Pandora 2016 Annual Report Download - page 88

stock price on the first date of the offering period, as well as other assumptions including the risk-free interest rate, the
estimated volatility of our stock price over the term of the offering period, the expected term of the offering period and the
expected dividend rate. Stock-based compensation expense related to the ESPP is recognized on a straight-line basis over the
offering period, net of estimated forfeitures.
Stock-Based Compensation — MSUs
We implemented a market stock unit program in March 2015 for certain key executives. Specifically, MSUs measure
Pandora’s total stockholder return (“TSR”) performance against that of the Russell 2000 Index across€three€performance
periods.
We have determined the grant-date fair value of the MSUs using a Monte Carlo simulation performed by a third-party
valuation specialist. The Monte Carlo simulation model utilizes multiple input variables to estimate the probability that market
conditions will be achieved. These variables include our expected stock price volatility over the expected term of the award,
actual and projected employee stock option exercise behaviors and the risk-free interest rate for the expected term of the award.
The variables used in these models are reviewed on an annual basis and adjusted, as needed. We recognize stock-based
compensation for the MSUs over the requisite service period using the accelerated attribution method.
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Cost of Revenue—Content Acquisition Costs
Cost of revenue—content acquisition costs principally consist of royalties paid for streaming music or other content to
our listeners. Royalties are currently calculated using negotiated rates documented in agreements. The majority of our royalties
are payable based on a fee per public performance of a sound recording, while in other cases our royalties are payable based on
a percentage of our revenue or a formula that involves a combination of per performance and revenue metrics. For certain
royalty arrangements, we accrue for estimated royalties based on the available facts and circumstances and adjust these
estimates as more information becomes available.
Cost of Revenue—Ticketing Service
Cost of revenue—ticketing service consists primarily of ticketing revenue share costs, credit card fees and intangible
amortization expense. The majority of the cost is related to revenue share costs which consist of royalties paid to clients for
their share of convenience and order processing fees. Payments to clients are recorded as an expense to the extent that the fair
value of the identifiable benefit received in the exchange exceeds the amount of the payment to the client. Intangible
amortization expense is related to amortization of developed technology.
Cost of Revenue—Other
Cost of revenue—other consists primarily of ad and music serving costs, employee-related and facilities and equipment
costs and other costs of ad sales. Ad and music serving costs consist of content streaming, maintaining our internet radio service
and creating and serving advertisements through third-party ad servers. We make payments to third-party ad servers for the
period the advertising impressions are delivered or click-through actions occur, and accordingly, we record this as a cost of
revenue in the related period. Employee-related costs include salaries and benefits associated with supporting music and ad
serving functions. Other costs of ad sales include costs related to music events that are sold as part of advertising arrangements.
Product Development
Product development consists primarily of employee-related, facilities and equipment costs, including salaries and
benefits related to employees in software engineering, music analysis and product management departments, information
technology and costs associated with supporting consumer connected-device manufacturers in implementing our service in
their products. We incur product development expenses primarily for improvements to our website and the Pandora app,
development of new advertising products and development and enhancement of our personalized station generating system. We
have generally expensed product development as incurred.
Certain website development and internal use software development costs are capitalized when specific criteria are met.
In such cases, the capitalized amounts are amortized over the useful life of the related application once the application is placed
in service.
Sales and Marketing
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Pandora Media,€Inc.
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