Pandora Media (P) Brian P. McAndrews on Q4 2015 Results - Earnings Call Transcript

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Pandora Media, Inc. (NYSE:P)

Q4 2015 Earnings Call

February 11, 2016 5:00 pm ET

Executives

Dominic Paschel - Vice President, Corporate Finance & Investor Relations

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Michael S. Herring - Chief Financial Officer

Analysts

Douglas T. Anmuth - JPMorgan Securities LLC

Jason Helfstein - Oppenheimer & Co., Inc. (Broker)

Amy Yong - Macquarie Capital (NYSE:USA), Inc.

Peter C. Stabler - Wells Fargo Securities LLC

Mark Mahaney - RBC Capital Markets LLC

John P. Egbert - Stifel, Nicolaus & Co., Inc.

Michael Graham - Canaccord Genuity, Inc.

Laura Martin - Needham & Co. LLC

Ryan Fiftal - Morgan Stanley & Co. LLC

Barton E. Crockett - FBR Capital Markets & Co.

Robert S. Peck - SunTrust Robinson Humphrey, Inc.

Justin T. Patterson - Raymond James & Associates, Inc.

Operator

Welcome to Pandora's Fourth Quarter 2015 Financial Results Conference Call. Opening today's call is Dominic Paschel, Vice President, Pandora. Sir, you may begin your conference.

Dominic Paschel - Vice President, Corporate Finance & Investor Relations

Thank you, Kyle. Good afternoon, and welcome to Pandora's fourth quarter 2015 financial results call. Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on our current assumptions, expectations and beliefs, which include risks and uncertainties. For a discussion of the specific risk factors that could cause our actual results to differ materially from today's discussion, please refer to our press release.

Also, during this call, we will discuss non-GAAP measures of our performance. GAAP financial reconciliations and supplemental financial information are provided in the press release filed today with the SEC, and detailed financials are available on our Investor Relations site. Today's call is available via webcast and a replay will be available for two weeks. We will also post the full text of today's prepared remarks once Mike concludes. You can find all of the other supplemental information I have just described on the Investor Relations of Pandora.com.

With that, let me turn the call over to Brian McAndrews, Pandora's Chairman and CEO.

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Thanks, Dom, and thank you all for being on the call today. Pandora capped 2015 with a strong quarter, delivering solid financial and listener-hour growth while achieving much-needed certainty for the future. During the quarter, we continued to produce record results with consolidated revenue reaching $336.2 million, an increase of 25% over the same quarter last year. For the year, we crossed over the $1 billion revenue mark and closed 2015 with consolidated revenue of $1.164 billion, representing 26% growth year-over-year on a GAAP basis, and 28% on a non-GAAP basis.

From an earnings perspective, fourth quarter consolidated adjusted EBITDA was $24.8 million. Excluding the impact of Ticketfly, adjusted EBITDA for the quarter was $27.3 million, in-line with our guidance. For the year, consolidated adjusted EBITDA was $51.7 million. Again excluding the impact of Ticketfly, adjusted EBITDA for the year was $54.2 million, also in-line with our guidance. Our non-GAAP fourth quarter net income was $10.2 million, or non-GAAP diluted earnings per share of $0.04.

Heading into 2016 and beyond, we are on a path to create the go-to music destination for listeners and artists alike, uniquely unifying the full music experience under one roof, spanning radio, on-demand, and live music. It will be a marketplace with potential to revolutionize the connections between listeners and music makers, creating the most powerful virtuous cycle in music. And we are well on our way with key investments and innovations around both music makers and listeners. The launch and expansion of our Artist Marketing Platform, our acquired capabilities with Next Big Sound and Ticketfly, and our recent publishing direct deals, all mark significant gains in our engagement with music makers and position us as a valued partner.

And we have been similarly ambitious on the listener side, with exciting innovations like Serial, Thumbprint Radio and Browse, all of which have shown early positive results as well as acquiring talent and technology assets from Rdio to accelerate and help ensure that our entry into the on-demand space is highly integrated and robust. These investments in fan and artist engagement grow and strengthen the marketplace, building new revenue streams that result from exchanges between these parties, starting with advertising, then subscriptions and now transactions and commerce.

In doing so, we're significantly expanding the financial opportunity available to Pandora, from today's roughly $45 billion U.S. radio and digital advertising market, to a much larger $200 billion global music marketplace. Simply put, it is a generational opportunity to drive the future of music for years, if not decades, to come. And in 2016 with a profitable core business, even with the step-up in royalty rates combined with a strong balance sheet and clear path to grow profitability in our core business, we are confidently making the decision to invest now to fully capture that opportunity, which is why we are comfortable being temporarily EBITDA negative.

Fortunately, we are building off an incredibly strong foundation. Our core business is growing and profitable and has developed four significant competitive advantages: our expertise in personalization and effortless discovery, our monetization, our scale and our data. Let me break those down.

First, our expertise in personalization and effortless discovery powers our best-in-the-world listening experience, resulting in the largest, most engaged audience in streaming music. Over the years, we have seen more than 30 imitators and so-called Pandora-killers. And yet, Pandora has thrived where others have not, becoming the mobile service with the highest engagement across the consumer internet. And that's precisely because we've built so much expertise and technology over more than a decade, dedicated to delivering precisely the song listeners want to hear at the right time. And rest assured, this relentless focus will guide our expanded offerings in the future.

Our second competitive advantage is monetization. We've proven Pandora's ability to monetize free-to-the-listener streaming radio better than anyone. In fact, our core revenue grew 27% in 2015 to $933.3 million. Total advertising RPMs for the year expanded 21% versus 2014 and gained momentum each quarter to reach $50.52 for the year. Just recently, we saw iTunes Radio cease to be a free advertising-supported product, underscoring what we have known for a long time, building a business like we have is very difficult, and we now have a huge lead and advantage that is incredibly challenging for new entrants to overcome. And now we have an even stronger leadership position, and we fully intend to strengthen and grow our core business from here. Simply put, we are leading the disruption of a $17 billion radio advertising market.

