8.	Stock-based Compensation Plans and Awards

Stock Compensation Plans

In February 2000, the board of directors of the Company adopted the 2000 Stock Incentive Plan, as amended (the "2000 Plan"). In March 2004, the board of directors of the Company adopted the 2004 Stock Option Plan (the "2004 Plan"), which replaced the 2000 Plan and provided for the issuance of incentive and non-statutory stock options to employees and other service providers of the Company.

In May 2011, the board of directors of the Company adopted the Pandora Media, Inc. 2011 Equity Incentive Plan (the "2011 Plan" and, together with the 2000 Plan and the 2004 Plan, the "Plans"). The 2011 Plan was the successor to the 2004 Plan and was available for grants starting on June 14, 2011. The 2011 Plan provides for the issuance of stock options, restricted stock units and other stock-based awards. Shares of common stock reserved for issuance under the 2011 Plan include (a) 12,000,000 shares of common stock reserved for issuance under the 2011 Plan as of June 14, 2011 plus (b) 1,506,424 shares of common stock previously reserved but unissued under the 2004 Plan as of June 14, 2011 that are now available for issuance under the 2011 Plan. To the extent awards outstanding as of June 14, 2011 under the 2004 Plan expire or terminate for any reason prior to exercise or would otherwise return to the share reserve under the 2004 Plan, the shares of common stock subject to such awards will instead be available for future issuance under the 2011 Plan. Each fiscal year, (beginning with the fiscal year that commenced February 1, 2012 and ending with the fiscal year commencing February 1, 2021), the number of shares in the reserve under the Plan may be increased by the lesser of (x) 10,000,000 shares, (y) 4.0% of the outstanding shares of common stock on the last day of the prior fiscal year or (z) another amount determined by the Company's board of directors. The 2011 Plan is scheduled to terminate in 2021, unless the board of directors determines otherwise.

Plans are administered by the compensation committee of the board of directors (the "Plan Administrator") of the Company.

Under the 2011 Plan, the Plan Administrator determines various terms and conditions of awards including option expiration dates (no more than ten years from the date of grant), vesting terms (generally over a four-year period), and payment terms. For stock option grants the exercise price is determined by the Plan Administrator, but generally may not be less than 100% of the fair market value of the common stock subject to the option on the date of grant.

Given the absence of a public trading market prior to the IPO, the Company's board of directors considered numerous objective and subjective factors to determine the fair market value of its common stock at each meeting at which stock option grants were approved. These factors included, but were not limited to; (i) contemporaneous valuations of common stock; (ii) the rights and preferences of redeemable convertible preferred stock relative to common stock; (iii) the lack of marketability of common stock; (iv) developments in the business; (v) recent issuances of redeemable convertible preferred stock; (vi) the likelihood of achieving a liquidity event, such as an initial public offering, or sale of the Company, given prevailing market conditions and (vii) secondary transactions in the Company's common and preferred stock. These determinations of fair market value were used for purposes of determining the Black-Scholes fair value of the Company's stock option awards and related stock-based compensation expenses.

 

Certain of the Company's options granted prior to the IPO provided the right to exercise those options before they are vested. The Company has a right to repurchase any unvested shares at a repurchase price equal to the exercise price during the 90-day period following the termination of an individual's service with the Company for any reason.

Valuation of Awards

The per-share fair value of each stock option was determined on the date of grant using the Black-Scholes option pricing model using the following assumptions:

 

		Fiscal Year Ended January 31,
		2010		2011		2012
Expected life (in years)		5.73 – 6.15		5.91 – 6.09		5.72 – 7.02
Risk-free interest rate		2.51% – 2.81%		1.41% – 2.92%		1.10% – 2.77%
Expected volatility		56% – 60%		57% – 58%		54% – 57%
Expected dividend yield		0%		0%		0%

The expected term of stock options granted represents the weighted average period that the stock options are expected to remain outstanding. The Company determined the expected term assumption based on the Company's historical exercise behavior combined with estimates of the post-vesting holding period. Expected volatility is based on historical volatility of peer companies in the Company's industry that have similar vesting and contractual terms. The risk free interest rate is based on the implied yield currently available on U.S. Treasury issues with terms approximately equal to the expected life of the option. The Company currently has no history or expectation of paying cash dividends on its common stock.

Common Stock

Each share of common stock has the right to one vote per share. The holders of common stock are also entitled to receive dividends as and when declared by the board of directors of the Company, whenever funds are legally available. These rights are subordinate to the dividend rights of holders of all classes of stock outstanding at the time.

Early Exercise Liability. In connection with the early exercise of stock options, the Company has the right, but not the obligation, to repurchase unvested shares of common stock upon termination of the individual's service to the Company at the original purchase price per share. During the fiscal years ended January 31, 2010, and 2012 there were no early exercises. During the fiscal year ended January 31, 2011, employees early exercised a total of 691,667 shares of common stock subject to these terms.

 

As of January 31, 2011 and 2012, 684,896, and 483,334 unvested restricted shares, respectively, of common stock were subject to repurchase. Repurchase rights with respect to the 483,334 restricted shares outstanding as of January 31, 2012 will expire ratably between February 1, 2011 and January 31, 2015.

