Tickers in this Article: P, EMMS, CMLS, SIRI
Internet radio provider Pandora Media (NYSE:P) posted second quarter results on Wednesday that surprised investors on the upside. Sales skyrocketed and profits were close to breakeven, by the company's estimates. The stock rallied as much as 20% following the solid results and is now trading in between its highs and lows over the past year. However, shareholders may want to temper their enthusiasm regarding their prospects for earning high returns on the stock, because the company's prospects down the road still remain highly uncertain.

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Recent Results and Outlook
There is little denying Pandora's rapid sales growth right now. Second quarter sales jumped 51% from last year's quarter and reached $101.3 million. Advertising revenue accounted for the bulk of the top line at $89.4 million and increased a very impressive 53%. Most Pandora subscribers choose to listen to their music without paying an annual subscription and instead listen to commercials in between every few songs that are played. Subscription revenue where subscribers pay a nominal annual fee of $36 or $3.99 for a month, advanced 36% to $11.9 million.

SEE: 7 Companies With Big Advertising Budgets

Total costs for the year increased 63% to $106.6 million year over year on an interesting increase in marketing costs and content acquisition costs, the last of which stems from the need to pay royalties to music companies for the right to play their music. As a result, operating income was negative at $5.3 million, following an increase of $1.4 million in last year's second quarter. A rise in other expenses meant net income was still in negative territory at $5.4 million, or 3 cents per diluted share. Operating cash flow was $2.8 million but free cash flow was positive at almost $.4 million due to short-term investments. For the full year, Pandora said to expect sales between $425 million and $432 million for impressive potential annual growth as high as 57%. It still expects to lose between 2 cents and 29 cents per share.

SEE: Free Cash Flow Yield: The Best Fundamental Indicator

The Bottom Line
Pandora boasted that its user subscriber base jumped 48% to a hair under 55 million accounts. Growth has indeed been spectacular on the sales and user fronts. But overall, the company still has quite a way to go to justify its current market capitalization of $2 billion. An eventual profit level of $100 million would mean a price-to-earnings ratio of 20, which is still lofty but potentially many years off because the company is still aiming to achieve steady breakeven results.

Sirius XM Radio (Nasdaq:SIRI) comes to mind as another company that sought to revolutionize the recorded music industry. Sirius sales continue to move forward and analysts project nearly a 13% annual growth to total sales of $3.4 billion for all of 2012. Profits should be modest at 55 cents per share, but are projected to fall to 10 cents by 2013. Subscribers love the service, but the stock has been a horrible investment.

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Pandora and Sirius are certainly in better competitive positions than more traditional radio firms such as Clear Channel Communications, Emmis Communications (Nasdaq:EMMS) and Cumulus Media (Nasdaq:CMLS). The subscription model to renting music, versus owning it by buying songs and albums through services such as Apple's (Nasdaq:AAPL) iTunes service, is yet to fully take off, but could help Pandora continue to grow rapidly. Pandora users are currently a happy bunch, but the investment signal is still not clear.

At the time of writing Ryan C. Fuhrmann did not own shares in any company mentioned in this article.

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