By Gerry Shih
SAN FRANCISCO (Reuters) - Internet radio service Pandora Media Inc <P.N> said on Thursday that rising expenditures to acquire music and expand its sales force would push fiscal 2014 earnings below analyst expectations, and its shares slumped 5 percent.
The company also backtracked on a 40-hour monthly limit on free music streaming that was announced just six months ago, a measure originally implemented to control rising costs. Pandora said it will lift the monthly cap September 1 after watching its margins improve.
The mixed message added to a sense of uncertainty surrounding Pandora, which has otherwise reclaimed favor recently on Wall Street. Aside from Spotify and Rdio, its usual rivals, Pandora will soon face competition from Apple Inc <AAPL.O>, which is preparing to launch its iTunes Radio offering in the coming weeks.
Excluding certain items, Pandora said it expected to earn between 0 and 5 cents per share for the year. That was below the 5 cent profit expected by analysts polled by Thomson Reuters I/B/E/S.
Its shares fell to $20.50 in extended trade.
But for the second quarter, Pandora exceeded expectations, posting revenue of $162 million, a 58 percent rise, as it continued to pick up listeners. Its earnings of 4 cents also topped Wall Street expectations of 2 cents.
In an interview, Chief Executive Joe Kennedy said he felt confident the company has proven its mobile monetization strategy. But he signaled that earnings would be depressed in the near future as he pursued an aggressive investment strategy. In the past year, for instance, the company has increased its sales force by three-quarters, he said.
"We're taking the increased margin that we're getting and reallocating to invest in future growth," Kennedy said on Thursday. "But everything says we're firing on all cylinders. We're still in the earliest days. We have to invest to make the most of a huge opportunity."
Kennedy downplayed the threat of competitors, saying that 7 percent of all radio listening was on Pandora, making it the most popular online radio option.
"We've been on the market now for 8 years, and we've had competitors large and small," he told Reuters. "We're still the undisputed leader."
Kennedy told analysts the company would keep its international expansion plans on hold but continue to aggressively expand at the local level by selling targeted ads for local businesses. But that would mean a significant effort to ramp up sales across the country, he warned.
Steven Frankel, an analyst at Dougherty & Co, said it was disappointing to see that "hard fought monetization gains aren't going to translate into bottom line upside."
"This guidance is a reflection that this is a very difficult and expensive business to scale," Frankel said. "Just when we thought we understood all the cost dynamics, there's another layer of complexity here."
Pandora's shares, which fluctuated wildly for the first year after its June 2011 initial public offering, surged to a record closing high of $21.71 on Thursday.
Pandora users listened to the service for a total of 3.88 billion hours during the quarter, an 18 percent increase from 3.30 billion hours a year ago, the company said.
Sameet Sinha, an analyst at B. Riley & Co, said although Apple's entry into the market could siphon away some listeners, it could ultimately help Pandora by expanding the market for Internet radio advertising.
The iPhone-maker has already signed up advertisers including McDonald's <MCD.N>, Pepsi <PEP.N> and Procter and Gamble <PG.N> ahead of the radio service's imminent launch, according to an AdAge report.
"If Apple can prove to those advertisers that Internet radio works, then you could expect to see a lot of advertising dollars come into the market," Sinha said.
(Reporting by Gerry Shih; Editing by Andre Grenon and Phil Berlowitz)