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 September 30, 2015March 31, 2016
 
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)
Delaware94-3352630
(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) 
 
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 October 22, 2015April 28, 2016 was: 213,417,153.228,777,595.

 

Table of Contents

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


2


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,
2014
 As of September 30,
2015
As of December 31,
2015
 As of March 31,
2016
Assets      
Current assets 
  
 
  
Cash and cash equivalents$175,957
 $242,981
$334,667
 $303,454
Short-term investments178,631
 120,614
35,844
 45,805
Accounts receivable, net of allowance of $1,218 at December 31, 2014 and $2,104 at September 30, 2015218,437
 262,910
Accounts receivable, net of allowance of $2,165 at December 31, 2015 and $2,739 at March 31, 2016277,075
 237,760
Prepaid expenses and other current assets15,389
 17,163
35,920
 48,182
Total current assets588,414
 643,668
683,506
 635,201
Long-term investments104,243
 78,982
46,369
 33,238
Property and equipment, net42,921
 56,424
66,370
 81,412
Goodwill
 23,052
303,875
 304,787
Intangible assets, net6,939
 9,138
110,745
 105,843
Other long-term assets6,773
 9,479
29,792
 31,860
Total assets$749,290
 $820,743
$1,240,657
 $1,192,341
Liabilities and stockholders’ equity 
  
 
  
Current liabilities 
  
 
  
Accounts payable$10,825
 $20,131
$17,897
 $9,922
Accrued liabilities15,754
 37,099
37,185
 35,375
Accrued royalties73,693
 163,047
97,390
 111,554
Deferred revenue14,412
 22,682
19,939
 27,579
Accrued compensation34,476
 36,856
43,788
 43,938
Other current liabilities15,632
 23,044
Total current liabilities149,160
 279,815
231,831
 251,412
Long-term debt, net234,577
 239,011
Other long-term liabilities16,773
 18,270
30,862
 31,521
Total liabilities165,933
 298,085
497,270
 521,944
Stockholders’ equity 
  
 
  
Common stock: 209,071,488 shares issued and outstanding at December 31, 2014 and 213,461,778 at September 30, 201521
 21
Common stock: 224,970,412 shares issued and outstanding at December 31, 2015 and 228,750,220 at March 31, 201623
 23
Additional paid-in capital781,009
 870,511
1,110,539
 1,152,577
Accumulated deficit(196,997) (347,249)(366,658) (481,760)
Accumulated other comprehensive loss(676) (625)(517) (443)
Total stockholders’ equity583,357
 522,658
743,387
 670,397
Total liabilities and stockholders’ equity$749,290
 $820,743
$1,240,657
 $1,192,341
 
The accompanying notes are an integral part of the condensed consolidated financial statements.

3


Pandora Media, Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts)
(unaudited)
 
Three months ended 
 September 30,
 Nine months ended 
 September 30,
Three months ended 
 March 31,
2014 2015 2014 20152015 2016
Revenue 
  
       
Advertising$194,293
 $254,656
 $512,251
 $664,316
$178,739
 $220,308
Subscription and other45,300
 56,906
 140,551
 163,570
52,025
 54,732
Ticketing service
 22,265
Total revenue239,593
 311,562
 652,802
 827,886
230,764
 297,305
Cost of revenue 
  
       
Cost of revenue - Content acquisition costs111,315
 211,272
 331,051
 467,429
126,023
 171,264
Cost of revenue - Other15,453
 21,414
 44,421
 57,690
16,233
 20,999
Cost of revenue - Ticketing service
 14,646
Total cost of revenue126,768
 232,686
 375,472
 525,119
142,256
 206,909
Gross profit112,825
 78,876
 277,330
 302,767
88,508
 90,396
Operating expenses 
  
       
Product development13,381
 21,849
 38,288
 56,466
15,875
 35,846
Sales and marketing72,320
 107,286
 200,416
 285,595
84,274
 117,622
General and administrative29,143
 35,603
 81,369
 111,169
36,754
 46,296
Total operating expenses114,844
 164,738
 320,073
 453,230
136,903
 199,764
Loss from operations(2,019) (85,862) (42,743) (150,463)(48,395) (109,368)
Other income (expense), net44
 (36) 236
 417
Interest expense(131) (6,175)
Other income, net328
 862
Total other income (expense), net197
 (5,313)
Loss before provision for income taxes(1,975) (85,898) (42,507) (150,046)(48,198) (114,681)
Provision for income taxes
(50) (32) (177) (206)(59) (421)
Net loss$(2,025) $(85,930) $(42,684) $(150,252)$(48,257) $(115,102)
Weighted-average common shares outstanding used in computing basic and diluted net loss per share206,982
 212,760
 204,208
 211,487
209,928
 226,659
Net loss per share, basic and diluted$(0.01) $(0.40) $(0.21) $(0.71)$(0.23) $(0.51)
 
The accompanying notes are an integral part of the condensed consolidated financial statements.


4


Pandora Media, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
 
Three months ended 
 September 30,
 Nine months ended 
 September 30,
Three months ended 
 March 31,
2014 2015 2014 20152015 2016
Net loss$(2,025) $(85,930) $(42,684) $(150,252)$(48,257) $(115,102)
Change in foreign currency translation adjustment(138) (127) (122) (274)(99) (233)
Change in net unrealized gains (losses) on marketable securities(217) 50
 (17) 324
Other comprehensive income (loss)(355) (77) (139) 50
Change in net unrealized gains on marketable securities558
 305
Other comprehensive income459
 72
Total comprehensive loss$(2,380) $(86,007) $(42,823) $(150,202)$(47,798) $(115,030)
 
The accompanying notes are an integral part of the condensed consolidated financial statements.


5


Pandora Media, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited) 
Nine months ended 
 September 30,
Three months ended 
 March 31,
2014 20152015 2016
Operating activities 
  
 
  
Net loss$(42,684) $(150,252)$(48,257) $(115,102)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities 
  
 
  
Depreciation and amortization11,224
 15,194
4,340
 13,277
Stock-based compensation60,116
 79,473
23,195
 38,655
Amortization of premium on investments, net2,106
 1,712
619
 140
Other operating activities797
 1,610
834
 895
Amortization of debt discount
 4,434
Changes in operating assets and liabilities 
 

 
  
Accounts receivable(34,142) (45,796)29,182
 38,514
Prepaid expenses and other assets(4,003) (6,564)(5,076) (19,742)
Accounts payable and accrued liabilities5,807
 31,101
Accounts payable, accrued and other current liabilities8,087
 (3,467)
Accrued royalties5,416
 89,423
6,896
 14,152
Accrued compensation12,579
 4,333
(4,390) 2,597
Other long-term liabilities(1,526) 659
Deferred revenue(24,407) 7,689
12,328
 7,640
Reimbursement of cost of leasehold improvements3,161
 1,014
749
 4,244
Net cash provided by (used in) operating activities(4,030) 28,937
26,981
 (13,104)
Investing activities 
  
 
  
Purchases of property and equipment(23,479) (27,333)(4,339) (14,371)
Internal-use software costs(1,592) (7,177)
Purchases of investments(273,427) (138,721)(56,790) (4,993)
Proceeds from maturities of investments186,667
 179,799
78,489
 8,332
Proceeds from sale of investments
 41,317
640
 
Payments related to acquisitions, net of cash acquired
 (23,028)
Payments related to acquisition, net of cash acquired
 (676)
Net cash provided by (used in) investing activities(110,239) 32,034
16,408
 (18,885)
Financing activities 
  
 
  
Proceeds from employee stock purchase plan4,388
 5,089
1,619
 1,687
Proceeds from exercise of stock options15,168
 3,718
1,094
 520
Tax payments from net share settlements of restricted stock units(1,986) (2,295)(888) (1,294)
Net cash provided by financing activities17,570
 6,512
1,825
 913
Effect of exchange rate changes on cash and cash equivalents(172) (459)(157) (137)
Net increase (decrease) in cash and cash equivalents(96,871) 67,024
45,057
 (31,213)
Cash and cash equivalents at beginning of period245,755
 175,957
175,957
 334,667
Cash and cash equivalents at end of period$148,884
 $242,981
$221,014
 $303,454
Supplemental disclosures of cash flow information      
Cash paid during the period for interest$314
 $343
$83
 $107
Purchases of property and equipment recorded in accounts payable and accrued liabilities$2,550
 $1,328
$2,783
 $6,356
 
The accompanying notes are an integral part of the condensed consolidated financial statements.


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



1.                      Description of Business and Basis of Presentation
 
Pandora Media, Inc. provides an internet radio service

Pandora is the world’s most powerful music discovery platform, offering a personalized experience for each listenerof our listeners wherever and whenever they want to listen to radiomusic—whether through earbuds, car speakers or live on a wide range of smartphones, tablets, computers and car audio systems, as well as a range of other internet-connected devices. We have pioneered a new form of radio—one that uses intrinsic qualitiesstage. Our vision is to be the definitive source of music to initially create stationsdiscovery and then adapts playlists in real-time basedenjoyment for billions. The majority of our listener hours occur on mobile devices, with the individual feedback of each listener. We generate a majority of our revenue by offeringgenerated from advertising on these devices. We offer both local and national advertisers anthe opportunity to deliver targeted messages to our listeners using a combination of audio, display and video advertisements. We also generate revenue by offering a paidan advertising-free subscription service which we call Pandora One. 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;States, and we also operate in Australia, New Zealand and New Zealand.Canada.

Ticketing Service

Ticketfly is a leading live events technology company that provides ticketing and marketing software and services for 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. We completed the acquisition of Ticketfly on October 31, 2015.

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, 2014.2015.
 
Certain changes in presentation have been made to conform the prior period presentation to current period reporting. We have reclassified goodwill and intangible assetscertain amounts from the accounts payable, accrued and other long-term assetscurrent liabilities line item to the goodwill and intangible assets, net line items in our condensed consolidated balance sheets. We have also reclassified certain non-cash amounts from the amortization of debt issuance costs and the change in accounts receivable line items to the other operating activitieslong-term liabilities line item inof our condensed consolidated statements of cash flows. Additionally, weWe have also reclassified certain non-cash amountsinternal-use software costs from the purchases of property and equipment line item to the prepaid expenses and other assetsinternal-use software costs line item of our condensed consolidated statements of cash flows. Lastly, we have reclassified interest expense from the other income (expense), net line item to the interest expense line item 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 royalties, selling prices for elements sold in multiple-element arrangements, the allowance for doubtful accounts, the fair value of stock options, market stock units ("MSUs") and the Employee Stock Purchase Plan ("ESPP"), the impact of forfeitures on stock-based compensation, the provision for (benefit from) income taxes the subscription return reserve, the fair value of acquired intangible assets and goodwill and the useful livesimpact of acquired intangible assets.forfeitures on stock-based compensation. 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 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.

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

2.                       Summary of Significant Accounting Policies
 
Other than discussed below, thereThere 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, 2014.

Business Combinations, Goodwill and Intangible Assets, net

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



We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.

We review goodwill and indefinite-lived intangible assets for impairment at least annually or more frequently if events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable. We first assess the qualitative factors to determine whether it is more likely than not that the fair value of our single reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test under Accounting Standards Update (ASU) No. 2011-08, Goodwill and Other (Topic 350): Testing Goodwill for Impairment, issued by the Financial Accounting Standards Board (FASB). If we determine that it is more likely than not that its fair value is less than its carrying amount, then the two-step goodwill impairment test is performed. The first step, identifying a potential impairment, compares the fair value of the reporting unit with its carrying amount. If the carrying amount exceeds its fair value, the second step would need to be performed; otherwise, no further step is required. The second step, measuring the impairment loss, compares the implied fair value of the goodwill with the carrying amount of the goodwill. Any excess of the goodwill carrying amount over the fair value is recognized as an impairment loss, and the carrying value of goodwill is written down to fair value. As of September 30, 2015, no impairment of goodwill has been identified.

Acquired finite-lived intangible assets are amortized over the estimated useful lives of the assets, which range from two to four years. Acquired finite-lived intangible assets consist primarily of patents, customer relationships, developed technology and trade names resulting from business combinations. We evaluate the recoverability of our intangible assets for potential impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of intangible assets is not recoverable, the carrying amount of such assets is reduced to the fair value.

In addition to the recoverability assessment, we routinely review the remaining estimated useful lives of finite-lived intangible assets. If we reduce the estimated useful life assumption for any asset, the remaining unamortized balance would be amortized over the revised estimated useful life.

Sales and Marketing Expenses - Advertising

We expense the costs of producing advertisements as they are incurred and expense the cost of communicating advertisements at the time the advertisement airs or the event occurs, in each case as sales and marketing expense within the accompanying condensed consolidated statements of operations. During the three months ended September 30, 2014 and 2015 and the nine months ended September 30, 2014 and 2015, we recorded advertising expenses of $3.9 million, $15.9 million, $6.2 million and $22.2 million, respectively.

Stock-Based Compensation — MSUs

We implemented a market stock unit program in March 2015 for certain key executives. Specifically, MSUs measure Pandora’s total stockholder return (“TSR”) performance against that of the Russell 2000 Index across three performance periods.

We have determined the grant-date fair value of the MSUs using a Monte Carlo simulation performed by a third-party valuation specialist. The Monte Carlo simulation model utilizes multiple input variables to estimate the probability that market conditions will be achieved. These variables include our expected stock price volatility over the expected term of the award, actual and projected employee stock option exercise behaviors and the risk-free interest rate for the expected term of the award.

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


The variables used in these models are reviewed on an annual basis and adjusted, as needed. We recognize stock-based compensation for the MSUs over the requisite service period using the accelerated attribution method.2015.

Concentration of Credit Risk
 
For the three and nine months ended September 30, 2014March 31, 2015 and 2015,2016, we had no customers that accounted for more than 10% of our total revenue. As of December 31, 20142015 and September 30, 2015,March 31, 2016, we had no customers that accounted for more than 10% of our total accounts receivable.
 