Our third competitive advantage is our scale and ubiquity, which are unmatched by any other U.S. music service and continue to expand. We are at an all-time high of more than 10% share of U.S. radio listening. We reach more than 80 million active users and engagement continues to grow, now at approximately 22 hours a month per user, the highest of any U.S. mobile application and more than double the next closest music service. And our footprint extends over a 100 million mobile phones, over 1,700 consumer electronic devices and into more than 190 car models through native in-dash integrations. With the opportunity to double hours by achieving our fair share of listening in the car alone, it bodes extremely well for Pandora as the connected car becomes more and more of a reality in the coming years.

There are tangible signs that our ubiquity is paying off. Consumer electronics activations increased 38% to 32 million, while related listening hours grew 26% year-over-year. Auto activations increased 64% to 15.5 million with listening hours increasing 55% year-over-year. And this is driving engagement: for example, an analysis of auto listeners' hours before and after showed that using an in-car Pandora integration increased listening by over 24%. We are growing and investing where the consumption model is heading, fueling future growth for years to come for Pandora.

And finally, data. Because we've amassed billions of hours of listening across well over 100 million cumulative users during 2015 alone, we've built a data set that is invaluable to delivering our listener and advertiser value proposition, and will be increasingly essential for music makers. This data will fuel new services and commerce on our platform, and create new revenue streams for Pandora, spanning live events, subscriptions, and other opportunities. The potential additional applications of our data are just beginning to be realized.

Each competitive advantage, personalization and effortless discovery, monetization, scale and data, is a powerful driver to expand our core business in the near and long term. And each lay groundwork to support our newly acquired capabilities and expand into new markets, creating rocket fuel to build our multi-billion dollar music marketplace. One example of this is our strategic expansion into live music, an already healthy growing industry of $7.2 billion in North America alone. In 2015, we definitively proved Pandora can drive significant ticket sales by leveraging our personalization, data and scale.

Today, 40% of all live music tickets go unsold, and that's primarily because fans don't know their favorite artist is playing. So imagine what our marketplace can do when we apply Pandora's existing core strengths to Ticketfly's fast-growing business. Pandora will dramatically increase tickets sales, drive substantially more transaction volume across Ticketfly's platform, and strengthen Ticketfly's position as the partner of choice for new and prospective clients.

The marketplace approach of combining Pandora's competitive strengths with our new capabilities also applies to expanding our subscription business. We already have one of the most loyal and engaged subscription audiences in the United States. By applying Rdio's expertise and technology with our competitive advantages, we can address a far larger market and have a far greater impact through the introduction of new services to our audience.

And because we already deeply know and understand our users' music preferences, we are uniquely positioned to deliver an expanded experience, including on-demand, that is personalized and rich with discovery right from the start. We believe we can convert millions of listeners to paying services by offering a truly differentiated easy-to-use and incredibly enjoyable experience. We also believe having a broader offering will attract and retain even more listeners to our core Pandora radio business. There will be every reason for music lovers of all kinds to stay on Pandora.

So now that I have outlined our marketplace approach, let me close by offering a few thoughts about what I believe Pandora can achieve over the next five years in the U.S. alone. First, we will continue to grow our profitable core internet radio business. We see that business expanding to over $2.4 billion in revenues in the next five years. Our cost structure for this business is fixed and known, and thus we will operate at greater than 40% gross margin in 2016. Improvements in monetization will largely accrue to gross profit and non-GAAP gross margins on the core business will approach 60% within five years.

Second, we will continue to optimize our data to accelerate ticketing growth, combining that with our opportunity in live event sponsorship, and our powerful existing sales resources, we see a $300 million-plus revenue opportunity in the next five years. Third, in 2016 we'll integrate the technology assets from Rdio in preparation to launch an expanded listening experience. As we roll out new services, we expect subscription-based revenue growth to accelerate as our new product tiers are launched and adopted.

We believe we can build a $1.3 billion subscription business over five years, conservatively based on 10% conversion of our current U.S. audience. The above projections take Pandora to a $4 billion-plus revenue business in the U.S. alone in five years. During this period, we also intend to have significantly expanded our global footprint, bringing Pandora to tens of millions of music lovers in many markets around the world. In 2016, our focus is on building a strong foundation from a licensing and product standpoint, enabling us to begin lighting up new markets in 2017.

So to wrap up, let me simply say that we have a big year ahead, and we have huge ambitions to help drive the future of music and greatly expand our revenue and profit potential. We're crystal clear on our strategy and how we intend to achieve it. For the first time in many years, we have essential clarity about our cost structure.

We have a strong core business with key differentiators that are nearly impossible to replicate. We've invested in technology capabilities and talent to propel our entry into very large new markets, and perhaps most importantly, we have a very strong team of talented employees who are energized by what's ahead and laser focused on executing. Delivering on our ambitions won't happen overnight, but nothing big and worth doing ever does. I want you to know that I'm incredibly bullish on our future. I have a 100% conviction that we are on the right path to capture the enormous opportunity ahead.

And with that, I'd like to turn call over to Mike Herring, our Chief Financial Officer.

Michael S. Herring - Chief Financial Officer

Thank you, Brian. With cost certainty, we now have business model clarity and thus the blueprint for driving significant cash flows through our core business over the next few years. I'll provide color around what that blueprint might look like, then I'll discuss our Q4 and calendar year 2015 financial results and provide guidance before opening the call to your questions.

To echo Brian's comments, we are entering a unique and exciting time at Pandora with the CRB decision behind us and publishing deals in place. We have certainty around our costs and confidence on how to operate in order to take advantage of the many business opportunities that Pandora is uniquely positioned to capture, given our monetization expertise, massive scale and proprietary data set.

While we will see a step back in the substantial gross margin expansion progress we've made recently, we expect the business to drive gross profit of $550 million in 2016. After sales expenses of 20% or $200 million and subscription commissions of $50 million, we expect the core business to generate $275 million of contribution margin in 2016. As we look forward however, we see significant potential to drive RPMs much higher and with LPMs now fixed at the $32 level under currently licensing terms adjusted for inflation, we will directly drive substantial expansion of contribution margins in our core business.

