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Section 1: 10-Q (10-Q)

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Table of Contents

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2017

or
 
¨     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to      
        
Commission File Number: 001-35198
Pandora Media, Inc.
(Exact name of registrant as specified in its charter)
Delaware
94-3352630
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
2101 Webster Street, Suite 1650
Oakland, CA
94612
(Address of principal executive offices)
(Zip Code)
(510) 451-4100
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted to its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
(Do not check if a smaller reporting company)
Emerging growth company o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x
 
The number of shares of registrant’s common stock outstanding as of May 4, 2017 was: 240,358,500.

 

Table of Contents

Pandora Media, Inc.
 
FORM 10-Q Quarterly Report
 
Table of Contents
 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

Table of Contents

PART I. FINANCIAL INFORMATION
 
Item 1. Financial Statements

Pandora Media, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share and per share amounts)
 (unaudited)
 
As of December 31,
2016
 
As of March 31,
2017
Assets
 
 
 
Current assets
 

 
 

Cash and cash equivalents
$
199,944

 
$
170,881

Short-term investments
37,109

 
32,123

Accounts receivable, net of allowance of $3,633 at December 31, 2016 and $3,912 at March 31, 2017
309,267

 
262,934

Prepaid content acquisition costs
46,310

 
48,542

Prepaid expenses and other current assets
33,191

 
29,422

Total current assets
625,821

 
543,902

Long-term investments
6,252

 

Property and equipment, net
124,088

 
128,815

Goodwill
306,691

 
306,421

Intangible assets, net
90,425

 
85,289

Other long-term assets
31,533

 
33,721

Total assets
$
1,184,810

 
$
1,098,148

Liabilities and stockholders’ equity
 

 
 

Current liabilities
 

 
 

Accounts payable
$
15,224

 
$
21,152

Accrued liabilities
35,465

 
33,878

Accrued content acquisition costs
93,723

 
89,972

Accrued compensation
60,353

 
43,871

Deferred revenue
28,359

 
32,355

Other current liabilities
20,993

 
32,848

Total current liabilities
254,117

 
254,076

Long-term debt, net
342,247

 
347,223

Other long-term liabilities
34,187

 
33,946

Total liabilities
630,551

 
635,245

Stockholders’ equity
 

 
 

Common stock: 235,162,757 shares issued and outstanding at December 31, 2016 and 240,334,808 at March 31, 2017
24

 
24

Additional paid-in capital
1,264,693

 
1,306,532

Accumulated deficit
(709,636
)
 
(843,057
)
Accumulated other comprehensive loss
(822
)
 
(596
)
Total stockholders’ equity
554,259

 
462,903

Total liabilities and stockholders’ equity
$
1,184,810

 
$
1,098,148

 
The accompanying notes are an integral part of the condensed consolidated financial statements.

3

Table of Contents

Pandora Media, Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts)
(unaudited)
 
 
Three months ended 
 March 31,
 
2016
 
2017
Revenue
 
 
 
Advertising
$
220,308

 
$
223,308

Subscription and other
54,732

 
64,878

Ticketing service
22,265

 
27,818

Total revenue
297,305

 
316,004

Cost of revenue
 
 
 
Cost of revenue—Content acquisition costs
171,264

 
187,420

Cost of revenue—Other
21,195

 
25,532

Cost of revenue—Ticketing service
14,646

 
18,618

Total cost of revenue
207,105

 
231,570

Gross profit
90,200

 
84,434

Operating expenses
 
 
 
Product development
35,611

 
39,588

Sales and marketing
117,433

 
125,102

General and administrative
46,524

 
44,525

Total operating expenses
199,568

 
209,215

Loss from operations
(109,368
)
 
(124,781
)
Interest expense
(6,175
)
 
(7,381
)
Other income, net
862

 
229

Total other expense, net
(5,313
)
 
(7,152
)
Loss before provision for income taxes
(114,681
)
 
(131,933
)
Provision for income taxes
(421
)
 
(334
)
Net loss
$
(115,102
)
 
$
(132,267
)
Weighted-average common shares outstanding used in computing basic and diluted net loss per share
226,659

 
237,515

Net loss per share, basic and diluted
$
(0.51
)
 
$
(0.56
)
 
The accompanying notes are an integral part of the condensed consolidated financial statements.


4

Table of Contents

Pandora Media, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
 
 
Three months ended 
 March 31,
 
2016
 
2017
Net loss
$
(115,102
)
 
$
(132,267
)
Change in foreign currency translation adjustment
(233
)
 
191

Change in net unrealized loss on marketable securities
305

 
35

Other comprehensive income
72

 
226

Total comprehensive loss
$
(115,030
)
 
$
(132,041
)
 
The accompanying notes are an integral part of the condensed consolidated financial statements.


5

Table of Contents

Pandora Media, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited) 
 
Three months ended 
 March 31,
 
2016
 
2017
Operating activities
 

 
 

Net loss
$
(115,102
)
 
$
(132,267
)
Adjustments to reconcile net loss to net cash used in operating activities
 

 
 

Depreciation and amortization
13,277

 
17,680

Stock-based compensation
38,655

 
29,618

Amortization of premium on investments, net
140

 
53

Other operating activities
895

 
1,665

Amortization of debt discount
4,434

 
4,886

Changes in operating assets and liabilities
 

 
 
Accounts receivable
38,514

 
44,941

Prepaid content acquisition costs
(16,775
)
 
(2,232
)
Prepaid expenses and other assets
(2,967
)
 
(5,579
)
Accounts payable, accrued and other current liabilities
(3,467
)
 
13,192

Accrued content acquisition costs
14,152

 
(3,762
)
Accrued compensation
2,597

 
(13,207
)
Other long-term liabilities
659

 
(244
)
Deferred revenue
7,640

 
3,996

Reimbursement of cost of leasehold improvements
4,244

 
5,236

Net cash used in operating activities
(13,104
)
 
(36,024
)
Investing activities
 

 
 

Purchases of property and equipment
(14,371
)
 
(1,980
)
Internal-use software costs
(7,177
)
 
(7,765
)
Purchases of investments
(4,993
)
 

Proceeds from maturities of investments
8,332

 
11,220

Payments related to acquisitions, net of cash acquired
(676
)
 

Net cash provided by (used in) investing activities
(18,885
)
 
1,475

Financing activities
 

 
 

Proceeds from employee stock purchase plan
1,687

 
2,798

Proceeds from exercise of stock options
520

 
2,388

Tax payments from net share settlements of restricted stock units
(1,294
)
 

Net cash provided by financing activities
913

 
5,186

Effect of exchange rate changes on cash and cash equivalents
(137
)
 
300

Net decrease in cash and cash equivalents
(31,213
)
 
(29,063
)
Cash and cash equivalents at beginning of period
334,667

 
199,944

Cash and cash equivalents at end of period
$
303,454

 
$
170,881

Supplemental disclosures of cash flow information
 
 
 
Cash paid during the period for interest
$
107

 
$
896

Purchases of property and equipment recorded in accounts payable and accrued liabilities
$
6,356

 
$
4,098

 
The accompanying notes are an integral part of the condensed consolidated financial statements.


6

Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements
(unaudited)


1.                       Description of Business and Basis of Presentation
 
Pandora—Internet Radio and On-Demand Music Services

Pandora is the world’s most powerful music discovery platform, offering a personalized experience for each of our listeners wherever and whenever they want to listen to music—whether through earbuds, car speakers or live on stage. Pandora is available as an ad-supported service, a radio subscription service called Pandora Plus and an on-demand subscription service called Pandora Premium. The majority of our listener hours occur on mobile devices, with the majority of our revenue generated from advertising on our ad-supported service on these devices. We offer both local and national advertisers the opportunity to deliver targeted messages to our listeners using a combination of audio, display and video advertisements. We also generate revenue from subscriptions to Pandora Plus and Pandora Premium. We were incorporated as a California corporation in January 2000 and reincorporated as a Delaware corporation in December 2010. Our principal operations are located in the United States, and we also are located in Australia, New Zealand, Canada and the United Kingdom.

Ticketing Service

We operate our ticketing service through our subsidiary Ticketfly, a leading live events technology company that provides ticketing and marketing software and services for our clients, which are venues and event promoters across North America. Ticketfly's ticketing, digital marketing and analytics software helps promoters book talent, sell tickets and drive in-venue revenue, while Ticketfly's consumer tools help fans find and purchase tickets to events. Ticketfly’s revenue primarily consists of service and merchant processing fees from ticketing operations.

As used herein, "Pandora," "we," "our," "the Company" and similar terms include Pandora Media, Inc. and its subsidiaries, unless the context indicates otherwise.
 
Basis of Presentation
 
The interim unaudited condensed consolidated financial statements and accompanying notes have been prepared in accordance with United States generally accepted accounting principles ("U.S. GAAP") along with the instructions to Form 10-Q and Article 10 of Securities and Exchange Commission ("SEC") Regulation S-X, and include the accounts of Pandora and our wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. In the opinion of our management, the interim unaudited condensed consolidated financial statements include all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of our financial position for the periods presented. These interim unaudited condensed consolidated financial statements are not necessarily indicative of the results expected for the full fiscal year or for any subsequent period and should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2016.
 