Recently Issued Accounting Standards

In September 2015,March 2016, the Financial Accounting Standards Board ("FASB")FASB issued Accounting Standards Update No. 2015-16,2016-09, Business Combinations Compensation - Stock Compensation (Topic 718)(" ("ASU 2015-16")2016-09)". ASU 2015-16 eliminates2016-09 requires all income tax effects of awards to be recognized in the requirementincome statement when the awards vest or are settled. Additionally, it allows an employer to repurchase more of an employee's shares for an acquirer intax withholding purposes without triggering liability accounting and to make a business combinationpolicy election to account for measurement-period adjustments retrospectively. Rather, the acquirer must recognize adjustments during the period in which the amounts are determined, including the effect on earnings of any amounts that would have been recorded in previous periods.forfeitures as they occur. The guidance is effective for fiscal years beginning after December 15, 2015,2016, and interim periods within that fiscal year, although early adoption is permitted. We are currently planning to early adoptevaluating implementation methods and the effect that implementation of this standard beginning with the three months ended December 31, 2015. We do not expect the adoption of this guidance towill have a material effect on our consolidated financial statements.statements upon adoption.

In August 2014, the FASB issued Accounting Standards Update No. 2014-15, Going Concern (Subtopic 205-40) (“ASU 2014-15”). ASU 2014-15 requires management of all entities to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued (or available to be issued when applicable). The guidance is effective for fiscal years beginning after December 15, 2016 and for interim periods within that fiscal year. We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update No. 2014-9, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-9”). ASU 2014-9 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. The standard may be 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 are currently evaluating implementation methods and the effect that implementation of this standard will have on our consolidated financial statements upon 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 are currently evaluating implementation methods and the effect that implementation of this standard will have on our consolidated financial statements upon adoption.

3.                       Cash, Cash Equivalents and Investments
 
Cash, cash equivalents and investments consisted of the following:
 

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


As of 
 December 31, 
 2014
 As of 
 September 30, 
 2015
As of 
 December 31, 
 2015
 As of 
 March 31, 
 2016
(in thousands)(in thousands)
Cash and cash equivalents 
  
 
  
Cash$72,487
 $79,423
$104,361
 $109,287
Money market funds89,113
 161,808
180,021
 112,561
Commercial paper9,349
 1,750
31,089
 68,547
Corporate debt securities5,008
 
2,000
 11,058
U.S. government and government agency debt securities17,196
 2,001
Total cash and cash equivalents$175,957
 $242,981
$334,667
 $303,454
Short-term investments 
  
 
  
Commercial paper$45,443
 $33,484
$4,792
 $8,795
Corporate debt securities128,691
 84,629
31,052
 37,010
U.S. government and government agency debt securities4,497
 2,501
Total short-term investments$178,631
 $120,614
$35,844
 $45,805
Long-term investments 
  
 
  
Corporate debt securities$100,998
 $78,982
$46,369
 $33,238
U.S. government and government agency debt securities3,245
 
Total long-term investments$104,243
 $78,982
$46,369
 $33,238
Cash, cash equivalents and investments$458,831
 $442,577
$416,880
 $382,497
 
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, 20142015 and September 30, 2015.March 31, 2016.
 
As of December 31, 2014As of December 31, 2015
Adjusted
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
Adjusted
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
(in thousands)(in thousands)
Money market funds$89,113
 $
 $
 $89,113
$180,021
 $
 $
 $180,021
Commercial paper54,792
 
 
 54,792
35,881
 
 
 35,881
Corporate debt securities235,135
 6
 (444) 234,697
79,760
 8
 (347) 79,421
U.S. government and government agency debt securities7,751
 
 (9) 7,742
17,198
 
 (2) 17,196
Total cash equivalents and marketable securities$386,791
 $6
 $(453) $386,344
$312,860
 $8
 $(349) $312,519

As of September 30, 2015As of March 31, 2016
Adjusted
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
Adjusted
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
(in thousands)(in thousands)
Money market funds$161,808
 $
 $
 $161,808
$112,561
 $
 $
 $112,561
Commercial paper35,234
 
 
 35,234
77,342
 
 
 77,342
Corporate debt securities163,735
 100
 (224) 163,611
81,342
 36
 (72) 81,306
U.S. government and government agency debt securities2,500
 1
 
 2,501
2,001
 
 
 2,001
Total cash equivalents and marketable securities$363,277
 $101
 $(224) $363,154
$273,246
 $36
 $(72) $273,210
 
The following table presents available-for-sale investments by contractual maturity date as of December 31, 2015 and March 31, 2016.

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


The following table presents available-for-sale investments by contractual maturity date as of December 31, 2014 and September 30, 2015.
As of December 31, 2014As of December 31, 2015
Adjusted
Cost
 Fair Value
Adjusted
Cost
 Fair Value
(in thousands)(in thousands)
Due in one year or less$282,206
 $282,101
$266,205
 $266,150
Due after one year through three years104,585
 104,243
46,655
 46,369
Total$386,791
 $386,344
$312,860
 $312,519
As of September 30, 2015As of March 31, 2016
Adjusted
Cost
 Fair Value
Adjusted
Cost
 Fair Value
(in thousands)(in thousands)
Due in one year or less$284,126
 $284,172
$239,998
 $239,972
Due after one year through three years79,151
 78,982
33,248
 33,238
Total$363,277
 $363,154
$273,246
 $273,210
 
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, 20142015 and September 30, 2015.March 31, 2016.

As of December 31, 2014As of December 31, 2015
Twelve Months or Less More than Twelve Months TotalTwelve Months or Less More than Twelve Months Total
Fair
Value
 Gross Unrealized Losses Fair
Value
 Gross Unrealized Losses Fair
Value
 Gross Unrealized LossesFair
Value
 Gross Unrealized Losses Fair
Value
 Gross Unrealized Losses Fair
Value
 Gross Unrealized Losses
(in thousands)(in thousands)
Money market funds$
 $
 $
 $
 $
 $
Commercial paper
 
 
 
 
 
Corporate debt securities192,699
 (422) 12,148
 (22) 204,847
 (444)$64,804
 $(293) $8,531
 $(54) $73,335
 $(347)
U.S. government and government agency debt securities5,240
 (9) 
 
 5,240
 (9)16,241
 (2) 
 
 16,241
 (2)
Total$197,939
 $(431) $12,148
 $(22) $210,087
 $(453)$81,045
 $(295) $8,531
 $(54) $89,576
 $(349)

 As of September 30, 2015
 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)
Money market funds$
 $
 $
 $
 $
 $
Commercial paper
 
 
 
 
 
Corporate debt securities82,366
 (209) 14,569
 (15) 96,935
 (224)
U.S. government and government agency debt securities
 
 
 
 
 
Total$82,366
 $(209) $14,569
 $(15) $96,935
 $(224)
 As of March 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$24,891
 $(30) $19,488
 $(42) $44,379
 $(72)
Total$24,891
 $(30) $19,488
 $(42) $44,379
 $(72)



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


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 September 30, 2015March 31, 2016 were primarily a result of unfavorable changes in interest rates subsequent to the initial purchase of these securities. As of September 30, 2015,March 31, 2016, we owned 7737 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 September 30, 2015March 31, 2016 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

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


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 and nine months ended September 30, 2015,March 31, 2016, we did not recognize any impairment charges. During the three and nine months ended September 30, 2015, proceeds from the sale of available-for-sale securities were $37.7 million and $41.3 million. We did not recognize a realized gain or loss in connection with these sales.

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, 20142015 and September 30, 2015:March 31, 2016:
 

12
 As of December 31, 2015
 Fair Value Measurement Using
 
Quoted Prices in Active Markets
for Identical
Instruments
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 Total
 (in thousands)
Assets 
  
  
Money market funds$180,021
 $
 $180,021
Commercial paper
 35,881
 35,881
Corporate debt securities
 79,421
 79,421
U.S. government and government agency debt securities
 17,196
 17,196
Total assets measured at fair value$180,021
 $132,498
 $312,519

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


 As of December 31, 2014
 Fair Value Measurement Using
 
Quoted Prices in Active Markets
for Identical
Instruments
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 Total
 (in thousands)
Assets 
  
  
Money market funds$89,113
 $
 $89,113
Commercial paper
 54,792
 54,792
Corporate debt securities
 234,697
 234,697
U.S. government and government agency debt securities
 7,742
 7,742
Total assets measured at fair value$89,113
 $297,231
 $386,344
As of September 30, 2015As of March 31, 2016
Fair Value Measurement UsingFair Value Measurement Using
Quoted Prices in Active Markets
for Identical
Instruments
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 Total
Quoted Prices in Active Markets
for Identical
Instruments
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 Total
(in thousands)(in thousands)
Assets 
  
  
 
  
  
Money market funds$161,808
 $
 $161,808
$112,561
 $
 $112,561
Commercial paper
 35,234
 35,234

 77,342
 77,342
Corporate debt securities
 163,611
 163,611

 81,306
 81,306
U.S. government and government agency debt securities
 2,501
 2,501

 2,001
 2,001
Total assets measured at fair value$161,808
 $201,346
 $363,154
$112,561
 $160,649
 $273,210
 
Our money market funds are classified as Level 1 within the fair value hierarchy because they are valued primarily using quoted market prices. 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, 20142015 and September 30, 2015,March 31, 2016, we held no Level 3 assets or liabilities.

5.                      Commitments and Contingencies
 
Legal Proceedings
 
We have been in the past, and continue to be, a party to rate-setting, privacy and patent infringement litigationvarious legal proceedings, which have consumed, and may continue to consume, financial and managerial resources. We are also from time to time subject to various other legal proceedings and claims arising in the ordinary course of our business. 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.

Performing Rights Organization ("PRO") rate-setting litigation
On November 5, 2012, we filed a petition in the rate court in the U.S. District Court for the Southern District of New York established by the consent decree between the American Society of Composers, Authors and Publishers (“ASCAP”) and the U.S. Department of Justice for the determination of reasonable license fees and terms for an ASCAP blanket license for the

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


period from January 1, 2011 through December 31, 2015. A trial to determine the royalty rate for this blanket license concluded in February 2014, and in March 2014, the court issued its opinion establishing a royalty rate of 1.85% of revenue before certain deductions. On April 14, 2014, ASCAP, Sony/ATV, EMI Music Publishing, and Universal Publishing Group filed notices of appeal of the district court’s decision with the Second Circuit Court of Appeals. Oral arguments were held before the Second Circuit on March 19, 2015. On May 6, 2015 the Second Circuit upheld the district court’s ruling. On June 3, 2015, ASCAP petitioned the Second Circuit for a rehearing. On June 26, 2015, that petition was denied.

On June 13, 2013, Broadcast Music, Inc. (“BMI”) filed a petition in the rate court in the U.S. District Court for the Southern District of New York established by the consent decree between BMI and the U.S. Department of Justice for the determination of reasonable fees and terms for a BMI blanket license for the period from January 1, 2013 through December 31, 2016. The rate proceeding concluded on March 13, 2015, and in May 2015, the court issued its opinion establishing a royalty rate of 2.5% of revenue before certain deductions. On June 26, 2015, we filed a notice of appeal of the court's decision with the Second Circuit Court of Appeals. On October 19, 2015, we filed our appeal brief. Briefing will continue through February 2016. The district court's decision and our appeal of the court's decision did not have a material impact on our consolidated statements of operations for the three and nine months ended September 30, 2015.
RMLC ("Radio Music Licensing Committee")

In June 2013, we entered into an agreement to purchase the assets of KXMZ-FM and in June 2015 the Federal Communications Commission ("FCC") approved the transfer of the FCC licenses and the acquisition was completed. The agreement to purchase the assets of KXMZ allowed us to qualify for the RMLC royalty rate of 1.7% of revenue for a license to the ASCAP and BMI repertoires, before certain deductions, beginning in June 2013. As a result, we recorded cost of revenue - content acquisition costs at the RMLC royalty rate starting in June 2013, rather than the rate that was set in rate court proceedings in March 2014 for ASCAP and in May 2015 for BMI.

In the three months ended September 30, 2015, despite confidence in our legal position that we were entitled to the RMLC royalty rate starting in June 2013, and as part of our strategy to strengthen our partnership with the music industry, management decided to forgo the application of the RMLC royalty rate from June 2013 through September 2015. As a result, we recorded a one-time cumulative charge to increase cost of revenue - content acquisition costs within our condensed consolidated financial statements of $23.9 million in the three and nine months ended September 30, 2015 related to spins played from June 2013 through September 30, 2015 in order to align the cumulative cost of revenue - content acquisition costs to the amounts previously paid at the rates that were set in the rate court proceedings in March 2014 for ASCAP and May 2015 for BMI.

Pre-1972 copyright litigation

On April 17, 2014, UMG Recordings, Inc., Sony Music Entertainment, Capitol Records, LLC, Warner Music Group Corp. and ABKCO Music and Records, Inc. filed suit against Pandora Media Inc. in the Supreme Court of the State of New York. The complaint claims common law copyright infringement and unfair competition arising from allegations that Pandora owes royalties for the public performance of sound recordings recorded prior to February 15, 1972.

In October 2015, the parties reached an agreement ("pre-1972 settlement") whereby we agreed to pay the plaintiffs a total of $90 million. The settlement resolves all past claims as to our use of pre-1972 recordings owned or controlled by the plaintiffs and enables us, without any additional payment, to reproduce, perform and broadcast such recordings in the United States through December 31, 2016. This agreement was approved by our board of directors and executed on October 21, 2015. Pursuant to this settlement, we agreed to paypaid the plaintiffs $60 million on or beforein October 23, 2015 and the plaintiffs will dismissdismissed the case with prejudice.  We recordedAs a result, cost of revenue - content acquisition costs increased by $65.4 million in the twelve months ended December 31, 2015, of which $57.9 million was related to a one-time cumulative charge of $57.9 million to cost of revenue - content acquisition costs within our condensed consolidated statements of operations for the three and nine months ended September 30, 2015 related to the pre-1972 spins played through September 30, 2015. The remaining charge of $32.1$24.6 million will be recorded in cost of revenue - content acquisition costs over the future service period of October 1, 2015 through December 31,in 2016 based on expected streaming of pre-1972 recordings over the period. ThisThe pre-72 settlement further requires that we make four additional installment payments of $7.5 million each. The first was paid in December 2015 and the second was paid in March 2016. The remaining two installments will be paid in five installments. The first installment of $60 million was paid in October 2015, and the remaining amount will be paid in four equal installments of $7.5 million from Januaryon or before July 1, 2016 throughand October 1, 2016.

