, or will start to do, is spend a little bit more dollars than we have, any dollars more than we have, historically, on marketing more generally, to our users in the marketplace. Now that we are generating gross profit in a way that gives us more investment dollars, we’ll be slightly more aggressive on that front.
Your next question comes from Jason Helfstein with Oppenheimer.
Jason Helfstein - Oppenheimer & Co.
Why did desktop RPMs have better sequential growth than mobile RPMs?
Because the demand for display advertising in Q4 was particularly strong this year. And display advertising, the desktop just has a much more robust, more developed, display demand profile in that market, relatively nascent, in the mobile side of things. And so you just see, when there’s a big display demand bulge, you see it reflected more in desktop. It happens in mobile as well. And that market is working hard to develop the right products, the right ad products, as well as the right delivery point to deliver display in a mobile environment. And frankly, also, the demand is still figuring out how to get comfortable with it and how to measure efficacy. So as we see those things happen, we’ll see that gap close.
Your next question comes from Michael Graham with Canaccord.
Michael Graham - Canaccord Genuity
Just had a question about the ad load. You mentioned that you raised the max to 6 ads per hour, and I think Mike, you had mentioned a while ago that the average system wide was 2.5. And I’m just wondering if that 2.5 has moved at all.
And related to that, it seems like you’ve got a big spread between sort of the major demographics in the big markets versus some of the less desirable demos in smaller markets. And in the past, when you’ve raised the max ad load, can you just comment on how long it’s taken for some of those other markets and other demos to sort of catch up to the ad load that your best markets are showing?
We certainly average well into 5 ads an hour in our high [unintelligible] demos, which include locations where both the targeting is really attractive and where our sales capacity is most mature. We’ve been in certain markets for years now. Other markets, we just entered and have only been there a month. So it’s a combination of the desirability of the target market as well as our ability to sell and the accepted nature of Pandora’s advertising in those markets determining whether we’re delivering 5.7 ads per hour or something closer to 1 or 2.
We’re definitely still in the twos on an average across all 4.5 billion hours, but it’s been slowly creeping up, greater than 2.5, as we finish the year, and I think we’ll slowly see that effective ad served per hour continue to rise.
And your final question comes from Peter Stabler with Wells Fargo Securities.
Peter Stabler - Wells Fargo Securities
Just going back to political for a second, it would seem to us that age, gender, and zipcode gives you guys one of the best political advertising platforms ever created. I’m wondering whether you’d ever be in a position to turn away political dollars to preserve the user experience. And then secondly, on the cash balance, can you talk about your appetite for acquisition?
We’re constantly reviewing our ad guidelines about what we’ll accept and what we won’t accept. And you kind of nailed it, in the sense that when we do take advertising dollars from political movements in particular, the number of emails and calls that customer service gets goes up quite dramatically, and not thanking us for targeting them, generally, because politics strikes some raw nerves, no matter what your demographic is.
So it’s something we think about but the [unintelligible] of doing political advertising isn’t something that we challenge. And so those dollars are, we think, fair dollars to accept, as long as it’s appropriate for our audience.
I think the reason we raised money was obviously just to have some cash. We had low cash relative to our revenue. And so that was part of it, but we also did want to have money so that we had the opportunity to do acquisitions or if we do direct deals, have that money for that, etc. So it is something that we consider. We are open to it, we’ve never done one before.
We certainly are open to it, and as we continue to develop our long term strategy, things that sit within that strategy, we’ll make a build or buy decision, as we’re making more and more investments in technology. We are definitely open to buying things, but it’s not part of our strategy to grow that way unless it makes sense as kind of a build or buy decision.
We do realize we left a good number of you in the queue. We hope to rotate through the next call. And with that, operator, could you take us back to Bruno Mars radio, on Pandora?
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