Pandora 2016 Annual Report Download - page 55

On December 9, 2015, we completed an unregistered Rule 144A offering of $345.0 million aggregate principal amount
of our 1.75% Convertible Senior Notes due 2020 (the “Notes”). The Notes were offered only to qualified institutional buyers
pursuant to Rule 144A under the Securities Act. In connection with the offering of the Notes, we entered into capped call
transactions with the initial purchaser of the Notes and an additional financial institution (“capped call transactions”), which are
designed to reduce the potential dilutive effect of issuing shares in connection with the future conversion of the Notes, if any.
The net proceeds from the sale of the Notes were approximately $336.5 million, after deducting the initial purchaser’s fees and
other estimated expenses. We used approximately $43.2 million of the net proceeds to pay the cost of the capped call
transactions, and we intend to use the remainder of the net proceeds for general corporate purposes, including funding
expansion of our business and to pursue additional growth opportunities. Refer to Note 7 "Debt Instruments" in the Notes to
Consolidated Financial Statements for further details.
Factors Affecting our Business Model
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A majority of our listener hours occur on mobile devices and as such, we face challenges in optimizing our advertising
products for delivery on mobile and other connected device platforms and monetizing inventory, or opportunities to sell
advertisements, generated by listeners using these platforms. As a greater share of our listener hours is consumed on mobile
devices, our ability to monetize increased mobile streaming may not achieve the levels of monetization of streaming we have
achieved on computers.
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In addition, our monetization strategy includes increasing the number of ad campaigns for computer, mobile and other
connected device platforms sold to local advertisers, placing us in more direct competition with broadcast radio for advertiser
spending, especially for audio advertisements. Key to the success of our strategy to increase local advertising is our ability to
convince a substantial base of local advertisers of the benefits of advertising on the Pandora service, including demonstrating
the effectiveness and relevance of our advertising products, in particular audio advertising products, across the range of our
delivery platforms.
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Growth in our active users and distribution platforms has fueled a corresponding growth in listener hours. Our total
number of listener hours is a key driver for both revenue generation opportunities and content acquisition costs, which are the
largest component of our expenses.
• Revenue.€Listener hours define the number of opportunities we have to sell advertisements, which we refer to as
inventory. Our ability to attract advertisers depends in large part on our ability to offer sufficient inventory within
desired demographics. In turn, our ability to generate revenue depends on the extent to which we are able to sell
the inventory we have.
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• Cost of Revenue—Content Acquisition Costs.€The number of sound recordings we transmit to users of the Pandora
service, as generally reflected by listener hours, drives a substantial majority of our content acquisition costs,
although historically certain of our licensing agreements required us to pay fees for public performances of
musical works based on a percentage of revenue.
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We pay content acquisition costs, or royalties, to the copyright owners and performers, or their agents, of each sound
recording that we stream, as well as to the publishers and songwriters, or their agents, for the musical works embodied in each
of those sound recordings, subject to certain exclusions. Royalties for sound recordings are negotiated with and paid to record
labels, rights organizations or to SoundExchange, Inc. ("SoundExchange") and Merlin Networks B.V ("Merlin"). Royalties for
musical works are most often negotiated with and paid to performing rights organizations (“PROs") such as ASCAP, BMI and
SESAC, Inc. (“SESAC”) or directly to publishing companies. Royalties are calculated based on the number of sound
recordings streamed, revenue earned or other usage measures.
We stream spoken word comedy content pursuant to a federal statutory license, for which the underlying literary works
are not currently entitled to eligibility for licensing by any PRO for the United States. Rather, pursuant to industry-wide custom
and practice, this content is performed absent a specific license from any such PRO or the copyright owner of such content.
However, we pay royalties to SoundExchange at rates negotiated between representatives of online music services and
SoundExchange for the right to stream this spoken word comedy content.
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Given the current royalty structures in effect through the end of 2020 with respect to the public performance of sound
recordings in the United States, our content acquisition costs increase with each additional listener hour, regardless of whether
we are able to generate more revenue. As such, our ability to achieve and sustain profitability and operating leverage depends
on our ability to increase our revenue per hour of streaming through increased advertising revenue across all of our delivery
platforms.
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