Certain changes in presentation have been made to conform the prior period presentation to current period reporting. We have reclassified prepaid content acquisition costs from the prepaid expenses and other assets line item to the prepaid content acquisition costs line item of our condensed consolidated statements of cash flows. We have also reclassified amortization of internal use-software costs from the product development and sales and marketing line items to the cost of revenue—other and general and administrative line items of our condensed consolidated statements of operations.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and the related disclosures at the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Estimates are used in several areas including, but not limited to determining accrued content acquisition costs, amortization of minimum guarantees under content acquisition agreements, selling prices for elements sold in multiple-element arrangements, the allowance for doubtful accounts, the fair value of stock options, market stock units ("MSUs"), stock-settled performance-based RSUs ("PSUs"), the Employee Stock Purchase Plan ("ESPP"), the provision for (benefit from) income taxes, the fair value of convertible debt, the fair value of acquired property and equipment, intangible assets and goodwill and the useful lives of acquired intangible assets. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements could be affected. In many cases, the accounting treatment of a particular transaction

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Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements
(unaudited)

is specifically dictated by U.S. GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting among available alternatives would not produce a materially different result.
 
2.                        Summary of Significant Accounting Policies
 
Other than discussed below, there have been no material changes to our significant accounting policies as compared to those described in our Annual Report on Form 10-K for the year ended December 31, 2016.

Stock-Based Compensation—Restricted Stock Units and Stock Options

Stock-based awards granted to employees, including grants of restricted stock units ("RSUs") and stock options, are recognized as expense in our statements of operations based on their grant date fair value. We recognize stock-based compensation expense on a straight-line basis over the service period of the award, which is generally three to four years. We estimate the fair value of RSUs at our stock price on the grant date. We generally estimate the grant date fair value of stock options using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model is affected by our stock price on the date of grant, the expected stock price volatility over the expected term of the award, which is based on projected employee stock option exercise behaviors, the risk-free interest rate for the expected term of the award and expected dividends.

Stock-based compensation expense is recorded in the statement of operations for only those stock-based awards that will vest. In the first quarter of 2017 we adopted new accounting guidance from the Financial Accounting Standards Board ("FASB") on stock compensation, or ASU 2016-09, as described in "Recently Adopted Accounting Standards" below and have elected to account for forfeitures as they occur, rather than estimating expected forfeitures.

Prior to the adoption of ASU 2016-09, we elected to use the "with and without" approach as described in Accounting Standards Codification 740—Income Taxes in determining the order in which tax attributes are utilized. As a result, we previously only recognized a tax benefit from stock-based awards in additional paid-in capital if an incremental tax benefit is realized after all other tax attributes currently available to us have been utilized. In addition, we elected to account for the indirect effects of stock-based awards on other tax attributes, such as the research tax credit, through the statement of operations.

Concentration of Credit Risk
 
For the three months ended March 31, 2016 and 2017, we had no customers that accounted for more than 10% of our total revenue. As of December 31, 2016 and March 31, 2017, we had no customers that accounted for more than 10% of our total accounts receivable.
 
Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board ("the FASB") issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"), which amends the existing accounting standards for revenue recognition. ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue. Under the guidance, revenue is recognized when a company transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In March 2016, the FASB issued Accounting Standards Update No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) ("ASU 2016-08") which clarifies the implementation guidance on principal versus agent considerations. The guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customers. The standard is effective for public entities with annual and interim reporting periods beginning after December 15, 2017. Entities have the option of using either a full retrospective or a modified retrospective approach to adopt the guidance. We expect to adopt ASU 2014-09 as of January 1, 2018 using the full retrospective method. We have completed our initial assessment and do not believe there will be a material impact to our condensed consolidated financial statements for the majority of our advertising and subscription revenue arrangements. We are currently continuing to evaluate the impact that the new principal versus agent guidance may have on certain of our advertising revenue arrangements and on our ticketing service revenue arrangements, and we are continuing to evaluate the expected impact on our business processes, systems and controls. We expect to complete our assessment of the effects of adopting ASU 2014-09 during 2017, and we will continue our evaluation of ASU 2014-09,

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Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


including how it may impact new arrangements we enter into as well as new or emerging interpretations of the standard, through the date of adoption.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) ("ASU 2016-02"). ASU 2016-02 requires lessees to put most leases on their balance sheets but recognize expenses on their income statement and eliminates the real estate-specific provisions for all entities. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We have completed our initial assessment and expect to early adopt ASU 2016-02 as of January 1, 2018 using the modified retrospective method. We expect the potential impact of adopting ASU 2016-02 to be material to our lease liabilities and assets on our consolidated balance sheets.

Recently Adopted Accounting Standards

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718) ("ASU 2016-09"). ASU 2016-09 requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. Additionally, it allows an employer to repurchase more of an employee's shares for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur. We adopted this guidance in the first quarter of 2017 using the modified retrospective transition method. Upon adoption, we recognized the previously unrecognized excess tax benefits as of January 1, 2017 through retained earnings. The previously unrecognized excess tax effects were recorded as a deferred tax asset, which was fully offset by a valuation allowance. As a result, the net impact had no effect on net deferred tax assets or our accumulated deficit as of January 1, 2017. Without the valuation allowance, the Company’s net deferred tax assets would have increased by approximately $142.0 million. Additionally, we have elected to account for forfeitures as they occur, rather than estimating expected forfeitures. The net cumulative effect of this change increased additional paid in capital as of January 1, 2017 by $1.2 million.

3.                        Cash, Cash Equivalents and Investments
 
Cash, cash equivalents and investments consisted of the following:
 
 
As of 
 December 31, 
 2016
 
As of 
 March 31, 
 2017
 
(in thousands)
Cash and cash equivalents
 

 
 

Cash
$
144,192

 
$
153,590

Money market funds
55,752

 
17,291

Total cash and cash equivalents
$
199,944

 
$
170,881

Short-term investments
 

 
 

Corporate debt securities
$
37,109

 
$
32,123

Total short-term investments
$
37,109

 
$
32,123

Long-term investments
 

 
 

Corporate debt securities
$
6,252

 
$

Total long-term investments
$
6,252

 
$

Cash, cash equivalents and investments
$
243,305

 
$
203,004


 
Our short-term investments have maturities of twelve months or less and are classified as available-for-sale. Our long-term investments have maturities of greater than twelve months and are classified as available-for-sale.
 
The following tables summarize our available-for-sale securities’ adjusted cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category as of December 31, 2016 and March 31, 2017.
 

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Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


 
As of December 31, 2016
 
Adjusted
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
(in thousands)
Money market funds
$
55,752

 
$

 
$

 
$
55,752

Corporate debt securities
43,413

 
3

 
(55
)
 
43,361

Total cash equivalents and marketable securities
$
99,165

 
$
3

 
$
(55
)
 
$
99,113


 
As of March 31, 2017
 
Adjusted
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
(in thousands)
Money market funds
$
17,291

 
$

 
$

 
$
17,291

Corporate debt securities
32,140

 
1

 
(18
)
 
32,123

Total cash equivalents and marketable securities
$
49,431

 
$
1

 
$
(18
)
 
$
49,414


 
The following table presents available-for-sale investments by contractual maturity date as of December 31, 2016 and March 31, 2017.
 
 
As of December 31, 2016
 
Adjusted
Cost
 
Fair Value
 
(in thousands)
Due in one year or less
$
92,914

 
$
92,861

Due after one year through three years
6,251

 
6,252

Total
$
99,165

 
$
99,113

 
As of March 31, 2017
 
Adjusted
Cost
 
Fair Value
 
(in thousands)
Due in one year or less
$
49,431

 
$
49,414

Total
$
49,431

 
$
49,414


 
The following tables summarize our available-for-sale securities’ fair value and gross unrealized losses aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position as of December 31, 2016 and March 31, 2017.

 
As of December 31, 2016
 
Twelve Months or Less
 
More than Twelve Months
 
Total
 
Fair
Value
 
Gross Unrealized Losses
 
Fair
Value
 
Gross Unrealized Losses
 
Fair
Value
 
Gross Unrealized Losses
 
(in thousands)
Corporate debt securities
$
34,257

 
$
(52
)
 
$
4,099

 
$
(3
)
 
$
38,356

 
$
(55
)
Total
$
34,257

 
$
(52
)
 
$
4,099

 
$
(3
)
 
$
38,356

 
$
(55
)


10

Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


 
As of March 31, 2017
 
Twelve Months or Less
 
More than Twelve Months
 
Total
 
Fair
Value
 
Gross Unrealized Losses
 
Fair
Value
 
Gross Unrealized Losses
 
Fair
Value
 
Gross Unrealized Losses
 
(in thousands)
Corporate debt securities
$
26,668

 
$
(17
)
 
$
454

 
$
(1
)
 
$
27,122

 
$
(18
)
Total
$
26,668

 
$
(17
)
 
$
454

 
$
(1
)
 
$
27,122

 
$
(18
)


Our investment policy requires investments to be investment grade, primarily rated "A1" by Standard & Poor’s or "P1" by Moody’s or better for short-term investments and rated "A" by Standard & Poor’s or "A2" by Moody’s or better for long-term investments, with the objective of minimizing the potential risk of principal loss. In addition, the investment policy limits the amount of credit exposure to any one issuer.
 
