UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2015

 

or

 

 

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, 2014 and March 31, 2015 .

 

 

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 March 31, 2015 .

 

 

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, 2014 and March 31, 2015 .

Our investment policy requires investments to be investment grade, primarily rated “A1” by Standard & Poor’s or “P1” by Moody’s or better for short-term investments and rated “A” by Standard & Poor’s or “A2” by Moody’s or better for long-term investments, with the objective of minimizing the potential risk of principal loss. In addition, the investment policy limits the amount of credit exposure to any one issuer.

 

The unrealized losses on our available-for-sale securities as of March 31, 2015 were primarily a result of unfavorable changes in interest rates subsequent to the initial purchase of these securities. As of March 31, 2015 , we owned 101 securities that were in an unrealized loss position. We do not intend nor expect to need to sell these securities before recovering the associated unrealized losses. We expect to recover the full carrying value of these securities. As a result, no portion of the unrealized losses at March 31, 2015 is deemed to be other-than-temporary and the unrealized losses are not deemed to be credit losses. When evaluating the investments for other-than-temporary impairment, we review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and our intent to sell, or whether it is more likely than not we will be required to sell, the investment before recovery of the investment’s amortized cost basis. During the three months ended March 31, 2015 , we did no t recognize any impairment charges.

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, 2014 and March 31, 2015 :

 

Pandora Media, Inc.  

Notes to Condensed Consolidated Financial Statements - Continued

(unaudited)

 

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, 2014 and March 31, 2015 , 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 privacy and patent infringement litigation which has 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 established by the consent decree between the American Society of Composers, Authors and Publishers (“ASCAP”) and the U.S. Department of Justice in the U.S. District Court for the Southern District of New York for the determination of reasonable license fees and terms for the ASCAP consent decree license applicable to the period January 1, 2011 through December 31, 2015. On June 11, 2013, we filed a motion for partial summary judgment seeking a determination that, as a matter of law, the publishers alleged to have withdrawn certain rights of public performance by digital audio transmission from the scope of grant of rights ASCAP could license on behalf of such publishers subsequent to the date of our request for a license from ASCAP were not valid as to our ASCAP consent decree license. On September 17, 2013, our motion for partial summary judgment was granted, alleviating the need to negotiate direct licenses for such purportedly withdrawn performance rights. A trial to determine the royalty rates we will pay ASCAP for the period from January 1, 2011 through December 31, 2015 concluded in February 2014 and the court issued its opinion in March 2014. 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 on March 19, 2015 and the parties are currently awaiting the appellate court’s decision.

On June 13, 2013, Broadcast Music, Inc. (“BMI”) filed a petition in the rate court established by the consent decree between BMI and the U.S. Department of Justice in the U.S. District Court for the Southern District of New York for the determination of reasonable fees and terms for the BMI consent decree license. We filed our response on July 19, 2013. While we seek a determination applicable to the period from January 1, 2013 through December 31, 2017, BMI has limited its requested determination to only cover January 1, 2013 through December 31, 2016. On November 1, 2013, we filed a motion

for partial summary judgment seeking a determination that, as a matter of law, the publishers alleged to have withdrawn certain rights of public performance by digital audio transmission from the scope of grant of rights BMI could license on behalf of such publishers subsequent to the date of our request for a license from BMI were not valid as to our BMI consent decree license. On December 18, 2013, our motion for summary judgment was denied based on the Court’s determination that an attempted partial withdrawal, although inconsistent with BMI’s obligations under its consent decree, would result in a publisher’s complete withdrawal from BMI. This rate proceeding commenced on February 10, 2015 and ended on March 13, 2015. The parties are currently awaiting the district court’s determination.

 

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.

On October 2, 2014, Flo & Eddie Inc. filed 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. This motion was denied and Pandora has appealed the ruling to the Ninth Circuit Court of Appeals.

The outcome of any litigation is inherently uncertain. Based on our current knowledge 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.

6.                        Other Long-Term Assets

 

Pandora Media, Inc.  

Notes to Condensed Consolidated Financial Statements - Continued

(unaudited)

 

Pending Acquisition

 

In June 2013, we entered into a local marketing agreement to program KXMZ-FM, a Rapid City, South Dakota-area terrestrial radio station. In addition, we entered into an agreement to purchase the assets of KXMZ-FM for a total purchase price of approximately $0.6 million in cash, subject to certain closing conditions. As of March 31, 2015 , we have paid $0.4 million of the purchase price, which is included in the other long-term assets line item of our balance sheets.

 

The completion of the KXMZ-FM acquisition is subject to various closing conditions, which include, but are not limited to, regulatory approval by the Federal Communications Commission. Upon completion of these conditions, we expect to account for this acquisition as a business combination.

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 March 31, 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 March 31, 2015 .

8.                        Stock-based Compensation Plans and Awards

 

Employee Stock Purchase Plan ("ESPP")

 

The Employee Stock Purchase Plan 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-share fair value of shares to be granted under the ESPP is determined on the first day of the offering period using the Black-Scholes option pricing model using the following assumptions:

 

During the three months ended March 31, 2014 and 2015 , we withheld $0.9 million and $1.6 million in contributions from employees and recognized $0.3 million and $0.6 million of stock-based compensation expense related to the ESPP, respectively. In the three months ended March 31, 2015 , 282,966  shares of common stock were issued under the ESPP.

 

Employee Stock-Based Awards

 

Our 2011 Equity Incentive Plan (the “2011 Plan”) provides for the issuance of stock options, restricted stock units and other stock-based awards to our employees. The 2011 Plan is administered by the compensation committee of our board of directors.

 

Stock options

 

We measure stock-based compensation 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 March 31, 2014 and 2015 , we recorded stock-based compensation expense from stock options of approximately $3.5 million and $2.9 million .

There were no options granted in the three months ended March 31, 2015 .

 

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 March 31, 2014 and 2015 , we recorded stock-based compensation expense from RSUs of approximately $13.6 million and $19.6 million .

 

Market stock units

We implemented a market stock unit program in March 2015 for certain key executives. Specifically, MSUs measure Pandora’s TSR performance against that of the Russell 2000 Index across three performance periods. Pandora’s relative TSR is calculated using the average adjusted closing stock price of Pandora stock, and the Russell 2000 Index, for ninety calendar days prior to the beginning of each performance period and the last ninety calendar days of the performance period. The target MSUs are divided across three performance periods as follows:

For each performance period, a “performance multiplier” is calculated by comparing Pandora’s relative TSR for the period to the Russell 2000 Index TSR for the same period. The target number of shares will vest if the Pandora TSR is equal to the Russell 2000 Index TSR for the period. 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 with all upside tied to the Three-Year Performance Period. 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% .

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 months ended March 31, 2015 , we granted 776,000 MSUs at a total grant-date fair value of $4.3 million . During the three months ended March 31, 2015 , we recognized $0.1 million in stock-based compensation expense from MSUs.

Stock-based Compensation Expense

 

Stock-based compensation expense related to all employee and non-employee stock-based awards was as follows:

 

Pandora Media, Inc.  

Notes to Condensed Consolidated Financial Statements - Continued

(unaudited)

9.                        Net Loss Per Share

 

Basic net loss per share is computed by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period.

 

Diluted net loss per share is computed by giving effect to all potential shares of common stock, including stock options and restricted stock units, to the extent dilutive. Basic and diluted net loss per share were the same for the three months ended March 31, 2014 and 2015 , 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:

 

 

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: