Pandora Media (P) Q4 2016 Results - Earnings Call Transcript

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Pandora Media, Inc. (NYSE:P) Q4 2016 Earnings Call February 9, 2017 5:00 PM ET

Executives

Dominic Paschel - Pandora Media, Inc.

Timothy Westergren - Pandora Media, Inc.

Michael S. Herring - Pandora Media, Inc.

Analysts

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

Michael Patrick Graham - Canaccord Genuity, Inc.

Dylan Haber - RBC Capital Markets LLC

Douglas T. Anmuth - JPMorgan Securities LLC

Matthew C. Thornton - SunTrust Robinson Humphrey, Inc.

Heath Terry - Goldman Sachs & Co.

Mark Kelley - Citigroup Global Markets, Inc.

Sameet Sinha - B. Riley & Co. LLC

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

Andy R. Hargreaves - Pacific Crest Securities

Barton E. Crockett - FBR Capital Markets & Co.

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

Jason Helfstein - Oppenheimer & Co., Inc.

Anthony DiClemente - Nomura Instinet

Operator

Welcome to Pandora's Fourth Quarter and Full-Year 2016 Financial Results Conference Call. Opening today's call is Dominic Paschel, Vice President, Pandora. Sir, you many begin your conference.

Dominic Paschel - Pandora Media, Inc.

Thanks, Michael. Good afternoon, and welcome to Pandora's fourth quarter and full-year 2016 financial results call. Before we begin, let me remind everyone that today's discussion will contain forward looking statements based on our current assumptions, expectations and beliefs, including projected financial results or operating metrics, business strategies, anticipated future products or services, anticipated market demand or opportunities and other forward-looking topics. For a discussion of the specific risk factors that could cause our actual results to differ materially from today's discussion, please refer to the documents we file with the Securities and Exchange Commission.

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 the information I have just described on the Investor Relations section of Pandora.com. On today's call, we have Tim Westergren, Founder and CEO, and Mike Herring, President and CFO. With that, let me turn the call over to Tim.

Timothy Westergren - Pandora Media, Inc.

Thanks, Dom, and thank you to everyone for joining the call today. I'm pleased to share further details regarding our fourth quarter and full-year 2016 results. As we previewed in January, we exceeded both our revenue and adjusted EBITDA guidance for the quarter. More specifically, we are reporting the largest quarter in Pandora's history with $392.6 million in revenue. Mike will discuss details regarding our financials for the quarter and the full year, but before he does that, I would like to offer some broader perspective on where we are as a company.

2016 was a very significant year for Pandora, with progress on every important front. In Q4, we demonstrated our ability to drive leverage in the ad-supported business while effectively accelerating subscriptions for our paid product. In fact, in Q4, we reignited growth and increased subscribers 12% year-over-year to 4.39 million. And the momentum continues as we exited January with 4.48 million subscribers.

We also accelerated our core advertising business with 16% year-over-year growth in Q4 advertising revenue, lifting Q4 ad RPMs to $67.43, an 18% year-over-year growth in our monetization efficiency.

We enter 2017 with a clear set of strategic priorities and a solid plan to execute against them. We are laser-focused on profitable growth of our ad-supported business, the launch and growth of our subscription products, and the robust artist-to-fan platform to drive ticket sales and engagement across the service. These three strategic pillars operate in harmony with mutually reinforcing revenue streams and represent the culmination of nearly two decades of investment, an investment that now places Pandora in the position to be a category king.

I will like to briefly touch on three dynamics that underscore our marketplace strategy and demonstrates the progress we are making across multiple dimensions. The first dynamic is our advertising business. We are in the midst of transforming our strategy around ad insertion and ad load, which we expect will positively impact revenue. In particular, a more sophisticated approach to both, coupled with a heavier investment in demand-channel enablement are improving are improving our efficiency, a trend reflected in our $67.43 Q4 ad RPM. Our ability to reach these levels with a fraction of the ad load endured by broadcast radio leaves plenty of capacity for growth. A capacity we know to be there through extensive testing and data science. This growing utilization of capacity highlights our broader strategy as we look to drive lifetime value of our entire user base.

The second dynamic is of course the evolution of our relationship with the rights holders. In September, for the first time in our history, we concluded a comprehensive set of direct licensing agreements with music labels and publishers. The speed of the negotiations, a mere six months, was a clear demonstration of the relationships we have built through years of commitment to developing a platform that truly supports artists.

The strength of these partnerships has enabled Pandora to accelerate the expansion of our product offerings into interactive subscription services and to further fuel our advertising capabilities for the valuable new features on the ad supported product. It has also established a great foundation, as we look to partner with artists and their labels and management teams and our go-to-market plan for premium. And we believe, we are uniquely positioned to find win-win marketing strategies with the industry that will accelerate the growth of industry revenues and our business.

The phased rollout of Pandora Premium is underway with select business and music industry partners already live. With the broader launch coming next month, we are on the cusp of completing the product portfolio that will drive our long-term strategy. And just as with Pandora Plus, where we drove more than 375,000 net new subscribers in Q4, we will leverage our existing audience to attract subscribers to Pandora Premium.

Notably, over 70% of new Plus subscribers have been acquired on platform, virtually free of acquisition cost. This up-sell path will continue to be the centerpiece of our go-to-market strategy for premium.

Finally, 2016 was the year in which we made great strides with regards to our third dynamic, artist-to-fan connections, including the launch of our redesigned Artist Marketing Platform. The industry has awoken to the promotional power of the platform and with the recent inclusion of Pandora's spin data in the Billboard Hot 100, this awareness only continues to grow. The adoption of AMP has far exceeded our expectations, with thousands of artists publishing messages heard by Pandora listeners over 600 million times.

This has resulted in click through rates averaging 2.6% with many campaigns reaching much higher levels. These click through rates are two to eight times higher than those typically seen by paid advertising and social media.

With these successes, Pandora's firmly establishing itself as a premier marketing and promotion platform for artists. And perhaps the most exciting trend is the early data showing a correlation between artist messaging and increased listenership. Here we see artists and listeners engage in a mutually reinforcing relationship, driving time spent, which ultimately boosts (07:11) advertising subscription revenue for Pandora and also propels our ticketing service as witnessed by yet another record-breaking year at Ticketfly with approximately 25% growth in revenue.

In 2016, Ticketfly entered into agreements with some iconic U.S. venues and promoters ending the year with more than 1,700 venues and promoters, adding more opportunity for artists to connect with their fans. Pandora's targeted messaging is proving to be a remarkably effective driver of ticket sales across the whole artist spectrum.

The operational efficiency measures announced in January to reduce overall operating costs in 2017, enable us to pursue these strategic priorities, while also enabling further investments in product innovation to drive advertising revenue and subscription growth all while managing toward adjusted EBITDA profitability in 2017. With all the elements of our strategy in place, we are entering the year with a crisp focus across the business. Simply put, our business goal is to find the right product for each listener that meets them where they are as a consumer and maximizes their lifetime value, whether they're an ad-supported listener, a Plus or a Premium subscriber. Ad load, features and pricing are all weapons in our arsenal to achieve that.

Now over to Mike.

Michael S. Herring - Pandora Media, Inc.

Thanks, Tim. I'm also looking forward to 2017 and building on the solid foundation we created in 2016. As we execute on our priorities, we remain committed to the focus and cost discipline that keeps us on a path towards our long-term financial target and helps us to manage the business towards profitability.

As Tim mentioned, Q4 revenue reached a record high of $392.6 million while ad RPMs reached $67.43, an increase of 18% over the same quarter last year. This enabled us to realize leverage against content cost to drive significant contribution from the ad-supported business. And thus we meaningfully exceeded our adjusted EBITDA guidance.

A key component of our financial model and long-term profit potential is our ability to grow ad RPMs over LPMs. This directly drives the expansion of gross profits in the ad business. Q4's ad RPMs of $67.43 were up 18% from $57.20 in the fourth quarter of 2015 with ad LPMs of $37.07. This increase in RPM was driven by expanded audio ad loads in key demographics and new sources of automated demand driving revenue uplift in display and mobile. And while ongoing ad LPMs increase under the new direct deal structure, in Q4 there were one-time costs associated with the transition to direct deals resulting in the $37 LPM. We expect LPMs to return to a normalized level of approximately $34 in 2017 and believe the incremental market opportunity from the deal is well worth the near-term expense trade off.

For example, under the new license structure we introduced Pandora Plus at the end of the third quarter. And with only a seven-day free trial in our acquisition toolkit, we have generated more than 465,000 net new subscribers since launch. As Tim highlighted, more than 70% of our new subscribers in Q4 came from Pandora's in-app promotion, a strong signal that we can drive paid subscribers with minimal customer acquisition costs.

In summary, we entered 2017 with a clear focus on driving top line revenue through advertising growth and subscription conversion and improving margins by aggressively managing both content costs and operating expenses.

Now, let's walk through our fourth quarter and full year results in more detail. We ended Q4 with record revenue of $392.6 million, an increase of 17% compared to $336.2 million in revenue for the same quarter last year. Excluding contributions from ticketing services, which I will discuss momentarily, revenue was $373.2 million, an increase of 14% over the year-ago quarter.

Advertising revenue increased in the fourth quarter of 2016 to $313.3 million, compared to $269 million in the same quarter last year and drove the beat against our Q4 guidance. Local advertising revenue accounted for 27% of total advertising revenue, and overall grew 26% year-over-year in the fourth quarter.

Fourth quarter subscription and other revenue was $59.8 million, an increase of 5% over $57 million in the same period in 2015. Our end of period paid subscribers increased to 4.39 million, an increase of 12% year-over-year.

Ticketing revenue in Q4 was $19.4 million with gross transaction value excluding box office sales of $130 million, growing approximately 30% year-over-year. We transacted approximately 3.8 million fee-generating tickets, excluding box office sales, in the quarter to approximately 1.6 million unique customers. This momentum in customer interactions presents a significant opportunity to leverage Ticketfly's business in the future to drive Premium subscription trials and ticket bundles.

For the 2016 fiscal year, we delivered consolidated total revenue of $1.385 billion, an increase of 19% compared to $1.164 billion in revenue in 2015. Excluding contributions from ticketing services, revenue was $1.298 billion, an increase of 13% over 2015.

Advertising revenue increased 15% to $1.072 billion, compared to $933.3 million in revenue in 2015. Local advertising revenue accounted for a new high of 28% of total advertising revenue in 2016.

Subscription and other revenue was $225.8 million for the full year, an increase of 2% over $220.6 million for 2015.

Ticketfly celebrated another record breaking year, due in large part to excitement around the Ticketfly/Pandora combination, with $86.6 million in revenue or approximately 25% growth year-over-year. In 2016, Ticketfly generated more than $0.5 billion in gross transaction value, excluding box office sales, or $615 million with record bookings of 6 million new tickets, an increase of approximately 25% year-over-year in gross transaction value. In total, Ticketfly sold over 15 million fee-generating tickets in 2016 to more than 5 million unique customers.

Consolidated adjusted EBITDA for the fourth quarter was a loss of $30.4 million, compared to a profit of $24.8 million in the same quarter last year. Adjusted EBITDA excludes $34.6 million in expense from stock-based compensation, $17.3 million of depreciation and amortization expense, approximately $7.2 million in other expense, and approximately $500,000 in provision for income taxes.

For the year, consolidated adjusted EBITDA was a loss of $119.5 million, compared to a profit of $51.7 million in 2015. Adjusted EBITDA excludes $138.5 million in expense from stock-based compensation, $60.8 million of depreciation and amortization expense, approximately $24.4 million in other expense, and approximately $200,000 in benefit from income taxes.

Fourth quarter 2016 GAAP basic and diluted net loss per share was $0.38. Non-GAAP basic and diluted net loss per share was $0.13, which excludes approximately $34.6 million in stock-based compensation expense, approximately $5.1 million in amortization of intangibles, approximately $1.6 million in amortization of non-recoupable ticketing contract advances and approximately $19.0 million in income tax effects of non-GAAP adjustments. GAAP and non-GAAP basic and diluted EPS were based upon 234 million weighted average shares outstanding.

For the year, 2016 GAAP basic and diluted net loss per share was $1.49. Non-GAAP basic and diluted net loss per share was $0.51, which excludes approximately $138.5 million in stock-based compensation expense, approximately $20.5 million in amortization of intangibles, approximately $5.7 million in amortization of non-recoupable ticketing contract advances and approximately $60.5 million of income tax effects of non-GAAP adjustments. GAAP and non-GAAP basic and diluted EPS were based on 231 million weighted average shares outstanding.

Content costs represented 54% of total revenue in Q4. For the year, content costs represented 53% of total revenue, up from 52% in 2015. Total content costs rose by almost $124 million in the year as a result of the new CRB rates enacted in January, the direct deal signed in September and growth in hours, subscribers and revenue.

It's important to highlight that more than $84 million or 68% of the 2016 increase in costs would have been the result of a one-time step-up in content costs related to the CRB rate outcome alone, irrespective of engaging in direct deals. And this would have occurred without getting in additional beloved consumer features and monetization opportunities such as replay, additional skips and offline listening.

As I mentioned earlier, our ability to drive leverage on these costs in 2016 was dependent on our ability to increase ad RPMs in excess of ad LPMs. 2016 total ad RPMs were $55.94 increasing by $5.42 or 11% compared to the year ago period. For the year, total ad LPMs were $32.40 increasing by $6.27, or 24% compared to 2015. Despite the step up in costs, our RPM growth is keeping pace and we expect it to continue to grow in future years as LPMs remain relatively static.

During the fourth quarter, non-GAAP gross margins were 36%, compared to 50% in the year-ago quarter primarily the result of costs associated with content, as discussed previously mentioned.

Turning to operating expenses, while we increased head count 12% year-over-year to 2,488 employees in 2016, we undertook operational efficiency measures to reduce overall operating costs in 2017. As such, we recently implemented a reduction in our U.S. employee base, excluding Ticketfly, of approximately 7%.

For the fourth quarter of 2016, non-GAAP sales and marketing expense was $115.8 million, or 29% of revenue, compared to $96.5 million, or 29% of revenue in the fourth quarter of 2015, as we continued to ramp our sales team to QBSRs at the end of Q4, 153 of which were focused on local markets, and increased brand and direct marketing activity. Approximately 36 QBSRs were impacted by the reduction in force announced in early January. While this will reduce our sales capacity temporarily in Q1 2017, it is part of our decision to focus on key competitive advantages around audio advertising and leverage partners in more digitally advanced markets, like display and video. Included in sales and marketing expense in the fourth quarter are commissions on subscriptions that we pay Google and Apple totaling $9.2 million, and $29.5 million in brand, direct response and SEM marketing activities.

Non-GAAP product development expense was $28.6 million for the fourth quarter, or 7% of revenue, an increase of 42% compared to $20.2 million in the fourth quarter of 2015.

Non-GAAP G&A expense was $36.1 million or 9% of revenue, compared to $31 million in the same quarter last year or 9% of revenue.

Turning to the balance sheet, Pandora ended the fourth quarter with $243.3 million in cash and investments compared to $264 million at the end of the prior quarter. Cash used by operating activities was $2.6 million for the fourth quarter compared to $71 million of cash used by operating activities in the year-ago quarter. Capital expenditures were $13.4 million in the fourth quarter. Internal-use software costs were $7.9 million in the fourth quarter, driven by capitalization of engineering costs associated with the development of new subscription services.

For 2017, we estimate total revenues in the range of $1.55 billion to $1.7 billion, or year-over-year growth at the mid-point of approximately 17%. This year, our guidance range is wider than usual due to the uncertainty around the speed at which subscription products ramp. We'll provide additional color as our visibility increases throughout the year.

We are reaffirming our previously stated intention to manage the business to 2017 adjusted EBITDA profitability. We are not giving specific EBITDA range because of the uncertainty around subscription ramp and the mix between advertising and subscription revenue and the associated users and hours and the differing impacts to margin. And while we expect total hours to be up for the year, we are consciously controlling ad-supported hours to manage towards profitability.

The subscription revenue ramp, compounded with the mix of advertising and subscription revenue and their associated hours and users, increases the variability of adjusted EBITDA to a point where it would be impractical to provide EBITDA guidance beyond our first quarter. To be clear, we are managing the company towards full year adjusted EBITDA profitability and our models show that it is achievable across a range of variables related to the ramp of Plus and Premium and current advertising revenue targets.

While the mix is variable, the financial model is pretty simple. We expect ad hours to be down anywhere from 5% to 10% varying by quarter, but our overall audience to increase, as we focus on the most profitable hours as subscriber conversions ramp. In short, this is part of Pandora's model and works to our financial advantage, as subscribers convert and ad hours decrease, content costs are moderated while ad RPM increases. In turn, as ad hours move to subscription hours, and users convert to subscribers, subscription revenue and profit per user increase.

For the first quarter of 2017, we estimate total revenues in the range of $310 million to $320 million, achieving year-over-year growth at the mid-point of 6%. Q4 is typically our strongest quarter and we usually experience a 10% to 15% decrease in advertising revenue as we move from Q4 to Q1. This year, the sequential decline is more pronounced due to the additional contribution in revenue from political advertising in Q4 compounded with the reset in our advertising strategy in Q1.

We estimate adjusted EBITDA for the first quarter to be in the range of an $80 million loss to a $70 million loss, excluding one-time severance costs of approximately $6 million, forecasted stock-based compensation expense of approximately $37 million, forecasted depreciation and amortization expense of approximately $19 million, other expense of approximately $7 million and a provision for income taxes of approximately $300,000. This assumes minimal cash taxes.

Basic shares outstanding for the first quarter of 2017 are expected to be approximately 238 million.

To close, I'll just reiterate my excitement for the business transformation taking place. We enter 2017 with a solid and diversified foundation and are focused on managing towards profitability as we get ready to bring to market our complete product portfolio.

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

Question-and-Answer Session

Operator

Your first question is from Ben Swinburne from Morgan Stanley.

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

Thanks. Good afternoon.

Michael S. Herring - Pandora Media, Inc.

Hey.

Benjamin Daniel Swinburne - Morgan Stanley & Co. LLC

A lot to digest there. Maybe Mike, just could you talk a little bit about the thought process of reducing your ad sales force? I realize there are tradeoffs across your investment opportunities and maybe you could just spend a little bit of time on how you think about driving ad RPM which you highlighted as a focus with a slightly smaller ad sales force? And if you are planning on doing much in the way of hiring, as you move through the year?

And then I just wanted to confirm on the ad LPMs. It sounds like that's going back down. I thought it was $33, but maybe its $34 now. Do you expect that number to grow over time through your direct deals and if so, any kind of growth rate you could help us with? Just trying to think about the gross margin potential as the business ramps.

Michael S. Herring - Pandora Media, Inc.

Yeah, Ben. Good question. So on the reduction in force relating to ad sales and the timing of it, its two things. One is Q1 has a dramatic kind of drop in demand from a seasonality perspective. And so, if you're going to kind of reset from an advertising footprint perspective, it's the right quarter to do so and the extent that the sales force that remains has a better chance of taking on the additional capacity.

Now that said, 37 is a decent number of people and it's a lot of quota to take out of the system. So there is some adjustment to do that, but if you're going to do that, it's in a quarter where it's our essentially seasonally lowest advertising quarter that's where it made the most sense.

We will be adding sales people back in as we move through the year, especially towards the back half of the year where demand picks up as we saw, of course, last year to some extreme. We also made that decision in a part pivoting away from some of the go-to-market strategy had had into some new ones that are now available to us. So focusing, as we mentioned, on our competitive advantage around audio and focusing more on partnerships in terms of optimizing some of the demand channels that are available now on display, for sure, as we are opening our kind of programmatic channels to more sources of demand, but also extending that to video which had a very strong quarter in Q4 and we continue to add new video inventory both in sponsored listening and in the flex features in the ad-supported business. So we expect to see that happen, to be able to drive revenue more efficiently and so still be able to drive RPM even with a slightly smaller sales team.

In terms of the LPM piece, I'm glad you bring that up, the $37 is a one quarter sort of anomaly related to deals that are expiring at the end of 2018, that overlap with the direct deals that we did.

That said, the $34 is the best estimate. The $33 to $34 really depends on how well we're monetizing, because as we monetize the significant levels, it does put a little bit. It can take RPMs up to more of a $34 level and that is what we expect to see next year based upon the performance coming out of Q4, but it's a very small difference really rounding error between the $33 and $34 LPMs.

We will see some seasonality on LPMs as well, tend to be lower in Q1 through Q3 and higher in Q4 purely on the fact that in holiday times songs tend to have a lower duration. Holiday songs tend to be shorter and so we play more in an hour period and so there's actually, because we play on a per-play basis, we actually pay a slightly higher royalty per hour in the fourth quarter because of the holiday effect. We also monetize much better. So the benefit of the holiday period is still significant from a contribution margin perspective.

Operator

The next question is from Michael Graham from Canaccord.

Michael Patrick Graham - Canaccord Genuity, Inc.

Hey, thanks a lot. Tim, I just want to ask about the launch of the Premium product. You mentioned that it's coming next month. I think you said a larger launch next month. I'm just wondering do you expect the product to be sort of fully launched and out there by the end of Q1, so it's there for all of Q2?

And I just wonder if you can comment on any free trial dynamics. Like, are you intending to go with the same seven days that you went with on the Plus side? And can you share anything about the economics of those trials? Thanks so much.

Timothy Westergren - Pandora Media, Inc.

Yeah, so you have the timing basically right. The speed of ramp, as we did with Plus, you put it out and then the way to do that effectively is grow it as you can and test the robustness and then ride that curve as fast as you can so the ramp period can kind of vary a little bit, but you had the timing essentially right. You want to take the trial stuff?

Michael S. Herring - Pandora Media, Inc.

Yeah. So, the seven-day trial limitation that we've had today, that's something that we've always had in the product. We expect to expand that pretty significantly with the launch of Premium. And we will expand the trial options also with Plus, but we're not going to give any specific details on those, but we're holding off on those trials until we have the full product complement, but we will launch with those trials in place.

And those trial lengths and offers will actually depend a little bit on what platform you are accessing the product, but also whether you are a current Plus subscriber. You will have access to certain advantages from a trial perspective.

Operator

The next question is from Mark Mahaney from RBC Capital Markets.

Dylan Haber - RBC Capital Markets LLC

Hey, guys. This is Dylan Haber on for Mark. Just with regards to the launch of Premium, can you give us a little bit more color around the go-to-market strategy, and whether there will be a significant advertising campaign with it? And then on political advertising in the quarter, can you just talk about how significant a contributor that was in Q4? Thanks.

Timothy Westergren - Pandora Media, Inc.

Yeah. So in terms of Premium launch, we're definitely going to make a statement. We have quite a bit of budget allocated to bringing this to market. We think we're bringing something new to this space. We're not coming to this with a me-too product that's going to look like the others. It's something very different, and we have I think a very exciting plan to get that out there. So you can expect us to be loud and proud and broad come launch time. So, there's a whole plan around that and we definitely will be investing after it. What was the second question...?

Michael S. Herring - Pandora Media, Inc.

Yeah, the second was on political. It was a good, an okay quarter, better than expected, but not dramatically. We're talking about just a little bit north of $10 million in political in Q4.

Operator

The next question is from Douglas Anmuth from JPMorgan.

Douglas T. Anmuth - JPMorgan Securities LLC

Great. Thanks for taking the question. A couple if I can. First, you guys talked a couple of times just about new partnerships and new sources of automated demand in terms of programmatic. Just hoping you can elaborate a little bit more there in terms of what you're talking about across formats, and explain a little bit more about why that's available to you now perhaps and maybe it wasn't in the past?

And then second, Mike, you also talked about efforts to control your ad-supported hours in 2017 and I was hoping you could talk there about some of the mechanisms or levers you can use to do that? Thanks.

Michael S. Herring - Pandora Media, Inc.

Sure. So on the demand side of things, we've been in programmatic display for mobile, for example, since Q3 of 2015 when we launched that and have been accessing various sources there. We rolled into new sources of demand in Q4 that were largely dependent on certain ad formats, et cetera, so and as well as measurement guideline. So if you saw some of our announcements around visual ad experience and such, the VAE product, there was a lot of excitement about that, bringing that to market in Q4. That also qualified as "to be included" in certain in new demand pools that now require those configurations. So these are things that we've really focused on in display and coming soon in video as a way of augmenting the competitive advantage we have in audio.

In terms of controlling ad hours, this is an ad science effort as well as just a blunt force trauma effort. So, historically we've controlled ad hours anywhere from using things like timeouts within the products to various other sort of limitations around use. Now, there's other things that we can do that are device specific that our ad scientists are using in order to understand where quality hours are versus non-quality hours and use dynamic personalization to actually make sure that we're preserving the highest quality hours, especially the ones that we can monetize effectively and looking to curb hours that are monetized less effectively, frankly.

And so there is a variety of aspects that we can do there. You don't want to give away too much of the secret sauce there other than it's connected with new features and functionality that we're rolling out and how we're using those to convert or at least put subscription promotion in front of people in order to drive conversion.

Operator

The next question is from Matthew Thornton from SunTrust.

Matthew C. Thornton - SunTrust Robinson Humphrey, Inc.

Hey, good afternoon, guys. Thanks for taking the question. A couple if I could here. Can you give us any kind of tangible proof points on what the impact from some of the new features on the free tier have been as it relates to churn or sharing the service with other platforms or engagement? And then related to that, the $5 tier, if you can talk about maybe the impacts – I know 70% I think, of the new adds came from on platform, but I mean the rest of those adds, was that predominantly from lower churn or gross adds from outside the ecosystem?

And one last question there, can you actually see offline listening and is that included in your hours from that new feature, any color across those points would be really helpful? Thanks.

Timothy Westergren - Pandora Media, Inc.

We can kind of tag team this I guess. I mean certainly in terms of feature use, we're seeing very robust use of the features, offline listening is a very popular one. I don't think we're putting metrics around that specifically, but a majority of that actually happens in an automated fashion, so people go into offline listening without actually proactively requesting it, which I think is a solid testimony to the use case. We've seen a substantial jump, 5% jump in video inventory from the capability to add (35:12) to ad-supported, which I think is a real plus.

The Plus feature has been strong, a lot of positive feedback on the product. We're not releasing the specific metrics within that right now but good signals in terms of people using that product and satisfaction. The bulk of the remaining 30% of the adds are coming kind of primarily off platform, but we find, of course, fishing in our own pond, by far the most efficient way to bring customers in right now, so we're targeting that for the time being.

Michael S. Herring - Pandora Media, Inc.

Yeah, so kind of just to delve quick, a little deeper on each of those things that Tim highlighted. From a feature usage perspective, we mentioned earlier 7% increase in video capacity in the initial rollout of the features in the free product. What that resulted in in Q4 was not only an additional 5% in ad inventory for video, which assisted in a outstanding quarter from being able to meet some video demand, and video overall up year-over-year, video revenue of about 15%, now about 14% in total ad revenue. It's giving us between that and sponsored listening we're getting – we're really starting to tap even just getting a little bit of the share of the video market allows us to participate, have the right conversations and then allow us to extend those advertisers into audio.

That also feature uses is also what's driving that 70% plus conversion into the Plus product because I would say maybe 30% to 40% of the conversions in the Plus are coming from what we call smart conversions or conversions that happen when people interact with features and functionality in the free products, that are limited, skips and replays being those and then driving them into trial and then converting them. So those features are getting a lot of use. Just as they design, we had confidence that would be the case through our own kind of testing event.

Now, in terms of those that aren't from on platform conversion are essentially that's really about us using what we know about the lapsed users and why they lapsed and going out and marketing to them either on other platforms or through e-mail and other forms, the existence of Plus and how effective it's now could meet their needs.

So if we know people churned out or stopped using Pandora after going offline quite a bit, we would target them specifically with a subscription trial around touting the advantages of offline listening within Plus. So that's an example of using paid media to drive subscribers still focused on people who have already had an experience with Pandora. This isn't introducing someone brand new to the Pandora brand, but it's reactivating use of lapsed listeners and we look at that as a paid acquisition channel.

So it's really can be effective from an acquiring perspective because we already know a lot about those users and we can drive...

Timothy Westergren - Pandora Media, Inc.

And one thing to underlying what's Mike is saying to this, there's a lot of data we have now from our own and external surveys about the appetite listeners have who are users of other products right now, that continue to be Pandora users, of wanting to come back to Pandora when we offer these products. So there's an appetite to have all of your habit met on one product, and I think we're going to see that more and more, it starts with Plus, but certainly expect that effect when we launch Premium.

Michael S. Herring - Pandora Media, Inc.

To quickly answer your last question, we do measure offline listening in terms of hours and report that as part of our total hours. I would just caution though, third-party measurement services, still are not measuring things like CE listening largely and which is our fastest growing and significant portion of our listening and such. So, some of the disconnects you'll see between Pandora's recorded metrics and some third-party metrics are related to that. Those are things that we're endeavoring to fix actually in the first half of 2017, so we have a much more clean kind of measurement you obviously could cross our first-party metrics and third-party metrics that are out there.

Operator

The next question is from Heath Terry from Goldman Sachs.

Heath Terry - Goldman Sachs & Co.

Great. Thanks. I was wondering if you could just give us a little bit more detail in terms of how you anticipate rolling out the on-demand product, particularly as we think about what's reflected in the Q1 numbers for that and how should we be thinking about the impact of having a full second quarter of that product and the associated expenses as we go through the rest of the year? I guess really just trying to get a sense of where your expectations are for sort of success for that product based on what you've learned today?

Timothy Westergren - Pandora Media, Inc.

So, let me answer that in a couple of ways. Our expectation is for to meet our guidance, we need to enroll between 6 million and 9 million subscribers, some mix between Plus and Premium, so we have some flexibility in what that mix is over the course of the year.

Michael S. Herring - Pandora Media, Inc.

Ending subscriber.

Timothy Westergren - Pandora Media, Inc.

Ending subscriber number for the year of between 6 million and 9 million subscribers, forgive me. So that is our target for the year. And that's baked into the guidance we've given for the year. So I think as I said earlier, we'll launch the product in March and our roll-out sort of velocity really is contingent on sort of how good we feel about the product in the first few days and how quickly we can kind of turn-up the dial to broad accessibility, so just as we did with Plus.

And in the case of Plus, we actually had the ramp shortened substantially from our internal projections, because the product was really holding up, so that's our plan that's baked into the model.

Operator

The next question is from Mark Kelley from Citi.

Mark Kelley - Citigroup Global Markets, Inc.

Hey, guys. Thanks a lot for taking my questions. The first one is on programmatic. You talked about video and that's kind of driver of growth. What are you seeing on the measurement side in terms of viewability, advertisers getting more comfortable with video, particularly on mobile? I think there was some viewability issues at the end of last year that some other ad tech firms called out, would love to get your thoughts there.

Timothy Westergren - Pandora Media, Inc.

I think the quality of inventory is a big strength at Pandora and our user base. I think you probably saw some of that reflected in Q4 as a sort of a general market reaction to some of the issues publishers had leading into that. So I think the more focus there is on that, the better off we are, and we are certainly at the forefront of clarifying and sort of unifying the standards around this. So we view kind of the higher bar as being something that's good for Pandora. I think that's sort of marketers would say if they asked you.

Operator

The next question is from Sameet Sinha from B. Riley.

Sameet Sinha - B. Riley & Co. LLC

Yes. Thank you very much. Actually a broader question. You spoke about ad hours being controlled next year while you speak about audience numbers going up, and of course then you have the new products launching. Can you, in broad terms, just talk about are you planning to take some of your heavy users, market heavily to them and try to convert them into subscribers, and how that the entire plan would impact, kind of ad RPMs versus subscribers? I know it's kind of a broad question, but any insight would be helpful. Thank you.

Timothy Westergren - Pandora Media, Inc.

Yeah. I think probably the best way to answer that question is, once the three products are out in the market, our ambition with listeners is to find the product that fits them, both as a consumer and their pocket book. And we start with 100 million people every quarter on Pandora that we know a ton about, about their usage habits and in some cases they're already paying.

So you have a large number of signals from them, I think about their propensity to be subscribers. So I think if you think about our ambition being a life time value for a listener, this isn't necessarily about jamming everybody into a subscription product if that leads to higher churn, that's not actually a wise financial move.

It's really about finding the nice, the perfect spot for them that leads to lifetime value and churn's a huge part of that. So, if someone has a product they really want and they're using it, and they're happy with it, they'll stay a lot longer and that's where you get the good economics.

The nice thing about our business is unlike I think other subscription businesses, we have a profitable funnel if you want to call it that, or foundation we like to think of it as. So, an engaged user base who are giving us signals and information about their preferences, all of which by the way makes the Premium products much better, that are engaged with Pandora that we can over time market to.

So we will target listeners based on what we believe to be their propensity to subscribe and that is a data science task. And there's a large crew at Pandora that are already working on signal, understanding the propensity for people to subscribe and we'll go after them.

So it doesn't necessarily mean someone's using it the most, that's certainly one of the signals we look at, but how you use it is equally important. So are you someone who goes offline a lot, are someone who keeps running out of skips, are you someone who searches a lot for an individual song indicating you're looking for sort of a play on demand. There are sort of numerous signals that matter for us. And, of course, factored into this is how valuable are you as an ad-supported listener, which speaks to hours, control and other things.

So, if you are difficult to monetize for some reason, you're someone who we will probably make work harder for remaining an ad-supported listener on Pandora. So, it's like a one gigantic math problem, but we have a lot of weapons to solve them.

Operator

The next question is from John Egbert with Stifel.

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

Thanks. So, it makes sense that an on-demand offering from Pandora has a much better chance of getting subscriber traction than smaller independent services like Tidal or Rhapsody since you have a base of 80 million-plus users to convert. But there's some media speculation in recent months that Google's paid music subscriptions failed to reach 2 million in their first year or so, and Google has an even larger funnel of free music listeners on YouTube to convert. So, I'm wondering what are some of the factors that give you confidence that Pandora can succeed at attracting millions of listeners in the first year or so of the service being launched.

Timothy Westergren - Pandora Media, Inc.

Yes. So, I think there are a couple of things that are foundations for success. And certainly have a scaled user base that you can market to is one of them and that maybe shared by some other companies, like Google that have a big audience. The quality and knowledge of that audience is another dimension there. So, just because you have a lot of people that use your service, if you don't have really good strong precise signals about what they like and don't like, it's much less valuable or harder to market to audience.

So, I think Pandora's unique in the size and the quality of its audience, and the ability to really message to them contextually, as Mike said earlier, that these coach marks, these sort of contextual up sells are sort of unique to Pandora. But ultimately, it's about the quality of the product. I think the reason that you're not seeing the kind of growth that some people anticipate that the products are very hard to use. We really don't think there is a true premium product on the market yet. We think Pandora will be the first premium product. And atop the list of sort of descriptors for that product is easy to use. And I think Pandora, because of all of this data we've been collecting and habits we have from our listeners are able to offer products that is going to solve that.

So keep in mind, if you're a Pandora listener which means most of American adults, when you launch Premium, it doesn't start with a search box that says get started, it's not 40 million songs and good luck. It starts pre-populated with essentially your entire music preference graph, so all the stations you've created, all the songs you've Thumbed are right there for you to access. And it creates a really elegant way and easy way to interact with this sort of infinite catalog, makes it navigable. And I just don't think people will know what subscription services can be like. Right now it's a very time intensive, labor intensive task and that's why you see such high churn. People do it for a while, they run out of time and effort and they don't want to keep doing it. We think Pandora's going to be very unique in this regard. It will be simple, easy to use and completely personalized in a way that it's unprecedented. So we are very confident about them.

And this is not so different from when we launched Internet radio so many years ago. We were not the first company to launch Internet radio. There were some large players already there, all offering personalized radio and Pandora came on the scene and we did it way better. We're going to do the same thing all over again here.

Operator

The next question is from Andy Hargreaves from Pacific Crest.

Andy R. Hargreaves - Pacific Crest Securities

Hi, thanks. Just I have a couple of clarifications. I wondered, one, if you could just give us a sort of comment on what ad volume was in the quarter, how much it grew in the quarter? And then wanted to go through the sales employee stuff a little bit more. So if I heard you right you ended at 529. Does that include the people that were let go or does that happen all in Q1? And associated with that, can you just give us any comment on how sort of the sales employee and facility cost should move quarter-to-quarter Q1?

Timothy Westergren - Pandora Media, Inc.

I'll start with the first part of that, the ad volume. If I understand your question, the average sold ads on Pandora went from 3.2 in Q4 2015 to 4.5. And when it's high as 11 in some cases, but the average is 4.5 sold out, so a pretty significant jump. And part of that, of course, is obviously execution on the sale side, but we also deliberately raised the capacity across the service to allow our sales team to sell more, which is something we had been deliberately constraining leading up to Q4 in the launch of these new products. So that's what you saw with the ad load change.

Michael S. Herring - Pandora Media, Inc.

I would also say that part of increasing the ad load allowed us some of the demand that we talked about earlier. The access demand that we previously didn't access because the pricing didn't meet the threshold. We literally didn't have any room to provide lower threshold pricing on to fit corner (50:20) cases, and we're able to do that in this case.

From a sales employee perspective, the number we gave was the year-end number, and the reductions did come in Q1. So we won't – you'll see a reduction in head count and QBSRs and such in the first quarter when we'll report the first quarter. In Q1, there's still much of the cost associated with the employees that are included in the reduction are still in the quarter. They essentially are still employed through half the quarter and there is the severance cost that we've disclosed separately, $6 million associated with it, that'll be expensed in the quarter. So, the full benefit from an expense perspective won't be realized until Q2.

Timothy Westergren - Pandora Media, Inc.

I think that, if you step back and if there is such a thing as kind of a pivot point for Pandora, this is what we're doing right now. We've been leading up to this place for a while, about to launch the new product, sort of redesigning our ad strategy, which impacts both the team and the sort of partnership approach – the go-to-market approach for advertising. So, it's a momentary sort of stutter step as we sort of blastoff into this next phase. But we feel really well positioned right now for what's ahead.

Operator

The next question is from Barton Crockett from FBR Capital Markets.

Barton E. Crockett - FBR Capital Markets & Co.

Okay, great. Thanks for taking the questions. I guess really two slightly different topics relatively straightforward. One is, your CFO search, I was wondering if you could update us on how that's going?

And then secondly, in terms of your revenue kind of outlook for the year, you told us about the sub kind of base case of 6 million to 9 million, what's your view on the ad trend? I mean you're going to the mid-single digit kind of slowdown here in the first quarter, do you see that accelerating or not over the balance of the year?

Timothy Westergren - Pandora Media, Inc.

Yeah. So, the search is going very well, very confident, we're going to find the right person for this job. We don't have news on that right now, but definitively headed right where we want to go, so very confident about finding the right person to fill out the team. Do you want to talk about ad revenue?

Michael S. Herring - Pandora Media, Inc.

Yeah. So, we do expect to see ad revenue rebound and accelerate from a year-over-year growth perspective from Q1 through the balance of the year.

Operator

The next question is from Amy Yong from Macquarie.

Amy Yong - Macquarie Capital (USA), Inc.

Thanks. Going back to the question of converting users, how do you think about converting users into the right bucket; ad, Plus, Premium as it relates to the number of listener hours per month? What kind of framework is best that monetizes your users or maximizes their lifetime value, just in terms of the hours listening? Thank you.

Timothy Westergren - Pandora Media, Inc.

Well, we have some theories about that right now, but that's a statistics question we're going to figure out in the coming months. I think it's reasonable to say that a heavy user is more likely to subscribe. So we'll certainly test that case. Kind of we're already doing that, but we'll get ever more precise about that in the coming months.

I think one thing that's important to understand too about this sort of up sell path and there really is a path here at Pandora, it starts with the ad-supported listener, then they go to Plus, which is I think a very attractive price point for folks. And Plus to Premium is a really easy jump for us. So you're on Plus, to shift into a free trial of Premium is a nice elegant experience where with doing very little modest upgrade on your product, you can suddenly start experiencing this whole new batch of features. And then with a trial that auto converts at the end, it's a very seamless way to bring somebody up the ARPU curve. So I think we will just get better and better with each month at identifying who should be moved up, how to move them up and when to move them up.

Operator

The next question is from Jason Helfstein from Oppenheimer.

Jason Helfstein - Oppenheimer & Co., Inc.

Thanks. Two questions. I just want to dig a bit more into the ad RPM. So given that you talked about increasing video benefited you, it sounded like you were able to get access to SSPs (54:44) opening up new demand sources. I guess when you think about 2017, is this kind of 18% give or take sustainable on an RPM basis as we move through the year?

And then second question, oh, I guess and then connecting to that, does it give you better visibility as you're expanding your ad products, meaning you're cutting deals that go further out? And then secondly, as you launch Premium, can you talk about – are you talking to the industry about getting kind of free and co-opted ad support or joint promotions as you launch the product? Thanks.

Timothy Westergren - Pandora Media, Inc.

I'll take those in reverse order. I'll take the first or the second, and Mike. So with respect to the industry, I think it's fair to say that they have been very, very supportive of us leading up to the go-to-market for premium. We're getting a lot of cooperation and the industry and artists are at the center of our plans in terms of promoting the product. So, I think, all the work we've done in the last few years to build the relationships, to raise awareness about Pandora, to demonstrate the promotional power of the platform, the kind of benefits of partnering with us are bearing fruit now.

And I think actually I think Pandora's somewhat unique in this regard too. I think that working artists, bands, management companies, et cetera understand that Pandora is not just a royalty check. It's got a lot more to offer you. And you're seeing that in just the response from the industry to us and that's going to find its way into our marketing plans and whether the specifics are co-op ads or artist participation or whatnot, you're going to see ways in which that drives leverage for us I think after the coming launch. And then there's (56:35).

Michael S. Herring - Pandora Media, Inc.

Yeah. So, on the advertising questions, is 18% year-over-year, RPM growth sustainable? I would certainly think it's possible, and this comes back a little bit to some of the conversations around EBITDA guidance and the lack thereof, and really focusing on, look we're going to manage to EBITDA profitability. The question is what combination of ad revenue versus subscription revenue and the margins associated would get us there. The reality is without knowing exactly how aggressively we're going to convert, and what population's are going to convert, it's really hard to predict ad RPM.

What we are confident is we'll see our ad RPMs grow helpfully in 2017, as we're making certain initiative around, emphasis on growing advertising revenue generally, and a willingness to be more aggressive with ad load. Two things we saw that we did in Q4 had immediate impact, immediate impacts on RPM in the quarter, immediate impacts on revenue in the quarter.

In terms of visibility in longer-term, the reality is there's kind of two pieces to that, and they are on either end of the spectrum. Yet there are some national deals more upfront deals and such which give us more visibility into the year as a whole, starting out. And that's great. Those are the things we had not done as much previously, because we just didn't have the inventory to be able to commit to do those deals, now we can do that.

But the other side of it is a lot of the channels are accessing that are much more real-time, automated, programmatic, or even just more performance based are not long-term locked in deals, but rather are variable based upon the activity in the quarter and so the visibility is very late. And we also saw that in Q4, where we saw a lot of revenue coming towards the end as we performed very aggressively and very well against more variable oriented revenue contract. So unfortunately, I don't think there's a good answer to that. I think the reality is in the short-term, in terms of looking at one quarter out, there's less visibility although more opportunity. As we look at the year, there's a little more visibility at least at a base level when you look at kind of national advertising commitments.

Operator

The last question will be from Anthony DiClemente from Nomura Instinet.

Anthony DiClemente - Nomura Instinet

Good afternoon and thanks for taking my questions. Mike and Tim, you mentioned the 70% of the new Plus subscribers come from the Pandora platform, kind of your strong funnel that you discussed. I'm curious about the retention rate. So what percentage of ad-supported listeners, upon deciding to transition to a subscription product, choose to transition to the Pandora subscription service versus exiting the platform and perhaps going to a competitor? And just wondering if there's a way to think about that or compare that retention rate versus what it was historically or think about whether it's improving or how it can improve?

And then a second kind of question which would be, just the recent news about Sprint's investment in TIDAL, Tim, it values TIDAL at a substantial premium and we just can't help but wonder, does that tell the same thing about the strategic benefit of a streaming service like Pandora's partnering with a large distributor. And could it give this launch strategy on the subscription product, a boost in terms of distribution, if you were to have that big tailwind from let's say a large mobile distributor? Thanks.

Timothy Westergren - Pandora Media, Inc.

Yeah. Well, I mean, if you were standing in my shoes, you'd be looking for distribution all day along right now. And I think what the TIDAL Sprint deal tells you is, I think any large business like that that's looking for value added capabilities or a reason to drive engagement, reason to drive data consumption like, music is the killer app. And so, I think there's demand for it. The structures of those partnerships have evolved over time. I think they're becoming a lot more attractive than they used to be, but you can bet that we're looking at all of those options. And I think that once we launch this product, and as we're launching it and services see how differentiated it is, there's going to be lot of demand for it. There already is.

Michael S. Herring - Pandora Media, Inc.

Yeah. On the first part, in terms of converting to the Plus platform, whether that's – I think it's too early to say that we are saving people that would have otherwise have gone to other platforms. That is absolutely something we believe will happen with the release of Premium. Plus itself is, is still pretty unique in the marketplace. If people are churning out of ad-supported business to go to other platforms, they're going there largely for on-demand features and functionality, which won't be available to Premium. We absolutely think that that is going to be a benefit in terms of retaining users (01:01:51) and frankly recapturing users that have lapsed and have gone over to other platforms. We think they will come back and convert back into Pandora users.

Some of that, when I mentioned earlier about recapturing people even back into radio, a lot of the learnings we've had over the last three months, we believe are going to really help us accelerate that once we get Premium into market.

Dominic Paschel - Pandora Media, Inc.

Great. With that, we recognize we didn't get to everyone's questions, but we will do the best to rotate through the next conference call. Michael, can you take us back to the 59th Annual GRAMMY Station sponsored by Aflac? The team at Pandora wishes the best to all the nominees this year on Sunday. Take care.

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