The unrealized losses on our available-for-sale securities as of March 31, 2017 were primarily a result of unfavorable changes in interest rates subsequent to the initial purchase of these securities. As of March 31, 2017, we owned 21 securities that were in an unrealized loss position. Based on our cash flow needs, we may be required to sell a portion of these securities prior to maturity. However, we expect to recover the full carrying value of these securities. As a result, no portion of the unrealized losses at March 31, 2017 is deemed to be other-than-temporary and the unrealized losses are not deemed to be credit losses. When evaluating the investments for other-than-temporary impairment, we review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and our intent to sell, or whether it is more likely than not we will be required to sell, the investment before recovery of the investment’s amortized cost basis. During the three months ended March 31, 2017, we did not recognize any impairment charges.


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Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


4.                        Fair Value
 
We record cash equivalents and short-term investments at fair value. Fair value is an exit price, representing the amount that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. Fair value measurements are required to be disclosed by level within the following fair value hierarchy:
 
Level 1 — Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
 
Level 2 — Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
 
Level 3 — Inputs lack observable market data to corroborate management’s estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
 
When determining fair value, whenever possible we use observable market data and rely on unobservable inputs only when observable market data is not available.
 
The fair value of these financial assets and liabilities was determined using the following inputs at December 31, 2016 and March 31, 2017:
 
 
As of December 31, 2016
 
Fair Value Measurement Using
 
Quoted Prices in Active Markets
for Identical
Instruments
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Total
 
(in thousands)
Assets
 

 
 

 
 

Corporate debt securities
$

 
$
43,361

 
$
43,361

Total assets measured at fair value
$

 
$
43,361

 
$
43,361


 
As of March 31, 2017
 
Fair Value Measurement Using
 
Quoted Prices in Active Markets
for Identical
Instruments
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Total
 
(in thousands)
Assets
 

 
 

 
 

Corporate debt securities
$

 
$
32,123

 
$
32,123

Total assets measured at fair value
$

 
$
32,123

 
$
32,123


 
Our other cash equivalents and short-term investments are classified as Level 2 within the fair value hierarchy because they are valued using professional pricing sources for identical or comparable instruments, rather than direct observations of quoted prices in active markets. As of December 31, 2016 and March 31, 2017, we held no Level 3 assets or liabilities.


12

Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


Our money market funds are no longer classified within the fair value hierarchy, as the fair values are measured at net asset value using the practical expedient. As of December 31, 2016 and March 31, 2017, the fair value of our money market funds were $55.8 million and $17.3 million.

Refer to Note 7, "Debt Instruments," for the carrying amount and estimated fair value of our convertible senior notes, which are not recorded at fair value as of March 31, 2017.

5.                       Commitments and Contingencies

Minimum Guarantees and Other Provisions—Content Acquisition Costs

Certain of our content acquisition agreements contain minimum guarantees, and require that we make upfront minimum guarantee payments. During the three months ended March 31, 2017, we prepaid $77.0 million in content acquisition costs related to minimum guarantees, which were offset by amortization of prepaid content acquisition costs of $28.5 million. As of March 31, 2017, we have future minimum guarantee commitments of $686.0 million, of which $278.6 million will be paid in 2017 and the remainder will be paid thereafter. On a quarterly basis, we record the greater of the cumulative actual content acquisition costs incurred or the cumulative minimum guarantee based on forecasted usage for the minimum guarantee period. The minimum guarantee period is the period of time that the minimum guarantee relates to, as specified in each agreement, which may be annual or a longer period. The cumulative minimum guarantee, based on forecasted usage considers factors such as listening hours, revenue, subscribers and other terms of each agreement that impact our expected attainment or recoupment of the minimum guarantees on a non-straight line basis.

Several of our content acquisition agreements also include provisions related to the royalty payments and structures of those agreements relative to other content licensing arrangements, which, if triggered, could cause our payments under those agreements to escalate. In addition, record labels, publishers and PROs with whom we have entered into direct license agreements have the right to audit our content acquisition payments, and any such audit could result in disputes over whether we have paid the proper content acquisition costs. However, as of March 31, 2017, we do not believe it is probable that these provisions of our agreements discussed above will, individually or in the aggregate, have a material adverse effect on our business, financial position, results of operations or cash flows.

Legal Proceedings
 
We have been in the past, and continue to be, a party to various legal proceedings, which have consumed, and may continue to consume, financial and managerial resources. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. Our management periodically evaluates developments that could affect the amount, if any, of liability that we have previously accrued and make adjustments as appropriate. Determining both the likelihood and the estimated amount of a loss requires significant judgment, and management’s judgment may be incorrect. We do not believe the ultimate resolution of any pending legal matters is likely to have a material adverse effect on our business, financial position, results of operations or cash flows.

Pre-1972 copyright litigation

On October 2, 2014, Flo & Eddie Inc. filed a class action suit against Pandora Media Inc. in the federal district court for the Central District of California. The complaint alleges misappropriation and conversion in connection with the public performance of sound recordings recorded prior to February 15, 1972. On December 19, 2014, Pandora filed a motion to strike the complaint pursuant to California’s Anti-Strategic Lawsuit Against Public Participation ("Anti-SLAPP") statute, which was appealed to the Ninth Circuit Court of Appeals. The district court litigation is currently stayed pending the Ninth Circuit’s decision. On December 8, 2016, the Ninth Circuit heard oral argument on the Anti-SLAPP motion. On March 15, 2017, the Ninth Circuit requested certification to the California Supreme Court on the substantive legal questions and a response from the California Supreme Court is pending.

Between September 14, 2015 and October 19, 2015, Arthur and Barbara Sheridan filed separate class action suits against the Company in the federal district courts for the Northern District of California, District of New Jersey and Northern District of Illinois. The complaints allege a variety of violations of common law and state copyright statutes, common law misappropriation, unfair competition, conversion, unjust enrichment and violation of rights of publicity arising from allegations that we owe royalties for the public performance of sound recordings recorded prior to February 15, 1972. Currently, the action

13

Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


in California is stayed pending the Ninth Circuit’s decision in Flo & Eddie, Inc. v. Pandora Media, Inc., and the actions in New Jersey and Illinois are stayed or otherwise suspended pending the Second Circuit’s decision in Flo & Eddie et al. v. Sirius XM. On March 16, 2017, the Second Circuit issued the final mandate in Flo & Eddie et al. v. Sirius XM, and on April 6, 2017, the Sheridans voluntarily dismissed their action in the Southern District of New York.

On September 7, 2016, Ponderosa Twins Plus One et al. filed a class action suit against the Company alleging claims similar to that of Flo & Eddie, Inc. v. Pandora Media Inc. The action is currently stayed in the Northern District of California pending the Ninth Circuit’s decision in Flo & Eddie, Inc. v. Pandora Media, Inc.

The outcome of any litigation is inherently uncertain. Except as noted above, we do not believe it is probable that the final outcome of the matters discussed above will, individually or in the aggregate, have a material adverse effect on our business, financial position, results of operations or cash flows; however, in light of the uncertainties involved in such matters, there can be no assurance that the outcome of each case or the costs of litigation, regardless of outcome, will not have a material adverse effect on our business.
 
Indemnification Agreements, Guarantees and Contingencies
 
In the ordinary course of business, we are party to certain contractual agreements under which we may provide indemnifications of varying scope, terms and duration to customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of breach of such agreements, services to be provided by us or from intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with directors and certain officers and employees that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. Such indemnification provisions are accounted for in accordance with guarantor’s accounting and disclosure requirements for guarantees, including indirect guarantees of indebtedness of others. To date, we have not incurred, do not anticipate incurring and therefore have not accrued for, any costs related to such indemnification provisions.
 
While the outcome of these matters cannot be predicted with certainty, we do not believe that the outcome of any claims under indemnification arrangements will have a material adverse effect on our business, financial position, results of operations or cash flows.

6.                       Goodwill and Intangible Assets

The changes in the carrying amount of goodwill for the three months ended March 31, 2017, are as follows:

 
Goodwill
 
(in thousands)
Balance as of December 31, 2016
$
306,691

Effect of currency translation adjustment and immaterial adjustments to fair value
(270
)
Balance as of March 31, 2017
$
306,421



 The following summarizes information regarding the gross carrying amounts and accumulated amortization of intangible assets.