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

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


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. This motion was denied, and we have appealed the ruling to the Ninth Circuit Court of Appeals. As a result, the district court litigation has been stayed pending the Ninth Circuit's review.

On September 14, 2015, Arthur and Barbara Sheridan, et al filed a class action suit against Pandora Media, Inc. in the federal district court for the Northern District of California. The complaint alleges common law misappropriation, unfair competition, conversion, unjust enrichment and violation of California rights of publicity arising from allegations that we owe royalties for the public performance of sound recordings recorded prior to February 15, 1972. We are currently preparing our responseOn October 28, 2015, the Court granted the parties’ stipulation to thesestay the district court action pending the Ninth Circuit’s review of Pandora’s appeal in Flo & Eddie et al. v. Pandora Media, Inc., which involves similar allegations.

On September 16, 2015, Arthur and Barbara Sheridan, et al filed a second class action suit against Pandora Media, Inc. in the federal district court for the Southern District of New York. The complaint alleges common law copyright infringement, violation of New York right of publicity, unfair competition and unjust enrichment arising from allegations that we owe royalties for the public performance of sound recordings recorded prior to February 15, 1972. We are currently preparing our responseOn October 28, 2015 the Court granted the parties’ stipulation to thesestay the district court action pending the Second Circuit’s review of Sirius XM’s appeal in the Flo & Eddie et al. v. Sirius XM matter, which involves similar allegations.

On October 17, 2015, Arthur and Barbara Sheridan, et al filed a third class action suit against us in the federal district court for the Northern District of Illinois (“Third Class Action Suit”). The complaint alleges common law copyright infringement, violation of the Illinois Uniform Deceptive Trade Practices Act, conversion, and unjust enrichment arising from allegations that we owe royalties for the public performance of sound recordings recorded prior to February 15, 1972. We are currently preparing our responseOn December 29, 2015, Pandora filed a motion to these allegations.dismiss and motion to stay the case pending the Second Circuit’s decision. The motion to stay was denied, and the motion to dismiss remains pending.

On October 19, 2015, Arthur and Barbara Sheridan, et al filed a fourth class action suit against us in the federal district court for the District of New Jersey (“Fourth Class Action Suit”). The complaint alleges common law copyright infringement, unfair competition and unjust enrichment arising from allegations that we owe royalties for the public performance of sound recordings recorded prior to February 15, 1972. We are currently preparing our responseOn December 29, 2015, Pandora filed a motion to these allegations.dismiss and motion to stay the case pending the Second Circuit’s decision. Both motions remain pending.

The outcome of any litigation is inherently uncertain. Except as noted above, including with respect to the $90 million settlement for UMG Recordings, Inc. et al v. Pandora Media Inc. in the Supreme Court of the State of New York, 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. In particular, rate court proceedings could take years to complete, could be very costly and may result in current and past royalty rates that are materially less favorable than rates we currently pay or have paid in the past.
 
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 financial position, results of operations or cash flows.

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



6.                      Goodwill and Intangible Assets

AcquisitionsDuring the three months ended March 31, 2016, we completed a business combination that was not material to our condensed consolidated financial statements. The changes in the carrying amount of goodwill for the three months ended March 31, 2016, are as follows:

 Goodwill
 (in thousands)
Balance as of December 31, 2015$303,875
Goodwill resulting from business combinations and finalization of fair value912
Balance as of March 31, 2016$304,787

 The following summarizes information regarding the gross carrying amounts and accumulated amortization of intangible assets.
  As of December 31, 2015 As of March 31, 2016
  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
 $(1,824) $6,206
 $8,030
 $(2,007) $6,023
Developed technology 56,050
 (1,265) 54,785
 56,166
 (4,346) 51,820
Customer relationships - clients 37,300
 (777) 36,523
 37,400
 (1,953) 35,447
Customer relationships - users 1,940
 (318) 1,622
 1,940
 (561) 1,379
Trade names 11,720
 (304) 11,416
 11,735
 (754) 10,981
Total finite-lived intangible assets $115,040
 $(4,488) $110,552
 $115,271
 $(9,621) $105,650
             
Indefinite-lived intangible assets            
FCC license - Broadcast Radio $193
 $
 $193
 $193
 $
 $193
             
Total intangible assets $115,233
 $(4,488) $110,745
 $115,464
 $(9,621) $105,843

Amortization expense of intangible assets was $0.2 million and $5.1 million for the three months ended March 31, 2015 and 2016.

The following is a schedule of future amortization expense related to finite-lived intangible assets as of March 31, 2016.

 As of 
 March 31, 
 2016
 (in thousands)
Remainder of 2016$15,414
201720,118
201817,654
201917,129
202015,896
Thereafter19,439
Total future amortization expense$105,650

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



7.Debt Instruments

Long-term debt, net consisted of the following:

 As of December 31, As of March 31,
 2015 2016
 (in thousands)
1.75% convertible senior notes due 2020$345,000
 $345,000
Unamortized discount on convertible senior notes(110,423) (105,989)
Long-term debt, net$234,577
 $239,011
Convertible Debt Offering

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 below; thereafter, until the second scheduled trading day prior to maturity, the Notes will be convertible at the option of holders at any time.

The conversion rate for the Notes is initially 60.9050 shares of common stock per $1,000 principal amount of the Notes, which is equivalent to an initial conversion price of approximately $16.42 per share of our common stock, and is subject to adjustment in certain circumstances.

We will not have the right to redeem the Notes prior to December 5, 2018. We may redeem all or any portion of the Notes for cash at our option on or after December 5, 2018 if the last reported sale price of our common stock is at least 130% of the conversion price then in effect for at least 20 trading days, whether or not consecutive, during any 30 consecutive trading day period, including the last trading day of such period, ending on, and including, any of the five trading days immediately preceding the date on which we provide notice of redemption. Any optional redemption of the Notes will be at a redemption price equal to 100% of the principal amount of the Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. The maximum number of shares of common stock the Notes are convertible into is approximately 27.3 million, and is subject to adjustment under certain circumstances.

The Notes will be convertible at the option of holders only under the following circumstances:

Prior to the close of business on the business day immediately preceding July 1, 2020, during any calendar quarter commencing after the calendar quarter ending on March 31, 2016 (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive), during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day;

Prior to the close of business on the business day immediately preceding July 1, 2020, during the five business day period after any ten consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less

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


Inthan 98% of the product of the last reported sale price of our common stock and the conversion rate on each such trading day;

Prior to the business day immediately preceding July 2015,1, 2020, upon the occurrence of specified corporate events; or

At any time on or after July 1, 2020 until the close of business on the second scheduled trading day immediately preceding the December 1, 2020 maturity date.

Upon the occurrence of a make-whole fundamental change or if we completedcall all or any portion of the acquisitionNotes for redemption prior to July 1, 2020, we will, in certain circumstances, increase the conversion rate by a number of Next Big Sound, Inc. ("NBS"). Goodwill generatedadditional shares for a holder that elects to convert its Notes in connection with such make-whole fundamental change or during the related redemption period.

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 business acquisitiondate of issuance through the December 1, 2020 maturity date.

The initial debt component of the Notes was valued at $233.5 million, based on the contractual cash flows discounted at an appropriate market rate for non-convertible debt at the date of issuance. The carrying value of the permanent equity component reported in additional paid-in-capital was initially valued at $103.0 million, which is primarily attributablenet of $2.6 million of fees and expenses allocated to expected synergies from future growththe equity component.

The following table outlines the effective interest rate, contractually stated interest expense and fromcosts related to the potential to expand our Artist Marketing Platform ("AMP") and is not deductibleamortization of the discount for tax purposes. We have accounted for this acquisition as a business combination in the three months ended September 30, 2015. NBS provides analytics for online music, including analyzing the popularity of musicians in social networks, streaming services and radio.Notes:

In June 2013, we entered into an agreement to purchase the assets of KXMZ-FM. The Federal Communications Commission ("FCC") approved the transfer of the FCC licenses and the acquisition was completed in June 2015. We have accounted for this acquisition as a business combination in the nine months ended September 30, 2015.

These acquisitions were not material to our condensed consolidated financial statements, either individually or in the aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the three and nine months ended September 30, 2015 have not been presented. We have included the financial results of these business acquisitions in our condensed consolidated financial statements from their respective dates of acquisition.
 Three months ended 
 March 31, 2016
 (in thousands except for effective interest rate)
Effective interest rate10.18%
Contractually stated interest expense$1,509
Amortization of discount$4,434

The changescapped call transactions are expected to reduce the potential dilution to our common stock and/or offset the cash payments we would be required to make in excess of the principal amount of the converted Notes in the carrying amountevent that the market price of goodwill forour common stock, as measured under the nine months ended September 30, 2015,terms of the capped call transaction, is greater than the strike price of the capped call transaction, with such reduction and/or offset subject to a cap based on the cap price of the capped call transactions. The strike price of the capped call transactions corresponds to the initial conversion price of the Notes and is subject to certain adjustments under the terms of the capped call transactions. The capped call transactions have an initial cap price of $25.26 per share and are subject to certain adjustments under the terms of the capped call transactions. The capped call transactions have been included as follows:
 Goodwill
 (in thousands)
Balance as of December 31, 2014$
Goodwill resulting from business combinations23,052
Balance as of September 30, 2015$23,052
a net reduction to additional paid-in capital within stockholders’ equity.

 The following summarizes information regarding the gross carrying amounts and accumulated amortization of intangibles.
   As of December 31, 2014 As of September 30, 2015
 Useful Lives From Date of Acquisition (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Value Gross Carrying Amount Accumulated Amortization Net Carrying Value
   (in thousands) (in thousands)
Finite-lived intangible assets             
Patents5.5 - 11 $8,030
 $(1,091) $6,939
 $8,030
 $(1,640) $6,390
Developed technology4 
 
 
 1,550
 (97) 1,453
Customer relationships2 
 
 
 940
 (118) 822
Trade names2 
 
 
 320
 (40) 280
Total finite-lived intangible assets  $8,030
 $(1,091) $6,939
 $10,840
 $(1,895) $8,945
              
Indefinite-lived intangible assets             
FCC license - Broadcast Radio  $
 $
 $
 $193
 $
 $193
              
Total intangible assets  $8,030
 $(1,091) $6,939
 $11,033
 $(1,895) $9,138
Credit Facility

Amortization expenseWe are party to a $120.0 million credit facility with a syndicate of intangible assets was $0.2 million and $0.4 million for the three months endedfinancial institutions, which expires on September 30, 2014 and 2015, and12, 2018. As of March 31, 2016, we had no borrowings outstanding, $0.5 million in letters of credit outstanding and $0.8$119.5 million forof available borrowing capacity under the nine months ended September 30, 2014 and 2015, respectively.credit facility. We are in compliance with all financial covenants associated with the credit facility as of March 31, 2016.


8.Stock-based Compensation Plans and Awards

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


The following is a schedule of future amortization expense related to finite-lived intangible assets as of September 30, 2015.

 As of 
 September 30, 
 2015
 (in thousands)
Three months ending December 31, 2015$439
20161,750
20171,435
20181,120
2019926
Thereafter3,275
Total future amortization expense$8,945

7.Debt Instruments
We are party to a $60.0 million credit facility with a syndicate of financial institutions, which expires on September 12, 2018. As of September 30, 2015, we had no borrowings outstanding, $1.1 million in letters of credit outstanding and $58.9 million of available borrowing capacity under the credit facility. We are in compliance with all financial covenants associated with the credit facility as of September 30, 2015.


8.Stock-based Compensation Plans and Awards
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.

The per-shareWe estimate the fair value of shares to be grantedissued under the ESPP is determined 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, net of estimated forfeitures.
The following assumptions for the Black-Scholes option pricing model usingwere used to determine the following assumptions:per-share fair value of shares to be granted under the ESPP:


Three months ended September 30, Nine months ended September 30,Three months ended March 31,
2014
2015 2014 20152015
2016
Expected life (in years)0.5
 0.5
 0.5
 0.5
0.5
 0.5
Risk-free interest rate0.05 - 0.08%
 0.07 - 0.24%
 0.05 - 0.08%
 0.05 - 0.24%
0.05 - 0.07%
 0.24 - 0.41%
Expected volatility42% 29 - 42%
 42% 29 - 42%
42% 41%
Expected dividend yield0% 0% 0% 0%0% 0%
 
During the three months ended September 30, 2014March 31, 2015 and 2015,2016, we withheld $1.9$1.6 million and $1.8$1.7 million in contributions from employees and recognized $0.6 million and $0.6 million of stock-based compensation expense related to the ESPP, respectively. During the nine months ended September 30, 2014 and 2015, we withheld $4.4 million and $5.1 million in contributions from employees and recognized $1.5 million and $1.9 million of stock-based compensation expense related to the ESPP, respectively. In the three months ended September 30, 2014March 31, 2015 and 2015, 149,3782016, 282,966 and 255,432 shares of common stock were issued under the ESPP. In the nine months ended September 30, 2014 and 2015, 149,378 and 538,398611,348 shares of common stock were issued under the ESPP.
 
Employee Stock-Based Awards
 

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


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 expenses for stock options at the grant date fair value of the award and recognize expenses 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 September 30, 2014March 31, 2015 and 2015,2016, we recorded stock-based compensation expense from stock options of approximately $4.0$2.9 million and $2.3 million. During the nine months ended September 30, 2014 and 2015, we recorded stock-based compensation expense from stock options of approximately $11.2 million and $7.5$6.8 million.

The per-share fair value of each stock option was determined onThere were no options granted in the grant date using the Black-Scholes option pricing model using the following assumptions.

 Three months ended September 30, Nine months ended September 30,
 2014 2015 2014 2015
Expected life (in years)6.08
 6.08
 6.08
 6.08
Risk-free interest rate1.93% 1.92% 1.71 - 1.93%
 1.92%
Expected volatility58% 49% 58 - 59%
 49%
Expected dividend yield0% 0% 0% 0%
three months ended March 31, 2015 and 2016.

