Zillow Group, Inc.
ZILLOW GROUP, INC. (Form: 10-Q, Received: 11/06/2018 17:02:59)
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________________________
FORM 10-Q
_____________________________________________________
 
x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT 1934
For the quarterly period ended September 30, 2018
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-36853
 
_____________________________________________________
ZILLOW GROUP, INC.
(Exact name of registrant as specified in its charter)
_____________________________________________________
Washington
 
47-1645716
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
1301 Second Avenue, Floor 31, Seattle, Washington
 
98101
(Address of principal executive offices)
 
(Zip Code)
(206) 470-7000
@ZillowGroup
(Registrant’s telephone number, including area code)
  _____________________________________________________ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No  ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes   x     No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
x

 
Accelerated filer
 
 
 
 
 
 
 
 
Non-accelerated filer
 
☐  
 
Smaller reporting company
 
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No   x
As of October 31, 2018 , 57,986,928 shares of Class A common stock, 6,217,447 shares of Class B common stock, and 139,042,266 shares of Class C capital stock were outstanding.
 


Table of Contents

ZILLOW GROUP, INC.
Quarterly Report on Form 10-Q
For the Three Months Ended September 30, 2018
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.
 
 
 
 
 

i

Table of Contents

As used in this Quarterly Report on Form 10-Q, the terms “Zillow Group,” “the Company,” “we,” “us” and “our” refer to Zillow Group, Inc., unless the context indicates otherwise.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including Part I, Item 2 (Management’s Discussion and Analysis of Financial Condition and Results of Operations), contains forward-looking statements based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include all statements that are not historical facts and generally may be identified by terms such as “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “expect” or the negative or plural of these words or similar expressions.
These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those risks, uncertainties and assumptions described in Part II, Item 1A (Risk Factors) of this report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the effect of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
You should not rely on forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. Moreover, except as required by law, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements, and we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations.
WHERE YOU CAN FIND MORE INFORMATION
Our filings with the Securities and Exchange Commission, or SEC, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are available on our website at www.zillowgroup.com, free of charge, as soon as reasonably practicable after the electronic filing of these reports with the SEC. The information contained on our website is not a part of this quarterly report on Form 10-Q or any other document we file with the SEC.
Investors and others should note that Zillow Group announces material financial information to its investors using its press releases, SEC filings and public conference calls and webcasts. Zillow Group intends to also use the following channels as a means of disclosing information about Zillow Group, its services and other matters and for complying with its disclosure obligations under Regulation FD:
 
Zillow Group Investor Relations Webpage (http://investors.zillowgroup.com)
Zillow Group Investor Relations Blog (http://www.zillowgroup.com/ir-blog)
Zillow Group Twitter Account (https://twitter.com/zillowgroup)
The information Zillow Group posts through these channels may be deemed material. Accordingly, investors should monitor these channels, in addition to following Zillow Group’s press releases, SEC filings and public conference calls and webcasts. This list may be updated from time to time. The information we post through these channels is not a part of this quarterly report on Form 10-Q or any other document we file with the SEC, and the inclusion of our website addresses and Twitter account are as inactive textual references only.

1

Table of Contents

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
ZILLOW GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data, unaudited)
 
September 30,
2018
 
December 31,
2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
643,792

 
$
352,095

Short-term investments
999,241

 
410,444

Accounts receivable, net of allowance for doubtful accounts of $5,276 and $5,341 at September 30, 2018 and December 31, 2017, respectively
66,337

 
54,396

Inventory
43,257

 

Prepaid expenses and other current assets
38,904

 
24,590

Restricted cash
3,203

 

Total current assets
1,794,734

 
841,525

Contract cost assets
45,238

 

Property and equipment, net
124,281

 
112,271

Goodwill
1,931,076

 
1,931,076

Intangible assets, net
290,887

 
319,711

Other assets
16,241

 
25,934

Total assets
$
4,202,457

 
$
3,230,517

Liabilities and shareholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
5,846

 
$
3,587

Accrued expenses and other current liabilities
58,533

 
61,373

Accrued compensation and benefits
25,612

 
19,109

Revolving credit facility
24,674



Deferred revenue
35,959

 
31,918

Deferred rent, current portion
2,566

 
2,400

Total current liabilities
153,190

 
118,387

Deferred rent, net of current portion
18,049

 
21,330

Long-term debt
690,338

 
385,416

Deferred tax liabilities and other long-term liabilities
21,861

 
44,561

Total liabilities
883,438

 
569,694

Commitments and contingencies (Note 17)

 

Shareholders’ equity:
 
 
 
Preferred stock, $0.0001 par value; 30,000,000 shares authorized; no shares issued and outstanding

 

Class A common stock, $0.0001 par value; 1,245,000,000 shares authorized; 57,965,662 and 56,629,103 shares issued and outstanding as of September 30, 2018 and December 31, 2017, respectively
6

 
6

Class B common stock, $0.0001 par value; 15,000,000 shares authorized; 6,217,447 shares issued and outstanding as of September 30, 2018 and December 31, 2017
1

 
1

Class C capital stock, $0.0001 par value; 600,000,000 shares authorized; 138,974,244 and 127,268,598 shares issued and outstanding as of September 30, 2018 and December 31, 2017, respectively
13

 
13

Additional paid-in capital
3,894,757

 
3,254,146

Accumulated other comprehensive loss
(1,661
)
 
(1,100
)
Accumulated deficit
(574,097
)
 
(592,243
)
Total shareholders’ equity
3,319,019

 
2,660,823

Total liabilities and shareholders’ equity
$
4,202,457

 
$
3,230,517

See accompanying notes to condensed consolidated financial statements.

