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Table of Contents

 

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

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2018

or
 
¨     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to      
        
Commission File Number: 001-35198
Pandora Media, Inc.
(Exact name of registrant as specified in its charter)
Delaware
94-3352630
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
2100 Franklin Street, Suite 700
Oakland, CA
94612
(Address of principal executive offices)
(Zip Code)
(510) 451-4100
(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x
 
The number of shares of registrant’s common stock outstanding as of October 31, 2018 was: 269,775,191.

 
Table of Contents

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


2
Table of Contents

PART I. FINANCIAL INFORMATION
 
Item 1. Financial Statements

Pandora Media, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share and per share amounts) (unaudited)
 
As of December 31,
2017
 
As of September 30,
2018
Assets
 
 
 
Current assets
 

 
 

Cash and cash equivalents
$
499,597

 
$
287,523

Short-term investments
1,250

 
100,119

Accounts receivable, net of allowance of $5,352 at December 31, 2017 and $7,855 at September 30, 2018
336,429

 
373,418

Prepaid content acquisition costs
55,668

 
32,219

Prepaid expenses and other current assets
19,220

 
25,673

Total current assets
912,164

 
818,952

Convertible promissory note receivable
35,471

 
—

Property and equipment, net
116,742

 
107,802

Goodwill
71,243

 
178,917

Intangible assets, net
19,409

 
55,557

Other long-term assets
11,293

 
11,575

Total assets
$
1,166,322

 
$
1,172,803

Liabilities, redeemable convertible preferred stock and stockholders’ equity
 

 
 

Current liabilities
 

 
 

Accounts payable
$
14,896

 
$
28,406

Accrued liabilities
34,535

 
72,311

Accrued content acquisition costs
97,751

 
123,910

Accrued compensation
47,635

 
45,687

Deferred revenue
31,464

 
55,678

Total current liabilities
226,281

 
325,992

Long-term debt, net
273,014

 
255,272

Other long-term liabilities
23,500

 
25,660

Total liabilities
522,795

 
606,924

Redeemable convertible preferred stock: 480,000 shares issued and outstanding at December 31, 2017 and 480,000 at September 30, 2018
490,849

 
513,270

Stockholders’ equity
 

 
 

Common stock: 250,867,462 shares issued and outstanding at December 31, 2017 and 269,774,079 at September 30, 2018
25

 
27

Additional paid-in capital
1,422,221

 
1,632,178

Accumulated deficit
(1,269,351
)
 
(1,579,125
)
Accumulated other comprehensive loss
(217
)
 
(471
)
Total stockholders’ equity
152,678

 
52,609

Total liabilities, redeemable convertible preferred stock and stockholders’ equity
$
1,166,322

 
$
1,172,803

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

3
Table of Contents

Pandora Media, Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts)
(unaudited)
 
 
Three months ended 
 September 30,
 
Nine months ended 
 September 30,
 
2017
 
2018
 
2017
 
2018
Revenue
 
 
 
 
 
 
 
Advertising
$
275,741

 
$
291,856

 
$
777,253

 
$
777,480

Subscription and other
84,414

 
125,772

 
218,192

 
344,175

Ticketing service
18,484

 
—

 
76,032

 
—

Total revenue
378,639

 
417,628

 
1,071,477

 
1,121,655

Cost of revenue
 
 
 
 
 
 
 
Cost of revenue—Content acquisition costs
204,222

 
222,191

 
587,517

 
666,631

Cost of revenue—Other
27,287

 
39,308

 
80,259

 
98,884

Cost of revenue—Ticketing service
11,269

 
—

 
50,397

 
—

Total cost of revenue
242,778

 
261,499

 
718,173

 
765,515

Gross profit
135,861

 
156,129

 
353,304

 
356,140

Operating expenses
 
 
 
 
 
 
 
Product development
39,469

 
42,553

 
120,290

 
118,788

Sales and marketing
107,588

 
124,760

 
378,581

 
374,351

General and administrative
48,171

 
47,273

 
150,650

 
142,521

Goodwill impairment
—

 
—

 
131,997

 
—

Contract termination (benefit) fees
(423
)
 
—

 
23,044

 
—

Total operating expenses
194,805

 
214,586

 
804,562

 
635,660

Loss from operations
(58,944
)
 
(58,457
)
 
(451,258
)
 
(279,520
)
Interest expense
(7,592
)
 
(6,768
)
 
(22,377
)
 
(20,799
)
Other income, net
559

 
1,684

 
866

 
6,033

Total other expense, net
(7,033
)
 
(5,084
)
 
(21,511
)
 
(14,766
)
Loss before (provision for) benefit from income taxes
(65,977
)
 
(63,541
)
 
(472,769
)
 
(294,286
)
(Provision for) benefit from income taxes
(266
)
 
(125
)
 
(877
)
 
6,933

Net loss
$
(66,243
)
 
$
(63,666
)
 
$
(473,646
)
 
$
(287,353
)
Net loss available to common stockholders
$
(84,562
)
 
$
(71,251
)
 
$
(506,493
)
 
$
(309,774
)
Basic and diluted net loss per common share
$
(0.34
)
 
$
(0.27
)
 
$
(2.10
)
 
$
(1.19
)
Weighted-average basic and diluted common shares
245,810

 
268,058

 
241,579

 
260,327

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


4
Table of Contents

Pandora Media, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
 
 
Three months ended 
 September 30,
 
Nine months ended 
 September 30,
 
2017
 
2018
 
2017
 
2018
Net loss
$
(66,243
)
 
$
(63,666
)
 
$
(473,646
)
 
$
(287,353
)
Change in foreign currency translation adjustment
(729
)
 
(243
)
 
(600
)
 
(241
)
Change in net unrealized gain (loss) on marketable securities
8

 
(5
)
 
50

 
(13
)
Other comprehensive loss
(721
)
 
(248
)
 
(550
)
 
(254
)
Total comprehensive loss
$
(66,964
)
 
$
(63,914
)
 
$
(474,196
)
 
$
(287,607
)
 
The accompanying notes are an integral part of the condensed consolidated financial statements.