Restricted stock units ("RSUs")
 
The fair value of the restricted stock units 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 four years. During the three months ended September 30, 2014March 31, 2015 and 2015,2016, we recorded stock-based compensation expense from RSUs of approximately $17.5$19.6 million and $25.4 million. During the nine months ended September 30, 2014 and 2015, we recorded stock-based compensation expense from RSUs of approximately $47.4 million and $69.1$31.0 million.
 
MSUsMarket stock units ("MSUs")

We implemented a market stock unit program in March 2015 for certain key executives. MSUs are earned as a function of Pandora’s TSR performance measured against that of the Russell 2000 Index across three performance periods:


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


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 target 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.

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



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.

During the three and nine months ended September 30,March 31, 2015 we granted 776,000 MSUs at a total grant-date fair value of $4.3 million. There were no MSUs granted in the three months ended March 31, 2016. During the three and nine months ended September 30,March 31, 2015 and 2016, we recorded stock-based compensation expense from MSUs of approximately $0.5$0.1 million and $1.0$0.2 million.

In February 2016, the compensation committee of the board of directors certified the results of the first performance period of the 2015 MSU grant, which concluded December 31, 2015. During the first 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 first MSU performance period at 22% of the one-third vesting opportunity for the performance period.

Stock-based Compensation Expense
 
Stock-based compensation expense related to all employee and non-employee stock-based awards was as follows:
 
Three months ended 
 September 30,
 Nine months ended 
 September 30,
Three months ended 
 March 31,
2014 2015 2014 20152015 2016
(in thousands) (in thousands)(in thousands)
Stock-based compensation expense 
  
     
  
Cost of revenue - Other$1,063
 $1,427
 $2,976
 $4,040
$1,207
 $1,477
Cost of revenue - Ticketing service
 60
Product development4,402
 6,189
 12,289
 16,148
4,605
 8,501
Sales and marketing10,442
 13,732
 28,675
 38,403
11,344
 13,613
General and administrative6,204
 7,446
 16,176
 20,882
6,039
 15,004
Total stock-based compensation expense$22,111
 $28,794
 $60,116
 $79,473
$23,195
 $38,655

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
 

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


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 and market stock units, to the extent dilutive. Basic and diluted net loss per share were the same for the three and nine months ended September 30, 2014March 31, 2015 and 2015,2016, as the inclusion of all potential common shares outstanding would have been anti-dilutive.
 
The following table sets forth the computation of historical basic and diluted net loss per share:
 
Three months ended September 30, Nine months ended September 30,Three months ended March 31,
2014 2015 2014 20152015 2016
(in thousands except per share amounts)(in thousands except per share amounts)
Numerator 
  
       
Net loss$(2,025) $(85,930) $(42,684) $(150,252)$(48,257) $(115,102)
Denominator 
  
       
Weighted-average common shares outstanding used in computing basic and diluted net loss per share206,982
 212,760
 204,208
 211,487
209,928
 226,659
Net loss per share, basic and diluted$(0.01) $(0.40) $(0.21) $(0.71)$(0.23) $(0.51)
 
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:
 

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


As of September 30,As of March 31,
2014 20152015 2016
(in thousands)(in thousands)
Options to purchase common stock11,571
 10,492
10,787
 12,627
Restricted stock units11,339
 16,653
15,764
 22,947
Market stock units
 776
776
 776
Total common stock equivalents22,910
 27,921
27,327
 36,350
 

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TableOn December 9, 2015, we completed an offering of Contents
Pandora Media, Inc.
our 1.75% convertible senior notes due 2020. Under the treasury stock method, the Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


10.Subsequent Eventswill 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, 2016, the conversion feature of the Notes was anti-dilutive.

AcquisitionIn connection with the pricing of Ticketfly, Inc. ("Ticketfly")

On October 7, 2015,the Notes, we entered into an agreement to acquire Ticketfly, a leading live events technology company that provides ticketing services and marketing software for venues and event promoters across North America. Pursuant tocapped call transactions which increase the merger agreement, we have agreed to pay $225 million in cash and approximately 11.6 million shares of common stock, subject to customary adjustments for working capital, cash, indebtedness and transaction expenses. Per the agreement, we are entitled to a net cash balance of $50 million as part of these adjustments. In addition to the purchaseeffective conversion price unvested options and unvested RSUs of Ticketfly held by Ticketfly employees will be converted respectively into unvested options and unvested RSUs to acquire our common stock. The closing is subject to customary closing conditions, including the expiration or termination of any waiting periods under applicable antitrust laws, and we expect the closing to occur in the three months ending December 31, 2015. We will include the financial results of Ticketfly in our condensed consolidated financial statements as of the date of acquisition.

Pre-1972 copyright litigation

Refer to the pre-1972 settlement, Third Class Action Suit and Fourth Class Action Suit matters under the “Legal Proceedings” subheading in Note 5. Commitments and Contingencies of the Notes, and are designed to Condensed Consolidated Financial Statements in Part I, Item 1reduce potential dilution upon conversion of this Quarterly Report on Form 10-Qthe 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 information related to the pre-1972 settlement and pending litigation filed after the three months ended September 30, 2015.further details regarding our Notes.







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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, 20142015 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, 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, 2014.2015. 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.
 
Some of the industry and market data contained in this Quarterly Report on Form 10-Q are based on independent industry publications, including those generated by Triton Digital Media (“Triton”) or other publicly available information. This information involves a number of assumptions and limitations. Although we believe that each source is reliable as of its respective date, we have not independently verified the accuracy or completeness of this information.
 
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 Service

Pandora is the leader in internet radio in the United States,world’s most powerful music discovery platform, offering a personalized experience for each of our listeners wherever and whenever they want to listen to radiomusic—whether through earbuds, car speakers or live on a wide rangestage. Our vision is to be the definitive source of smartphones, tablets, computersmusic discovery and car audio systems, as well as a range of other internet-connected devices.enjoyment for billions. The majority of our listener hours occur on mobile devices, with the majority of our revenue generated from advertising on these devices. We have pioneered a new form of radio—one that uses intrinsic qualities of music to initially create stations and then adapts playlists in real-time based on the individual feedback of each listener. We offer both local and national advertisers anthe opportunity to deliver targeted messages to our listeners using a combination of audio, display and video advertisements. Founded by musicians, Pandora also empowers artists with valuable data and tools to help grow their careers and connect with their fans.
 
For the three months ended September 30, 2015,March 31, 2016, we streamed 5.145.52 billion hours of radio, and as of September 30, 2015,March 31, 2016, we had 78.179.4 million active users during the prior 30-day period. Since we launched our free, advertising-supportednon-subscription, ad-supported radio service in 2005 our listeners have created over 910 billion stations.
 
At the coreheart 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 1,000,000 uniquely analyzed songs from over 350,000150,000 artists, spanning over 600 genres and sub-genres, which we develop one song at a time by evaluating and cataloging each song’s particular attributes. 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. Based on listener

reactions to the recordings we pick, we further tailor the station to match the listener's preferences. Listeners also have the ability to add variety to and rename stations, which further allows for the personalization of our service.

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We currently provide the Pandora service through two models:
 
Free Service. Our free service is advertising-basedadvertising-supported and allows listeners access to our music and comedy catalogs and personalized playlist generating system for free across all of our delivery platforms.
 
Pandora One. Pandora One is a premium daily, monthly or annual paid subscriptionversion of the Pandora service, without any advertising.which currently includes advertisement-free access. Pandora One also enables listeners to have more daily skips, enjoy higher quality audio on supported devices and enjoy longer timeout-free listening.

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, Android and the Windows Phone and for tablets including the iPad and Android tablets. We distribute those mobile apps free to listeners via app stores. In addition to smartphones and tablets, Pandora is now integrated with more than 1,0001,700 connected devices, including automobiles, automotive aftermarket devices and consumer electronic devices.

Recent Events
AcquisitionsTicketing Service

Acquisition of Ticketfly Inc. ("Ticketfly")

On October 7, 2015, we entered into an agreement to acquire Ticketfly,is a leading live events technology company that provides ticketing services and marketing software and services for venues and event promoters across North America. PursuantTicketfly'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 merger agreement, we have agreed to pay $225 million in cash and approximately 11.6 million shares of common stock, subject to customary adjustments for working capital, cash, indebtedness and transaction expenses. Per the agreement, weTicketfly platform but are entitled to a net cash balance of $50 millionalso sold through other channels such as part of these adjustments. In addition to the purchase price, unvested options and unvested restricted stock units ("RSUs") of Ticketfly held by Ticketfly employees will be converted respectively into unvested options and unvested RSUs to acquire our common stock. The closing is subject to customary closing conditions, including the expiration or termination of any waiting periods under applicable antitrust laws, and we expect the closing to occur in the three months ending December 31, 2015. We will include the financial results of Ticketfly in our condensed consolidated financial statements as of the date of acquisition.

Acquisition of Next Big Sound, Inc. ("NBS")

In July 2015, we completed the acquisition of NBS. Goodwill generated from the business acquisition is primarily attributable to expected synergies from future growth and from the potential to expand our Artist Marketing Platform ("AMP") and is not deductible for tax purposes. We have accounted for this acquisition as a business combination in the three months ended September 30, 2015. NBS provides analytics for online music, including analyzing the popularity of musicians in social networks, streaming services and radio. The results of NBS in the three months ended September 30, 2015 were not material to our operating results.

Acquisition of KXMZ-FM

In June 2013, we entered into an agreement to purchase the assets of KXMZ-FM. The Federal Communications Commission ("FCC") approved the transfer of the FCC licenses and the acquisition was completed in June 2015. We have accounted for this acquisition as a business combination in the nine months ended September 30, 2015. The agreement to acquire the assets of KXMZ-FM was done in part to allow us to qualify for certain settlement agreements concerning royalties for the public performance of musical works between the Radio Music Licensing Committee (“RMLC”) and American Society of Composers, Authors and Publishers (“ASCAP”) and Broadcast Music, Inc. (“BMI”) as of the date of the agreement. The results of KXMZ-FM in the three and nine months ended September 30, 2015 were not material to our operating results.

Music Royalty Matters

Pre-1972 copyright litigation

On April 17, 2014, UMG Recordings, Inc., Sony Music Entertainment, Capitol Records, LLC, Warner Music Group Corp. and ABKCO Music and Records, Inc. filed suit against Pandora Media Inc. in the Supreme Court of the State of New

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York. The complaint claims common law copyright infringement and unfair competition arising from allegations that Pandora owes royalties for the public performance of sound recordings recorded prior to February 15, 1972.

In October 2015 the parties reached an agreement whereby we agreed to pay the plaintiffs a total of $90 million. The settlement resolves all past claims as to our use of pre-1972 recordings owned or controlled by the plaintiffs and enables us, without any additional payment, to reproduce, perform and broadcast such recordings in the United States through December 31, 2016. This agreement was approved by our board of directors and executed on October 21, 2015. Pursuant to this settlement, which covers approximately 90% of total pre-1972 spins on our service, we agreed to pay the plaintiffs $60 million on or before October 23, 2015 and the plaintiffs will dismiss the case with prejudice. We recorded a one-time cumulative charge of $57.9 million to cost of revenue - content acquisition costs within our condensed consolidated statements of operations for the three and nine months ended September 30, 2015 related to the pre-1972 spins played through September 30, 2015. The remaining charge of $32.1 million will be recorded in cost of revenue - content acquisition costs over the future service period of October 1, 2015 through December 31, 2016 based on expected streaming of pre-1972 recordings over the period. This settlement will be paid in five installments. The first installment of $60.0 million was paid in October 2015, and the remaining amount will be paid in four equal installments of $7.5 million from January 1, 2016 through October 1, 2016.

RMLC

In June 2013, we entered into an agreement to purchase the assets of KXMZ-FM and in June 2015 the Federal Communications Commission ("FCC") approved the transfer of the FCC licenses and the acquisition was completed. The agreement to purchase the assets of KXMZ allowed us to qualify for the RMLC royalty rate of 1.7% of revenue for a license to the ASCAP and BMI repertoires, before certain deductions, beginning in June 2013. As a result, we recorded cost of revenue - content acquisition costs at the RMLC royalty rate starting in June 2013, rather than the rate that was set in rate court proceedings in March 2014 for ASCAP and in May 2015 for BMI.

box offices. In the three months ended September 30, 2015, despite confidenceMarch 31, 2016, Ticketfly had approximately 35 thousand live events on sale, for which approximately 3.8 million tickets, excluding box office sales were sold, to approximately 1.6 million unique ticket buyers, which resulted in our legal position that we were entitled to the RMLC royalty rate starting in June 2013 and as part of our strategy to strengthen our partnership with the music industry, management decided to forgo the application of the RMLC royalty rate from June 2013 through September 2015. As a result, we recorded a one-time cumulative charge to increase cost of revenue - content acquisition costs within our condensed consolidated financial statements of $23.9more than $170 million in gross transaction value, excluding box office sales. We completed the three and nine months ended September 30, 2015 related to spins played from June 2013 through September 30, 2015 in order to align the cumulative costacquisition of revenue - content acquisition costs to the amounts previously paid at the rates that were set in the rate court proceedings in March 2014 for ASCAP and May 2015 for BMI. We intend to record cost of revenue - content acquisition costs for the performing rights organizations ("PRO") at the rates established by the rate courts for the foreseeable future.

BMI Royalty Agreement

In June 2013, BMI filed a petition in the rate court in the U.S. District Court for the Southern District of New York established by the consent decree between BMI and the U.S. Department of Justice for the determination of reasonable fees and terms for a BMI blanket license for the period from January 1, 2013 through DecemberTicketfly on October 31, 2016. The rate proceeding concluded in March 2015, and in May 2015, the court issued its opinion establishing a royalty rate of 2.5% of revenue before certain deductions. In June 2015, we filed a notice of appeal of the court's decision with the Second Circuit Court of Appeals. In October 2015, we filed our appeal brief. Briefing will continue through February 2016. The district court's decision and our appeal of the court's decision did not have a material impact on our consolidated statements of operations for the three and nine months ended September 30, 2015.