14

Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


 
 
As of December 31, 2016
 
As of March 31, 2017
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Value
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Value
 
 
(in thousands)
 
(in thousands)
Finite-lived intangible assets
 
 
 
 
 
 
 
 
 
 
 
 
Patents
 
$
8,030

 
$
(2,556
)
 
$
5,474

 
$
8,030

 
$
(2,740
)
 
$
5,290

Developed technology
 
56,162

 
(13,599
)
 
42,563

 
56,162

 
(16,681
)
 
39,481

Customer relationships—clients
 
37,399

 
(5,487
)
 
31,912

 
37,399

 
(6,664
)
 
30,735

Customer relationships—users
 
1,940

 
(1,288
)
 
652

 
1,940

 
(1,531
)
 
409

Trade names
 
11,735

 
(2,104
)
 
9,631

 
11,735

 
(2,555
)
 
9,180

Total finite-lived intangible assets
 
$
115,266

 
$
(25,034
)
 
$
90,232

 
$
115,266

 
$
(30,171
)
 
$
85,096

 
 
 
 
 
 
 
 
 
 
 
 
 
Indefinite-lived intangible assets
 
 
 
 
 
 
 
 
 
 
 
 
FCC license - Broadcast Radio
 
$
193

 
$

 
$
193

 
$
193

 
$

 
$
193

 
 
 
 
 
 
 
 
 
 
 
 
 
Total intangible assets
 
$
115,459

 
$
(25,034
)
 
$
90,425

 
$
115,459

 
$
(30,171
)
 
$
85,288

Note: Amounts may not recalculate due to rounding


Amortization expense of intangible assets was $5.1 million and $5.1 million for the three months ended March 31, 2016 and 2017.

The following is a schedule of future amortization expense related to finite-lived intangible assets as of March 31, 2017.

 
As of 
 March 31, 
 2017
 
(in thousands)
Remainder of 2017
$
14,978

2018
17,654

2019
17,129

2020
15,896

2021
6,690

Thereafter
12,749

Total future amortization expense
$
85,096



7.                       Debt Instruments

Long-term debt, net consisted of the following:

 
As of December 31,
 
As of March 31,
 
2016
 
2017
 
(in thousands)
1.75% convertible senior notes due 2020
$
345,000

 
$
345,000

Credit facility
90,000

 
90,000

Unamortized discount and deferred issuance costs
(92,753
)
 
(87,777
)
Long-term debt, net
$
342,247

 
$
347,223


 
Convertible Debt Offering

15

Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)



On December 9, 2015, we completed an unregistered Rule 144A offering for the issuance of $345.0 million aggregate principal amount of our 1.75% Convertible Senior Notes due 2020 (the "Notes"). In connection with the issuance of the Notes, we entered into capped call transactions with the initial purchaser of the Notes and an additional financial institution ("capped call transactions"). The net proceeds from the sale of the Notes were approximately $336.5 million, after deducting the initial purchasers' fees and other estimated expenses. We used approximately $43.2 million of the net proceeds to pay the cost of the capped call transactions.

The Notes are unsecured, senior obligations of Pandora, and interest is payable semi-annually at a rate of 1.75% per annum. The Notes will mature on December 1, 2020, unless earlier repurchased or redeemed by Pandora or converted in accordance with their terms prior to such date. Prior to July 1, 2020, the Notes are convertible at the option of holders only upon the occurrence of specified events or during certain periods as further described in Note 7 "Debt Instruments" in our Annual Report on Form 10-K for the year ended December 31, 2016; thereafter, until the second scheduled trading day prior to maturity, the Notes will be convertible at the option of holders at any time.

The Notes were separated into debt and equity components and assigned a fair value. The value assigned to the debt component is the estimated fair value as of the issuance date of similar debt without the conversion feature. The difference between the cash proceeds and this estimated fair value represents the value which has been assigned to the equity component and recorded as a debt discount. The debt discount is being amortized using the effective interest method over the period from the date of issuance through the December 1, 2020 maturity date. The valuation of the Notes is further described in Note 7 "Debt Instruments" in our Annual Report on Form 10-K for the year ended December 31, 2016.
The following table outlines the effective interest rate, contractually stated interest expense and costs related to the amortization of the discount for the Notes:

 
Three months ended 
 March 31,
 
2016
 
2017
 
(in thousands except for effective interest rate)
Effective interest rate
10.18
%
 
10.18
%
Contractually stated interest expense
$
1,509

 
$
1,514

Amortization of discount
$
4,434

 
$
4,886



The total estimated fair value of the Notes as of March 31, 2017 was $333.7 million. The fair value was determined using a methodology that combines direct market observations with quantitative pricing models to generate evaluated prices. We consider the fair value of the Notes to be a Level 2 measurement due to the limited trading activity of the Notes.

The closing price of our common stock was $11.81 on March 31, 2017, which was less than the initial conversion price for the Notes of approximately $16.42 per share. As such, the if-converted value of the Notes was less than the principal amount of $345.0 million.

Credit Facility

We are party to a $120.0 million credit facility with a syndicate of financial institutions, which expires on September 12, 2018. In September 2016, we borrowed $90.0 million from the credit facility to enhance our working capital position. The amount borrowed is included in long-term debt on our balance sheet. Interest is payable quarterly at the applicable annual interest rate of 3.81% through September 2017. The applicable interest rate will be adjusted in September 2017.

As of March 31, 2017, we had $1.2 million in letters of credit outstanding and $28.8 million of available borrowing capacity under the credit facility. We are in compliance with all financial covenants associated with the credit facility as of March 31, 2017.


8.                       Stock-based Compensation Plans and Awards

16

Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


 
ESPP
 
The ESPP allows eligible employees to purchase shares of our common stock through payroll deductions of up to 15% of their eligible compensation. The ESPP provides for six-month offering periods, commencing in February and August of each year.

We estimate the fair value of shares to be issued under the ESPP on the first day of the offering period using the Black-Scholes valuation model. The determination of the fair value is affected by our stock price on the first date of the offering period, as well as other assumptions including the risk-free interest rate, the estimated volatility of our stock price over the term of the offering period, the expected term of the offering period and the expected dividend rate. Stock-based compensation expense related to the ESPP is recognized on a straight-line basis over the offering period. Forfeitures are recognized as they occur.
 
The following assumptions for the Black-Scholes option pricing model were used to determine the per-share fair value of shares to be granted under the ESPP:


Three months ended March 31,
 
2016

2017
Expected life (in years)
0.5

 
0.5

Risk-free interest rate
0.24 - 0.41%

 
0.44 - 0.65%

Expected volatility
41%

 
39 - 52%

Expected dividend yield
0
%
 
0
%

 
During the three months ended March 31, 2016 and 2017, we withheld $1.7 million and $2.8 million in contributions from employees and recognized $0.6 million and $0.9 million of stock-based compensation expense related to the ESPP, respectively. In the three months ended March 31, 2016 and 2017, 611,348 and 547,765 shares of common stock were issued under the ESPP.
 
Employee Stock-Based Awards
 
Our 2011 Equity Incentive Plan (the "2011 Plan") provides for the issuance of stock options, restricted stock units and other stock-based awards to our employees. The 2011 Plan is administered by the compensation committee of our board of directors.
 
Stock options
 
We measure stock-based compensation expense for stock options at the grant date fair value of the award and recognize expense on a straight-line basis over the requisite service period, which is generally the vesting period. We estimate the fair value of stock options using the Black-Scholes option-pricing model. During the three months ended March 31, 2016 and 2017, we recorded stock-based compensation expense from stock options of approximately $6.8 million and $1.9 million.

The per-share fair value of each stock option was determined on the grant date using the Black-Scholes option pricing model using the following assumptions:

 
Three months ended March 31,
 
2016
 
2017
Expected life (in years)
N/A
 
5.93 - 6.05

Risk-free interest rate
N/A
 
2.03 - 2.18%

Expected volatility
N/A
 
61%

Expected dividend yield
N/A
 
0
%



17

Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


There were no options granted in the three months ended March 31, 2016.

RSUs
 
The fair value of RSUs is expensed ratably over the vesting period. RSUs typically have an initial annual cliff vest and then vest quarterly thereafter over the service period, which is generally three to four years. During the three months ended March 31, 2016 and 2017, we recorded stock-based compensation expense from RSUs of approximately $31.0 million and $25.4 million.
 
MSUs

In March 2015, the compensation committee of the board of directors granted performance awards consisting of market stock units to certain key executives under our 2011 Plan.

MSUs granted in March 2015 are earned as a function of Pandora’s TSR performance measured against that of the Russell 2000 Index across three performance periods:

One-third of the target MSUs are eligible to be earned for a performance period that is the first calendar year of the MSU grant (the "One-Year Performance Period");
One-third of the target MSUs are eligible to be earned for a performance period that is the first two calendar years of the MSU grant (the "Two-Year Performance Period"); and
Any remaining portion of the total potential MSUs are eligible to be earned for a performance period that is the entire three calendar years of the MSU grant (the "Three-Year Performance Period").