5
Table of Contents

Pandora Media, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Nine months ended 
 September 30,
 
2017
 
2018
Operating activities
 

 
 

Net loss
$
(473,646
)
 
$
(287,353
)
Adjustments to reconcile net loss to net cash used in operating activities
 

 
 

Goodwill impairment
131,997

 
—

Loss on dispositions
9,459

 
2,173

Loss on extinguishment of convertible debt
—

 
14,600

Depreciation and amortization
49,121

 
44,167

Stock-based compensation
98,327

 
82,802

Amortization (accretion) of premium on investments
78

 
(1,200
)
Accretion of discount on convertible promissory note receivable
(171
)
 
(534
)
Other operating activities
290

 
802

Amortization of debt discount
14,934

 
15,391

Interest income
(258
)
 
(810
)
Provision for bad debt
10,851

 
3,960

Changes in operating assets and liabilities
 

 
 
Accounts receivable
(11,294
)
 
(20,160
)
Prepaid content acquisition costs
(33,842
)
 
32,529

Prepaid expenses and other assets
(17,955
)
 
(4,892
)
Accounts payable, accrued and other current liabilities
(257
)
 
26,193

Accrued content acquisition costs
6,063

 
26,159

Accrued compensation
(12,646
)
 
550

Other long-term liabilities
(532
)
 
(9,286
)
Deferred revenue
5,618

 
14,914

Reimbursement of cost of leasehold improvements
5,236

 
894

Net cash used in operating activities
(218,627
)
 
(59,101
)
Investing activities
 

 
 

Purchases of property and equipment
(12,861
)
 
(7,290
)
Internal-use software costs
(13,948
)
 
(15,235
)
Payments related to acquisition, net of cash acquired
—

 
(66,924
)
Purchases of investments
—

 
(244,744
)
Proceeds from maturities of investments
37,084

 
147,170

Proceeds from cancellation of convertible promissory note receivable
—

 
34,742

Proceeds from sales of subsidiaries, net of cash
122,912

 
—

Net cash provided by (used in) investing activities
133,187

 
(152,281
)
Financing activities
 
 
 
Proceeds from issuance of redeemable convertible preferred stock
480,000

 
—

Payments of issuance costs
(29,284
)
 
(4,886
)
Repayment of debt arrangements
(90,000
)
 
—

Proceeds from employee stock purchase plan
8,012

 
4,156

Proceeds from exercise of stock options
7,836

 
779

Tax withholdings related to net share settlements of restricted stock units
—

 
(1,651
)
Net cash provided by (used in) financing activities
376,564

 
(1,602
)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
237

 
(347
)
Net increase (decrease) in cash, cash equivalents and restricted cash
291,361

 
(213,331
)
Cash, cash equivalents and restricted cash at beginning of period
201,820

 
500,854

Cash, cash equivalents and restricted cash at end of period
$
493,181

 
$
287,523

Supplemental disclosures of cash flow information
 
 
 
Purchases of property and equipment recorded in accounts payable and accrued liabilities
$
2,294

 
$
1,515

Cash paid during the period for interest
$
5,791

 
$
3,659

Accretion of preferred stock issuance costs
$
29,259

 
$
—

Stock dividend payable to preferred stockholders
$
3,588

 
$
22,421

Contingent consideration related to acquisition
$
—

 
$
5,000

Fair value of shares issued related to acquisition
$
—

 
$
72,956

Fair value of convertible promissory note received as partial consideration for sale of subsidiary
$
36,203

 
$
—

Employee stock purchase plan ("ESPP") purchases
$
11,387

 
$
7,169


6
Table of Contents

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

7
Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements
(unaudited)


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

Pandora is the world’s most powerful music discovery platform, offering a personalized experience for each of our listeners wherever and whenever they want to listen to music—whether through mobile devices, car speakers or connected devices in the home.

Pandora is available as an ad-supported radio service, a radio subscription service called Pandora Plus and an on-demand subscription service called Pandora Premium. The majority of our listener hours occur on mobile devices, with the majority of our revenue generated from advertising on our ad-supported service on these devices. With billions of data points that help us understand our users' preferences, we offer both local and national advertisers the opportunity to deliver targeted messages to our listeners using a combination of audio, display and video advertisements. We also generate increasing revenue from subscriptions to Pandora Plus and Pandora Premium. We were incorporated as a California corporation in January 2000 and reincorporated as a Delaware corporation in December 2010. Our principal operations are located in the United States.

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, 2017.
 
Certain changes in presentation have been made to conform the prior period presentation to current period reporting. We have shown the changes in the total of cash, cash equivalents and restricted cash in the Condensed Consolidated Statements of Cash Flows.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and the related disclosures at the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Estimates are used in several areas including, but not limited to determining accrued content acquisition costs, amortization of minimum guarantees under content acquisition agreements, selling prices for elements sold in arrangements with multiple performance obligations, the allowance for doubtful accounts, the fair value of stock options, the ESPP, the provision for (benefit from) income taxes, fair value of convertible debt, fair value of contingent consideration, fair value of acquired intangible assets and goodwill and the useful lives of acquired intangible assets. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements could be affected. In many cases, the accounting treatment of a particular transaction is specifically dictated by U.S. GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting among available alternatives would not produce a materially different result. 

2.                        Summary of Significant Accounting Policies
 
Other than discussed below, there have been no material changes to our significant accounting policies as compared to those described in our Annual Report on Form 10-K for the year ended December 31, 2017.


8
Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


Revenue Recognition

Refer to Note 3 "Revenues" in the Notes to Condensed Consolidated Financial Statements for our Revenue Recognition policy.

Business Combinations, Goodwill and Intangible Assets, net

We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, 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. Additionally, any contingent consideration is recorded at fair value on the acquisition date and classified as a liability. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets and contingent consideration. 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, 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 test goodwill and intangible assets with indefinite useful lives for impairment at least annually, or more frequently if events or changes in circumstances indicate that the assets may be impaired. We perform our annual goodwill and intangible asset impairment tests in the fourth quarter of each year.

Acquired finite-lived intangible assets are amortized over the estimated useful lives of the assets, which range from three to eleven 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. We record the amortization of intangible assets to the financial statement line item in our consolidated statement of operations that the asset directly relates to. To the extent that purchased intangibles are used in revenue generating activities, we record the amortization of these intangible assets to cost of revenue.

Convertible Senior Notes due 2020 ("2020 Notes")

We allocate the principal amount of our 2020 Notes between the liability and equity components. The value assigned to the debt components of the 2020 Notes 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. The equity component is recorded to additional paid-in capital and is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the Notes over the carrying amount of the liability component is recorded as a debt discount, and is being amortized to interest expense using the effective interest method through the December 1, 2020 maturity date. We allocate the total amount of transaction costs incurred to the liability and equity components.