Naxos of America, Inc. ("Naxos") Royalty Agreement

In February 2015, we announced a United States licensing agreement to partner with Naxos, one of the world’s leading classical music labels representing a collection of classical music works. This partnership is designed to help classical labels and artists increase the audiences they reach. Participating labels and the artists they represent can also take advantage of the marketing capabilities of our connected platform, which capabilities include providing direct access to our metadata to help participating labels make data-driven business decisions. We do not expect this partnership to have a material effect on our financial condition or operating results.

Factors Affecting our Business Model
 
Internet Radio Service

A majority of ourthe listener hours for our internet radio service, our core business, occur on mobile devices and as such, we face challenges in optimizing our advertising products for delivery on mobile and other connected device platforms and monetizing inventory, or opportunities to sell

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advertisements, generated by listeners using these platforms. The mobile digital advertising industry is at an early stage of development, with lower overall spending levels than traditional online advertising markets, and faces technical challenges due to fragmented platforms and a lack of standard audience measurement protocols. As a greater share of our listener hours is consumed on mobile devices, our ability to monetize increased mobile streaming may not achieve the levels of monetization of streaming we have achieved on computers.
 
In addition, our monetization strategy includes increasing the number of ad campaigns for computer, mobile and other connected device platforms sold to local advertisers, placing us in more direct competition with broadcast radio for advertiser spending, especially for audio advertisements. By contrast, historically our advertisers have been predominantly national brands. Key to the success of our strategy to increase local advertising is our ability to convince a substantial base of local advertisers of the benefits of advertising on the Pandora service, including demonstrating the effectiveness and relevance of our advertising products, in particular audio advertising products, across the range of our delivery platforms.products.

Growth in our active users and distribution platforms has fueled a corresponding growth in listener hours. Our total number of listener hours is a key driver for both revenue generation opportunities and content acquisition costs, which are the largest component of our expenses.

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. In turn, our ability to generate revenue depends on the extent to which we are able to sell the inventory we have.
 
Cost of Revenue—Content Acquisition Costs. We pay content acquisition costs, or royalties, 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. Content acquisition costs are calculated based on the number of sound recordings streamed, revenue earned or other usage measures. The number of sound recordings we transmit to users of the Pandora service, as generally reflected by listener hours, drives a substantial majority of our content acquisition costs, although

certain of our licensing agreements require us to pay fees for public performances of musical works based on a percentage of revenue.

We pay content acquisition costs, or royalties, to the copyright owners, or their agents, of each sound recording that we stream and to the copyright owners, or their agents, for the sound recordings that we perform, as well as the musical works embodied in each of those sound recordings, subject to certain exclusions. Royalties for sound recordings are negotiated with and paid to record labels, rights organizations or to SoundExchange, Inc. ("SoundExchange") and Merlin Networks B.VB.V. ("Merlin"). During 2015, we paid performance rates for the sound recordings we streamed according to the terms of the Pureplay Settlement agreement (the “2015 Pureplay Rates”). On December 16, 2015, the Copyright Royalty Board ("CRB") announced new per-performance rates that apply for commercial webcasters for calendar years 2016 through 2020 (the “Web IV Rates”). Unlike the royalty structure applicable under the Pureplay Settlement agreement, the Web IV Rates do not include an alternative calculation based on percentage of revenue, but instead are solely based on per-performance rates. The rates for non-subscription services were set at $0.0017 per play, and represent an approximate 21% increase from the 2015 Pureplay Rate for non-subscription services. The rates for subscription services were set at $0.0022 per play and represent a 12% decrease from the 2015 Pureplay Rate for subscription services. The Web IV Rates took effect January 1, 2016 and the rates for the calendar years 2017 through 2020 will be adjusted by the CRB to reflect the increases or decreases, if any, in the Consumer Price Index, applicable to that rate year.

Royalties for musical works are most often negotiated with and paid to performing rights organizations (“PROs") such as ASCAP, BMI, SESAC and SESAC, Inc. (“SESAC”Global Music Rights ("GMR") or directly to publishing companies. RoyaltiesDuring the twelve months ended December 31, 2015, we entered into several direct deals with ASCAP, BMI and music publishers. The majority of the licenses are calculatedstructured so that each publisher or PRO receives a pro rata share of a royalty pool equal to 20% of the royalties paid by us for sound recordings, with the pro rata share of the pool paid to each publisher or PRO being determined based on the numberour usage of sound recordings streamed,its works. These license agreements are structured differently from previous PRO and publisher licenses, which have traditionally been based on a percentage of a service’s revenue earned or other usage measures.a flat fee.

We stream spoken word comedy content pursuant to a federal statutory license, for which the underlying literary works are not currently entitled to eligibility for licensing by any PRO for the United States. Rather, pursuant to industry-wide custom and practice, this content is performed absent a specific license from any such PRO or the copyright owner of such content. However, we pay royalties to SoundExchange at rates negotiated between representatives of online music services and SoundExchange for the right to stream this spoken word comedy content.
Given the currentper-play royalty structures in effect throughstructure of the end of 2015 with respect to the public performance of sound recordings in the United States,Web IV Rates, our content acquisition costs increase with each additional listener hour, regardless of whether we are able to generate more revenue. As such, our ability to achieve and sustain profitability and operating leverage on our advertising-supported service depends on our ability to increase our revenue per hour of streaming through increased advertising revenue across all of our delivery platforms. We are presently involved in proceedings to set the royalties we pay to SoundExchange for streaming performances of musical works for the period from 2016 through 2020. Depending on the outcome of those proceedings, our royalty costs could change significantly. Please refer to our discussion of these matters in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 20142015 for further information.

WeOther Offerings

In 2016, we expect to invest heavilysubstantially increase our investments in our operations to supportdrive anticipated future growth. One of our key objectives is furthering our industry leadership in internet radio,to be the most powerful music discovery platform, which we believe will strengthen our brand and help us to convince advertisers to allocate spending towards our ad products. As such, a central focus is adding, retaining and engaging listeners to build market share and grow our listener hours. As our business matures, we expect thathas matured, our revenue growth will exceedhas exceeded the growth in our listener hours. However, we expect to incur increasing annual net losses on a U.S. GAAP basis in the near term because our current strategy is to leverage improvements in gross profit by investing in broadening distribution channels and developing innovative and scalable advertising products, increasing utilizationproducts.

In 2016 and 2017, we intend to launch new subscription offerings that provide additional functionality, including an on-demand music streaming service. The development and launch of advertising inventorysuch additional service offerings will require significant engineering effort, as well as marketing, and buildingother resources. In order to successfully launch such additional service offerings, we will need to obtain the associated content licensing rights and we will need to attract listeners to these new service offerings. The market for subscription-based music services, including on-demand services, is intensely competitive, and our sales force. These investments are intendedability to drive further growthrealize a return on this investment will depend on our ability to leverage brand awareness and deliver a differentiated service that listeners find attractive.

We also intend to leverage the core Pandora internet radio service to expand our ticketing service. Our ticketing service consists of the Ticketly platform, which is a fully-integrated cloud ticketing platform for live events. 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.

Please refer to our discussion of these matters in “Risk Factors” in our business through both increased listener hours and monetization of

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those hours, and as a result we are targeting gradual improvements in gross profit over time. Our planned reinvestment ofAnnual Report on Form 10-K for the resulting incremental gross profit will continue to depress the growth of our bottom line profitability.year ended December 31, 2015 for further information.

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

Listener Hours

We track listener hours because it is a key indicator of the growth of our business. Beginning with the listener hours disclosed in our Annual Report on Form 10-K for the year ended December 31, 2015, 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 Premiers and artist mixtapes. Historically, listener hours related to non-radio content represented a negligible number of listener hours. Including non-radio content in the listener hours we have previously reported for the three months ended March 31, 2015 would not have changed the reported listener hours. 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 and nine months endedSeptember 30, 2014 March 31, 2015 and 2015.2016.

 Three months ended 
 September 30,
 Nine months ended 
 September 30,
 20142015 20142015
 (in billions) (in billions)
Listener hours4.99
5.14
 14.83
15.74
 Three months ended 
 March 31,
 20152016
 (in billions)
Listener hours5.30
5.52

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. Beginning with the active users disclosed in our Annual Report on Form 10-K for the year ended December 31, 2015, we are also including active users who only request non-radio content offerings in the definition of active users. Including users who only request non-radio content in the calculation of active users would not have materially changed the reported active users for the three months ended March 31, 2015.
The table below sets forth our total active users as of September 30, 2014March 31, 2015 and 20152016.
 As of September 30,
 20142015
 (in millions)
Active users76.5
78.1
 As of March 31,
 20152016
 (in millions)
Active users79.2
79.4
We define advertising-based active users (“ad-based active users”) as the number of users, excluding subscribers, that have requested audio from our servers within the trailing 30 days to the end of the final calendar month of the period. We define subscribers as the number of distinct users at the end of the period that have subscribed to our service. Inactive subscribers are included as they contribute towards revenue per thousand listener hours (“RPMs”), which are described in further detail below.

The table below sets forth our users on an advertising and subscription basis as of September 30, 2014March 31, 2015 and 2015.2016.


As of September 30,As of March 31,
2014201520152016
User typeUsers (in millions)Users (in millions)
Ad-based active users73.5
74.7
76.1
76.3
Subscribers*3.5
3.9
3.8
3.9
Total77.0
78.6
79.9
80.2
* Includes subscribers that have not used our service within the trailing 30 days to the end of the final calendar month of the period.

The table below sets forth our listener hours on an advertising and subscription basis for the three and nine months ended September 30, 2014March 31, 2015 and 20152016.

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Three months ended 
 September 30,
 Nine months ended 
 September 30,
Three months ended 
 March 31,
20142015 2014201520152016
User typeListener hours (in billions) Listener hours (in billions)Listener hours (in billions)
Ad-based active users4.38
4.48
 13.01
13.77
4.68
4.85
Subscribers0.61
0.66
 1.82
1.97
0.62
0.67
Total4.99
5.14
 14.83
15.74
5.30
5.52

Advertising Revenue per Thousand Listener Hours (“ad RPMs”)

We track ad RPMs for our free, advertising-supportednon-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.

Subscription and Other Revenue per Thousand Listener Hours (“subscription RPMs”)

We track subscription RPMs because it is a key indicator of the performance of our subscription service. We focus on subscription RPMs across all of our delivery platforms. Subscription RPMs are calculated by dividing subscription and other revenue by the number of thousands of listener hours of our subscription service.

Total Revenue per Thousand Listener Hours (“total RPMs”)    

We track total RPMs for our service, which includes ad and subscription RPMs, because it is a key indicator of our ability to monetize our listener hours. Total RPMs compare advertising and subscription and other revenue in a given period to total listener hours in the period. We calculate total RPMs by dividing the total revenue by the number of thousands of listener hours.
Licensing Costs per Thousand Listener Hours (“LPMs”)

We track LPMs and analyze them in combination with our analysis of RPMs as they provide a key indicator of our profitability. LPMs are relatively fixed licensing costs with scheduled annual rate increases that drive period-over-period changes in LPMs. As such, the margin on our business varies principally with variances in ad RPMs and subscription RPMs. 

Estimated RPMs and LPMs by Platform

We also provideHistorically, we provided estimates of disaggregated ad RPMs, subscription RPMs, total RPMs and related LPMs for our computer platform as well as our mobile and other connected devices platforms, whichplatforms. Starting in the three months ended March 31, 2016, we calculate by dividingwill no longer present disaggregated RPMs or LPMs for our computer or mobile and other connected devices platforms. Previously, we had provided this information in order to demonstrate the estimatedpotential monetization expansion opportunity as mobile and other connected devices markets matured. Revenue and listener hours for mobile and other connected devices have since grown to represent the significant majority of our total revenue and costs generated throughlistener hours. In addition, we currently manage the respectivebusiness to optimize revenue across our device platforms by the number of thousands of listener hours ofand thus we no longer assess our services delivered throughperformance on a disaggregated basis. As such, platforms. While we no longer believe that such disaggregated data provides directional insight for evaluating our efforts to monetize our service, we do not validate such disaggregated data to the level of financial statement reporting. Such data should be seen as indicative only and as management's best estimate.this disaggregation is relevant.


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 including total, computer and mobile and other connected devices, on an ad, subscription and total basis for the three months ended September 30, 2014March 31, 2015 and 2015.

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  Three months ended September 30,
  2014 2015
  RPMLPM* RPMLPM*
 Advertising     
 Computer$64.13
$20.59
 $71.88
$45.62
 Mobile and other connected devices40.82
20.33
 54.31
34.92
 Total advertising$44.35
$20.37
 $56.84
$36.46
       
 Subscription     
 Computer$61.56
$33.53
 $73.35
$68.11
 Mobile and other connected devices78.11
36.94
 88.35
73.12
 Total subscription$74.14
$36.12
 $85.28
$72.10
       
 Total     
 Total computer$63.67
$22.94
 $72.14
$49.53
 Total mobile and other connected devices44.96
22.18
 58.44
39.55
 Total$48.00
$22.30
 $60.52
$41.06
 *Under the Pureplay Settlement agreement, we pay per-performance rates for the streaming of sound recordings for our Pandora One subscription service that are higher than the per-performance rates for our free, advertising-supported service.
 
2016.

The table below sets forth our RPMs and LPMs, including total, computer and mobile and other connected devices, on an ad, subscription and total basis for the nine months ended September 30, 2014 and 2015.
  Nine months ended September 30,
  2014 2015
  RPMLPM* RPMLPM*
 Advertising     
 Computer$59.64
$20.76
 $67.82
$30.21
 Mobile and other connected devices35.55
20.38
 45.01
26.23
 Total advertising$39.37
$20.44
 $48.24
$26.79
       
 Subscription     
 Computer$59.38
$33.54
 $70.98
$46.81
 Mobile and other connected devices83.40
36.59
 86.02
50.79
 Total subscription$77.32
$35.82
 $82.84
$49.95
       
 Total     
 Total computer$59.59
$23.09
 $68.38
$33.13
 Total mobile and other connected devices40.82
22.16
 49.78
29.08
 Total$44.02
$22.32
 $52.57
$29.69
 *Under the Pureplay Settlement agreement, we pay per-performance rates for the streaming of sound recordings for our Pandora One subscription service that are higher than the per-performance rates for our free, advertising-supported service.
 