We are already well in excess of $70 RPMs in many markets in the high value demos. For example, in the San Francisco Bay Area for ages 25 to 34, we have driven mobile RPM growth 69% to $83 in Q4 2015 from $49 in Q4 2013. With advances in programmatic and novel ad units, we believe we can drive total ad RPM well above $70, but we will optimize to drive revenue and profits over the long term. With cost structures known and new products coming to market, we don't have to monetize at all cost. With LPMs fixed, as we push to $70 RPMs and beyond, the majority of the increase in monetization accrues to profit and thus we have a clear path to $1.4 billion-plus in annual gross margin and 20% operating margins by 2020.

As Brian discussed, given our confidence in our profitable core model, we believe now is the time to invest towards these goals. In subscriptions, we have the opportunity to leverage Pandora's data and audience to convert millions to paid services. We expect lower profit margins in these services, but higher unit economics with our customer acquisition costs viewed as an internal trade-off versus the advertising opportunity. In live events, we see an opportunity to leverage data and audience for commerce. Ticketing is just the first foray in this direction. We have a five-year plan to scale these upsell and cross-sell paths to approximately $4 billion in revenue, including greater than $1 billion in new services and $300 million in live events, and a 20% operating margin by 2020.

During this time, our plan expects the core internet radio business to grow to more than $2 billion in revenue. Our core business funds new business line development and provides the customer pool for these new business lines. We are excited about our plan for the next five years and believe this is the optimal time to build on the strong foundation we have exited 2015.

Now, I'll take you through our fourth quarter and calendar year 2015 results. Starting with revenue, we ended the fourth quarter of 2015 with consolidated total revenue of $336.2 million. Excluding revenue from ticketing services, revenue was $326 million, in line with guidance, an increase of 22% compared to $268 million in total revenue from the same quarter last year. Advertising revenue increased 22% in the fourth quarter of 2015 to $269 million, compared to $220.1 million in revenue in the same quarter last year.

Revenue from local advertising represented 25% in the quarter, up from 23%. Fourth quarter subscription and other revenue was $57 million, an increase of 19% over $47.9 million in the same period in 2014. Ticketing service revenue for the two-month period ending December 31, 2015 was $10.2 million, as a result of our acquisition of Ticketfly, which closed on October 31, 2015. Our end of period paid subscribers increased from 3.6 million to 3.9 million, an increase of approximately 10% year-over-year.

For the year ended December 31, 2015, Pandora delivered consolidated total revenue of $1.164 billion. Excluding revenue from ticketing services, revenue was $1.154 billion or growth of 25% on a GAAP basis and growth of 27% on a non-GAAP basis compared to the prior year. Advertising revenue was $933.3 million, a 27% increase, while subscription and other revenue was $220.6 million, or 17% growth on a GAAP basis and 27% growth on a non-GAAP basis year-over-year. For the year, local advertising revenue was at an all-time high of 25% of the annual revenue with 154 local sales people now in market, up from 111 at the end of 2014.

For the quarter, consolidated adjusted EBITDA was $24.8 million. Adjusted EBITDA for the quarter excluding Ticketfly was $27.3 million, compared to $43.8 million in the same quarter last year and in line with guidance. Consolidated adjusted EBITDA excludes $32.2 million in expense from stock-based compensation, $9.3 million of depreciation and amortization expense, $2.9 million of Ticketfly and Rdio transaction costs, approximately $1.8 million in benefit from income taxes, and approximately $1.6 million in other expense.

For the year, consolidated adjusted EBITDA was $51.7 million. Adjusted EBITDA for the year excluding Ticketfly was $54.2 million, compared to $58.2 million last year and in line with guidance. Our full year consolidated adjusted EBITDA excludes one-time cumulative charges to cost of revenue, content acquisition costs of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management's decision to forgo the application of the RMLC royalty rate from June 2013 to September 2015, $111.6 million in expense from stock-based compensation, $24.5 million of depreciation and amortization expense, $3.7 million of Ticketfly and Rdio transaction costs, approximately $1.6 million of benefit from income taxes, and approximately $1.2 million of other expense.

Fourth quarter 2015 GAAP basic and diluted net loss per share was $0.09. Basic and diluted non-GAAP earnings per share were $0.05 and $0.04, which excludes approximately $32.2 million in stock-based compensation expense and approximately $3.3 million in amortization of intangibles and amortization of non-recoupable ticketing contract advances and $2.9 million in Ticketfly and Rdio transaction costs, offset by $8.7 million in income tax effects of non-GAAP adjustments. GAAP basic and diluted and non-GAAP basic EPS were based on 220.6 million weighted average shares outstanding. Non-GAAP diluted EPS was based on 229.4 shares outstanding.

Full year 2015 GAAP basic and diluted net loss per share was $0.79. Basic and diluted non-GAAP earnings per share were $0.10 and $0.09, which exclude one-time cumulative charges to cost of revenue, content acquisition costs of $57.9 million for the pre-1972 sound recordings settlement and $23.9 million as a result of management's decision to forgo the application of the RMLC royalty rate from June 2013 to September 2015, approximately $111.6 million in stock-based compensation expense and approximately $4.1 million in amortization of intangibles and amortization of non-recoupable ticketing contract advances and $3.7 million in Ticketfly and Rdio transaction costs, offset by $11 million in income tax effects of non-GAAP adjustments. GAAP basic and diluted and non-GAAP basic EPS were based on 213.8 million weighted average shares outstanding. Non-GAAP diluted EPS was based on 222.7 million shares outstanding.

We continued to leverage our content costs to drive gross profitability and in the fourth quarter, they represented 43% of total revenue, an improvement of approximately 50 basis points over Q4 2014 based on total consolidated revenue. As we have previously emphasized, our ability to leverage these costs is dependent on our ability to increase RPMs in excess of our LPMs. Q4 2015 total RPMs reached a record high of $60.75 increasing by $9.21 or 18% compared to the year-ago period. For the quarter, total LPMs increased by $4.47, or 20% compared to the same quarter last year. Total web RPM and total mobile RPM for the fourth quarter were $69.31 and $59.11, respectively. Web advertising RPM reached $68.42 and mobile advertising RPM reached $55.14.

For the year, total RPMs were $54.65 increasing by $8.68 or 19% on a GAAP basis and 21% on a non-GAAP basis compared to the year-ago period. Total web RPM and total mobile RPM for 2015 were $68.63 and $52.13, respectively. Web advertising RPM reached $67.99 and mobile advertising RPM reached $47.56. During the fourth quarter, non-GAAP gross margin was 50% compared to 51% in the year-ago quarter. Content costs, excluding the pre-1972 and RLMC-related charges, were $528.5 million, or 45% of revenue for the full year 2015. Non-GAAP gross margin was 48% of revenue, compared to 44% in 2014.