Convertible Senior Notes due 2023 ("2023 Notes")

We allocate the principal amount of our 2023 Notes between the liability and equity components. The value assigned to the debt components of the 2023 Notes is the estimated fair value as of the issuance date of similar debt without the conversion feature. The difference between the fair value of the total instrument and this estimated fair value of the debt component represents the value which has been assigned to the equity component. The equity component is recorded to additional paid-in capital and is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the Notes over the carrying amount of the liability component is recorded as a debt discount, and is being amortized

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


to interest expense using the effective interest method through the December 1, 2023 maturity date. We allocate the total amount of transaction costs incurred to the liability and equity components.

Concentration of Credit Risk
 
For the three and nine months ended September 30, 2017 and 2018, we had no customers that accounted for more than 10% of our total revenue. As of December 31, 2017 and September 30, 2018, we had no customers that accounted for more than 10% of our total accounts receivable.
 
Recently Issued Accounting Standards

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 and recognize expenses on their income statements and also 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 expect to adopt ASU 2016-02 as of January 1, 2019 using the modified retrospective method. We are in the process of evaluating the impact of ASU 2016-02 on our consolidated financial statements and expect there to be a material impact related to the recognition of new right of use assets and lease liabilities on our balance sheet for operating leases.

In June 2016, the FASB issued Accounting Standards Update No. 2016-13, Credit Losses—Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 will replace today’s incurred loss approach with an expected loss model for instruments measured at amortized cost and require entities to record allowances for available-for-sale debt securities rather than reduce the carrying amount. The guidance is effective for fiscal years beginning after December 15, 2019, and interim periods within that fiscal year, although early adoption is permitted. We are currently evaluating the impact that this standard update will have on our condensed consolidated financial statements.

In June 2018, the FASB issued Accounting Standards Update No. 2018-07, Improvements to Nonemployee Share-Based Payment Accounting ("ASU 2018-07"), which simplifies the accounting for share-based payments granted to nonemployees for goods and services. Under ASU 2018-07, certain guidance on such payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within that fiscal year, although early adoption is permitted. As we do not have material nonemployee awards, we do not expect the adoption of ASU 2018-07 to have a material impact on our condensed consolidated financial statements.

Recently Adopted Accounting Standards

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"), which amends the existing accounting standards for revenue recognition. ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue. Under the guidance, revenue is recognized when a company transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. We have adopted ASU 2014-09 as of January 1, 2018 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Revenues and contract assets or liabilities for contracts completed prior to January 1, 2018 are presented under Topic 605, and revenues and contract assets and liabilities from contracts which were not completed or started after December 31, 2017 are presented under Topic 606. The adoption of this guidance does not have a material impact on our consolidated financial statements. Refer to Note 3 "Revenues" in the Notes to Condensed Consolidated Financial Statements for further information.

In August 2016, the FASB issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"), which eliminates the diversity in practice related to the classification of certain cash receipts and payments for debt prepayment or extinguishment costs, the maturing of a zero-coupon bond, the settlement of contingent liabilities arising from a business combination, proceeds from insurance settlements, distributions from certain equity method investees and beneficial interests obtained in a financial asset securitization. ASU 2016-15 designates the appropriate cash flow classification, including requirements to allocate certain components of these cash receipts and payments among operating, investing and financing activities. We adopted this guidance effective January 1, 2018, using the retrospective transition approach for all periods presented. The adoption of ASU 2016-15 did not have a material impact on our condensed consolidated financial statements.

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



In November 2016, the FASB issued Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash ("ASU 2016-18"). ASU 2016-18 requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. The guidance is effective retrospectively for fiscal years beginning after December 15, 2017, and interim periods within that fiscal year. We adopted this guidance effective January 1, 2018, using the retrospective transition approach for all periods presented. The adoption of ASU 2016-18 did not have a material impact on our condensed consolidated financial statements.

In January 2017, the FASB issued Accounting Standards Update No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (ASU 2017-01). ASU 2017-01 revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and activities is considered a business. We adopted this guidance effective January 1, 2018, using the prospective approach. The adoption of ASU 2017-01 did not have a material impact on our condensed consolidated financial statements.


3.                        Revenues

Adoption of ASC Topic 606, "Revenue from Contracts with Customers"

The new accounting standard under ASC 606 became effective for all public companies with fiscal years beginning after December 15, 2017. On January 1, 2018, we adopted ASC 606 using the modified retrospective method. This method required retrospective application of the new accounting standard to all unfulfilled contracts that were outstanding as of January 1, 2018. Revenues and contract assets or liabilities for contracts completed prior to January 1, 2018, including ticketing revenue related to Ticketfly, are presented under Topic 605, and revenues and contract assets and liabilities from contracts which were not completed or started after December 31, 2017 are presented under Topic 606.

We recorded an immaterial adjustment to opening accumulated deficit as of January 1, 2018 due to the cumulative impact of adopting Topic 606, primarily related to deferred revenue.

Revenue Recognition

Revenues are recognized when a contract with a customer exists, and the control of the promised services are transferred to our customers, in an amount that reflects the consideration we expect to receive in exchange for those services. Substantially all of our revenues are generated from contracts with customers in the United States.

Gross Versus Net Revenue Recognition 

We report revenue on a gross or net basis based on management’s assessment of whether we act as a principal or agent in the transaction. To the extent we act as the principal, revenue is reported on a gross basis unless we are unable to determine the amount on a gross basis, in which case we report revenue on a net basis. The determination of whether we act as a principal or an agent in a transaction is based on an evaluation of whether we control the good or service prior to transfer to the customer. We have determined that we act as the principal in all of our revenue streams.

Advertising Revenue 

We generate advertising revenue primarily from audio, display and video advertising. We generate the majority of our advertising revenue through the delivery of advertising impressions sold on a cost per thousand basis (“CPM”). We also offer advertising on other units of measure, such as cost per engagement (“CPE”) and cost per view ("CPV"), under which an advertiser pays us based on the number of times a listener engages with an ad. We consider the performance obligation as the ad insertion on the order, which is a series type performance obligation.