 Three months ended March 31, 2016
 2015 2016
 RPM LPM* RPM LPM*
      
  
Advertising$38.30
 $21.72
 $45.47
 $30.48
Subscription82.07
 38.88
 81.48
 35.17
Total$43.53
 $23.77
 $49.84
 $31.05
*We pay per-performance rates for the streaming of sound recordings for our Pandora One subscription service that are higher than the per-performance rates for our advertising-supported service.
Total ad
Advertising RPMs 
For the three months ended September 30, 2015March 31, 2016 compared to 2014, total ad2015, advertising RPMs increased primarily due to an increase in ad RPMs on the mobile and other connected devices platform. Ad RPMs on the mobile and other connected devices platform increased as advertising revenue growth outpacedoutpacing the growth in advertising listener hours as a result of an increase in the average price per ad sold.

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For the nine months ended September 30, 2015 compared to 2014, total ad RPMs increased primarily due to an increase in ad RPMs on the mobile and other connected devices platform. Ad RPMs on the mobile and other connected devices platform increased as advertising revenue growth outpaced the growth in advertising listener hours as a result of an increase in the average price per ad sold and an increase in the number of ads sold on that platform.
Total subscriptionSubscription RPMs
For the three months ended September 30, 2015March 31, 2016 compared to 2014, total2015, subscription RPMs increased primarily due to an increase in subscription RPMs onwere flat as the computer platform. Subscription RPMs on the computer platform increased due to growth in subscription revenue as a result of an increase inlistening hours approximated the average price per subscription and an increase in the number of subscribers.
For the nine months ended September 30, 2015 compared to 2014, total subscription RPMs increased primarily due to an increase in subscription RPMs on the computer platform. Subscription RPMs on the computer platform increased due to growth in subscription revenue as a result of an increase in the average price per subscription and an increase in the number of subscribers. Subscription RPMs on the mobile and other connected devices platform grew at a slower rate as a result of the one-time recognition of the accumulation of deferred revenue related to certain subscriptions purchased through mobile app stores of $14.2 million inrevenue.
Advertising LPMs
For the three months ended March 31, 2014.
Total ad LPMs
For the three and nine months ended September 30, 20152016 compared to 2014, total ad2015, advertising LPMs increased as a result of the one-time cumulative charges, inclusive of the effect of the current quarter, of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management’s decision to forgo the application of the RMLC publisher royalty rate from June 2013increases of 21% on our advertising-supported platform and increases in content acquisition costs paid to September 2015PROs and scheduledpublishers due to the royalty rate increases.structure of our new publishing licenses.
Total subscriptionSubscription LPMs

For the three and nine months ended September 30, 2015March 31, 2016 compared to 2014, total2015, subscription LPMs increaseddecreased as a result of the one-time cumulative charges, inclusive of the effect of the current quarter, of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management’s decision to forgo the application of the RMLC publisher royalty rate from June 2013decreases of 12% on our subscription-supported platform, offset by increases in content acquisition costs paid to September 2015PROs and scheduledpublishers under the royalty rate increases.structure of our new publishing licenses.
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.
 

29


 Three months ended 
 September 30,
 Nine months ended 
 September 30,
 20142015 20142015
Revenue 
 
   
Advertising81 %82 % 78 %80 %
Subscription and other19
18
 22
20
Total revenue (2)100
100
 100
100
Cost of revenue



   
Cost of revenue — Content acquisition costs46
68
 51
56
Cost of revenue — Other(1)6
7
 7
7
Total cost of revenue (2)53
75
 58
63
Gross profit (2)47
25
 42
37
Operating expenses



   
Product development(1)6
7
 6
7
Sales and marketing(1)30
34
 31
34
General and administrative(1)12
11
 12
13
Total operating expenses (2)48
53
 49
55
Loss from operations (2)(1)(28) (7)(18)
Other income, net

 

Loss before provision for income taxes (2)(1)(28) (7)(18)
Provision for income taxes

 

Net Loss (2)(1)%(28)% (7)%(18)%
 Three months ended 
 March 31,
 20152016
Revenue  
Advertising77 %74 %
Subscription and other23
18
Ticketing service
7
Total revenue100
100
Cost of revenue  
Cost of revenue — Content acquisition costs55
58
Cost of revenue — Other (1)7
7
Cost of revenue — Ticketing service (1)
5
Total cost of revenue62
70
Gross profit38
30
Operating expenses  
Product development (1)7
12
Sales and marketing (1)37
40
General and administrative (1)16
16
Total operating expenses59
67
Loss from operations(21)(37)
Interest expense
(2)
Other income, net

Total other income (expense), net
(2)
Loss before provision for income taxes(21)(39)
Provision for income taxes

Net loss(21)%(39)%
 
(1) Includes stock-based compensation as follows: 
 
   
Cost of revenue - Other0.4%0.5% 0.5%0.5%0.5%0.5%
Cost of revenue - Ticketing service

Product development1.8
2.0
 1.9
2.0
2.0
2.9
Sales and marketing4.4
4.4
 4.4
4.6
4.9
4.6
General and administrative2.6
2.4
 2.5
2.5
2.6
5.0
(2) Note: Amounts may not recalculate due to rounding   
Note: Amounts may not recalculate due to rounding 

Revenue

Three months ended 
 September 30,
   Nine months ended 
 September 30,
  Three months ended 
 March 31,
  
2014 2015 $ Change 2014 2015 $ Change2015 2016 $ Change
(in thousands) (in thousands)(in thousands)
Revenue                
Advertising$194,293
 $254,656
 $60,363
 $512,251
 $664,316
 $152,065
$178,739
 $220,308
 $41,569
Subscription and other45,300
 56,906
 11,606
 140,551

163,570
 23,019
52,025

54,732
 2,707
Ticketing service
 22,265
 22,265
Total revenue$239,593
 $311,562
 $71,969
 $652,802
 $827,886
 $175,084
$230,764
 $297,305
 $66,541
 
Advertising revenue

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-throughs. 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

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September 30, 2014 and March 31, 2015 and the nine months ended September 30, 2014 and 2015,2016, advertising revenue accounted for 81%, 82%, 78%77% and 80%74%, of our total revenue, respectively.revenue. We expect that advertising will comprise a substantial majority of our revenue for the foreseeable future.

For the three months ended September 30, 2015March 31, 2016 compared to 2014,2015, advertising revenue increased $60.4$41.6 million or 31%23%, primarily due to an approximate 35%40% increase in the average price per ad due in part to our increase in relative volume of local ad sales and our focus on monetizing mobile inventory.

For the nine months ended September 30, 2015 compared to 2014, advertising revenue increased $152.1 million or 30%, primarily due to an approximate 20% increase in the average price per ad due in part to our increase in relative volume of local ad sales and our focus on monetizing mobile inventory and an approximate 5% increase in the number of ads sold as a result of an increase in advertising listener hours.
Subscription and other revenue
 
Subscription and other revenue is generated primarily through the sale of Pandora One, a premium version of the Pandora service, which currently includes advertisement-free access and higher audio quality on the devices that support it. Subscription revenue is recognized on a straight-line basis over the duration of the subscription period. For the three months ended September 30, 2014 andMarch 31, 2015 and the nine months ended September 30, 2014 and 2015,2016, subscription and other revenue accounted for 19%,23% and 18%, 22% and 20% of our total revenue, respectively.revenue.

For the three months ended September 30, 2015March 31, 2016 compared to 2014,2015, subscription revenue increased $11.6$2.7 million or 26%5%, primarily due to an approximate 15% increase in average price per subscription and an approximate 10%5% 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 ninethree months ended September 30, 2015 comparedMarch 31, 2016, ticketing service revenue was $22.3 million and accounted for approximately 7% of our total revenue. In the three months ended March 31, 2016, Ticketfly had approximately 35 thousand live events on sale, for which approximately 3.8 million tickets, excluding box office sales were sold, to 2014, subscriptionapproximately 1.6 million unique ticket buyers, which resulted in more than $170 million in gross transaction value, excluding box office sales. We had no ticketing service revenue increased $23.0 million or 16%, primarily due to an approximate 15% increase in the average price per subscription and an approximate 10% increase in the number of subscribers. This was partially offset by a decrease in subscription revenue as a result of the one-time recognition of the accumulation of deferred revenue related to certain subscriptions purchased through mobile app stores of $14.2 million in the three months ended March 31, 2014.2015, given that the acquisition of Ticketfly was completed on October 31, 2015.

Deferred revenue
 
Our deferred revenue consists principally of both prepaid but unrecognized subscription revenue and advertising fees received or billed in advance of the delivery or completion of the delivery of services. Deferred revenue is recognized as revenue when the services are provided and all other revenue recognition criteria have been met.
 
In addition, subscription revenue derived from sales through certain mobile devices may be subject to refund or cancellation terms which may affect the timing or amount of the subscription revenue recognition. When refund rights exist, we recognize revenue when services have been provided and the rights lapse or when we have developed sufficient transaction history to estimate a return reserve.

Costs and Expenses
 
Cost of revenue consists of cost of revenue—content acquisition costs, cost of revenue—other and cost of revenue—other. 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 - revenue—Content acquisition costs
 

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 Three months ended 
 September 30,
   Nine months ended 
 September 30,
  
 2014 2015 $ Change 2014 2015 $ Change
 (in thousands) (in thousands)
Cost of revenue - Content acquisition costs$111,315
 $211,272
 $99,957
 $331,051
 $467,429
 $136,378
Content acquisition costs as a percentage of advertising revenue by platform
 Three months ended 
 September 30,
 Nine months ended 
 September 30,
 2014 2015 2014 2015
Computer33% 54% 35% 42%
Mobile and other connected devices50% 68% 56% 60%
 Three months ended 
 March 31,
  
 2015 2016 $ Change
 (in thousands)
Cost of revenue - Content acquisition costs$126,023
 $171,264
 $45,241
 
Cost of revenue—content acquisition costs principally consist of royalties paid for streaming music or other content to our listeners. Royalties are currently calculated using negotiated rates documented in agreements. The majority of our royalties are payable based on a fee per public performance of a sound recording, while in other cases our royalties are payable based on a percentage of our revenue, or a formula that involves a combination of per performance and revenue metrics.metrics or a percentage of royalties paid for sound recordings. For certain royalty arrangements, under negotiation, we accrue for estimated royalties based on the available facts and circumstances and adjust these estimates as more information becomes available. The results of any finalized negotiation may be materially different from our estimates.
 
We estimate our advertising-based content acquisition costs attributable to specific platforms by allocating costs from royalties payable based on a fee per track to the platform for which the track is served and by allocating costs from royalties based on a percentage of our revenue in accordance with the overall percentage of our revenue estimated to be attributable to such platforms. While we believe that comparing disaggregated content acquisition costs and revenues across our delivery platforms may provide directional insight for evaluating our efforts to monetize the rapid adoption of our service on mobile and other connected devices, we do not validate such disaggregated metrics to the level of financial statement reporting. We continue to refine our systems and methodologies used to categorize such metrics across our delivery platforms and the period-to-period comparisons of results are not necessarily indicative of results for future periods.

For the three months ended September 30, 2015March 31, 2016 compared to 2014,2015, content acquisition costs increased $100.0$45.2 million or 90%36%, primarily due to the one-time cumulative charges, inclusive of the effect of the current quarter, of $57.9 million for the pre-1972blended sound recordings settlement and $23.9 million as a result of management’s decision to forgo the application of the RMLC publisher royalty rate from June 2013 to September 2015 and scheduledrecording royalty rate increases of 8%.15%, an approximate 5% increase in listener hours and an increase in content acquisition costs paid to publishers and PROs due to the royalty structure of our new publishing licenses. Content acquisition costs as a percentage of total revenue increased from 46%55% to 68%58%, primarily due to the one-time cumulative charges, inclusive of the effect of the current quarter, of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management’s decision to forgo the application of the RMLC publisher royalty rate from June 2013 to September 2015 and scheduledblended royalty rate increases of 8%,15% and an increase in content acquisition costs paid to publishers and PROs due to the royalty structure of our new publishing licenses, offset by an increase in advertising sales. Estimated content acquisition costs as a percentage of the advertising revenue attributable to our computer platform increased from 33% to 54% and estimated content acquisition costs as a percentage of the advertising revenue attributable to our mobile and other connected devices platforms increased from 50% to 68%, in each case primarily due to the one-time cumulative charges, inclusive of the effect of the current quarter, of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management’s decision to forgo the application of the RMLC publisher royalty rate from June 2013 to September 2015 and scheduled royalty rate increases of 8%, offset by an increase in advertising sales on both the computer and mobile and other connected devices platforms.

For the nine months ended September 30, 2015 compared to 2014, content acquisition costs increased $136.4 million or 41%, primarily due to the one-time cumulative charges, inclusive of the effect of the current quarter, of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management’s decision to forgo the application of the RMLC publisher royalty rate from June 2013 to September 2015 and scheduled royalty rate increases of 8%. Content acquisition costs as a percentage of total revenue increased from 51% to 56%, primarily due to the one-time cumulative charges, inclusive of the effect of the current quarter, of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management’s decision to forgo the application of the RMLC publisher royalty rate from June 2013 to September 2015 and scheduled royalty rate increases of 8%, offset by an increase in advertising sales. Estimated content acquisition costs as a percentage of the advertising revenue attributable to our computer platform increased from 35% to 42% and estimated content acquisition costs as a percentage of the advertising revenue attributable to our mobile and other

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connected devices platform increased from 56% to 60%, in each case primarily due to the one-time cumulative charges, inclusive of the effect of the current quarter, of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management’s decision to forgo the application of the RMLC publisher royalty rate from June 2013 to September 2015 and scheduled royalty rate increases of 8%, offset by an increase in advertising sales on both the computer and mobile and other connected devices platforms.revenue.
 
Cost of revenue—Other
 
 Three months ended 
 September 30,
   Nine months ended 
 September 30,
  
 2014 2015 $ Change 2014 2015 $ Change
 (in thousands) (in thousands)
Cost of revenue — Other$15,453
 $21,414
 $5,961
 $44,421
 $57,690
 $13,269
 Three months ended 
 March 31,
  
 2015 2016 $ Change
 (in thousands)
Cost of revenue — Other$16,233
 $20,999
 $4,766
 
Cost of revenue—other consists primarily of hostingad and admusic serving costs, employee-related and facilities and equipment costs and other costs of ad sales. HostingAd and admusic serving costs consist of content streaming, maintaining our internet radio service 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 hostingmusic and ad serving functions. Other costs of ad sales include costs related to music events that are sold as part of advertising arrangements.