For each performance period, a "performance multiplier" is calculated by comparing Pandora’s TSR for the period to the Russell 2000 Index TSR for the same period, using the average adjusted closing stock price of Pandora stock, and the Russell 2000 Index, for ninety calendar days prior to the beginning of the performance period and the last ninety calendar days of the performance period. In each period, the target number of shares will vest if the Pandora TSR is equal to the Russell 2000 Index TSR. For each percentage point that the Pandora TSR falls below the Russell 2000 Index TSR for the period, the performance multiplier is decreased by three percentage points. The performance multiplier is capped at 100% for the One-Year and Two-Year Performance Periods. However, the full award is eligible for a payout up to 200% of target, less any shares earned in prior periods, in the Three-Year Performance Period. Specifically, for each percentage point that the Pandora TSR exceeds the Russell 2000 Index TSR for the Three-Year Performance Period, the performance multiplier is increased by 2%. As such, the ability to exceed the target number of shares is determined exclusively with respect to Pandora's three-year TSR during the term of the award.

We have determined the grant-date fair value of the MSUs using a Monte Carlo simulation performed by a third-party valuation firm. We recognize stock-based compensation for the MSUs over the requisite service period, which is approximately three years, using the accelerated attribution method.

There were no MSUs granted in the three months ended March 31, 2016 or 2017. During the three months ended March 31, 2016 and 2017, we recorded stock-based compensation expense from MSUs of approximately $0.2 million and $0.3 million.

In February 2016 and January 2017, the compensation committee of the board of directors certified the results of the One-Year Performance Period and Two-Year Performance Period of the 2015 MSU grant, which concluded December 31, 2015 and 2016. During the One-Year Performance Period, our relative TSR declined 26 percentage points relative to the Russell 2000 Index TSR for the period, which resulted in the vesting of the One-Year Performance Period at 22% of the one-third vesting opportunity for the period. During the Two-Year Performance Period, our relative TSR declined 48 percentage points relative to the Russell 2000 Index TSR for the period, which resulted in vesting of the Two-Year Performance Period at 0% of the one-third vesting opportunity for the period.

PSUs

In April and October 2016, the compensation committee of the board of directors granted 2016 Performance Awards consisting of stock-settled performance-based RSUs to certain key executives under our 2011 Plan.

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Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)



PSUs granted in April and October 2016 have a vesting period that includes a four-year service period, during which one fourth of the awards will vest after one year and the remainder will vest quarterly thereafter. The PSUs are earned when our trailing average ninety-day stock price is equal to or greater than $20.00. If the trailing average ninety-day stock price does not equal or exceed $20.00 on the applicable vesting date, then the portion of the award that was scheduled to vest on such vesting date shall not vest but shall vest on the next vesting date on which the trailing average ninety-day stock price equals or exceeds $20.00. Any portion of the award that remains unvested as of the final vesting date shall be canceled and forfeited.

We have determined the grant-date fair value of the PSUs granted in April and October 2016 using a Monte Carlo simulation performed by a third-party valuation firm. We recognize stock-based compensation for the PSUs over the requisite service period, which is approximately four years, using the accelerated attribution method.

There were no PSUs granted in the three months ended March 31, 2016 or 2017. During the three months ended March 31, 2017, we recorded stock-based compensation expense from PSUs of approximately $1.1 million. There was no stock-based compensation expense from PSUs in the three months ended March 31, 2016.

Stock-based Compensation Expense
 
Stock-based compensation expense related to all employee and non-employee stock-based awards was as follows:
 
 
Three months ended 
 March 31,
 
2016
 
2017
 
(in thousands)
Stock-based compensation expense
 

 
 

Cost of revenue—Other
$
1,477

 
$
815

Cost of revenue—Ticketing service
60

 
29

Product development
8,501

 
7,915

Sales and marketing
13,613

 
13,496

General and administrative
15,004

 
7,363

Total stock-based compensation expense
$
38,655

 
$
29,618



In the three months ended March 31, 2016, we recorded stock-based compensation expense of $6.8 million related to accelerated awards in connection with executive severance. This amount is included in the general and administrative line item of our condensed consolidated statements of operations.

9.                       Net Loss Per Share
 
Basic net loss per share is computed by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period.
 
Diluted net loss per share is computed by giving effect to all potential shares of common stock, including stock options, restricted stock units, market stock units and performance-based RSUs, to the extent dilutive. Basic and diluted net loss per share were the same for the three months ended March 31, 2016 and 2017, as the inclusion of all potential common shares outstanding would have been anti-dilutive.
 

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Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


The following table sets forth the computation of historical basic and diluted net loss per share:
 
 
Three months ended March 31,
 
2016
 
2017
 
(in thousands except per share amounts)
Numerator
 
 
 
Net loss
$
(115,102
)
 
$
(132,267
)
Denominator
 
 
 
Weighted-average common shares outstanding used in computing basic and diluted net loss per share
226,659

 
237,515

Net loss per share, basic and diluted
$
(0.51
)
 
$
(0.56
)

 
The following potential common shares outstanding were excluded from the computation of diluted net loss per share because including them would have been anti-dilutive:
 
 
As of March 31,
 
2016
 
2017
 
(in thousands)
Options to purchase common stock
12,627

 
9,367

Restricted stock units
22,947

 
23,830

Performance awards*
776

 
2,056

Shares issuable pursuant to the ESPP
743

 
604

Total common stock equivalents
37,093

 
35,857

*Includes potential common shares outstanding for MSUs and PSUs

 
On December 9, 2015, we completed an offering of our 1.75% convertible senior notes due 2020. Under the treasury stock method, the Notes will generally have a dilutive impact on earnings per share if our average stock price for the period exceeds approximately $16.42 per share of our common stock, the conversion price of the Notes. For the period from the issuance of the offering of the Notes through March 31, 2017, the conversion feature of the Notes was anti-dilutive, as our average stock price was less than the conversion price.

In connection with the pricing of the Notes, we entered into capped call transactions which increase the effective conversion price of the Notes, and are designed to reduce potential dilution upon conversion of the Notes. Since the beneficial impact of the capped call is anti-dilutive, it is excluded from the calculation of earnings per share. Refer to Note 7 "Debt Instruments" for further details regarding our Notes.


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Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


10.                       Segment Data and Revenue by Geographic Area

Segment Data

Our two operating segments, which are the same as our two reportable segments, are as follows:

Pandora—Internet radio and on-demand music services


Pandora is the world’s most powerful music discovery platform, offering a personalized experience for each of our listeners wherever and whenever they want to listen to music—whether through earbuds, car speakers or home audio/video equipment. Pandora is available as an ad-supported service, a radio subscription service called Pandora Plus and an on-demand subscription service called Pandora Premium. The majority of our listener hours occur on mobile devices, with the majority of our revenue generated from advertising on our ad-supported service on these devices. We offer both local and national advertisers the opportunity to deliver targeted messages to our listeners using a combination of audio, display and video advertisements. We also generate revenue from subscriptions to Pandora Plus and Pandora Premium.

Ticketing service

We operate our ticketing service through our subsidiary Ticketfly, a leading live events technology company that provides ticketing and marketing software and services for clients, which are venues and event promoters, across North America. Ticketfly's ticketing, digital marketing and analytics software helps promoters book talent, sell tickets and drive in-venue revenue, while Ticketfly's consumer tools help fans find and purchase tickets to events. Tickets are primarily sold through the Ticketfly platform but are also sold through other channels such as box offices.

The measurement basis of segment profit or loss is gross profit, as operating expenses and working capital are all managed on an aggregate basis. Total segment assets have not been presented as segment assets are not reported to, used by management to allocate resources to or used to assess performance of the segments.

The following table provides the financial performance of our reportable segments, including a reconciliation of gross profit from segment operations to gross profit from total operations:

 
Three months ended March 31,
 
2016
 
2017
 
Pandora
 
Ticketfly
 
Total
 
Pandora
 
Ticketfly
 
Total
 
(in thousands)
 
(in thousands)
Revenues
$
275,040

 
$
22,265

 
$
297,305

 
$
288,186

 
$
27,818

 
$
316,004

Cost of revenues
192,459

 
14,646

 
207,105

 
212,952

 
18,618

 
231,570

Gross profit
$
82,581

 
$
7,619

 
$
90,200

 
$
75,234

 
$
9,200

 
$
84,434

Operating and other expenses
 
 
 
 
(205,302
)
 
 
 
 
 
(216,701
)
Net loss
 
 
 
 
$
(115,102
)
 
 
 
 
 
$
(132,267
)

The following table provides depreciation and amortization costs included in costs of revenues by segment included in the consolidated statements of operations:

 
Three months ended March 31,
 
2016
 
2017
 
Pandora
 
Ticketfly
 
Total
 
Pandora
 
Ticketfly
 
Total
 
(in thousands)
 
(in thousands)
Depreciation and amortization
$
2,146

 
$
1,433

 
$
3,579

 
$
3,347

 
$
1,430

 
$
4,777



Revenue by Geographic Area

The following table sets forth revenue by geographic area:

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Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)



 
 
Three months ended March 31,
 
 
2016
 
2017
 
 
(in thousands)
Revenue by geographic area
 
 
 
 
United States
 
$
293,260

 
$
311,295

International
 
4,045

 
4,709

Total revenue
 
$
297,305

 
$
316,004


No individual foreign country represented a material portion of our consolidated revenue during the three months ended March 31, 2016 and 2017.

11.                       Restructuring Charges

On January 12, 2017, we announced a reduction in force plan affecting approximately 7% of our U.S. employee base, excluding Ticketfly. We incurred approximately $6.2 million of cash expenditures, substantially all of which are related to employee severance and benefits costs. Total reduction in force expenses were $5.7 million, which was lower than cash reduction in force costs due to a credit related to non-cash stock-based compensation expense reversals for unvested equity awards. The reduction in force plan was substantially completed in the three months ended March 31, 2017. The remaining accrued liability for payments related to the reduction in force was not material as of March 31, 2017.  

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A")
 
You should read the following discussion of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act").
 
This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve substantial risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Exchange Act, including, but not limited to, statements regarding our expectations, beliefs, intentions,

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strategies, future operations, future financial position, future revenue, projected expenses, plans and objectives of management and economic, competitive and technological trends. In some cases, you can identify forward-looking statements by terms such as "anticipate," "believe," "estimate," "expect," "intend," "may," "might," "plan," "project," "will," "would," "should," "could," "can," "predict," "potential," "continue," "objective," or the negative of these terms, and similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words. These forward-looking statements reflect our current views about future events and involve known risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievement to be materially different from those expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2016. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. We qualify all of our forward-looking statements by these cautionary statements. These and other factors could cause our results to differ materially from those expressed in this Quarterly Report on Form 10-Q.
 
As used herein, "Pandora," the "Company," "we," "our," and similar terms refer to Pandora Media, Inc., unless the context indicates otherwise.
 
"Pandora" and other trademarks of ours appearing in this report are our property. This report may contain additional trade names and trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies.

Overview
 
Pandora—Internet Radio and On-Demand Music Services

Pandora is the world’s most powerful music discovery platform, offering a personalized experience for each of our listeners wherever and whenever they want to listen to music—whether through earbuds, car speakers or home audio/video equipment. Our vision is to be the definitive source of music discovery and enjoyment for billions. Pandora is available as an ad-supported service, a radio subscription service called Pandora Plus and an on-demand subscription service called Pandora Premium. The majority of our listener hours occur on mobile devices, with the majority of our revenue generated from advertising on our ad-supported service on these devices. We offer both local and national advertisers the opportunity to deliver targeted messages to our listeners using a combination of audio, display and video advertisements. We also generate revenue from subscriptions to Pandora Plus and Pandora Premium. Founded by musicians, Pandora also empowers artists with valuable data and tools to help grow their careers and connect with their fans.
 
At the heart of our service is our set of proprietary personalization technologies, including the Music Genome Project and our playlist generating algorithms. The Music Genome Project is a database of over 1,500,000 uniquely analyzed songs from over 200,000 artists, spanning over 650 genres and sub-genres, which our team of trained musicologists has developed one song at a time by evaluating and cataloging each song’s particular attributes. The Music Genome Project database is a subset of our full catalog available to be played. When a listener enters a single song, artist, comedian or genre to start a station, the Pandora service instantly generates a station that plays music or comedy we think that listener will enjoy. Over time, our service has evolved by using data science to further tailor the listener experience based on listener reactions to the recordings we pick. Listeners also have the ability to add variety to and rename stations, which further allows for the personalization of our service. We have integrated this technology into Pandora Premium, giving listeners the ability to search and play any track or album as well as offering unique playlist features tailored to each listener's distinct preferences.
 
For the three months ended March 31, 2017, we streamed 5.21 billion hours of radio, and as of March 31, 2017, we had 76.7 million active users during the prior 30-day period and 4.71 million paid subscribers. Since we launched the Pandora service in 2005 our listeners have created over 11 billion stations.
 
We currently provide the Pandora service through three models:
 
Ad-Supported Service. Our ad-supported Pandora service allows listeners to access our music and comedy catalogs and personalized playlist generating system for free across all of our delivery platforms. Listeners can obtain more features, such as skips and the ability to replay tracks, by watching an advertisement.


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Subscription Service—Pandora Plus. Pandora Plus is a paid, ad-free subscription version of the Pandora service that includes replays, additional skipping, offline listening, higher quality audio on supported devices and longer timeout-free listening.

Subscription Service—Pandora Premium. Our on-demand subscription service, Pandora Premium, launched to select listeners on March 15, 2017, with general availability in the United States on April 18, 2017. Pandora Premium is a paid, ad-free version of the Pandora service that offers a unique, on-demand experience, providing users with the ability to search, play and collect songs and albums, build playlists on their own or with the tap of a button and automatically generates playlists based on the user’s listening activity. The features of Pandora Plus are also included in Pandora Premium.

A key element of our strategy is to make the Pandora service available everywhere that there is internet connectivity. To this end, we make the Pandora service available through a variety of distribution channels. In addition to streaming our service to computers, we have developed Pandora mobile device applications ("apps") for smartphones and mobile operating systems, such as the iPhone and Android and for tablets including the iPad and Android tablets. We distribute those mobile apps free to listeners via app stores.

The development and launch of Pandora Plus and Pandora Premium have and will continue to require significant engineering effort, as well as marketing, and other resources. In addition, to support the launch of these services we have entered into direct license agreements with major and independent record labels, some of which include substantial minimum guarantee payments. In order for Pandora Plus and Pandora Premium to be successful, we will need to attract subscribers to these new service offerings. The market for subscription-based music services, including on-demand services, is intensely competitive, and our ability to realize a return on our investments in these new service offerings will depend on our ability to leverage the existing audience of our ad-supported service, our brand awareness and our ability to deliver differentiated subscription services with features and functionality that listeners find attractive. Refer to our discussion of these matters in Item 1A—"Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2016.

Ticketing Service

We operate our ticketing service through our subsidiary Ticketfly, a leading live events technology company that provides ticketing and marketing software and services for our clients, which are venues and event promoters, across North America. Ticketfly's ticketing, digital marketing and analytics software helps promoters book talent, sell tickets and drive in-venue revenue, while Ticketfly's consumer tools help fans find and purchase tickets to events. Tickets are primarily sold through the Ticketfly platform but are also sold through other channels such as box offices. In the three months ended March 31, 2017, Ticketfly had approximately 44 thousand live events on sale, for which approximately 4.8 million tickets, excluding box office sales, were sold to approximately 2.0 million unique ticket buyers, which resulted in more than $215.0 million in gross transaction value, excluding box office sales.

Ticketfly's platform provides ticketing and marketing services for venues and event promoters across North America and makes it easy for fans to find and purchase tickets to events, and also gives artists a means to more effectively promote their events. We also connect our listeners to events through promotion on our internet radio service.

Recent Events

Pandora Premium
Our on-demand subscription service, Pandora Premium, launched to select listeners on March 15, 2017, with general availability in the United States on April 18, 2017. Pandora Premium is a paid version of the Pandora service that offers a unique, on-demand experience, providing users with the ability to search, play and collect songs and albums, build playlists on their own or with the tap of a button and automatically generates playlists based on the user’s listening activity.

Factors Affecting our Business Model

Content Acquisition Costs
We pay content acquisition costs based on the terms of direct license agreements with major and independent music labels and distributors for the significant majority of the sound recordings we stream on our ad-supported service, Pandora Plus and Pandora Premium. Depending on the applicable service, these license agreements generally require us to pay either a per-performance fee based on the number of sound recordings we transmit, a percentage of revenue associated with the service, or a

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per-subscriber minimum amount, all generally subject to certain discounts. Certain of these license agreements require minimum guarantee payments, some of which are paid in advance.

If we have not entered into a direct license agreement with the copyright owner of a particular sound recording that is streamed on our services, we stream that sound recording pursuant to the statutory license and pay the applicable rates set by the Copyright Royalty Board on December 16, 2015 (the "Web IV Proceeding"). The rates for non-subscription services, such as our ad-supported service, were set at $0.0017 per play and the rates for subscription services, such as Pandora Plus, were set at $0.0022 per play beginning in 2016. Sound recordings streamed under the statutory license and paid at the Web IV Proceeding rates can only be played in radio mode on our services—these sound recordings cannot be played on-demand or offline and are not eligible for replay or additional skips.
Content acquisition costs for musical works are negotiated with and paid to performing rights organizations ("PROs") such as ASCAP, BMI, SESAC and Global Music Rights and directly to publishing companies. Content acquisition costs for the streaming of musical works on our ad-supported service are calculated such that each copyright holder receives its usage-based and ownership-based share of a royalty pool equal to 20% of the content acquisition costs paid by us for sound recordings. Content acquisition costs for the streaming of musical works on our subscription services are equal to the rates determined in accordance with the statutory license set forth in 17 U.S.C. §115 ("Section 115").
The current rate structure for the statutory license for reproduction rights under Section 115 expires at the end of 2017. We are currently one of five commercial music service operators (along with Amazon, Apple, Google and Spotify) participating in rate-setting proceedings in which three judges of the CRB will determine the Section 115 rates for calendar years 2018 to 2022 (the "Phonorecords III Proceedings"). The Nashville Songwriters Association International, the National Association of Music Publishers and George Johnson Music Publishing are also participating in the Phonorecords III Proceedings. A trial before the CRB concluded in April 2017, and the CRB is expected to render a decision prior to the end of 2017. The rates established by the CRB in the Phonorecords III Proceedings may be higher, lower or the same as the rates currently in effect.
The Phonorecords III Proceedings are important to us because our direct licenses with music publishers reference the Section 115 rates. As a result, any increase in the Section 115 rates would increase our content acquisition costs, which, if such increase were substantial, could materially harm our financial condition and hinder our ability to provide interactive features in our services, or cause one or more of our subscription services to not be economically viable.
Ad-Supported Service
Our ad-supported service is monetized through the sale of display, audio and video advertisements to national, regional and local advertisers. We compete with digital advertising networks such as Google and Facebook, other digital media companies and local broadcast radio stations in our advertising business.
Our total number of listener hours is a key driver for both advertising revenue generation opportunities and content acquisition costs, which are the largest component of our ad-related expenses.
Advertising Revenue. Listener hours define the number of opportunities we have to sell advertisements, which we refer to as inventory. Our ability to attract advertisers depends in large part on our ability to offer sufficient inventory within desired demographics.
 