2

Table of Contents

ZILLOW GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data, unaudited)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Revenue:
 
 
 
 
 
 
 
IMT
$
332,076

 
$
281,839

 
$
957,201

 
$
794,464

Homes
11,018

 

 
11,018

 

Total revenue
343,094

 
281,839

 
968,219

 
794,464

Cost of revenue (exclusive of amortization) (1):
 
 
 
 
 
 
 
IMT
26,386

 
22,152

 
75,832

 
62,644

Homes
10,286

 

 
10,286

 

Total cost of revenue
36,672

 
22,152

 
86,118

 
62,644

Sales and marketing
128,734

 
107,108

 
413,752

 
344,266

Technology and development
105,314

 
83,389

 
299,623

 
234,798

General and administrative
70,743

 
54,226

 
187,395

 
153,038

Impairment costs
10,000

 

 
10,000

 

Acquisition-related costs
1,405

 
218

 
2,064

 
366

Integration costs
523

 

 
523

 

Total costs and expenses
353,391

 
267,093

 
999,475

 
795,112

Income (loss) from operations
(10,297
)
 
14,746

 
(31,256
)
 
(648
)
Other income
7,773

 
1,407

 
13,308

 
3,970

Interest expense
(12,668
)
 
(6,906
)
 
(26,928
)
 
(20,526
)
Income (loss) before income taxes
(15,192
)
 
9,247

 
(44,876
)
 
(17,204
)
Income tax benefit (expense)
14,700

 
(41
)
 
22,700

 
(41
)
Net income (loss)
$
(492
)
 
$
9,206

 
$
(22,176
)
 
$
(17,245
)
Net income (loss) per share — basic and diluted
$

 
$
0.05

 
$
(0.11
)
 
$
(0.09
)
Weighted-average shares outstanding — basic
202,416

 
187,692

 
195,208

 
185,447

Weighted-average shares outstanding — diluted
202,416

 
196,425

 
195,208

 
185,447

 ____________________
(1) Amortization of website development costs and intangible assets included in technology and development
$
18,165

 
$
23,537

 
$
61,735

 
$
69,957

See accompanying notes to condensed consolidated financial statements.


3

Table of Contents

ZILLOW GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands, unaudited)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Net income (loss)
$
(492
)
 
$
9,206

 
$
(22,176
)
 
$
(17,245
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized gains (losses) on investments
(428
)
 
99

 
(537
)
 
(103
)
Currency translation adjustments
42

 

 
(24
)
 

Total other comprehensive income (loss)
(386
)
 
99

 
(561
)
 
(103
)
Comprehensive income (loss)
$
(878
)
 
$
9,305

 
$
(22,737
)
 
$
(17,348
)
See accompanying notes to condensed consolidated financial statements.

4

Table of Contents

ZILLOW GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
 
Nine Months Ended
September 30,
 
2018
 
2017
Operating activities
 
 
 
Net loss
$
(22,176
)
 
$
(17,245
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
76,301

 
81,576

Share-based compensation expense
111,366

 
84,162

Amortization of contract cost assets
27,227

 

Amortization of discount and issuance costs on 2021 and 2023 Notes
17,990

 
13,391

Impairment costs
10,000

 

Deferred income taxes
(22,700
)
 

Loss on disposal of property and equipment
3,129

 
4,085

Bad debt expense
1,053

 
5,861

Deferred rent
(3,116
)
 
3,072

Amortization (accretion) of bond premium (discount)
(2,172
)
 
451

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(12,994
)
 
(19,272
)
Inventory
(43,257
)
 

Prepaid expenses and other assets
(15,012
)
 
4,434

Contract cost assets
(32,143
)
 

Accounts payable
2,254

 
224

Accrued expenses and other current liabilities
(3,751
)
 
13,174

Accrued compensation and benefits
6,503

 
1,194

Deferred revenue
4,041

 
1,775

Other long-term liabilities

 
41

Net cash provided by operating activities
102,543

 
176,923

Investing activities
 
 
 
Proceeds from maturities of investments
261,675

 
204,520

Purchases of investments
(848,838
)
 
(303,241
)
Purchases of property and equipment
(44,482
)
 
(51,580
)
Purchases of intangible assets
(8,179
)
 
(9,377
)
Purchase of equity investment

 
(10,000
)
Proceeds from divestiture of a business

 
579

Cash paid for acquisition, net
(2,000
)
 
(11,147
)
Net cash used in investing activities
(641,824
)
 
(180,246
)
Financing activities
 
 
 
Proceeds from issuance of 2023 Notes, net of issuance costs
364,020

 

Premiums paid for Capped Call Confirmations
(29,414
)
 

Proceeds from issuance of Class C Capital Stock, net of issuance costs
360,345

 

Proceeds from borrowing on revolving credit facility
24,674



Proceeds from exercise of stock options
114,623

 
80,010

Value of equity awards withheld for tax liability
(67
)
 
(337
)
Net cash provided by financing activities
834,181

 
79,673

Net increase in cash, cash equivalents and restricted cash during period
294,900

 
76,350

Cash, cash equivalents and restricted cash at beginning of period
352,095

 
243,592

Cash, cash equivalents and restricted cash at end of period
$
646,995

 
$
319,942

Supplemental disclosures of cash flow information
 
 
 
Cash paid for interest
$
4,800

 
$
4,458

Noncash transactions:
 
 
 
Capitalized share-based compensation
$
6,674

 
$
8,915

Write-off of fully depreciated property and equipment
$
18,687

 
$
12,685

Write-off of fully amortized intangible assets
$
10,797

 
$
5,454

See accompanying notes to condensed consolidated financial statements.