Turning to operating expenses, we increased head count 57% year-over-year to 2,219 employees at the end of the fourth quarter of calendar year 2015, which includes 96 employees and 165 employees that joined in the fourth quarter from Rdio and Ticketfly, respectively. This is up from 1,414 employees in the same period last year.

For the fourth quarter of 2015, non-GAAP sales and marketing expense was $96.5 million, or 29% of revenue, compared to $63.4 million, or 24% of revenue in the fourth quarter of 2014 as we continued to ramp our sales team and our brand and direct marketing activities. Included in sales and marketing expense are commissions on subscriptions that we pay Google and Apple totaling $11.1 million, and $22.2 million in brand, direct response and search engine marketing activities.

Non-GAAP product development expense was $20.2 million for the fourth quarter, or 6% of revenue, an increase of 110% compared to $9.6 million in the fourth quarter of 2014. As we have said previously, we believe product development is an investment to drive revenue 13 months to 36 months out, and thus we remain committed to increasing our spending in this critical area. Non-GAAP G&A expense was $31.0 million, or 9% of revenue, compared to $24.1 million in the same quarter last year, and consistent on a percentage of revenue basis.

For the calendar year 2015, non-GAAP sales and marketing expense was $343.6 million, or 30% of revenue, compared to $235.2 million, or 26% of non-GAAP revenue for the calendar year 2014. Included in sales and marketing expense are commissions on subscriptions that we pay Google and Apple totaling $42.6 million, and $63.5 million in brand, direct response and SEM activities for the year 2015.

Non-GAAP product development expense was $60.3 million for the calendar year 2015, or 5% of revenue, a 100 basis-point increase compared to the calendar year 2014 on a non-GAAP basis. Non-GAAP G&A expense was $119.9 million, or 10% of revenue, and consistent with calendar year 2014 G&A expenses as a percentage of non-GAAP revenues.

Turning to the balance sheet, Pandora ended the fourth quarter with $416.9 million in cash and investments, compared to $442.6 million at the end of the prior quarter. Cash used in operating activities was $71.0 million for the fourth quarter compared to $25.1 million of cash generated by operating activities in the year-ago quarter, as a result of timing of royalty payments related to the settlements entered into in the third quarter of 2015. Capital expenditures were $4.7 million in the fourth quarter. Lastly, we completed a convertible debt financing in the quarter for approximately net proceeds of $300 million, optimizing our capital structure as we enter 2016.

Now, I'll wrap up with some thoughts regarding our guidance for the calendar year 2016 and the first quarter. I'm going to run through numbers related to the profitability profile of Pandora's core business and our investments. To make it easier for you, we've posted them on our Investor Relations website. As a result of the Web IV/CRB decision, expected growth in hours, the pre-1972 settlement and the recently signed direct publishing deals, content costs in 2016 are increasing $160 million over 2015. Our progress made in driving gross profit and EBITDA growth over the past few years will take a step back due to this cumulative $160 million in additional expense in 2016, but these events have significant long-term upside as they have created the certainty and fixed-cost framework that will allow us to drive improving profit margins over the next few years.

Despite this large increase in royalty costs, we expect our core business to reach $1.325 billion in revenue and $50 million in EBITDA in 2016, or 4% EBITDA margin. As we look forward, we believe we can drive the business profitably over the next few years to achieve over $2.4 billion in revenue and $480 million in operating profit in 2020, or 20% non-GAAP operating margins. To grow beyond our core business and increase revenue to $4.0 billion in 2020, we are initiating investments in our scaling infrastructure and in new lines of business, totaling $345 million in 2016.

Those investments in 2016 include the following: $120 million in marketing, including $80 million in external marketing spend, to maintain and grow our audience base and position Pandora's brand for the next phase; $100 million in product development, an increase from 5.0% to 8.0% of revenue, a step function in investment driven by the acquisition of the assets and key talent of Rdio last month. These investments are focused on bringing new products to market and supporting our growth initiatives; $125 million in G&A, from 10.2% to 9.4% of revenue, to build infrastructure for the future, including content licensing and reporting infrastructure; Ticketfly will see significant investment, but covered by its own revenue performance, so we expect an additional $80 million to $90 million in revenue in 2016 from that business and minimal impact to EBITDA after investment of its contribution margin into sales and marketing and product and development; of the investments we are outlining, $120 million of it is earmarked specifically to develop and launch new music services that we believe will accelerate revenue growth in 2017 and beyond; thus, with $275 million in contribution margin from the core business, $345 million in investments and minimal impact from Ticketfly, we are expecting an approximate $70 million EBITDA loss in 2016. However, as we look to the next few years we have a clear path to drive significant cash flow as these investments show returns.

Also, to clarify the impact of the new publishing arrangements for the U.S. based core radio service, the majority of the deals are structured based on a pro rata share of 20% of the sound recording pool, so publishers are paid based on usage of their works out of that pool. The deal is a different structure than previous PRO industry deals, which have traditionally been based on a percentage of a service's revenue. Under those deals, if a service does not earn significant revenue, the total payments to the publishers are low and there is no incentive to earn. This structure, which is based on a percentage of the pool of sound recording payments, guarantees publishers that they will receive revenue from the service, while allowing Pandora to keep the upside when we are successful in monetizing above the per play rates. It is a great model for services like Pandora that are able to monetize well and a structure the publishing industry has embraced, a win-win solution that has ended years of acrimony

Now, moving to our revenue and adjusted EBITDA guidance, and starting with the calendar year 2016, we estimate total revenues in the range of $1.4 billion to $1.42 billion, or year-over-year growth at the mid-point of approximately 21%. We expect calendar year 2016 adjusted EBITDA loss to be in the range of a loss of $80 million to a loss of $60 million. Adjusted EBITDA excludes forecasted stock-based compensation expense of approximately $164 million and forecasted depreciation and amortization expense of approximately $62 million and a provision of income taxes of approximately $2 million and assumes minimal cash taxes given our net loss position for the year.