We determine that a contract exists when we have an agreed-to insertion order or a fully executed customer-specific agreement. The duration of our contracts is generally less than one year. Revenue is recognized as performance obligations are satisfied, which generally occurs as ads are delivered through our platform. We generally recognize revenue based on delivery information from our campaign trafficking systems. Certain advertising arrangements include performance obligations other than

11
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Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


advertising, such as music events. For these performance obligations, revenue is recognized when the customer obtains control of the promised services, such as when a music event occurs.

Certain customers may receive cash-based incentives or rebates, which are accounted for as variable consideration in the determination of the transaction price. We use the expected value method to estimate the value of such variable consideration to include in the transaction price and reflect changes to such estimates in the period in which they occur. The amount of variable consideration included in revenues is limited to the extent that it is probable that the amount will not be subject to a significant reversal when the uncertainty associated with the variable consideration is subsequently resolved.

Certain contracts include added value (“AV”) elements, under which the customer may receive credits for free advertising services in exchange for advertising spend commitments, either based on total contract amount, defined spend tiers or overall commitments across multiple contracts. We have determined that these AV elements represent a material right to the customer, and therefore are treated as distinct performance obligations. We determine an estimated selling price for these items and include them in the allocation of the transaction price of a contract or series of contracts, as applicable.

Our payment terms vary by the type and location of customers. The time between satisfaction of performance obligations and when payment is due does not exceed one year. For certain services and customer types, upon the execution of a contract, we may require payment before the services are delivered to the customer. These payments are recorded as contract liabilities in our condensed consolidated financial statements.

Arrangements with multiple performance obligations—Advertising revenue

Our contracts with customers generally include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on an analysis of the historical prices charged to customers, or by estimating the standalone selling price using expected cost plus margin.

Subscription and Other Revenue 

Pandora is also available as a radio subscription service called Pandora Plus and an on-demand subscription service called Pandora Premium. Pandora Plus is a paid, ad-free subscription version of the Pandora service that includes replays, additional skipping, offline listening, higher quality audio on supported devices and longer timeout-free listening.

The features of Pandora Plus are also included in Pandora Premium. Pandora Premium is a paid, ad-free version of the Pandora service that offers a unique, on-demand experience, providing users with the ability to search, play and collect songs and albums, build playlists on their own or with the tap of a button the app will automatically generate a playlist based on the user’s listening activity.

We generate revenue for these subscription services on both a direct basis and through subscriptions sold through certain third-party mobile device app stores. For subscriptions sold through third-party mobile device app stores, the subscriber executes a click-through agreement with Pandora outlining the terms and conditions between Pandora and the subscriber upon purchase of the subscription. The mobile device app stores promote the Pandora app through their e-store, process payments for subscriptions, and retain a percentage of revenue as a fee. We report this revenue gross of the fee retained by the mobile device app stores, as the subscriber is Pandora’s customer in the contract and Pandora controls the service prior to the transfer to the subscriber.

Subscription revenue is a series type performance obligation and is recognized net of sales tax amounts collected from subscribers. The enforceable rights in monthly subscription contracts are the monthly service period, whereas the annual subscriptions are cancelable at any time. For monthly subscriptions where there are no cancellation provisions, we recognize revenue on a straight-line basis over the monthly service term. Because of the cancellation clauses for the annual subscriptions, the duration of these contracts is daily, and revenue for these contracts is recognized on a daily ratable basis. Historically, cancellation rates have been immaterial.

Subscription revenue from monthly subscriptions sold indirectly through mobile device app stores may be subject to partners’ refund or cancellation terms. Revenues are recognized net of any adjustments for variable consideration, including refunds and other fees, as reported by the partners.

Our payment terms vary based on whether the subscription is sold on a direct basis or through mobile device app stores. Subscriptions sold on a direct basis require payment before the services are delivered to the customer. The payment terms for subscriptions sold through mobile device app stores vary and generally range from 30 to 60 days.

12
Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)



Contract Assets and Liabilities

We record those services which we have delivered and have a right to invoice as a contract asset. We record any payments which are received or due in advance of our performance, and where a contract exists, as contract liabilities. The increase in the deferred revenue balance as of  September 30, 2018 is primarily driven by cash payments received or due in advance of satisfying our performance obligations, offset by $29.4 million of revenues recognized that were included in the deferred revenue balance as of December 31, 2017.

Practical Expedients and Exemptions

We generally expense sales commissions when incurred because the duration of the contracts for which we pay commissions are less than one year. These costs are included in the sales and marketing line item of our Condensed Consolidated Statements of Operations.

We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.


4.                        Cash, Cash Equivalents and Investments
 
Cash, cash equivalents and investments consisted of the following:
 
 
As of 
 December 31, 
 2017
 
As of 
 September 30, 
 2018
 
(in thousands)
Cash and cash equivalents
 

 
 
Cash
$
146,294

 
$
134,862

Money market funds
353,303

 
51,273

Commercial paper
—

 
89,387

Certificates of deposit
—

 
7,504

U.S. government and government agency debt securities
—

 
4,497

Total cash and cash equivalents
$
499,597

 
$
287,523

Short-term investments
 

 
 

Commercial paper
$
—

 
$
80,915

Corporate debt securities
1,250

 
19,204

Total short-term investments
$
1,250

 
$
100,119

Cash, cash equivalents and investments
$
500,847

 
$
387,642


 
Our short-term investments have maturities of twelve months or less and are classified as available-for-sale.

The following table summarizes our available-for-sale securities’ adjusted cost, gross unrealized losses and fair value by significant investment category as of September 30, 2018. We had no gross unrealized gains as of September 30, 2018. As of December 31, 2017, the adjusted cost and fair value by significant investment category are the same.
 


13
Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


 
As of September 30, 2018
 
Adjusted
Cost
 
Unrealized
Losses
 
Fair
Value
 
(in thousands)
Money market funds
$
51,273

 
$
—

 
$
51,273

Commercial paper
170,302

 
—

 
170,302

Certificates of deposit
7,504

 
—

 
7,504

Corporate debt securities
19,217

 
(13
)
 
19,204

U.S. government and government agency debt securities
4,497

 
—

 
4,497

Total cash equivalents and marketable securities
$
252,793

 
$
(13
)
 
$
252,780


 
All of our investments have maturities of twelve months or less as of December 31, 2017 and September 30, 2018.
 
The unrealized losses on our available-for-sale securities as of September 30, 2018 were not significant. We had no securities that had been in a continuous unrealized loss position for greater than 12 months as of December 31, 2017 and September 30, 2018. As of September 30, 2018, we considered the decreases in market value on our available-for-sale securities to be temporary in nature and did not consider any of our investments to be other-than-temporarily impaired. During the three and nine months ended September 30, 2018, we did not recognize any impairment charges. There were no sales of available-for-sale securities during the three and nine months ended September 30, 2018.