5

Table of Contents

ZILLOW GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1 . Organization and Description of Business
Zillow Group, Inc. operates the largest portfolio of real estate and home-related brands on mobile and the web which focus on all stages of the home lifecycle: renting, buying, selling and financing. Zillow Group is committed to empowering consumers with unparalleled data, inspiration and knowledge around homes, and connecting them with great real estate professionals. The Zillow Group portfolio of consumer brands includes real estate and rental marketplaces Zillow, Trulia, StreetEasy, HotPads, Naked Apartments, RealEstate.com and Out East. In addition, Zillow Group provides a comprehensive suite of marketing software and technology solutions to help real estate professionals maximize business opportunities and connect with millions of consumers. Beginning in April of 2018, Zillow Offers provides homeowners in certain metropolitan areas with the opportunity to receive offers to purchase their home from Zillow. When Zillow buys a home, it makes certain repairs and updates and lists the home for resale on the open market. We also own and operate a number of business brands for real estate, rental and mortgage professionals, including Mortech, dotloop, Bridge Interactive and New Home Feed. Zillow, Inc. was incorporated as a Washington corporation in December 2004, and we launched the initial version of our website, Zillow.com, in February 2006. Zillow Group, Inc. was incorporated as a Washington corporation in July 2014 in connection with our acquisition of Trulia, Inc. (“Trulia”). Upon the closing of the Trulia acquisition in February 2015, each of Zillow, Inc. and Trulia became wholly owned subsidiaries of Zillow Group.
Certain Significant Risks and Uncertainties
We operate in a dynamic industry and, accordingly, can be affected by a variety of factors. For example, we believe that changes in any of the following areas could have a significant negative effect on us in terms of our future financial position, results of operations or cash flows: rates of revenue growth; our ability to manage advertising inventory or pricing; engagement and usage of our products; our investment of resources to pursue strategies that may not prove effective; competition in our market; the stability of the residential real estate market and the impact of interest rate changes; changes in government regulation affecting our business; outcomes of legal proceedings; natural disasters and catastrophic events; scaling and adaptation of existing technology and network infrastructure; management of our growth; our ability to attract and retain qualified employees and key personnel; our ability to successfully integrate and realize the benefits of our past or future strategic acquisitions or investments; protection of customers’ information and other privacy concerns; protection of our brand and intellectual property; and intellectual property infringement and other claims, among other things.
Note 2 . Summary of Significant Accounting Policies
Basis of Presentation
The accompanying condensed consolidated financial statements include Zillow Group, Inc. and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. These condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the audited financial statements and accompanying notes included in Zillow Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2017 , which was filed with the SEC on February 15, 2018. The condensed consolidated balance sheet as of December 31, 2017 , included herein, was derived from the audited financial statements of Zillow Group, Inc. as of that date.
The unaudited condensed consolidated interim financial statements, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly our financial position as of September 30, 2018 , our results of operations and comprehensive income (loss) for the three and nine month periods ended September 30, 2018 and 2017 , and our cash flows for the nine month periods ended September 30, 2018 and 2017 . The results of the three and nine month periods ended September 30, 2018 are not necessarily indicative of the results to be expected for the year ending December 31, 2018 or for any interim period or for any other future year.

6


Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and the related disclosures at the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. On an ongoing basis, we evaluate our estimates, including those related to the net realizable value of inventory, amortization period and recoverability of contract cost assets, website and software development costs, recoverability of long-lived assets and intangible assets with definite lives, share-based compensation, income taxes, business combinations, and the recoverability of goodwill and indefinite-lived intangible assets, among others. To the extent there are material differences between these estimates, judgments, or assumptions and actual results, our financial statements will be affected.
Recently Adopted Accounting Standards
In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance on revenue from contracts with customers. The guidance states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those products or services. It also states that an entity should recognize as an asset the incremental costs of obtaining a contract that the entity expects to recover and amortize the costs consistent with the transfer to the customer of the products or services to which the asset relates. The guidance requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. We adopted this guidance effective January 1, 2018 using the modified retrospective transition approach applied to all contracts at the date of initial application. We recorded an adjustment of $40.3 million to decrease accumulated deficit as of January 1, 2018 related to the accounting for the cost of sales commissions, primarily related to sales commissions for our Premier Agent and Premier Broker advertising products. Historically, we expensed these sales commission costs as incurred, but under the new guidance, the cost of certain sales commissions is recorded as a contract cost asset and recognized as an operating expense over the period that we expect to recover the costs.
The amount by which each financial statement line item is affected by the application of this guidance for the three months ended September 30, 2018 is as follows (in thousands, except per share data):
 
 
New Guidance
 
Prior Guidance
 
Change
Condensed Consolidated Statement of Operations:
 
 
 
 
 
 
Sales and marketing
 
$
128,734

 
$
130,588

 
$
(1,854
)
Total costs and expenses
 
353,391

 
355,245

 
(1,854
)
Loss from operations
 
(10,297
)
 
(12,151
)
 
1,854

Loss before income taxes
 
(15,192
)
 
(17,046
)
 
1,854

Income tax benefit
 
14,700

 
14,992

 
(292
)
Net loss
 
(492
)
 
(2,054
)
 
1,562

Net loss per share — basic and diluted
 

 
(0.01
)
 
0.01


7


The amount by which each financial statement line item is affected by the application of this guidance as of and for the nine months ended September 30, 2018 is as follows (in thousands, except per share data):
 