Stock Options. Stock option activity during the year ended January 31, 2012 was as follows:

 

		Options Outstanding
		Shares Available for Grant				Outstanding Stock Options				Weighted- Average Exercise Price				Weighted- Average Remaining Contractual Term (in years)				Aggregate(1) Intrinsic  Value
		(in thousands, except share and per share data)
Balance as of January 31, 2011			6,310,291				33,407,775			$	0.63							$	83,960
Additional shares authorized			12,000,000
Granted			(7,903,325	)			7,903,325				8.86
Restricted stock			(1,426,975	)
2000 Plan Cancelled			(55,984	)
Exercised			—				(5,165,112	)			0.40
Cancelled/Forfeited			1,335,062				(1,335,062	)			3.16
Balance as of January 31, 2012			10,259,069				34,810,926			$	2.43				7.04			$	379,355
Exercisable as of January 31, 2012							18,759,021			$	0.52				5.74			$	237,673
Vested as of January 31, 2012 and expected to vest thereafter(2)							33,197,211			$	2.33				6.96			$	365,082

 

(1)	Amounts represent the difference between the exercise price and the fair value of common stock at each period end for all in the money options outstanding based on the fair value per share of common stock of $0.17, $3.14 and $13.19 as of January 31, 2010, 2011 and 2012, respectively.

(2)	Options expected to vest reflect an estimated forfeiture rate.

 

As of January 31, 2012, there was $41.9 million of unrecognized compensation cost related to outstanding employee stock options. This amount is expected to be recognized over a weighted-average period of 2.62 years. To the extent the actual forfeiture rate is different from what we have estimated, stock-based compensation related to these awards will be different from our expectations.

Options to Non-Employees. The per-share fair value of stock options granted to non-employees is determined on the date of grant using the Black-Scholes option pricing model with the same assumptions as those used for employee awards with the exception of expected term. The expected term for non-employee awards is the contractual term of 10 years.

As of January 31, 2010, 2011 and 2012, respectively, a total of 406,595, 431,359 and 59,375 common stock options, issued to non-employees were vested and outstanding.

During the years ended January 31, 2010, 2011 and 2012, the Company recorded $3,000, $15,500 and $0.3 million, respectively, in stock-based compensation expenses related to stock option grants made to non-employees. As of January 31, 2012, total compensation cost related to stock options granted to non-employees but not yet recognized, was $0.8 million which the Company expects to recognize over a weighted-average period of 2.93 years. The fair value of these options will be remeasured on each vesting date and as of each reporting date until the options vest. The remeasured fair value will be recognized as compensation expense over the remaining vesting term of the options.

Option Granted to Related Party

During January of 2011, the Company entered into a consulting arrangement with a spouse of one of the Company's executive officers, pursuant to which the consultant will provide consulting services to the Company for a period of four years. Pursuant to this arrangement, the Company granted the consultant options to purchase 40,000 shares of its common stock at $3.14 per share, to vest over four years at a rate of 1/48th per month. Using the Black-Scholes option pricing model, the initial grant date fair value of these options was determined to be $60,000. As of January 31, 2012, $0.1 million compensation cost has been recognized related to these options due to the remeasured fair value at the reporting date.

Stock-based Compensation Expenses

The weighted-average fair value of stock option grants made during the fiscal years ended January 31, 2010, 2011 and 2012 was $0.09, $1.17 and $4.83 per share, respectively. As of January 31, 2012, total compensation cost related to stock options granted, but not yet recognized, was $42.7 million which the Company expects to recognize over a weighted-average period of approximately 2.6 years.

The intrinsic value of options exercised during the years ended January 31, 2010, 2011 and 2012 was $89,000, $5.8 million, $51.9 million, respectively. The total fair value of options vested during the years ended January 31, 2010, 2011 and 2012 was $440,000, $909,000 and $5.2 million, respectively.

 

Stock-based compensation expenses related to all employee and non-employee stock-based awards for fiscal 2010, 2011 and 2012 was as follows:

 

		Fiscal Year Ended January 31,
		2010				2011				2012
		(in thousands)
Stock-based compensation expenses:
Cost of revenue		$	18			$	85			$	582
Product development			125				329				1,638
Marketing and sales			225				549				4,866
General and administrative			109				492				2,101
Total stock-based compensation, recorded in costs and expenses		$	477			$	1,455			$	9,187

Restricted Stock Units

During the fiscal year ended January 31, 2012, Pandora granted 1,431,475 restricted stock units ("RSUs"), respectively, under the 2011 Plan at a weighted average value of $12.02 per share. The fair value of the restricted stock units is expensed ratably over the vesting period. RSUs vest annually on a cliff basis over the service period, generally four years. The Company recorded stock-based compensation expense related to restricted stock units of approximately $1.0 million during the fiscal year ended January 31, 2012. As of January 31, 2012, total compensation cost not yet recognized of approximately $16.2 million related to non-vested restricted stock units, is expected to be recognized over a weighted average period of 3.70 years.

The following table summarizes the activities for our RSUs for the year ended January 31, 2012:

 

		Number of Shares				Weighted- Average Grant-Date Fair Value
Unvested at January 31, 2011			0			$	0.00
Granted			1,431,475				12.02
Vested			0				0.00
Canceled			(4,500	)			11.41
Unvested at January 31, 2012			1,426,975			$	12.03
Expected to vest after January 31, 2012(1)			1,276,436			$	12.03

 

(1)	Options expected to vest reflect an estimated forfeiture rate.