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.


14
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Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


5.                        Fair Value
 
We record cash equivalents and 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 following fair value hierarchy tables categorize information regarding our financial assets and liabilities measured at fair value on a recurring basis at December 31, 2017 and September 30, 2018:
 
 
As of December 31, 2017
 
Fair Value Measurement Using
 
Quoted Prices in Active Markets
for Identical
Instruments
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Total
 
(in thousands)
Assets
 

 
 

 
 

Money market funds
$
353,303

 
$
—

 
$
353,303

Corporate debt securities
—

 
1,250

 
1,250

Total assets measured at fair value
$
353,303

 
$
1,250

 
$
354,553


 
As of September 30, 2018
 
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
$
51,273

 
$
—

 
$
51,273

Commercial paper
—

 
170,302

 
170,302

Certificate of deposit
—

 
7,504

 
7,504

Corporate debt securities
—

 
19,204

 
19,204

U.S. government and government agency debt securities
—

 
4,497

 
4,497

Total assets measured at fair value
$
51,273

 
$
201,507

 
$
252,780


 

15
Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


Our cash equivalents and short-term investments, excluding money market funds, 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, 2017 and September 30, 2018, we held no Level 3 assets or liabilities measured on a recurring basis. The fair value of our convertible subordinated promissory note receivable ("Convertible Promissory Note") was calculated on a nonrecurring basis as of September 1, 2017 and was classified as a Level 3 measurement within the fair value hierarchy as of December 31, 2017. The Convertible Promissory Note was canceled on March 30, 2018. Refer to Note 10 "Convertible Promissory Note Receivable" in the Notes to Condensed Consolidated Financial Statements for further details on the cancellation of the Convertible Promissory Note.

The fair value of our 2023 Notes was calculated on a nonrecurring basis as of May 24, 2018. Refer to Note 11, "Debt Instruments", in the Notes to Condensed Consolidated Financial Statements for the carrying amount and estimated fair value of our 2023 Notes and 2020 Notes (collectively the "Notes"), which are not recorded at fair value as of September 30, 2018.

6.                       Commitments and Contingencies

Minimum Guarantees and Other Provisions—Content Acquisition Costs

Certain of our content acquisition agreements contain minimum guarantees, and require that we make upfront minimum guarantee payments. During the three and nine months ended September 30, 2018, we prepaid $148.6 million and $321.3 million in content acquisition costs related to minimum guarantees. As of September 30, 2018, we have future minimum guarantee commitments of $183.7 million, of which $57.7 million will be paid in 2018 and the remainder will be paid thereafter. On a quarterly basis, we record the greater of the cumulative actual content acquisition costs incurred or the cumulative minimum guarantee based on forecasted usage for the minimum guarantee period. The minimum guarantee period is the period of time that the minimum guarantee relates to, as specified in each agreement, which may be annual or a longer period. The cumulative minimum guarantee, based on forecasted usage, considers factors such as listening hours, revenue, subscribers and other terms of each agreement that impact our expected attainment or recoupment of the minimum guarantees based on the relative attribution method.

Several of our content acquisition agreements also include provisions related to the royalty payments and structures of those agreements relative to other content licensing arrangements, which, if triggered, could cause our payments under those agreements to escalate. In addition, record labels, publishers and performing rights organizations ("PROs") with whom we have entered into direct license agreements have the right to audit our content acquisition payments, and any such audit could result in disputes over whether we have paid the proper content acquisition costs. However, as of September 30, 2018, we do not believe it is probable that these provisions of our agreements discussed above will, individually or in the aggregate, have a material adverse effect on our business, financial position, results of operations or cash flows.

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

Pre-1972 copyright litigation

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

16
Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


Ninth Circuit requested certification to the California Supreme Court on the substantive legal questions. The California Supreme Court has accepted certification and has received all written briefing on the case, but has not yet scheduled oral argument.

Between September 14, 2015 and October 19, 2015, Arthur and Barbara Sheridan filed separate class action suits against the Company in the federal district courts for the Northern District of California and the District of New Jersey. The complaints allege a variety of violations of common law and state copyright statutes, common law misappropriation, unfair competition, conversion, unjust enrichment and violation of rights of publicity arising from allegations that we owe royalties for the public performance of sound recordings recorded prior to February 15, 1972. The actions in California and New Jersey are currently stayed pending the Ninth Circuit's decision in Flo & Eddie, Inc. v. Pandora Media, Inc.

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

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

7.                      Business Combination

On May 25, 2018, we completed the acquisition of AdsWizz Inc. ("AdsWizz"), a leading digital audio ad technology company with a comprehensive digital audio software suite of solutions that connects audio publishers to the advertising community, for an aggregate purchase price of $146.6 million in a combination of cash and common stock. Cash paid was $73.7 million and 9,588,312 shares of the Company's common stock were issued. The purchase price includes a contingent consideration of $5.0 million, measured at its fair value, which is dependent on achievement of certain business milestones. In addition to the purchase price, unvested options of AdsWizz were converted into unvested options to acquire our common stock.

Upon acquisition, AdsWizz became a wholly owned subsidiary of Pandora. The acquisition was accounted for as a business combination, and the financial results of AdsWizz are included in our consolidated financial statements from the date of acquisition. Pro forma results of operations related to the acquisition have not been presented because it is not material to our consolidated statements of operations.

The following table summarizes the allocation of estimated fair values of the net assets acquired during the nine months ended September 30, 2018, including the related estimated useful lives, where applicable:


17
Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


 
 
Estimated fair value
 
Estimated useful life in years
 
 
(in thousands)
 
 
Finite-lived intangible assets
 
 
 
 
Developed technology
 
$
32,000

 
4
Customer relationships
 
12,000

 
4
Trade name
 
600

 
4
Total finite-lived intangible assets
 
$
44,600

 
 
Tangible assets acquired, net
 
1,581

 
 
Deferred tax liabilities
 
(7,216
)
 
 
Net assets acquired
 
$
38,965

 
 
Goodwill
 
107,673

 
 
Total fair value consideration
 
$
146,638

 
 


The fair value of assets acquired and liabilities assumed from our acquisition of AdsWizz was based on a preliminary valuation and our estimates and assumptions are subject to change. We will recognize any subsequent adjustments to the purchase price prospectively in the period in which the adjustments are determined. A portion of the purchase price is held in escrow and may be recovered from this escrow amount.

Goodwill generated from the AdsWizz acquisition is primarily attributable to expected synergies from future growth and strategic advances in the digital audio ad technology industry. Goodwill generated during the period is not deductible for tax purposes.


8.                       Goodwill and Intangible Assets

During the nine months ended September 30, 2018, we completed the acquisition of AdsWizz. The changes in the carrying amount of goodwill for the nine months ended September 30, 2018, are as follows:

 
9/30/2018
 
(in thousands)
Balance as of December 31, 2017
$
71,243

Goodwill related to acquisition of AdsWizz
107,674

Balance as of September 30, 2018
$
178,917




The following summarizes information regarding the gross carrying amounts and accumulated amortization of intangible assets:
 
 
As of December 31, 2017
 
As of September 30, 2018
 
 
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

 
$
(3,289
)
 
$
4,741

 
$
8,030

 
$
(3,839
)
 
$
4,191

Developed technology
 
27,950

 
(13,608
)
 
14,342

 
59,950

 
(20,160
)
 
39,790

Customer relationships
 
940

 
(940
)
 
—

 
12,940

 
(1,988
)
 
10,952

Trade names
 
1,320

 
(994
)
 
326

 
1,920

 
(1,296
)
 
624

Total finite-lived intangible assets
 
$
38,240

 
$
(18,831
)
 
$
19,409

 
$
82,840

 
$
(27,283
)
 
$
55,557

Note: Amounts may not recalculate due to rounding



18
Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


Amortization expense of intangible assets was $1.9 million and $4.3 million for the three months ended September 30, 2017 and 2018. Amortization expense of intangible assets was $11.2 million and $8.5 million for the nine months ended September 30, 2017 and 2018.

The following is a schedule of future amortization expense related to finite-lived intangible assets as of September 30, 2018.

 
As of 
 September 30, 
 2018
 
(in thousands)
Remainder of 2018
$
4,299

2019
16,696

2020
16,401

2021
11,877

2022
5,193

Thereafter
1,091

Total future amortization expense
$
55,557



9.                       Dispositions

On September 1, 2017, we completed the sale of Ticketfly, our ticketing service segment, to Eventbrite Inc. ("Eventbrite") for an aggregate unadjusted purchase price of $200.0 million. The aggregate unadjusted purchase price consisted of $150.0 million in cash and a $50.0 million Convertible Promissory Note, which were paid and issued at the closing of the transaction. The Convertible Promissory Note was recorded at its fair value at the date of sale, which resulted in a discount of $13.8 million. The aggregate purchase price was further reduced by $4.8 million in costs to sell and $7.5 million in working capital adjustments and certain indemnification provisions, for a net purchase price of $174.0 million.

On March 30, 2018, we amended our Membership Interest Purchase Agreement ("MIPA") with Eventbrite which resulted in the cancellation of our Convertible Promissory Note for a cancellation fee of $34.7 million. Upon completion of the cancellation of the Convertible Promissory Note, the remaining unpaid principal and interest balance were forgiven.

In the nine months ended September 30, 2018, we recognized a loss on sale of $2.1 million related to the cancellation of the Convertible Promissory Note. The loss is included in the general and administrative line item of our Condensed Consolidated Statements of Operations and was based on the cancellation fee of $34.7 million.

10.                       Convertible Promissory Note Receivable

On September 1, 2017, we completed the sale of Ticketfly, our ticketing service segment, to Eventbrite for an aggregate unadjusted purchase price of $200.0 million. The aggregate unadjusted purchase price consists of $150.0 million in cash and a $50.0 million Convertible Promissory Note, which were paid and issued at the closing of the transaction. On March 30, 2018, we amended our MIPA with Eventbrite which resulted in the cancellation of our Convertible Promissory Note for a cancellation fee of $34.7 million. Refer to Note 9, "Dispositions" in the Notes to Condensed Consolidated Financial Statements for further details on the cancellation of the Convertible Promissory Note.

Prior to the cancellation, the Convertible Promissory Note was due five years from its issuance date (the "Convertible Promissory Note Maturity Date") and accrued interest at a rate of 6.5% per annum, payable quarterly in cash or in-kind for the first year at the discretion of Eventbrite, and in cash thereafter. Prior to the Convertible Promissory Note Maturity Date, the Convertible Promissory Note was convertible at our option into shares of Eventbrite’s common stock.

The Convertible Promissory Note was recorded at its fair value of $36.2 million as of the issuance date of September 1, 2017, which resulted in a discount of $13.8 million. The note was further reduced by $2.5 million in purchase price

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


adjustments. As of March 30, 2018 ("Cancellation Date"), the balance of the Convertible Promissory Note also included $1.9 million in interest receivable and $1.2 million in accretion of the discount, for a total carrying value of $36.8 million.

The discount on the Convertible Promissory Note was being amortized to interest income using the effective interest method over the period from the date of issuance through the Cancellation Date. The following table outlines the effective interest rate, contractually stated interest income and amortization of the discount for the Convertible Promissory Note for the period from January 1, 2018 through the Cancellation Date.

 
(in thousands except for effective interest rate)
Effective interest rate
14.73
%
Contractually stated interest income
$
1,892

Amortization of discount
$
1,221



11.                       Debt Instruments

Long-term debt, net consisted of the following:

 
As of December 31,
 
As of September 30,
 
2017
 
2018
 
(in thousands)
1.75% convertible senior notes due 2020
$
345,000

 
$
152,100

Unamortized discount and deferred issuance costs
(71,986
)
 
(24,453
)
Carrying value of 1.75% convertible senior notes due 2020
$
273,014

 
$
127,647

1.75% convertible senior notes due 2023
—

 
192,900

Unamortized discount and deferred issuance costs
—

 
(65,275
)
Carrying value of 1.75% convertible senior notes due 2023
$
—

 
$
127,625

Long-term debt, net
$
273,014

 
$
255,272


 
Convertible Debt Offering Due 2020

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% 2020 Notes. In connection with the issuance of the 2020 Notes, we entered into capped call transactions with the initial purchaser of the 2020 Notes and an additional financial institution ("Capped Call Transactions").