 
New Guidance
 
Prior Guidance
 
Change
Condensed Consolidated Statement of Operations:
 
 
 
 
 
 
Sales and marketing
 
$
413,752

 
$
418,668

 
$
(4,916
)
Total costs and expenses
 
999,475

 
1,004,391

 
(4,916
)
Loss from operations
 
(31,256
)
 
(36,172
)
 
4,916

Loss before income taxes
 
(44,876
)
 
(49,792
)
 
4,916

Income tax benefit
 
22,700

 
23,892

 
(1,192
)
Net loss
 
(22,176
)
 
(25,900
)
 
3,724

Net loss per share — basic and diluted
 
(0.11
)
 
(0.13
)
 
0.02

Condensed Consolidated Balance Sheet:
 
 
 
 
 
 
Contract cost assets
 
45,238

 

 
45,238

Total assets
 
4,202,457

 
4,157,219

 
45,238

Deferred tax liabilities and other long-term liabilities
 
21,861

 
20,669

 
1,192

Total liabilities
 
883,438

 
882,246

 
1,192

Accumulated deficit
 
(574,097
)
 
(619,335
)
 
45,238

Total shareholders’ equity
 
3,319,019

 
3,282,422

 
36,597

Total liabilities and shareholders’ equity
 
4,202,457

 
4,157,219

 
45,238

Recently Issued Accounting Standards Not Yet Adopted
In August 2018, the FASB issued guidance related to a customer’s accounting for implementation costs incurred in hosting arrangements. The guidance aligns the requirements for capitalizing implementation costs incurred in cloud computing arrangements with the requirements for capitalizing costs to develop or obtain internal-use software. This guidance is effective for interim and annual reporting periods beginning after December 15, 2019, and early adoption is permitted. This guidance may be applied either retrospectively or prospectively. We expect to adopt this guidance on January 1, 2020. We have not yet determined the impact the adoption of this guidance will have on our financial position, results of operations or cash flows.
In August 2018, the FASB issued guidance related to disclosure requirements for fair value measurements. This guidance removes, modifies and adds disclosures related to fair value measurements. This guidance is effective for interim and annual periods beginning after December 15, 2019, and early adoption is permitted. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim and annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. We expect to adopt this guidance on January 1, 2020. We have not yet determined the impact the adoption of this guidance will have on our financial statement disclosures.
In June 2018, the FASB issued guidance related to contributions received and made. This guidance assists entities with evaluating whether a transfer of assets is considered a contribution or an exchange transaction. This guidance is effective for interim and annual reporting periods beginning after June 15, 2018 for contributions received and after December 15, 2018 for contributions made, and early adoption is permitted. The guidance should be applied on a modified prospective basis, though retrospective application is permitted. We expect to adopt this guidance on January 1, 2019. The adoption of this guidance is not expected to have a material impact on our financial position, results of operations or cash flows.
In February 2018, the FASB issued guidance on income tax accounting related to the Tax Act. This guidance permits a reclassification from accumulated other comprehensive income (loss) to accumulated deficit for the adjustment of deferred taxes due to the reduction of the historical corporate income tax rate to the newly enacted corporate income tax rate under the Tax Act. It also requires certain disclosures regarding these reclassifications. The guidance is effective for interim and annual reporting periods beginning after December 15, 2018, and early adoption is permitted. This guidance must be applied either on a prospective basis in the period of adoption or retrospectively to each period in which the effect of the change in the corporate income tax rate is recognized. We expect to adopt this guidance on January 1, 2019. The adoption of this guidance is not expected to have a material impact on our financial position, results of operations or cash flows.

8


In March 2017, the FASB issued guidance related to the premium amortization on purchased callable debt securities. This guidance shortens the amortization period for certain callable debt securities purchased at a premium by requiring that the premium be amortized to the earliest call date. This guidance is effective for interim and annual reporting periods beginning after December 15, 2018, and early adoption is permitted. This guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We expect to adopt this guidance on January 1, 2019. The adoption of this guidance is not expected to have a material impact on our financial position, results of operations or cash flows.
In June 2016, the FASB issued guidance on the measurement of credit losses on financial instruments. This guidance requires the use of an expected loss impairment model for instruments measured at amortized cost. For available-for-sale debt securities, an entity is required to recognize credit losses through an allowance for credit losses rather than as a write-down. This guidance is effective for interim and annual reporting periods beginning after December 15, 2019, and early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. The adoption of this guidance requires a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. We expect to adopt this guidance on January 1, 2020. We have not yet determined the impact the adoption of this guidance will have on our financial position, results of operations or cash flows.
In February 2016, the FASB issued guidance on leases. This guidance requires the recognition of a right-of-use asset and lease liability on the balance sheet for all leases. This guidance also requires more detailed disclosures to enable users of financial statements to understand the amount, timing, and uncertainty of cash flows arising from leases. This guidance is effective for interim and annual reporting periods beginning after December 15, 2018. In July 2018, the FASB issued certain targeted improvements to the accounting and disclosure requirements for leases, including an additional optional transition method that allows entities to initially apply the new standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption without restating prior periods. We will adopt this guidance on January 1, 2019 using the optional transition method. Under this approach, we will not restate the prior financial statements presented. As we progress through our implementation of this guidance, we continue to expect a significant impact on our financial position upon adoption, primarily due to our office space operating leases, as we will be required to recognize lease assets and lease liabilities on our condensed consolidated balance sheet. As our leases do not provide an implicit rate, we plan to use our incremental borrowing rate based on information available at the commencement date to determine the present value of future payments. We continue to evaluate the incremental borrowing rate, changes to our internal control structure, accounting policies and disclosures. We continue to assess the impact the adoption will have on our results of operations and cash flows.
Note 3 . Fair Value Measurements
Accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. The standards also establish a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:
 
Level 1—Quoted prices in active markets for identical assets or liabilities.
Level 2—Assets and liabilities valued based on observable market data for similar instruments, such as quoted prices for similar assets or liabilities.
Level 3—Unobservable inputs that are supported by little or no market activity; instruments valued based on the best available data, some of which is internally developed, and considers risk premiums that a market participant would require.
We applied the following methods and assumptions in estimating our fair value measurements:
Cash equivalents — The fair value measurement of money market funds is based on quoted market prices in active markets. The fair value measurement of corporate notes and bonds, commercial paper, U.S. government agency securities and certificates of deposit is based on observable market-based inputs or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Short-term investments — The fair value measurement of our short-term investments is based on observable market-based inputs or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

9


Restricted cash — Restricted cash consists of cash received from the resale of homes through Zillow Offers which is used to repay amounts borrowed on the Revolving Credit Facility (see Note 12 ) as well as certain reserves we are required to maintain pursuant to the Revolving Credit Facility. The carrying value of restricted cash approximates fair value due to the short period of time amounts borrowed on the Revolving Credit Facility are outstanding.

The following tables present the balances of assets measured at fair value on a recurring basis, by level within the fair value hierarchy, as of the dates presented (in thousands):
 
September 30, 2018
 
Total
 
Level 1
 
Level 2
Cash equivalents:
 
 
 
 
 
Money market funds
$
543,703

 
$
543,703

 
$

Commercial paper
3,490

 

 
3,490

Certificates of deposit
249

 

 
249

Short-term investments:
 
 
 
 
 
U.S. government agency securities
717,927

 

 
717,927

Corporate notes and bonds
121,875

 

 
121,875

Commercial paper
92,674

 

 
92,674

Municipal securities
43,154

 

 
43,154

Foreign government securities
17,905

 

 
17,905

Certificates of deposit
5,706

 

 
5,706

        Total
$
1,546,683

 
$
543,703

 
$
1,002,980

 
December 31, 2017
 
Total
 
Level 1
 
Level 2
Cash equivalents:
 
 
 
 
 
Money market funds
$
233,508

 
$
233,508

 
$

Corporate notes and bonds
6,199

 

 
6,199

Commercial paper
3,987

 

 
3,987

U.S. government agency securities
1,748

 

 
1,748

Certificates of deposit
249

 

 
249

Short-term investments:
 
 
 
 
 
U.S. government agency securities
298,758

 

 
298,758

Corporate notes and bonds
44,607

 

 
44,607

Commercial paper
39,325

 

 
39,325

Municipal securities
11,459

 

 
11,459

Certificates of deposit
10,297

 

 
10,297

Foreign government securities
5,998

 

 
5,998

        Total
$
656,135

 
$
233,508

 
$
422,627


See Note 12 for the carrying amount and estimated fair value of the Company’s Convertible Senior Notes due in 2023, Convertible Senior Notes due in 2021 and Trulia’s Convertible Senior Notes due in 2020.
We did no t have any Level 3 assets as of September 30, 2018 or December 31, 2017 . There were no liabilities measured at fair value on a recurring basis as of September 30, 2018 or December 31, 2017 .

10


Note 4 . Cash and Cash Equivalents, Short-term Investments and Restricted Cash
The following tables present the amortized cost, gross unrealized gains and losses, and estimated fair market value of our cash and cash equivalents, available-for-sale investments and restricted cash as of the dates presented (in thousands):
 
September 30, 2018
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Market
Value
Cash
$
96,350

 
$

 
$

 
$
96,350

Cash equivalents:
 
 
 
 
 
 
 
Money market funds
543,703

 

 

 
543,703

Commercial paper
3,490

 

 

 
3,490

Certificates of deposit
249

 

 

 
249

Short-term investments:
 
 
 
 
 
 
 
U.S. government agency securities
719,380

 

 
(1,453
)
 
717,927

Corporate notes and bonds
121,987

 
1

 
(113
)
 
121,875

Commercial paper
92,674

 

 

 
92,674

Municipal securities
43,237

 

 
(83
)
 
43,154

Foreign government securities
17,940

 

 
(35
)
 
17,905

Certificates of deposit
5,706

 
1

 
(1
)
 
5,706

Restricted cash
3,203

 

 

 
3,203

        Total
$
1,647,919

 
$
2

 
$
(1,685
)
 
$
1,646,236

 
December 31, 2017
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Market
Value
Cash
$
106,404

 
$

 
$

 
$
106,404

Cash equivalents:
 
 
 
 
 
 
 
Money market funds
233,508

 

 

 
233,508

Corporate notes and bonds
6,200

 

 
(1
)
 
6,199

Commercial paper
3,987

 

 

 
3,987

U.S. government agency securities
1,748

 

 

 
1,748

Certificates of deposit
249

 

 

 
249

Short-term investments:
 
 
 
 
 
 
 
U.S. government agency securities
299,814

 

 
(1,056
)
 
298,758

Corporate notes and bonds
44,661

 
1

 
(55
)
 
44,607

Commercial paper
39,325

 

 

 
39,325

Municipal securities
11,494

 

 
(35
)
 
11,459

Certificates of deposit
10,296

 
2

 
(1
)
 
10,297

Foreign government securities
6,000

 

 
(2
)
 
5,998

        Total
$
763,686

 
$
3

 
$
(1,150
)
 