Cost of Revenue—Content Acquisition Costs—Ad-Supported Service. We pay content acquisition costs to the copyright owners and performers, or their agents, of each sound recording that we stream, as well as to the publishers and songwriters, or their agents, for the musical works embodied in each of those sound recordings, subject to certain exclusions. The majority of the content acquisition costs related to our ad-supported service are driven by direct license agreements with major and independent labels and distributors, as discussed above in "Factors Affecting Our Business Model—Content Acquisition Costs". Certain of these license agreements include minimum guarantee payments, some of which are paid in advance.

As a result of the structure of our license agreements, our ability to achieve and sustain profitability and operating leverage on our ad-supported service depends on our ability to increase our revenue per thousand listener hours of streaming through increased advertising revenue across all of our delivery platforms.
Subscription Services
We monetize our subscription services through subscription payments made by users of the services. We drive subscriber growth in our subscription services by providing the world's most powerful music discovery platform, offering a personalized experience for each of our listeners. In addition, we invest in marketing and free-trials to promote our service.

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Our total number of paid subscriptions is a key driver for both subscription revenue and content acquisition costs related to our subscription services, which is the largest component of our subscription-related expenses. In order to drive greater subscription revenue, we must increase the number of new subscribers to our subscription services and minimize the number of current subscribers who discontinue their subscriptions.
Subscription Revenue. Our subscription revenue depends upon the number of paid subscriptions we are able to sell and the price that our subscribers pay for those subscriptions. Our ability to attract subscribers depends in large part on our ability to offer features and functionality on our subscription services that are valued by consumers within desired demographics, on terms that are attractive to those consumers, and still enable us to maintain adequate gross margins.

Cost of Revenue—Content Acquisition Costs—Subscription Service. We pay content acquisition costs to the copyright owners, performers, songwriters, or their agents, subject to certain exclusions. The majority of our content acquisition costs related to our subscription service are generally driven by direct license agreements with major and independent labels and distributors, PROs and publishers, as discussed above in "Factors Affecting Our Business Model—Content Acquisition Costs". Certain of these license agreements include minimum guarantee payments, some of which are paid in advance.

Given the structure of our license agreements for our subscription services, the majority of our content acquisition costs increase as subscription revenue increases and are subject to minimum guarantee payments. As such, our ability to achieve and sustain profitability and operating leverage on our subscription services depends on our ability to increase our revenue through increased paid subscriptions on terms that maintain an adequate gross margin. Refer to our discussion of these matters in Item 1A—"Risk Factors" below and in our Annual Report on Form 10-K for the year ended December 31, 2016.

Key Metrics
 
In the quarter ended December 31, 2016, we began reporting updated key metrics on a prospective basis as a result of a change in our service offerings. We discontinued our previous key metrics as of October 1, 2016. Certain of our new key metrics are not comparable to prior periods given the lack of history of our new service offerings. As such, these metrics have not been presented for, nor compared against, these periods. Refer to the "Key Metrics" section of Item 7—"Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2016 for a summary of the changes in our key metrics.

The below key metrics do not include amounts related to our ticketing service, unless otherwise specifically stated.

Subscription Services—Total

Paid Subscribers

Paid subscribers are defined as the number of distinct users that have current, paid access to our subscription service as of the beginning or the end of the period. Net new subscribers are defined as the net number of distinct new users that have paid for access to our subscription services in the period. We track paid subscribers because it is a key indicator of the growth of our subscription services.

The below table sets forth the detail of the change in paid subscribers in the three months ended March 31, 2017, which includes paid subscribers as of December 31, 2016, net new subscribers during the three months ended March 31, 2017 and paid subscribers as of March 31, 2017.

 
Subscribers
 
(in millions)
Paid subscribers as of December 31, 2016
4.39

   Net new paid subscribers
0.32

Paid subscribers as of March 31, 2017
4.71


Penetration rate


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Penetration rate is defined as paid subscribers divided by total trailing 30-day active users. We track penetration rate as it is an indicator of the relative scale of our subscriber base. Our penetration rate as of March 31, 2017 was 6.1%.

Average revenue per paid subscriber ("ARPU") and average licensing costs per paid subscriber ("LPU")

ARPU is defined as average monthly revenue per paid subscriber on our subscription services. LPU is defined as average monthly content acquisition costs per paid subscriber on our subscription services. We believe ARPU to be the central top-line indicator for evaluating the results of our monetization efforts on our subscription services. We track LPU because it is a key measure of our ability to manage costs for our subscription services. The below table sets forth our ARPU and LPU for our subscription services for the three months ended March 31, 2017.

 
 
Three months ended March 31, 2017
 
 
ARPU
 
LPU
Subscription services
 
$
4.76

 
$
2.96


Total Service

Listener hours

We track listener hours because it is a key indicator of the growth of our business and the engagement of our listeners. We include listener hours related to our non-radio content offerings in the definition of listener hours. These offerings include non-music content such as podcasts, as well as custom music content such as Pandora Premieres and artist mixtapes. We calculate listener hours based on the total bytes served for each track that is requested and served from our servers, as measured by our internal analytics systems, whether or not a listener listens to the entire track. For non-music content such as podcasts, episodes are divided into approximately track-length parts, which are treated as tracks under this definition. To the extent that third-party measurements of listener hours are not calculated using a similar server-based approach, the third-party measurements may differ from our measurements.

The table below sets forth our total listener hours for the three months ended March 31, 2016 and 2017.

 
Three months ended 
 March 31,
 
2016
 
2017
Service
(in billions)
Advertising
4.85

 
4.38

Subscription
0.67

 
0.83

Total
5.52

 
5.21


Active users
We track the number of active users as an additional indicator of the breadth of audience we are reaching at a given time. We define active users as the number of distinct registered users, including subscribers, that have requested audio from our servers within the trailing 30 days to the end of the final calendar month of the period. The number of active users may overstate the number of unique individuals who actively use our service within a month as one individual may register for, and use, multiple accounts. We include active users who only request non-radio content offerings in the definition of active users.
The table below sets forth our total active users as of March 31, 2016 and 2017.
 
As of March 31,
 
2016
2017
 
(in millions)
Active users—all services
79.4

76.7


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Advertising-based service

Advertising Revenue per Thousand Listener Hours ("ad RPMs")

We track ad RPMs for our non-subscription, ad-supported service because it is a key indicator of our ability to monetize advertising inventory created by our listener hours. We focus on ad RPMs across all of our delivery platforms. We believe ad RPMs to be the central top-line indicator for evaluating the results of our monetization efforts. Ad RPMs are calculated by dividing advertising revenue by the number of thousands of listener hours of our advertising-based service.

Advertising LPMs

We track advertising LPMs for our non-subscription, ad-supported service across all delivery platforms. Prior to September 15, 2016, advertising LPMs were relatively fixed content acquisition costs with scheduled annual rate adjustments, per thousands of listener hours. Subsequent to September 15, 2016, LPMs are our content acquisition costs as calculated either under the rates set by our license agreements with record labels, PROs and music publishers or under the Web IV rates if we have not entered into a license agreement with the copyright owner of a particular sound recording, in each case per thousands of listener hours.

Period-to-period results should not be regarded as precise nor can they be relied upon as indicative of results for future periods. In addition, as our business matures and in response to technological evolutions, we anticipate that the relevant indicators we monitor for evaluating our business may change.
The table below sets forth our RPMs and LPMs for our ad-supported service for the three months ended March 31, 2016 and 2017.

 
Three months ended March 31,
 
2016
 
2017
 
RPM*
 
LPM
 
RPM*
 
LPM
Advertising
$
45.47

 
$
30.48

 
$
50.87

 
$
33.44

*The calculation of RPMs does not include revenue generated by Ticketfly or Next Big Sound.