The net proceeds from the sale of the 2020 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.
On May 24, 2018, we exchanged $192.9 million in aggregate principal of the 2020 Notes for new 2023 Notes. As a result of the transaction, $192.9 million in aggregate principal of the 2020 Notes was extinguished. The extinguishment resulted in the derecognition of the carrying value of the debt, including the debt discount, of $157.4 million. We recognized a loss on exchange of $14.6 million based on the difference between the carrying value of the exchanged notes and the portion of the consideration allocated to the fair value of the new notes. The loss is included in the general and administrative line item of our Condensed Consolidated Statements of Operations. The carrying value of the existing 2020 notes as of September 30, 2018 is $127.6 million and will continue to accrete to par using the same effective interest rate as when the transaction was executed.

The 2020 Notes are unsecured, senior obligations of Pandora, and interest is payable semi-annually at a rate of 1.75% per annum. The 2020 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 2020 Notes are convertible at the option of holders only upon the occurrence of specified events or during certain periods as further described in Note 9 "Debt Instruments" in our Annual Report on Form 10-K for the year ended December 31, 2017; thereafter, until the second scheduled trading day prior to maturity, the 2020 Notes will be convertible at the option of holders at any time.


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


The conversion rate for the 2020 Notes is initially 60.9050 shares of common stock per $1,000 principal amount of the 2020 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 2020 Notes were separated into debt and equity components and assigned a fair value. The value assigned to the debt component is the estimated fair value as of the issuance date of similar debt without the conversion feature. The difference between the cash proceeds and this estimated fair value represents the value which has been assigned to the equity component and recorded as a debt discount. The debt discount is being amortized using the effective interest method over the period from the date of issuance through the December 1, 2020 maturity date. The valuation of the 2020 Notes is further described in Note 9 "Debt Instruments" in our Annual Report on Form 10-K for the year ended December 31, 2017.
The initial debt component of the 2020 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 net of $2.6 million of fees and expenses allocated to the equity component.

Convertible Debt Offering Due 2023

On May 24, 2018, we completed an exchange of $192.9 million in aggregate principal of the 2020 notes in separate transactions with the note holders. Pursuant to the exchange, the note holders received $192.9 million in aggregate principal of the 1.75% 2023 Notes.

The 2023 Notes are unsecured, senior obligations of Pandora, and interest is payable semi-annually at a rate of 1.75% per annum. The 2023 Notes will mature on December 1, 2023, unless earlier repurchased or redeemed by Pandora or converted in accordance with their terms prior to such date. Prior to July 1, 2023, the 2023 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 2023 Notes will be convertible at the option of holders at any time.

The conversion rate for the 2023 Notes is initially 104.4778 shares of common stock per $1,000 principal amount of the 2023 Notes, which is equivalent to an initial conversion price of approximately $9.57 per share of our common stock, and is subject to adjustment in certain circumstances.

We will not have the right to redeem the 2023 Notes prior to December 5, 2021. We may redeem all or any portion of the 2023 Notes for cash at our option on or after December 5, 2021 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 2023 Notes will be at a redemption price equal to 100% of the principal amount of the 2023 Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. We have the right to settle the 2023 Notes in cash, shares or a combination thereof. The maximum number of shares of common stock the 2023 Notes are convertible into is approximately 27.2 million, and is subject to adjustment under certain circumstances.

The 2023 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, 2023, during any calendar quarter commencing after the calendar quarter ended on September 30, 2018 (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, 2023, 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 2023 Notes for each trading day of the measurement period was

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


less than 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 1, 2023, upon the occurrence of specified corporate events; or

•
At any time on or after July 1, 2023 until the close of business on the second scheduled trading day immediately preceding the December 1, 2023 maturity date.

Upon the occurrence of a make-whole fundamental change or if we call all or any portion of the 2023 Notes for redemption prior to July 1, 2023, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2023 Notes in connection with such make-whole fundamental change or during the related redemption period.

The 2023 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 initial debt component of the 2023 Notes was valued at $124.3 million, which is net of $3.2 million of fees and expenses allocated to the debt component. The difference between the fair value of the total instrument and this estimated fair value of the debt component represents the value which has been assigned to the equity component. The fair value of the equity component reported in additional paid-in capital is $67.3 million, which is net of $1.7 million of fees and expenses allocated to the equity component. The difference between the principal exchanged, which is par value or $192.9 million, and the estimated fair value of the new debt represents the amount recorded as a debt discount. The debt discount is being amortized using the effective interest method over the period from the date of issuance through the December 1, 2023 maturity date.

The following tables outlines the effective interest rate, contractually stated interest expense and costs related to the amortization of the discount for the Notes:

 
Three months ended 
 September 30,
 
2017
 
2018
 
2017
 
2018
 
2020 Notes
 
2023 Notes
 
(in thousands except for effective interest rate)
Effective interest rate
10.18
%
 
10.18
%
 
N/A
 
10.38
%
Contractually stated interest expense
$
1,509

 
$
691

 
N/A
 
$
844

Amortization of discount
$
5,135

 
$
2,593

 
N/A
 
$
2,381



 
Nine months ended 
 September 30,
 
2017
 
2018
 
2017
 
2018
 
2020 Notes
 
2023 Notes
 
(in thousands except for effective interest rate)
Effective interest rate
10.18
%
 
10.18
%
 
N/A
 
10.38
%
Contractually stated interest expense
$
4,511

 
$
3,320

 
N/A
 
$
1,191

Amortization of discount
$
14,934

 
$
12,031

 
N/A
 
$
3,360




The total estimated fair value of the 2020 Notes and 2023 Notes as of September 30, 2018 was $148.7 million and $222.7 million. The fair value was determined using a methodology that combines direct market observations with quantitative pricing models to generate evaluated prices. We consider the fair value of the Notes to be a Level 2 measurement due to the limited trading activity of the Notes.


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


The closing price of our common stock was $9.51 on September 30, 2018, which was less than the initial conversion price for the 2020 Notes and 2023 Notes of approximately $16.42 and $9.57 per share. As such, the if-converted values of the 2020 Notes and 2023 Notes were less than the principal amounts of $152.1 million and $192.9 million.

Credit Facility

On December 29, 2017, we entered into a credit facility for an aggregate commitment amount of $200.0 million, with an option to increase the commitment amount by $50.0 million. As of September 30, 2018, the credit facility had a maturity date of the earliest of December 29, 2022; 120 days prior to the 2020 Notes maturity date of December 1, 2020, provided that the 2020 Notes have not been converted into common stock prior to such date; or 120 days prior to the Series A redeemable convertible preferred stock ("Series A") redemption date of September 22, 2022, provided that the Series A has not been converted into common stock prior to such date. The amount of borrowings available under the credit facility at any time is limited by our monthly accounts receivable balance at such time. The credit facility is further described in Note 9 "Debt Instruments" in our Annual Report on Form 10-K for the year ended December 31, 2017.

As of September 30, 2018, we had no outstanding borrowings, $0.8 million in letters of credit outstanding and $199.2 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, 2018.



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


12.                       Redeemable Convertible Preferred Stock

In June 2017, we entered into an agreement with Sirius XM Radio Inc. ("Sirius XM Radio") to sell 480,000 shares of Series A for $1,000 per share, with gross proceeds of $480.0 million. The Series A shares were issued in two rounds: an initial closing of 172,500 shares for $172.5 million that occurred on June 9, 2017 upon signing the agreement with Sirius XM Radio, and an additional closing of 307,500 shares for $307.5 million that occurred on September 22, 2017. Total proceeds from the initial and additional closing, net of preferred stock issuance costs of $29.3 million, were $450.7 million.

The voting rights, conversion feature, redemption feature, fundamental changes and recognition of the Series A is further described in Note 10 "Redeemable Convertible Preferred Stock" in our Annual Report on Form 10-K for the year ended December 31, 2017.

As of December 31, 2017 and September 30, 2018, redeemable convertible preferred stock consisted of the following:

 
As of December 31,
 
As of September 30,
 
2017
 
2018
 
(in thousands)
 
(in thousands)
Series A redeemable convertible preferred stock
$
480,000

 
$
480,000

Issuance costs
(29,318
)
 
(29,318
)
Accretion of issuance costs
29,318

 
29,318

Stock dividend payable to preferred stockholders
10,849

 
33,270

Redeemable convertible preferred stock
$
490,849

 
$
513,270



13.                       Stock-based Compensation Plans and Awards
 
Employee Stock-Based Awards
 
Our 2011 Equity Incentive Plan (the "2011 Plan") provides for the issuance of stock options, restricted stock units and other stock-based awards to our employees. The 2011 Plan is administered by the compensation committee of our board of directors.
 
Stock options
 
We measure stock-based compensation expense for stock options at the grant date fair value of the award and recognize expense on a straight-line basis over the requisite service period, which is generally the vesting period. We estimate the fair value of stock options using the Black-Scholes option-pricing model. During the three months ended September 30, 2017 and 2018, we recorded stock-based compensation expense from stock options of approximately $0.9 million and $1.5 million. During the nine months ended September 30, 2017 and 2018, we recorded stock-based compensation expense from stock options of approximately $6.9 million and $3.6 million.

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

 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2018
 
2017
 
2018
Expected life (in years)
6.25

 
N/A
 
5.93 - 6.25

 
2.05 - 6.25

Risk-free interest rate
1.97
%
 
N/A
 
1.92 - 2.18%

 
2.49 - 2.79 %

Expected volatility
61
%
 
N/A
 
61
%
 
58 - 60%

Expected dividend yield
0
%
 
N/A
 
0
%
 
0
%


Restricted stock units ("RSUs")
 

24
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Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)


The fair value of RSUs is expensed ratably over the vesting period. RSUs typically have an initial annual cliff vest and then vest quarterly thereafter over the service period, which is generally three to four years. During the three months ended September 30, 2017 and 2018, we recorded stock-based compensation expense from RSUs of approximately $27.7 million and $26.3 million. During the nine months ended September 30, 2017 and 2018, we recorded stock-based compensation expense from RSUs of approximately $86.5 million and $76.2 million.

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

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

 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2018
 
2017
 
2018
Expected life (in years)
0.5

 
0.5

 
0.5

 
0.5

Risk-free interest rate
0.65 - 1.13%

 
1.83 - 2.24%

 
0.44 - 1.13%

 
1.13 - 2.24%

Expected volatility
39 - 45%

 
57
%
 
39 - 52%

 
45 - 57%

Expected dividend yield
0
%
 
0
%
 
0
%
 
0
%

 
During the three months ended September 30, 2017 and 2018, we withheld $1.9 million and $1.9 million in contributions from employees and recognized $1.0 million and $0.9 million of stock-based compensation expense related to the ESPP, respectively. During the nine months ended September 30, 2017 and 2018, we withheld $8.0 million and $5.5 million in contributions from employees and recognized $2.9 million and $2.5 million of stock-based compensation expense related to the ESPP, respectively. In the three months ended September 30, 2017 and 2018, 739,922 and 855,415 shares of common stock were issued under the ESPP. In the nine months ended September 30, 2017 and 2018, 1,287,687 and 1,651,405 shares of common stock were issued under the ESPP.
 
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,
 
2017
 
2018
 
2017
 
2018
 
(in thousands)
 
(in thousands)
Stock-based compensation expense
 

 
 

 
 
 
 
Cost of revenue—Other
$
803

 
$
742

 
$
2,432

 
$
2,284

Cost of revenue—Ticketing service
6

 
—

 
69

 
—

Product development
8,428

 
8,884

 
25,765

 
23,329

Sales and marketing
14,059

 
11,300

 
42,657

 
34,209

General and administrative
6,805

 
7,912

 
27,404

 
22,980

Total stock-based compensation expense
$
30,101

 
$
28,838

 
$
98,327

 
$
82,802



25
Table of Contents
Pandora Media, Inc. 
Notes to Condensed Consolidated Financial Statements - Continued
(unaudited)




14.                       Net Loss Per Common Share

Basic net loss per common share is computed by dividing net loss available to common stockholders by the weighted-average number of shares of common stock outstanding during the period.
 
Diluted net loss per common share is computed by giving effect to all potential shares of common stock, including stock options, restricted stock units, market stock units, performance-based RSUs, potential ESPP shares and instruments convertible into common stock, to the extent dilutive. For the three and nine months ended September 30, 2017 and 2018, basic net loss per common share was the same as diluted net loss per common share, 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 common share:
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2017
 
2018
 
2017
 
2018
 
(in thousands except per share amounts)
Numerator
 
 
 
 
 
 
 
Net loss
$
(66,243
)
 
$
(63,666
)
 
$
(473,646
)
 
$
(287,353
)
Less: Stock dividend payable and transaction costs
18,319

 
7,585

 
32,847