$
762,539


The following table presents available-for-sale investments by contractual maturity date as of September 30, 2018 (in thousands):
 
Amortized
Cost
 
Estimated Fair
Market Value
Due in one year or less
$
846,217

 
$
844,993

Due after one year through two years
154,707

 
154,248

Total
$
1,000,924

 
$
999,241


Note 5 . Accounts Receivable, net
The opening balance of accounts receivable, net was $54.4 million as of January 1, 2018.
The following table presents the changes in the allowance for doubtful accounts (in thousands):
Balance as of January 1, 2018
$
5,341

Bad debt expense
1,053

Less: write-offs, net of recoveries and other adjustments
(1,118
)
Balance as of September 30, 2018
$
5,276


Note 6 . Inventory
The components of inventory, net of applicable lower of cost or net realizable value write-downs, were as follows (in thousands):
 
September 30,
2018
 
December 31,
2017
Work-in-progress
$
16,010

 
$

Finished goods
27,247

 

Inventory
$
43,257

 
$


Note 7 . Contract Cost Assets
As of September 30, 2018 , we had $45.2 million of contract cost assets. During the three and nine month periods ended September 30, 2018 , we recorded no impairment losses. During the three and nine month periods ended September 30, 2018 , we recorded $8.9 million and $27.2 million , respectively, of amortization expense related to contract cost assets.
Note 8 . Property and Equipment, net
The following table presents the detail of property and equipment as of the dates presented (in thousands):
 
September 30,
2018
 
December 31,
2017
Website development costs
$
147,416

 
$
130,072

Leasehold improvements
58,354

 
47,321

Computer equipment
30,896

 
30,071

Construction-in-progress
26,150

 
28,150

Office equipment, furniture and fixtures
26,221

 
22,887

Property and equipment
289,037

 
258,501

Less: accumulated amortization and depreciation
(164,756
)
 
(146,230
)
Property and equipment, net
$
124,281

 
$
112,271


We recorded depreciation expense related to property and equipment (other than website development costs) of $5.1 million and $3.8 million , respectively, during the three months ended September 30, 2018 and 2017 , and $14.2 million and $11.5 million , respectively, during the nine months ended September 30, 2018 and 2017 .

We capitalized $8.0 million and $13.4 million , respectively, in website development costs during the three months ended September 30, 2018 and 2017 , and $26.6 million and $39.8 million , respectively, during the nine months ended September 30, 2018 and 2017 . Amortization expense for website development costs included in technology and development expenses was $6.2 million and $10.1 million , respectively, during the three months ended September 30, 2018 and 2017 , and $24.2 million and $30.0 million , respectively, during the nine months ended September 30, 2018 and 2017 .

11


Note 9 . Equity Investments
In June 2017, we purchased an equity interest in a privately held corporation for approximately $10.0 million .
In October 2016, we purchased a 10% equity interest in a privately held variable interest entity within the real estate industry for $10.0 million . The entity is financed through its business operations. We are not the primary beneficiary of the entity, as we do not direct the activities that most significantly impact the entity’s economic performance. Therefore, we do not consolidate the entity. Our maximum exposure to loss is $10.0 million , the carrying amount of the investment as of September 30, 2018 .
These investments are equity securities without readily determinable fair values which we account for at cost minus any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. During the three months ended September 30, 2018 , we recognized a non-cash impairment charge of $10.0 million related to our June 2017 investment. The impairment charge is included in Impairment costs within our condensed consolidated statements of operations. In connection with our quarterly qualitative assessment of this investment for impairment indicators, we identified factors that led us to conclude that the investment was impaired and the fair value of the investment was less than the carrying value. The most significant of such factors was related to the business prospects of the investee. Accordingly, we performed an analysis to determine the fair value of the investment and concluded that our best estimate of its fair value was $0.0 million as of September 30, 2018 . This is considered a Level 3 measurement under the fair value hierarchy.
There has been no impairment or upward or downward adjustments for our October 2016 equity investment as of September 30, 2018 that would impact the carrying amount of the investment. The October 2016 investment is classified within other assets in the condensed consolidated balance sheet.
Note 10 . Intangible Assets, net
The following tables present the detail of intangible assets subject to amortization as of the dates presented (in thousands):
 
September 30, 2018
 
Cost
 
Accumulated
Amortization
 
Net
Purchased content
$
39,105

 
$
(27,978
)
 
$
11,127

Software
21,893

 
(12,534
)
 
9,359

Customer relationships
103,900

 
(57,304
)
 
46,596

Developed technology
111,980

 
(69,137
)
 
42,843

Trade names and trademarks
4,900

 
(4,658
)
 
242

Intangibles-in-progress
3,720

 

 
3,720

Total
$
285,498

 
$
(171,611
)
 
$
113,887

 
December 31, 2017
 
Cost
 
Accumulated
Amortization
 
Net
Purchased content
$
35,260

 
$
(20,480
)
 
$
14,780

Software
18,957

 
(8,899
)
 
10,058

Customer relationships
103,900

 
(46,365
)
 
57,535

Developed technology
113,380

 
(56,664
)
 
56,716

Trade names and trademarks
4,900

 
(3,943
)
 
957

Advertising relationships
9,000

 
(8,525
)
 
475

Intangibles-in-progress
2,190

 

 
2,190

Total
$
287,587

 
$
(144,876
)
 