Basic shares outstanding for the calendar year 2016 are expected to be approximately 231 million. We are also forecasting a non-GAAP effective tax rate between 30% and 35% cumulatively for each quarter and the year.

For the first quarter of 2016, we expect total revenues in the range of $280 million to $290 million, achieving year-over-year growth at the mid-point of 23%. Adjusted EBITDA is expected to be in the range of a loss of $75 million to a loss of $65 million for the first quarter. Adjusted EBITDA excludes forecasted stock-based compensation expense of approximately $38 million and forecasted depreciation and amortization expense of approximately $14 million and a provision for income taxes of approximately $0.5 million and assumes minimal cash taxes given our net loss position for the first quarter. We are also forecasting a non-GAAP effective tax rate between 30% and 35% for the quarter. Basic shares outstanding for the first quarter 2016 are expected to be approximately 227 million.

In summary, we believe at a high level there is a huge upside for Pandora. Building off our music platform for engagement and discovery, we have a tremendous global market opportunity in music. There are major multi-billion dollar markets to address: the global radio advertising market, the mobile advertising market, paid music services and live events.

As we've outlined in this call, Pandora has a clear path to success, and we are focusing on the following: operating the core business to generate significant cash flow, bringing new products to market that have compelling competitive differentiation, demonstrating the power of Pandora's scale and data to drive live events demand, and building and maintaining the scale necessary to execute on the opportunity We're well prepared for the challenge and excited for the future.

And with that we're ready to take some questions. Operator?

Question-and-Answer Session

Operator

Your first question comes from the line of Douglas Anmuth. Your line is open.

Douglas T. Anmuth - JPMorgan Securities LLC

Thanks for taking the question. Two things. First, just thanks for putting some numbers around your longer-term outlook. But first as part of that, the $1.3 billion new music service business, so that's about a third of the $4 billion, and it obviously is a business that doesn't truly exist yet. Can you just give us some more color what that 10% penetration is based on, more on what that service could look like? And then also really your confidence level in getting this done with the labels. Assume that has to be fairly high here given that you are putting out this kind of number. And then secondly, if all this happens as you think in 2016, is it right to think about 2017 theoretically as a big leverage here with the new music service investments behind and better overall monetization? Thanks.

Michael S. Herring - Chief Financial Officer

So obviously, we're putting a stake in the ground where we believe we can take this business. The 10% penetration, we think it's a conservative penetration based upon what is happening in the market today. We've seen penetration rates in other services at higher rates than that. We think we can provide a clear path of value proposition to users to incentivize them to move into paid services over time. And we think we have really unique approach to those paid services that will actually be attractive to listeners. So we're confident that we can do that. But we obviously have to build and launch those products and prove out that path to that success.

Now a big part of doing that is attain the licensing. And to your point, we don't have the license to launch the services now. So that's why it's five years out. We have taken huge steps and been very definitive about our intention to bring services to market that bring up our average revenue per user, and acquiring the assets of Rdio and bringing on the 96 employees from that business into our service was obviously a very public step in that direction. And we've been working hard with the music industry to figure out the right way to balance economics in order to make that happen. We've accomplished that with the publishing industry. So half of the two licenses that you need to achieve that are now under our belts and it's important that we find the right win-win solutions now with the labels and the sound recording industry in order to bring that second part to market.

Your last question about is 2017 a leverage year I think largely depends on our ability to get those licenses in place and get those products launched. We do think that this is a year where we'll be figuring out the live events space, bringing new products and capabilities to market that can accelerate the Ticketfly business within Pandora, but a big part of accelerating margins is actually driving revenue off of the $120 million annual investment that we're undertaking in 2016 towards products that we're currently not selling. And as soon as we can get those to market, the sooner we can drive margin against that investment and our plan is certainly to see that happen in 2017, but it is one that is dependent on partnerships with the content holders.

Douglas T. Anmuth - JPMorgan Securities LLC

Great. Thank you, Mike.

Operator

Your next question comes from the line of Jason Helfstein. Your line is open.

Jason Helfstein - Oppenheimer & Co., Inc. (Broker)

Thanks. I just wanted to ask about two things. One, what initiatives you guys have planned for 2016 that you're willing to share to try to drive engagement? And maybe you want to share what your expectation is for listenership growth is for this year? And then second, just a follow up on that. The margin assumption that you have in this five-year forecast, I mean this is based on your expectation of the licensing costs for the new music service or discussions in contracts you've already had? Thanks.

Brian P. McAndrews - Chairman, President & Chief Executive Officer

I'll say a couple of things. In terms of listener growth, we don't forecast listener growth, but we're not expecting significant growth in 2016 because of the competitive environment and continued existence of free on-demand services and significant competitive spending. But we are investing to maintain growth and we do expect to see some continued increase in engagement.

And in terms of initiatives, some of the things that we're continuing to do and seeing results on, some of which I talked about, is expanding all the new consumer electronic devices, continue to expand in autos as well as the marketing spend that Mike talked about, which we also think will be beneficial in terms of bringing back last users or just encouraging people to come back more frequently. Also innovations like Thumbprint Radio which we recently launched and are seeing good results on that and Serial.

So those kinds of things will be new product enhancements to improve the product, marketing and then continuing our scale into new areas where people are listening. And then in terms of the five-year forecast, I would say it's not based on deals we have in hand other than the publisher deals that Mike talked about, but we need to finalize the label deals, but again we're making investment, we'll able to do that and based on that we believe these are appropriate forecast numbers in terms of revenue.

Operator

Your next question comes from the line of Amy Yong. Your line is open.

Amy Yong - Macquarie Capital (USA), Inc.

Thanks. Can you hear me?

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Hi, Amy Yong. Yes.

Amy Yong - Macquarie Capital (USA), Inc.

Hello.

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Yes, we can hear you.

Amy Yong - Macquarie Capital (USA), Inc.

Hi. So thank you for taking the question. I was just wondering, if you could talk a little about the competitive landscape in Rdio and on-demand, and how that might change your view of the mix between ad and subscription based longer-term, and specifically should we expect any cannibalization on near-term metrics. And then separately I know there is a lot of discussion on industry cost structure and perhaps I think the labels are going after Spotify right now and these three tiers, and it seems like they are actually asking for 2x the rate that Pandora is paying. Can you comment just on industry structure and what you are seeing between the labels and the rest of the industry? Thank you.

Michael S. Herring - Chief Financial Officer

Well, I will start out by talking about the Spotify. We don't have any insight into their negotiations as to what rates they are asking or what rate they have been being paying historically. So I don't really have anything to offer there. In terms of canalizing our core as we launch new services, although this has somewhat lower margins, I think, I mentioned briefly in my comments, the unit economics are higher on a per user basis. So it does put pressure on gross margin percentages, but it drives higher absolute dollars on a per user basis. So as we drive the business, we'll balance those two considerations.

Operator

Your next question comes from the line of Peter Stabler. Your line is open.

Peter C. Stabler - Wells Fargo Securities LLC

Thanks for taking the questions. A follow-up on to the last question there, Mike. So on the unit economics piece, obviously, a huge swing factor here is the relative exposure to Google and Apple and I'm trying to piece together your comments here. You said on the sub-commissions, there was a $11 million exposure in Q4, $42 million for 2015 and a projected $50 million for 2016. So that's not a tremendous ramp, so I guess I'm reading from this that you're not expecting a large ramp on the subs this year. And I guess more importantly, can you just talk to us a little bit about how you mitigate the exposure to Google and Apple? And what kind of assumptions you're baking in here on the longer-term? I hope this makes sense. Thanks.

Michael S. Herring - Chief Financial Officer

Yes. Actually, it makes perfect senses, Peter. Thank you for the question. So, yes, we don't expect sub revenue to grow very quickly this year, until we are launching, sort of, the next generation of Pandora 1 and additional services on top of that. I think, maybe about 5% year-over-year from a revenue perspective. So that's why we don't see the mix shifting from in-app purchases versus direct purchases changing a lot, so that those costs shouldn't grow a lot. But you're right to point out that that dynamic is important.

It certainly puts independent music services at a disadvantage where we're paying 30% of the economics out to the platforms that distribute our apps, who also happen to be competing with us, and for the same users, and the same economics. So that said, there is lots of other ways to approach that. And we're being creative as we roll things out. One of the advantages of having a service like Ticketfly, is as we unify the user IDs between Pandora's IDs and Ticketfly customers, that we have a much more transactional capability with those customers including credit cards on file. One click ticketing also means one click purchasing, which could also mean one click subscription at that time where we're charging them through a credit card relationship versus an in-app purchase. It's one of the side benefits of developing deeper and more inclusive relationships with our listeners.

Operator

Your next question comes from the line of Mark Mahaney. Your line is open.

Mark Mahaney - RBC Capital Markets LLC

In terms of driving engagement, could you talk a little bit about the product roadmap, there's actually been just as an average user a fair amount of innovation that I've seen over the last six months. What are you thinking about for the next 12 months, could you talk about that a little bit? And what impact, do you think, that's already had in terms of driving those hours, the increase in hours that you've driven this last six months?

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Sure, Mark. In terms of some of the innovations that you're talking about we have seen, it's still relatively early, but we've seen some really positive results from, for example, Thumbprint Radio and Serial. Thumbprint Radio has over 4 million station ads and the average daily time spent listening is an incremental 60 minutes per listener, an hour per listener, listening to that. And actually at this point it's the second most listened to Pandora station. So we consider it a really – early success so far, and we want to continue to see that grow, we're continuing to market that, and we think there's a lot more upside there.

Serial, we've had over 5 million station ads to-date and is an example of how many people have been engaged, we had over 5 million listeners for the first four episodes of Season Two, our understanding is iTunes reported that same number for the first five episodes for Season One. So we're seeing some great engagement and people coming back, some of whom have not been listening to Pandora as frequently others who have. So, I think, you'll continue to see that kind of innovation. We aren't the business really saying what we're going to do in terms of our product roadmap looking forward other than in broad strokes about adding tiers and going into on-demand down the road, but with our core business we do anticipate continuing to innovate there.

Operator

Your next question comes from the line of John Egbert. Your line is open.

John P. Egbert - Stifel, Nicolaus & Co., Inc.

Thanks. So if you assume a $10 ASP for on-demand, it sounds like you're anticipating having 110 million total listeners about five years from now. At the Analyst Day a while back you discussed a larger quarterly active user number that you could potentially draw from and reactivate to drive monthly active users. Can you give us any context on what that is? And what are the initiatives that give you confidence in in growing from here to that larger number five years down the road?

Brian P. McAndrews - Chairman, President & Chief Executive Officer

So in terms of the overall number of listeners, we think we're going to continue on the path we're on. We think increased penetration of consumer electronic devices are growing. We have significant upside in autos as I mentioned in my comments. Our overall market share past 10% for radio listening in the U.S. and yet it's under 2% in cars and cars represent nearly half of radio listening. So as we continue to grow in cars and we've seen significant increase in our number of integration as these cars become connected kind of the final phase and the user experience continues to get better and better, we think we've just tremendous upside there.

Similarly consumer electronic devices aren't slowing down, that's where people are moving and listing in all different ways and we're in over a thousand of them and saw significant increase as I talked about in terms of up to 32 million activations now, and 15.5 million in the car. So, we think we can get to 100 million listeners in the next three years to five years, and so that's kind of where we're basing our estimates off of, that kind of growth and that kind of continued penetration.

Operator

Your next question comes from the line of Michael Graham. Your line is open.

Michael Graham - Canaccord Genuity, Inc.

Hey, thank you. Just on the timing of things here. Can you put any more color around, do you expect to launch this new service in this year in time for any meaningful revenue contribution? And can you say anything about when you might expect to have the label deals done? And then just on the RPM outlook, Mike, when you mentioned expanding RPMs pretty sharply, are you getting a little looser on how you're thinking about expanding the ad load as part of that? Or do you expect that to come from sort of the existing ad load structure? Thanks.

Brian P. McAndrews - Chairman, President & Chief Executive Officer

So, I'll answer the first part and then Mike can answer the second. In terms of the timing of our full offering with on-demand, we do not expect meaningful revenue from on-demand in this year. We expect to be in the market, we hope to be in the market by the end of the year, but more generally available in early 2017, and that presupposes that we do of course have agreements with the labels at that point.

Michael S. Herring - Chief Financial Officer

Yeah. In terms of the question about driving RPMs I mean, at the current ad loads we're at now, so averaging in this high-value demos and areas, 5, 5.5 ads at the most on a per hour basis, it will grow well into the $70, $80, $90 RPMs. So we're very confident we can do that, it's a matter of both penetrating markets, driving budgets from terrestrial radio to Pandora, and it's about expanding into new sources of demand where we can under-monetize demographics and geographics. So, there's lots of ideas there. It is true though that as we bring new products to market from a paid services perspective, it will give us more leeway to increase ad load.

We know that a lot of our users also use other services. This is a way of keeping them within the Pandora family. And as we over time increase ad load, and we have other products to offer them at that time, we want them to be able to make a choice to stay within Pandora, have best-in-class radio products, lean-back products, but also significantly differentiated other new music services on-demand and otherwise that they're willing to pay for it. And once those are available, I think we'll get much more aggressive in terms of monetizing service.

Operator

Your next question comes from the line of Laura Martin. Your line is open.

Laura Martin - Needham & Co. LLC

Do you hear me okay guys?

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Yeah. We can hear you now. Hi, Laura.

Laura Martin - Needham & Co. LLC

Great. Hi, there, how are you? So one question I have for you Brian is, Pandora's stock price is down 32% year-to-date. And one of the really important things as an input to your business is your employees and since a lot of their comp is often in shares, do you start losing employees unless you reset the options or are you seeing any impacts of the weakness in the shares? Why don't you answer that first and then I got one for Mike.

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Okay. Yeah. I mean clearly, we do have compensation based on that includes equity, and I think people are here because they believe there's upside in the equity and even though they're, and obviously it's granted at different times, so you get some at higher prices and some at lower prices depending on where we are in the cycle. But I think we've had good retention and I think our employees are very much rallied behind the strategy we have and very much believe in what we're doing.

So, certainly like any tech company in the Valley, we're going to have some attrition, but we've actually been very fortunate to not have much and we've actually been hiring and bringing people onboard. So something we're clearly aware of and we want to make sure that we're driving value for our shareholders which include employees over time for sure, but we are where we are and we're working hard on the strategy to make sure that we can build that value over time. Laura, did you have a second question or?

Dominic Paschel - Vice President, Corporate Finance & Investor Relations

I think we lost her.

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Okay. Maybe we'll catch you in the second go round.

Dominic Paschel - Vice President, Corporate Finance & Investor Relations

Go ahead Kyle.

Operator

Next question comes from line of Ben Swinburne. Your line is open.

Ryan Fiftal - Morgan Stanley & Co. LLC

Ryan Fiftal on for Ben. I had two questions if I may, so. First, I'd like to follow up on your conversations with the record labels that's obviously so important to these new businesses. So I guess with the CRB now behind us, can you give us any better sense of what you think is holding up these deals. Do you think that you and the labels have any kind of really fundamental differences about how the industry should be structured or do you really think at this point this is a matter of just splitting the economics correctly?

Brian P. McAndrews - Chairman, President & Chief Executive Officer

I think it's a matter of finding the right balance. Certainly having the CRB behind us is a great benchmark, and it also has driven the right conversations between Pandora and frankly all the services in terms of what are the right services that should be free to the consumer ad supported, how do those compensate the copyright holders in the right way, but also like what should be behind a paid wall and how do we make that consistent across the industry.

One of the reasons why maybe from your perspective it's holding it up, I wouldn't say it's that. It's about the music industry really understanding what their strategy is in terms of how music is going to be distributed and how it should be available to consumers in this new world. Our argument has always been a radio product like this is a great way to drive discovery, to drive awareness and it ought to be monetized appropriately and ought to pay a fair royalty and Pandora I think is getting credit now for stepping up and doing that the right way.

We're paying real royalties. We've reached out and found the right balance with the publishers and I think we'll find out with the labels as well. We also think that there are certain aspects of music listening that ought to be behind a paid wall. And on one far end that's on-demand listening, we're proposing that as we move into products that have more on-demand features that those are behind paid walls and they paid a different royalty rate.

I think everyone agrees with that at some level, at least most of the labels in Pandora do, and most of the services, but they've got more work to sort out. And if it was just Pandora and the labels in a vacuum, maybe things would be happening quickly, but there are obviously other players in here that also are negotiating with the labels at the same time. And I think eventually we're going to get all these things to sort out, but in the meantime, we're well set to operate well this year. We're not under any sort of gun. We're willing to work with them, and are having the right conversations, and I think we'll get there.

Dominic Paschel - Vice President, Corporate Finance & Investor Relations

Great. Kyle, I think we have Laura back for the second part of her question.

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Laura?

Operator

Your next question comes from the Laura Martin. Your line is open.

Laura Martin - Needham & Co. LLC

Okay. Thank you. I'm sorry. Mike, $160 million of costs, right. So, we're going to take our EBITDA estimate from positive $80 million to negative $80 million for 2016, that's right, right $160 million of extra costs in 2016, right?

Michael S. Herring - Chief Financial Officer

That's correct.

Laura Martin - Needham & Co. LLC

Okay. Great. So, then my question is, how much of those costs, I'm going to call them variable, but I don't mean that word, what I mean is how much was the CRB where sort of you're screwed. It can't change based on new listening. So how of that is fixed because of the CRB? And then how much is, if you don't get all the record labels, so you actually can't launch the service on the timetable, how much is sort of dependent on a bunch of dominos having to fall on place, so some of those costs might get shifted to the subsequent year?

Brian P. McAndrews - Chairman, President & Chief Executive Officer

So, those costs are all based upon activities that occurred in 2015. So that is, those are the only thing that would change how much we paid would be the amount of music we played. We have a fixed rate essentially on a per-play basis now for the next five years and so the only thing that changes in terms of absolute dollars we pay is the sheer amount of music we play.

Now, so no future deals are in that $160 million. That is the CRB rate is, and then publisher agreements and the pre-1972 agreement kind of all wrapped up. And so it's a big step function in what that rate is. It takes it from the LPMs that we were paying at around $25 in 2015 to new LPMs around $32. So it's a big number that changes year-over-year, but then it stays there and that's where the real advantage to Pandora is, is we now have clear and fixed rates that we pay. Now this is a problem for anybody else. And if you've been reading any of the music trades, many small webcasters shutdown on January 1, because a $32 LPM for them is impossible.

If you are getting network rates or you're selling through Caps Media or somebody, you're getting $2, $3 CPMs if you're lucky. There is no way you can cover anything close to a $32. That means you're selling 11 ads before you even break even on your content cost, doesn't happen. So all these guys are going out of business. The reality is Pandora, because of our advertising prowess and because of our engine that we've built over these years, we already have RPMs well in excess of that $32. We are like the exception that can survive and thrive in a cost structure that looks like that.

That's a huge competitive advantage for us. It allows us to not just continue to lead but grow our leadership in this space. But the reality is, in the short term we're taking that step back to your point. And all the good work that we've done the last three years is not for nothing, it put us in a situation to now thrive over the next five.

Laura Martin - Needham & Co. LLC

Okay. So there is just not a lot of money in there for these new products that you've been talking about. I guess I was thinking there was more for sort of the – okay, that's what I didn't understand. Okay, that's very helpful. Thank you.

Brian P. McAndrews - Chairman, President & Chief Executive Officer

The incremental $120 million for new products is all product development back-office infrastructure stuff we're doing this year to get ready to launch. We could launch as early as end of Q3, Q4 with some of these products if we are able to get licensing in place.

Operator

Your next question comes from the line of Barton Crockett. Your line is open.

Barton E. Crockett - FBR Capital Markets & Co.

Okay. Thanks for taking the questions. Hello? Okay.

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Go ahead Bart.

Barton E. Crockett - FBR Capital Markets & Co.

Okay. Thank you. I'd like to slip in two if I can. One is just the elephant in the room, I haven't heard you guys address The New York Times report. I assume that the answer is pretty straightforward, but I want to make sure that if you can address it that you will. But my real question is really more on the assumption there for the on-demand services, that $120 million of cost. Could you give us a sense of how much of that is fixed versus variable as people start using the service that those costs will grow, so we'll get a better sense of what the ramp in profit and contribution could be for that as you go into 2017 and beyond?

Brian P. McAndrews - Chairman, President & Chief Executive Officer

Barton, this is Brian. I'll address the first part and let Mike address the second part, and you're right it's a short and easy answer. We don't want to comment on rumors. We'll say that we're very confident in our ability to continue to drive significant value for our shareholders by executing the strategy that you've heard us talk about and that's where we're focused on.

Michael S. Herring - Chief Financial Officer

Yeah. So, the $120 million is on a run rate of engineering and technical resources and back office systems and teams in order to do rights management, royalty reporting, but also to develop and deliver on a product at scale that has a lot of features that our current product doesn't have. Whether it's on-demand features or the offline features or it's new features that we're going to bring to market that don't exist in the market today. That's a whole body of work that's being consolidated now and so that's more of like – that's the operating expense that creates the product.

When we bring that to product, it will have a royalty structure. That probably won't look significantly different than current on-demand businesses that are out there, we're talking gross profit margins that instead of 60% where we think our current core business can operate, it's probably more like 35% at the end of the day, but because we don't have the customer acquisition cost act part of that, this is really about an up-sell, cross-sell path on to our 60% profit margin, core business. And it has unit economics that are still even at that lower margin of multiple of the unit economics of the ad supported business, that's a healthy up-sell, cross-sell into there. So, when we get to – so I would say that's more like a fixed cost in your definition, meaning that's a cost that will keep repeating, it won't grow a lot, because that's a core team that can build this and did operate it, for example at Rdio for years, although we will be adding and enhancing those capabilities. So the variable cost will be dependent really more on the royalty structure and not on the customer acquisition cost or anything, because those are cost that we think we already have built in as part of our core business.

Operator

Your next question comes from the line of Robert Peck. Your line is open.

Robert S. Peck - SunTrust Robinson Humphrey, Inc.

Yeah. Hi, thanks for taking my question. Just following up on the last question there. Brian, I know you can't comment directly on rumors, but given the stock is down so much, does it even make sense to consider or entertain M&A at this point or is it so artificially suppressed we could actually rule M&A off the table?

Brian P. McAndrews - Chairman, President & Chief Executive Officer

I don't know how to answer that, this is not something we are focused on, we are focused on working as an independent company and driving our business and we're a public company and all that that entails.

Operator

Your next question comes from the line of Justin Patterson. Your line is open.

Justin T. Patterson - Raymond James & Associates, Inc.

Great. Thanks for taking the question. In terms of, Mike, you outlined on the core service growth, based off of what you have for 2016 and what you're getting at a couple years down the road? That implies a significant acceleration. This year it looks like listener hours, active users aren't growing that much. So can you give us the sense of just what's driving that acceleration and you are confident in that? Thanks.

Michael S. Herring - Chief Financial Officer

So, we believe that there's a lot of listening that is occurring off Pandora by Pandora, by Pandora users that we can bring on to our platform with the right product strategy. And we're also seeing a lot of growth from new platforms as they're coming on. I know Brian has already mentioned it twice now, but around the CE devices growing very quickly, so we put some meat around that as well as auto. CE probably over the next one year to two years in auto is really like three-year to five-year growth vector. You add those things in, we think that the 240 million people that are listening to terrestrial radio, as connected devices become more common, we're seeing that movement of listening move much more aggressively to digital services.

Where that's happening right now in a very striking fashion is in a home system, whether it's Roku or Sonos or Apple TV or Chromecast, we're seeing tremendous growth in the use of these in the home, probably there used to be a receiver or a CD player where people are turning them on. Now people are listening to music through streaming services, because it's just a lot easier, the friction has been taken out. We think that that's going to drive more opportunity for ours, but also more opportunity for active users to grow or people who currently aren't addressing digital sources for their music consumption.

Justin T. Patterson - Raymond James & Associates, Inc.

Great.

Dominic Paschel - Vice President, Corporate Finance & Investor Relations

Thanks Mike and Brian. We've run out of time, but we will entertain your questions offline. Kevin, if you can please take us back to the 58th Annual Grammy Aflac sponsored channel. We wish all the nominees the best of luck. Take care.

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