For the three months ended September 30, 2015March 31, 2016 compared to 2014,2015, cost of revenue—other increased $6.0$4.8 million or 39%29%, primarily due to a $3.3$3.4 million increase in employee-related and facilities and equipment costs driven by an approximate 35% increase in headcount and a $1.9 million increase in hosting and ad serving costs driven by an increase in advertising revenue.
Cost of revenue - Ticketing service

 Three months ended 
 March 31,
  
 2015 2016 $ Change
 (in thousands)
Cost of revenue — Ticketing service$
 $14,646
 $14,646

Cost of revenue—ticketing service consists primarily of ticketing revenue share costs, credit card fees and other cost of revenue and a $1.6 million increaseintangible amortization expense. The majority of these costs are related to revenue share costs, which consist of fees paid to clients for their share of convenience and order processing fees. Intangible amortization expense is related to amortization of developed technology acquired in employee-related and facilities and equipment costs driven by an approximate 40% increase in headcount.connection with the Ticketfly acquisition.

For the ninethree months ended September 30, 2015 compared to 2014,March 31, 2016, cost of revenue—ticketing service was $14.6 million and consisted primarily of $10.1 million in ticketing revenue share costs, $2.9 million in credit card fees and other increased $13.3 million or 30%, primarily due to a $7.4 million increase in hosting and ad serving costs driven by an increase in advertisingcost of revenue and a $4.9 $1.4

million increase in employee-related and facilities and equipment costs driven by an approximate 40% increaseintangible amortization expense. We had no cost of revenue—ticketing service in headcount.the three months ended March 31, 2015, given that the acquisition of Ticketfly was completed on October 31, 2015.

Gross profit
 
Three months ended 
 September 30,
   Nine months ended 
 September 30,
  Three months ended 
 March 31,
  
2014 2015 $ Change 2014 2015 $ Change2015 2016 $ Change
(in thousands) (in thousands)(in thousands)
Gross profit                
Total revenue$239,593
 $311,562
 $71,969
 $652,802
 $827,886
 $175,084
$230,764
 $297,305
 $66,541
Total cost of revenue126,768
 232,686
 105,918
 375,472
 525,119
 149,647
142,256
 206,909
 64,653
Gross profit$112,825
 $78,876
 $(33,949) $277,330
 $302,767
 $25,437
$88,508
 $90,396
 $1,888
Gross margin47% 25%  
 42% 37%  38% 30%  
 
For the three months ended September 30, 2015March 31, 2016 compared to 2014,2015, gross profit decreasedincreased by $33.9$1.9 million or 30%2% and gross margin decreased from 47%38% to 25%30% as the growth in content acquisition costs outpaced the growth in revenue, primarily due to the one-time cumulative charges, inclusive of the effect of the current quarter, of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management’s decision to forgo the application of the RMLC publisher royalty rate from June 2013 to September 2015 and scheduledblended royalty rate increases of 8%.

For the nine months ended September 30, 2015 compared to 2014, gross profit increased by $25.4 million or 9%15%, an approximate 5% increase in listener hours and gross margin decreased from 42% to 37% as the growthan increase in content acquisition costs outpacedpaid to publishers and PROs under the growth in revenue, primarily due to the one-time cumulative charges, inclusiveroyalty structure of the effect of the current quarter, of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management’s decision to forgo the application of the RMLC publisher royalty rate from June 2013 to September 2015 and scheduled royalty rate increases of 8%, offset by an increase in advertising sales.our new publishing licenses.


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Product development
 
 Three months ended 
 September 30,
   Nine months ended 
 September 30,
  
 2014 2015 $ Change 2014 2015 $ Change
 (in thousands) (in thousands)
Product development$13,381
 $21,849
 $8,468
 $38,288
 $56,466
 $18,178
 Three months ended 
 March 31,
  
 2015 2016 $ Change
 (in thousands)
Product development$15,875
 $35,846
 $19,971
 
Product development consists primarily of employee-related and facilities and equipment costs, including salaries and benefits related to employees in software engineering, music analysis and product management departments, information technology, and costs associated with supporting consumer connected-device manufacturers in implementing our service in their products.products and amortization expense related to acquired intangible assets. We incur product development expenses primarily for improvements to our website and the Pandora app, development of new advertising products and development and enhancement of our personalized station generating system. We have generally expensed product development as incurred. These amounts are offset by costs that we capitalize to develop software for internal use. Certain website development and internal use software development costs are capitalized when specific criteria are met. In such cases, the capitalized amounts are amortized over the useful life of the related application once the application is placed in service. We expect these capitalized costs to increase during the remainder of 2016 as we develop an on-demand streaming service. We intend to continue making significantsubstantially increase investments in developing new products and enhancing the functionality of our existing products.
 
For the three months ended September 30, 2015March 31, 2016 compared to 2014,2015, product development expenses increased $8.5$20.0 million or 63%126%, primarily due to an $8.1a $16.9 million increase in employee-related and facilities and equipment costs driven by an approximate 60%105% increase in headcount.

For the nine months ended September 30, 2015 compared to 2014, product development expenses increased $18.2headcount, an increase of $1.8 million or 47%, primarily due to a $17.9in intangible amortization expense and an increase of $1.2 million increase in employee-related and facilities and equipment costs driven by an approximate 60% increase in headcount.professional fees.

Sales and marketing
 
 Three months ended 
 September 30,
   Nine months ended 
 September 30,
  
 2014 2015 $ Change 2014 2015 $ Change
 (in thousands) (in thousands)
Sales and marketing$72,320
 $107,286
 $34,966
 $200,416
 $285,595
 $85,179
 Three months ended 
 March 31,
  
 2015 2016 $ Change
 (in thousands)
Sales and marketing$84,274
 $117,622
 $33,348
 
Sales and marketing consists primarily of employee-related and facilities and equipment costs, including salaries, commissions and benefits related to employees in sales, sales support, marketing, advertising and music industrymaker group

departments. In addition, sales and marketing expenses include transaction processing commissions on subscription purchases through mobile app stores, external sales and marketing expenses such as brand marketing, advertising, direct response and search engine marketing costs, public relations expenses, costs related to music events, agency platform and media measurement expenses, facilitiesinfrastructure costs and equipment expenses and infrastructure costs.amortization expense related to acquired intangible assets.

We expectare substantially increasing sales and marketing expenses to increasedrive growth as we hire additional personnel to build out our sales and sales support teams, particularly as we continue to build out our local market sales team. WhileIn 2015, we have historically relied onlaunched advertising campaigns to increase the success of viral marketing to expand consumer awareness of our service, in 2014 we began to launch marketing campaigns to increase consumer awareness and expand our listener base and in 2015, we began to launch advertising campaigns.brand. We anticipate that we will continue to utilize these types of marketing and advertising campaigns in the future. As such, we anticipate higher overall levels of sales and marketing expense going forward.
 
For the three months ended September 30, 2015March 31, 2016 compared to 2014,2015, sales and marketing expenses increased $35.0$33.3 million or 48%40%, primarily due to a $17.6$18.9 million increase in employee-related and facilities and equipment costs driven by an approximate 20% increase in headcount, an $8.7 million increase in brand marketing, advertising, direct response and search engine marketing costs driven by our advertising campaigns launched in the three months ended September 30, 2015,March 31, 2016, a $12.3$1.7 million increase in employee-related and facilities and equipment costs driven by an approximate 30% increase in headcount andintangible amortization expense, a $2.8$1.4 million increase in transaction processing commissions on subscription purchases through mobile app stores.

For the nine months ended September 30, 2015 comparedcosts related to 2014, sales and marketing expenses increased $85.2 million or 43%, primarily due to a $39.3 million increase in employee-related and facilities and equipment costs driven by an approximate 30% increase in headcount, a $30.6 million increase in brand marketing, advertising, direct response and search

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engine marketing costs driven by our advertising campaigns launched in the three months ended September 30, 2015music events and a $9.0$1.4 million increase in transaction processing commissions on subscription purchases through mobile app stores.
 
General and administrative
 
 Three months ended 
 September 30,
   Nine months ended 
 September 30,
  
 2014 2015 $ Change 2014 2015 $ Change
 (in thousands) (in thousands)
General and administrative$29,143
 $35,603
 $6,460
 $81,369
 $111,169
 $29,800
 Three months ended 
 March 31,
  
 2015 2016 $ Change
 (in thousands)
General and administrative$36,754
 $46,296
 $9,542
 
General and administrative consists primarily of employee-related and facilities and equipment costs, including salaries, benefits and benefitsseverance expense for finance, accounting, legal, internal information technology and other administrative personnel. In addition, general and administrative expenses include professional services costs for outside legal and accounting services, infrastructure costs, and credit card fees.fees and sales and other tax expense. We expect general and administrative expenses to increase in future periods as we continue to invest in corporate infrastructure, including adding personnel and systems to our administrative functions.
 
For the three months ended September 30, 2015March 31, 2016 compared to 2014,2015, general and administrative expenses increased $6.5$9.5 million or 22%26%, primarily due to a $3.6$15.6 million increase in employee-related and facilities and equipment costs driven by executive severance and an approximate 25%35% increase in headcount and a $1.9$1.0 million increase in sales and other tax expense, offset by a $7.2 million decrease in professional service costsfees related to royalty and other legal matters.
Interest expense

ForInterest expense in the ninethree months ended September 30, 2015 comparedMarch 31, 2016 consists of interest expense on our 1.75% Convertible Senior Notes due 2020. Refer to 2014, general and administrative expenses increased $29.8 million or 37%, primarily dueNote 7 “Debt Instruments” in the Notes to a $14.8 million increase in employee-related and facilities and equipment costs driven by an approximate 25% increase in headcount and an $11.6 million increase in professional service costs related to royalty and other legal matters.Consolidated Financial Statements for further details on our Notes.

Provision for (benefit from) income taxes
 
We have historically been subject to income taxes in the United States Australia and New Zealand.various foreign jurisdictions. As we expand our operations outside of theseto other foreign locations, we become subject to taxation based on the applicable foreign statutory rates and our effective tax rate could fluctuate accordingly.
 
Our provision for (benefit from) income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted statutory income tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce net deferred tax assets to the amount expected to be realized.
 
Off-Balance Sheet Arrangements
 

Our liquidity is not dependent on the use of off-balance sheet financing arrangements and as of September 30, 2015March 31, 2016 we had no such arrangements.

Contractual Obligations

The following summarizes changes toThere has been no material change in our contractual obligations other than in the three and nine monthsordinary course of business since the year ended September 30,December 31, 2015.

 Payments Due by Period
 Remainder of 2015 2016 Total
 (in thousands)
Purchase obligation$60,000
 $30,000
 $90,000

Our purchase obligation represents a non-cancelable royalty-related contractual obligation at September 30, 2015 related to the pre-1972 sound recordings settlement.

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Quarterly Trends
 
Our operating results fluctuate from quarter to quarter as a result of a variety of factors. We expect our operating results to continue to fluctuate in future quarters.
 
Pandora

Our results reflect the effects of seasonal trends in listener and advertising behavior. We expect to experience both higher advertising sales due to greater advertiser demand during the holiday season and increased usage due to the popularity of holiday music during the last three months of each calendar year. In addition, we expect to experience lower advertising sales in the first three months of each calendar year due to reduced advertiser demand and increased usage due to increased use of media-streaming devices received as gifts during the holiday season. We believe these seasonal trends have affected, and will continue to affect our operating results, particularly as increases in content acquisition costs from increased usage are not offset by increases in advertising sales in the first calendar quarter.

In addition, expenditures by advertisers tend to be cyclical and discretionary in nature, reflecting overall economic conditions, the economic prospects of specific advertisers or industries, budgeting constraints and buying patterns and a variety of other factors, many of which are outside our control. As a result of these and other factors, the results of any prior quarterly or annual periods should not be relied upon as indications of our future operating performance.
 
Ticketing Service

Ticketfly's results reflect the effects of seasonality related to the timing of events. Tickets for festivals typically go on sale during the first half of the year. As such, the Ticketfly business has historically experienced an increase in revenue in the first half of each year relative to the fourth quarter of the prior year. We expect these seasonal trends to continue to affect our operating results.

Liquidity and Capital Resources
 
As of September 30, 2015,March 31, 2016, we had cash, cash equivalents and investments totaling $442.6$382.5 million, which primarily consisted of cash and money market funds held at major financial institutions, commercial paper and investment-grade corporate debt securities. On October 7, 2015, we entered into an agreement to acquire Ticketfly. Pursuant to the merger agreement, we have agreed to pay $225 million in cash and approximately 11.6 million shares of common stock, subject to customary adjustments for working capital, cash, indebtedness and transaction expenses. Per the agreement, we are entitled to a net cash balance of $50 million as part of these adjustments. In addition to the purchase price, unvested options and unvested RSUs of Ticketfly held by Ticketfly employees will be converted respectively into unvested options and unvested RSUs to acquire our common stock. The closing is subject to customary closing conditions, including the expiration or termination of any waiting periods under applicable antitrust laws, and we expect the closing to occur in the three months ending December 31, 2015. We expect to pay the cash portion of the purchase price for the transaction using cash and cash equivalents on hand.
 
Our principal uses of cash during the three and nine months ended September 30, 2015March 31, 2016 were funding our operations, as described below, and capital expenditures.

Sources of Funds
 
We believe, based on our current operating plan, that our existing cash and cash equivalents and available borrowings under our credit facility will be sufficient to meet our anticipated cash needs for at least the next twelve months.
 
From time to time, we may explore additional financing sources and means to lower our cost of capital, which could include equity, equity-linked and debt financing. In addition, in connection with any future acquisitions, we may require additional funding which may be provided in the form of additional debt, equity or equity-linked financing or a combination thereof. There can be no assurance that any additional financing will be available to us on acceptable terms.
 