$
142,711



12


Amortization expense recorded for intangible assets for the three months ended September 30, 2018 and 2017 was $12.0 million and $13.4 million , respectively. Amortization expense recorded for intangible assets for the nine months ended September 30, 2018 and 2017 was $37.6 million and $39.9 million , respectively. These amounts are included in technology and development expenses.
We have an indefinite-lived intangible asset that we recorded in connection with our February 2015 acquisition of Trulia for Trulia’s trade names and trademarks that is not subject to amortization. The carrying value of the Trulia trade names and trademarks intangible asset was $177.0 million as of September 30, 2018 and December 31, 2017 .
Intangibles-in-progress consists of software that is capitalizable but has not been placed in service.
Note 11 . Deferred Revenue
The following tables present the changes in deferred revenue for the periods presented (in thousands):
 
Three Months Ended
September 30, 2018
Balance as of July 1, 2018
$
35,920

Deferral of revenue
253,571

Less: Revenue recognized
(253,532
)
Balance as of September 30, 2018
$
35,959


 
Nine Months Ended
September 30, 2018
Balance as of January 1, 2018
$
31,918

Deferral of revenue
742,427

Less: Revenue recognized
(738,386
)
Balance as of September 30, 2018
$
35,959


During the three months ended September 30, 2018 , we recognized as revenue a total of $33.0 million pertaining to amounts that were recorded in deferred revenue as of June 30, 2018. During the nine months ended September 30, 2018 , we recognized as revenue a total of $30.6 million pertaining to amounts that were recorded in deferred revenue as of December 31, 2017 .
Note 12 . Debt
Revolving Credit Facility
On July 31, 2018, certain wholly owned subsidiaries of Zillow Group entered into a revolving credit agreement with Credit Suisse AG, Cayman Islands Branch, as the directing lender, and certain other parties thereto (the “Revolving Credit Facility”). The Revolving Credit Facility provides for a maximum borrowing capacity of $250.0 million (the “Maximum Amount”) with a current borrowing capacity of $25.0 million as of September 30, 2018 , which amount may be increased up to the Maximum Amount subject to the satisfaction of certain conditions, through a non-recourse credit facility secured by a pledge of the equity of certain Zillow Group subsidiaries that purchase and sell select residential properties through Zillow Offers. In certain circumstances Zillow Group may be obligated to fund some or all of the payment obligations under the Revolving Credit Facility. Zillow Group formed certain special purpose entities to effectuate the transactions contemplated by the agreement underlying the Revolving Credit Facility. Each special purpose entity is a wholly owned subsidiary of Zillow Group and a separate legal entity, and neither the assets nor credit of any such entity are available to satisfy the debts and other obligations of any affiliate or other entity.
The Revolving Credit Facility has an initial term of one year which may be extended for up to three years , subject to agreement by the directing lender. The Revolving Credit Facility includes customary representations and warranties, covenants (including financial covenants applicable to Zillow Group), and provisions regarding events of default. As of September 30, 2018, Zillow Group was in compliance with all financial covenants and no event of default had occurred. Availability under the Revolving Credit Facility is limited by a formula equal to the lower of 85% of the aggregate acquisition cost of financed residential properties or 85% of the aggregate market value, which for each residential property is the sum of the value established by an independent broker-pricing opinion and renovation costs paid.

13


Pursuant to the terms of the Revolving Credit Facility, we are required to establish, maintain, and in certain circumstances fund, certain specified reserve accounts. These reserve accounts include, but are not limited to, interest reserves, insurance, tax and HOA fee reserves, renovation cost reserves and special reserves. The credit facility reserve accounts and the collection account into which funds are deposited upon the resale of financed residential properties, which funds are used to repay amounts borrowed on the Revolving Credit Facility, are under the sole control of Credit Suisse AG, New York Branch, as defined in the agreement governing the Revolving Credit Facility. Amounts funded to these reserve accounts and the collection account have been classified within our condensed consolidated balance sheets as restricted cash. Borrowings on our Revolving Credit Facility bear interest at the one-month London Interbank Offered Rate (“LIBOR”) plus an applicable margin. We are also required to pay a funding fee for each financed residential property and certain other fees to certain other parties to the agreement. Interest, funding fees and other fees, including the amortization of deferred issuance costs, are classified within interest expense in our condensed consolidated statements of operations.
As of September 30, 2018, we have outstanding $24.7 million of borrowings on the Revolving Credit Facility and approximately $0.3 million is currently available for future borrowings.
Convertible Senior Notes due in 2023
On July 3, 2018, Zillow Group issued $373.8 million aggregate principal amount of Convertible Senior Notes due 2023 (the “2023 Notes”), which includes $48.8 million principal amount of 2023 Notes sold pursuant to the underwriters’ option to purchase additional 2023 Notes. The 2023 Notes bear interest at a fixed rate of 1.50% per year, payable semiannually in arrears on January 1 and July 1 of each year, beginning on January 1, 2019. The 2023 Notes are convertible into cash, shares of Class C capital stock or a combination thereof, at our election. The 2023 Notes will mature on July 1, 2023, unless earlier repurchased, redeemed, or converted in accordance with their terms.
The net proceeds from the issuance of the 2023 Notes were approximately $364.0 million , after deducting underwriting discounts and commissions and offering expenses payable by the Company. We used approximately $29.4 million of the net proceeds from the issuance of the 2023 Notes to pay the cost of the Capped Call Confirmations described below. The Company intends to use the remainder of the net proceeds for general corporate purposes.
Prior to the close of business on the business day immediately preceding April 1, 2023, the 2023 Notes are convertible at the option of the holders only under certain conditions. On or after April 1, 2023, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their 2023 Notes at their option at the conversion rate then in effect, irrespective of these conditions. The Company will settle conversions of the 2023 Notes by paying or delivering, as the case may be, cash, shares of the Company’s Class C capital stock, or a combination of cash and shares of Class C capital stock, at its election. The conversion rate will initially be 12.7592 shares of Class C capital stock per $1,000 principal amount of 2023 Notes (equivalent to an initial conversion price of approximately $78.37 per share of Class C capital stock). The conversion rate is subject to customary adjustments upon the occurrence of certain events. The Company may redeem for cash all or part of the 2023 Notes, at its option, on or after July 6, 2021, under certain circumstances at a redemption price equal to 100% of the principal amount of the 2023 Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date (as defined in the indenture governing the 2023 Notes). The conversion option does not meet the criteria for separate accounting as a derivative as it is indexed to our own stock.
If the Company undergoes a fundamental change (as defined in the indenture governing the 2023 Notes), holders may require the Company to repurchase for cash all or part of their 2023 Notes at a repurchase price equal to 100% of the principal amount of the 2023 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date (as defined in the indenture governing the 2023 Notes). In addition, if certain fundamental changes occur, the Company may be required in certain circumstances to increase the conversion rate for any Notes converted in connection with such fundamental changes by a specified number of shares of its Class C capital stock. Certain events are also considered “Events of Default,” which may result in the acceleration of the maturity of the 2023 Notes, as described in the indenture governing the 2023 Notes. There are no financial covenants associated with the 2023 Notes.
We may not redeem the 2023 Notes prior to July 6, 2021. We may redeem for cash all or any portion of the 2023 Notes, at our option, in whole or in part on or after July 6, 2021 if the last reported sale price per share of our Class C capital stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period.
In accounting for the issuance of the 2023 Notes, the Company separated the 2023 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, representing the conversion