Advertising RPMs 
For the three months ended March 31, 2017 compared to 2016, the increase in ad RPMs was primarily due to a decrease in advertising listener hours as a result of hours control mechanisms.
Advertising LPMs
For the three months ended March 31, 2017 compared to 2016, the increase in ad LPMs was primarily due to a decrease in advertising listener hours as a result of hours control mechanisms.
Basis of Presentation and Results of Operations
 
The following table presents our results of operations for the periods indicated as a percentage of total revenue. The period-to-period comparisons of results are not necessarily indicative of results for future periods.
 

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Three months ended 
 March 31,
 
2016
2017
Revenue
 
 
Advertising
74
 %
71
 %
Subscription and other
18

21

Ticketing service
7

9

Total revenue
100

100

Cost of revenue
 
 
Cost of revenue — Content acquisition costs
58

59

Cost of revenue — Other (1)
7

8

Cost of revenue — Ticketing service (1)
5

6

Total cost of revenue
70

73

Gross profit
30

27

Operating expenses
 
 
Product development (1)
12

13

Sales and marketing (1)
39

40

General and administrative (1)
16

14

Total operating expenses
67

66

Loss from operations
(37
)
(39
)
Interest expense
(2
)
(2
)
Other income, net


Total other expense, net
(2
)
(2
)
Loss before provision for income taxes
(39
)
(42
)
Provision for income taxes


Net loss
(39
)%
(42
)%
 
(1) Includes stock-based compensation as follows:
 
 
Cost of revenue - Other
0.5
%
0.3
%
Cost of revenue - Ticketing service


Product development
2.9

2.5

Sales and marketing
4.6

4.3

General and administrative
5.0

2.3

Note: Amounts may not recalculate due to rounding
 
 

Revenue
 
Three months ended 
 March 31,
 
 
 
2016
 
2017
 
$ Change
 
(in thousands)
Revenue
 
 
 
 
 
Advertising
$
220,308

 
$
223,308

 
$
3,000

Subscription and other
54,732

 
64,878

 
10,146

Ticketing service
22,265

 
27,818

 
5,553

Total revenue
$
297,305

 
$
316,004

 
$
18,699

 
Advertising revenue
 

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We generate advertising revenue primarily from audio, display and video advertising, which is typically sold on a cost-per-thousand impressions, or CPM, basis. Advertising campaigns typically range from one to twelve months, and advertisers generally pay us based on the number of delivered impressions or the satisfaction of other criteria, such as click-through rates. We also have arrangements with advertising agencies under which these agencies sell advertising inventory on our service directly to advertisers. We report revenue under these arrangements net of amounts due to agencies. For the three months ended March 31, 2016 and 2017, advertising revenue accounted for 74% and 71% of our total revenue. We expect that advertising will comprise a substantial majority of revenue for the foreseeable future.

For the three months ended March 31, 2017 compared to 2016, advertising revenue increased $3.0 million or 1%, primarily due to an approximate 15% increase in the number of ads sold, offset by an approximate 15% decrease in the average price per ad.

Subscription and other revenue
 
Subscription and other revenue is generated primarily through the sale of monthly or annual paid subscriptions to Pandora Plus and Pandora Premium. Pandora Plus is a paid, ad-free version of the Pandora service that includes replays, additional skipping, offline listening, higher quality audio on supported devices and longer timeout-free listening. Pandora Premium is a paid, ad-free version of the Pandora service that offers a unique, on-demand experience, providing users with the ability to search, play and collect songs and albums, build playlists on their own or with the tap of a button and automatically generates playlists based on their listening activity. Subscription revenue is recognized on a straight-line basis over the duration of the subscription period. For the three months ended March 31, 2016 and 2017, subscription and other revenue accounted for 18% and 21% of our total revenue.

For the three months ended March 31, 2017 compared to 2016, subscription and other revenue increased $10.1 million or 19%, primarily due to an approximate 20% increase in the number of subscribers.

Ticketing service

Ticketing service revenue is generated primarily from service and merchant processing fees generated on ticket sales through the Ticketfly platform. Ticketfly sells tickets to fans for events on behalf of clients and charges a fee per ticket, which generally increases as the face value of the ticket increases, or a percentage of the total convenience charge and order processing fee, for its services at the time the ticket for an event is sold. Ticketing service revenue is recorded net of the face value of the ticket at the time of the sale, as Ticketfly generally acts as the agent in these transactions. For the three months ended March 31, 2016 and 2017, ticketing service revenue accounted for 7% and 9% of our total revenue.

For the three months ended March 31, 2017 compared to 2016, ticketing service revenue increased $5.6 million or 25%, primarily due to an approximate 25% increase in the number of tickets sold, excluding box office sales.

Costs and Expenses
 
Cost of revenue consists of cost of revenue—content acquisition costs, cost of revenue—other and cost of revenue— ticketing. Our operating expenses consist of product development, sales and marketing and general and administrative costs. Cost of revenue—content acquisition costs are the most significant component of our costs and expenses, followed by employee-related costs, which include stock-based compensation expenses. We expect to continue to hire additional employees in order to support our anticipated growth and our product development initiatives. In any particular period, the timing of additional hires could materially affect our cost of revenue and operating expenses, both in absolute dollars and as a percentage of revenue. We anticipate that our costs and expenses will increase in the future.
 
Cost of revenue—Content acquisition costs
 
 
Three months ended 
 March 31,
 
 
 
2016
 
2017
 
$ Change
 
(in thousands)
Cost of revenue—Content acquisition costs
$
171,264

 
$
187,420

 
$
16,156

 

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Cost of revenue—content acquisition costs primarily consist of licensing fees paid for streaming music or other content to our listeners, and licensing fees paid for the streaming of musical works embedded in sound recordings.

During the three months ended March 31, 2016, we obtained the rights to stream the majority of sound recordings on our service through statutory licenses, with the costs for such licenses determined according to the per play rates set by the Copyright Royalty Board. We obtained the rights to the majority of the musical works streamed on our service through direct licensing agreements with PROs or publishers, with the costs for such licenses based on a percentage of the content acquisition costs we paid for sound recordings.

During the three months ended March 31, 2017, the majority of our content acquisition costs were calculated using mainly negotiated rates documented in direct license agreements with record labels, music publishers and PROs. Depending on the applicable service, our sound recording license agreements generally require us to pay either a per-performance fee based on the number of sound recordings we transmit, a percentage of revenue associated with the service, or a per-subscriber minimum amount, all generally subject to certain discounts. For our ad-supported service, the majority of our content acquisition costs for musical works are based on a percentage of content acquisition costs paid for sound recordings. For our subscription services, content acquisition costs for musical works are determined in accordance with the statutory license set forth in 17 U.S.C. § 115. Certain of our direct license agreements are also subject to minimum guarantee payments, some of which are paid in advance and amortized over the minimum guarantee period. For certain content acquisition arrangements, we accrue for estimated content acquisition costs based on the available facts and circumstances and adjust these estimates as more information becomes available. For additional information, see above in "Factors Affecting Our Business Model—Content Acquisition Costs".
 
For the three months ended March 31, 2017 compared to 2016, content acquisition costs increased $16.2 million or 9% and content acquisition costs as a percentage of total revenue increased from 58% to 59%, primarily due to an increase in content acquisition costs pursuant to our direct license agreements for sound recordings with major and independent labels, distributors, PROs and publishers.

Cost of revenue—Other
 
 
Three months ended 
 March 31,
 
 
 
2016
 
2017
 
$ Change
 
(in thousands)
Cost of revenue—Other
$
21,195

 
$
25,532

 
$
4,337

 
Cost of revenue—other consists primarily of ad and music serving costs, employee-related and facilities and equipment costs, other costs of ad sales and amortization of internal-use software. In the three months ended March 31, 2017 we reallocated headcount from cost of revenue—other to product development, sales and marketing and general and administrative due to a reorganization of the company. Ad and music serving costs consist of content streaming, maintaining our internet radio and on-demand subscription services and creating and serving advertisements through third-party ad servers. We make payments to third-party ad servers for the period the advertising impressions are delivered or click-through actions occur, and accordingly, we record this as a cost of revenue in the related period. Employee-related costs include salaries and benefits associated with supporting music and ad-serving functions. Other costs of ad sales include costs related to music events that are sold as part of certain of our advertising arrangements.

For the three months ended March 31, 2017 compared to 2016, cost of revenue—other increased $4.3 million or 20%, primarily due to a $5.2 million increase in ad and music serving costs driven by an increase in revenue, a $0.9 million increase in costs related to music events and a $0.9 million increase in amortization of internal-use software, offset by a $2.5 million decrease in employee-related and facilities and equipment costs driven by an approximate 35% decrease in average headcount related to the reorganization of the company and the reduction in force.

Cost of revenue—Ticketing service


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Three months ended 
 March 31,
 
 
 
2016
 
2017
 
$ Change
 
(in thousands)
Cost of revenue—Ticketing service
$
14,646

 
$
18,618

 
$
3,972