Our Indebtedness
 
Credit Facility


We are party to a $60.0$120.0 million credit facility with a syndicate of financial institutions, which expires on September 12, 2018. As of September 30, 2015,March 31, 2016, we had no borrowings outstanding, $1.1$0.5 million in letters of credit outstanding and $58.9$119.5 million of available borrowing capacity under the credit facility.

1.75% Convertible Senior Notes Due 2020

On December 9, 2015, we completed an unregistered Rule 144A offering of $345.0 million aggregate principal amount of our 1.75% Convertible Senior Notes due 2020. The net proceeds from the sale of the Notes were approximately $336.5 million, after deducting the initial purchaser’s fees and other estimated expenses. We used approximately $43.2 million of the net proceeds to pay the cost of the capped call transactions. Refer to Note 7 “Debt Instruments” in the Notes to Consolidated Financial Statements for further details on our Notes.

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; thereafter, until the second scheduled trading day prior to maturity, the Notes will be convertible at the option of holders at any time.

The conversion rate for the Notes is initially 60.9050 shares of common stock per $1,000 principal amount of the Notes, which is equivalent to an initial conversion price of approximately $16.42 per share of our common stock, and is subject to adjustment in certain circumstances.

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.

The capped call transactions are expected generally to reduce the potential dilution to our common stock and/or offset the cash payments we would be required to make in excess of the principal amount of the converted Notes in the event that the market price of our common stock, as measured under the terms of the capped call transaction, is greater than the strike price of the capped call transaction, with such reduction and/or offset subject to a cap based on the cap price of the capped call transactions. The strike price of the capped call transactions corresponds to the initial conversion price of the Notes and is subject to certain adjustments under the terms of the capped call transactions. The capped call transactions have an initial cap price of $25.26 per share and are subject to certain adjustments under the terms of the capped call transactions. The capped call transactions have been included as a net reduction to additional paid-in capital within stockholders’ equity.

Capital Expenditures
 
Consistent with previous periods, future capital expenditures will primarily focus on acquiring additional hosting and general corporate infrastructure. Our access to capital is adequate to meet our anticipated capital expenditures for our current plans.
 
Historical Trends
 

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The following table summarizes our cash flow data for the ninethree months ended September 30, 2014March 31, 2015 and 2015.2016.
 
Nine months ended 
 September 30,
Three months ended 
 March 31,
2014 20152015 2016
(in thousands)(in thousands)
Net cash provided by (used in) operating activities$(4,030) $28,937
$26,981
 $(13,104)
Net cash provided by (used in) investing activities(110,239) 32,034
16,408
 (18,885)
Net cash provided by financing activities17,570
 6,512
1,825
 913
 
Operating activities
 

In the ninethree months ended September 30, 2015,March 31, 2016, net cash provided byused in operating activities was $28.9$13.1 million and included an $89.4primarily consisted of our net loss of $115.1 million, increase in accrued royalties primarily due to the one-time cumulative charge of $57.9 million related to the pre-1972 sound recordings settlement, the one-time cumulative charge of $23.9 million related to the RMLC rate and a $7.7 million increase in deferred revenue primarily due to the reinstatement of the annual subscription option in December 2014. Net cash providedwhich was partially offset by operating activities also included non-cash charges of $98.0$57.4 million, primarily related to $79.5$38.7 million in stock-based compensation charges and $15.2$13.3 million in depreciation and amortization expense,expense. Net cash used in operating activities also included an increase in prepaid expenses and other assets of $19.7 million primarily related to advance payments made for the publishing agreements signed in 2015, offset by a decrease of $38.5 million in cash from collections of accounts receivable. Net cash used in operating activities increased by $40.1 million from the three months ended March 31, 2015, primarily due to an increase in our net loss of $150.3$66.8 million. Net cash provided by operating activities improved by $33.0 million from the nine months ended September 30, 2014, primarily due to a $32.1 million increase in deferred revenue primarily due to the reinstatement of the annual subscription option in December 2014.

Investing activities
 
In the ninethree months ended September 30, 2015,March 31, 2016, net cash provided byused in investing activities was $32.0$18.9 million and included $221.1 million in proceeds from sales and maturities of investments, offset by $138.7 million in purchases of investments, $27.3$14.4 million of capital expenditures for leasehold improvements and server equipment, $7.2 million of capital expenditures for internal-use software and $23.0$5.0 million in payments related to mergerspurchases of investments, offset by $8.3 million in proceeds from sales and acquisitions.maturities of investments. Net cash provided byused in investing activities improvedincreased by $142.3$35.3 million from the ninethree months ended September 30, 2014,March 31, 2015, primarily due to a decrease in purchases of investments of $134.7 million and an increase in proceeds from sales and maturities of investments of $34.4$70.8 million, an increase in capital expenditures for leasehold improvements and server equipment of $10.0 million and an increase in capital expenditures for internal-use software of $5.6 million, offset by an increasea decrease in payments related to mergers and acquisitionspurchases of $23.0investments of $51.8 million.

Financing activities
 
In the ninethree months ended September 30, 2015,March 31, 2016, net cash provided by financing activities was $6.5$0.9 million and included $5.1$1.7 million in proceeds from our employee stock purchase plan and $3.7$0.5 million in proceeds from the exercise of stock options, offset by $2.3$1.3 million in tax payments from net share settlements of RSUs. Net cash provided by financing activities decreased $11.1$0.9 million from the ninethree months ended September 30, 2014,March 31, 2015, primarily due to a decrease in proceeds from the exercise of stock options of $11.5$0.6 million and an increase in tax payments from net share settlements of RSUs of $0.4 million.
 
Critical Accounting Policies and Estimates
 
Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Our estimates form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
 
An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimate that are reasonably likely to occur, could materially impact the condensed consolidated financial statements. We believe that our critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the condensed consolidated financial statements.
 

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Other than those discussed below, thereThere have been no material changes to our critical accounting policies and estimates as compared to those described in our Annual Report on Form 10-K for the year ended December 31, 20142015 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates.”

Business Combinations, Goodwill and Intangible Assets, Net

We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives, and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.

We review goodwill and indefinite-lived intangible assets for impairment at least annually or more frequently if events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable. We first assess the qualitative factors to determine whether it is more likely than not that the fair value of our single reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test under Accounting Standards Update (ASU) No. 2011-08, Goodwill and Other (Topic 350): Testing Goodwill for Impairment, issued by the Financial Accounting Standards Board (FASB). If we determine that it is more likely than not that its fair value is less than its carrying amount, then the two-step goodwill impairment test is performed. The first step, identifying a potential impairment, compares the fair value of the reporting unit with its carrying amount. If the carrying amount exceeds its fair value, the second step would need to be performed; otherwise, no further step is required. The second step, measuring the impairment loss, compares the implied fair value of the goodwill with the carrying amount of the goodwill. Any excess of the goodwill carrying amount over the applied fair value is recognized as an impairment loss, and the carrying value of goodwill is written down to fair value. As of September 30, 2015, no impairment of goodwill has been identified.

Acquired finite-lived intangible assets are amortized over the estimated useful lives of the assets. Acquired finite-lived intangible assets consist primarily of patents, customer relationships, developed technology and trade names resulting from business combinations. We evaluate the recoverability of our intangible assets for potential impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value.

In addition to the recoverability assessment, we routinely review the remaining estimated useful lives of finite-lived intangible assets If we reduce the estimated useful life assumption for any asset, the remaining unamortized balance would be amortized over the revised estimated useful life.

Stock-Based Compensation — Market Stock Units ("MSUs")
We implemented a market stock unit program in March 2015 for certain key executives. Specifically, MSUs measure Pandora’s total stockholder return ("TSR”) performance against that of the Russell 2000 Index across three performance periods.

We have determined the grant-date fair value of the MSUs using a Monte Carlo simulation performed by a third-party valuation firm. The Monte Carlo simulation model utilizes multiple input variables to estimate the probability that market conditions will be achieved. These variables include our expected stock price volatility over the expected term of the award, actual and projected employee stock option exercise behaviors and the risk-free interest rate for the expected term of the award. The variables used in these models are reviewed on an annual basis and adjusted, as needed. We recognize stock-based compensation for the MSUs over the requisite service period using the accelerated attribution method.





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Table of Contents

Item 3. Quantitative and Qualitative Disclosure About Market Risk
 
Interest Rate Fluctuation Risk
 
There have been no material changes in our primary market risk exposures or how those exposures are managed from the information disclosed in Part II, Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2014.2015. For further discussion of quantitative and qualitative disclosures about market risk, reference is made to our Annual Report on Form 10-K.
 


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Item 4. Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. Based on their evaluation at the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2015.March 31, 2016.
 
Changes in Internal Control over Financial Reporting
 
We are in the process of implementing a new enterprise resource planning ("ERP") system, which will occur over a period of more than one year. During the three months ended September 30, 2015, we completed the implementation of several significant ERP modules including core financial and purchasing modules. In connection with the implementation of the ERP system, we updated the processes that constitute our internal control over financial reporting, as necessary, to accommodate related changes to our business processes and accounting procedures. We will continue to implement additional ERP modules in a phased approach.

Although the processes that constitute our internal control over financial reporting have been materially affected by the implementation of several significant ERP modules and will require testing for effectiveness as the implementation progresses, we do not believe that the implementation of the ERP system has had or will have a material adverse effect on our internal control over financial reporting.

Except as otherwise described above, thereThere have been no other changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the three and nine months ended September 30, 2015,March 31, 2016, that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.





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PART II. OTHER INFORMATION

Item 1. Legal Proceedings
 
The material set forth in Note 5 in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q is incorporated herein by reference.

Item 1A. Risk Factors
 
Investing in our common stock involves a high degree of risk. Before deciding to invest in our common stock, you should carefully consider each of the risk factors described in “Part I - Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 20142015 and all information set forth in this Quarterly Report on Form 10-Q. Those risks and the risks described in this Quarterly Report on Form 10-Q, including in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” could materially harm our business, financial condition, operating results, cash flow and prospects. If that occurs, the trading price of our common stock could decline, and you may lose all or part of your investment.

There have been no material changes to the Risk Factors described under “Part I - Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014, other than as set forth below. The risk factors below, all of which originally appear in our Annual Report on Form 10-K, have been updated to reflect additional information regarding programmatic buying on mobile and platforms for deploying and monitoring ads, among other things.2015.

Advertising spending is increasingly being placed through new data-driven channels, such as the programmatic buying ecosystem, where mobile offerings are not as mature as their web-based equivalents. Because the majority of our listener hours occur on mobile devices, our growth prospects and revenue may be adversely impacted if the advertising ecosystem is slow to adopt data-driven mobile advertising offerings.

As new advertising channels, such as programmatic buying, develop around data-driven technologies and advertising products, an increasing percentage of advertising spend is likely to shift to such channels and products. These data-driven advertising products and programmatic buying channels allow publishers to use data to target advertising toward specific groups of consumers who are more likely to be interested in the advertising message delivered. These advertising products and programmatic channels are currently more developed in terms of ad technology and industry adoption on the web than they are on mobile. Due to the fact that the majority of our listener hours occur on mobile devices, our ability to attract advertising spend, and ultimately our ad revenue, may be negatively impacted by this shift. We have no reliable way to predict how significantly or how quickly advertisers will shift buying to programmatic channels and data-driven advertising products on the web.

We have developed a data-driven, programmatic advertising capability for mobile in an effort to take advantage of this trend. However, we only released this capability to the market in the second quarter of 2015, and we have no reliable way to predict how significantly or how quickly advertisers will shift buying toward such data-driven ad products and programmatic channels on mobile. If advertising spend continues to be reallocated to web-based programmatic channels and mobile programmatic adoption lags, our ability to grow revenue may be impacted and our business could be materially and adversely affected.

We rely upon an agreement with DoubleClick, which is owned by Google, for delivering and monitoring most of our ads. Failure to renew the agreement on favorable terms, or termination of the agreement, could adversely affect our business.
We use DoubleClick's ad-serving platform to deliver and monitor most of the ads for our service. There can be no assurance that our agreement with DoubleClick, which is owned by Google, will be extended or renewed upon expiration, that we will be able to extend or renew our agreement with DoubleClick on terms and conditions favorable to us or that we could identify another alternative vendor to take its place. Our agreement with DoubleClick also allows DoubleClick to terminate our relationship before the expiration of the agreement on the occurrence of certain events, including material breach of the agreement by us, and to suspend provision of the services if DoubleClick determines that our use of its service violates certain security, technology or content standards.



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Item 6. Exhibits
 
    Incorporated by Reference  
Exhibit
No.
 Exhibit Description Form File No. Exhibit 
Filing
Date
 Filed By 
Filed
Herewith
10.29+10.19
 Settlement2016 Corporate Incentive PlanX
10.34†
Severance and Release Agreement bybetween Simon Fleming-Wood and among Pandora Media, Inc., dated April 3, 2016X
10.35†
Severance and Capitol Records, LLC et al.Release Agreement between Brian McAndrews and Pandora Media, Inc., dated April 13, 2016           X
31.01
 Certification of the Principal Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002           X
31.02
 Certification of the Principal Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002           X
32.01
 Certification of the Principal Executive Officer and Principal Financial Officer Pursuant to 8 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002           X
101
 Interactive Data Files Pursuant to Rule 405 of Regulation S-T: (i) Condensed Balance Sheets as of September 30, 2015March 31, 2016 and December 31, 2014,2015, (ii) Condensed Statements of Operations for the three and nine months ended September 30,March 31, 2016 and 2015, and 2014, (iii) Condensed Statements of Comprehensive Loss for the three and nine months ended September 30,March 31, 2016 and 2015, and 2014, (iv) Condensed Statements of Cash Flows for the ninethree months ended September 30,March 31, 2016 and 2015 and 2014 and (v) Notes to Condensed Financial Statements           X
 
†   Indicates management contract or compensatory plan.
+ Confidential treatment requested as to certain portions of this exhibit, which portions have been omitted and submitted separately to the Securities and Exchange Commission.


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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, Pandora Media, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 PANDORA MEDIA, INC.
  
Date: October 26, 2015May 2, 2016By:/s/ Michael S. Herring
  Michael S. Herring
  Executive Vice President and Chief Financial Officer
  (Duly Authorized Officer and Principal Financial and Accounting Officer)


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