14


option, was determined by deducting the fair value of the liability component from the par value of the 2023 Notes. The difference between the principal amount of the 2023 Notes and the liability component represents the debt discount, which is recorded as a direct deduction from the related debt liability in the condensed consolidated balance sheet and amortized to interest expense using the effective interest method over the term of the 2023 Notes. The equity component of the 2023 Notes of approximately $78.6 million is included in additional paid-in capital in the condensed consolidated balance sheet and is not remeasured as long as it continues to meet the conditions for equity classification.
Interest expense related to the 2023 Notes for the three and nine month periods ended September 30, 2018 was $5.0 million , which is comprised of approximately $3.6 million related to the amortization of debt discount and debt issuance costs and $1.4 million for the contractual coupon interest.
The effective interest rate on the liability component of the 2023 Notes for the three and nine month periods ended September 30, 2018 is 6.99% . Accrued interest related to the 2023 Notes as of September 30, 2018 was $1.4 million and is recorded in accrued expenses and other current liabilities in the condensed consolidated balance sheet.
The following table presents the outstanding principal amount and carrying value of the 2023 Notes as of the date presented (in thousands):
 
Outstanding
Principal
Amount
 
Unamortized
Debt Discount
and Debt
Issuance Costs
 
Carrying
Value
September 30, 2018
$
373,750

 
$
(82,717
)
 
$
291,033


As of September 30, 2018 , the unamortized debt discount and debt issuance costs for the 2023 Notes will be amortized to interest expense over a remaining period of approximately 57 months.
The estimated fair value of the 2023 Notes was $344.3 million as of September 30, 2018 . The estimated fair value of the 2023 Notes was determined through consideration of quoted market prices. The fair value is classified as Level 3 due to the limited trading activity for the 2023 Notes.
The Capped Call Confirmations are expected generally to reduce the potential dilution of our Class C capital stock upon any conversion of 2023 Notes and/or offset the cash payments the Company is required to make in excess of the principal amount of the 2023 Notes in the event that the market price of the Class C capital stock is greater than the strike price of the Capped Call Confirmations (which initially corresponds to the initial conversion price of the 2023 Notes and is subject to certain adjustments under the terms of the Capped Call Confirmations), with such reduction and/or offset subject to a cap based on the cap price of the Capped Call Confirmations. The Capped Call Confirmations have an initial cap price of  $105.45 per share, which represents a premium of approximately  85% over the public offering price of the Company’s Class C capital stock in the concurrent share offering of $57.00 , and is subject to certain adjustments under the terms of the Capped Call Confirmations. The Capped Call Confirmations will cover, subject to anti-dilution adjustments substantially similar to the 2023 Notes, the number of shares of Class C capital stock that will underlie the 2023 Notes. The Capped Call Confirmations do not meet the criteria for separate accounting as a derivative as they are indexed to our own stock. The premiums paid for the Capped Call Confirmations have been included as a net reduction to additional paid-in-capital within shareholders’ equity.
Convertible Senior Notes due in 2021
On December 12, 2016, Zillow Group issued $460.0 million aggregate principal amount of 2.00% Convertible Senior Notes due 2021 (the “2021 Notes”), which amount includes the exercise in full of the $60.0 million over-allotment option, to Citigroup Global Markets Inc. as the initial purchaser of the 2021 Notes in a private offering to the initial purchaser in reliance on the exemption from the registration requirements provided by Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”) for resale to qualified institutional buyers as defined in, and pursuant to, Rule 144A under the Securities Act. The 2021 Notes bear interest at a fixed rate of 2.00%  per year, payable semiannually in arrears on June 1 and December 1 of each year. The 2021 Notes are convertible into cash, shares of our Class C capital stock or a combination thereof, at the Company’s election. The 2021 Notes will mature on December 1, 2021, unless earlier repurchased, redeemed, or converted in accordance with their terms.

15


The net proceeds from the issuance of the 2021 Notes were approximately $447.8 million , after deducting fees and expenses. The Company used approximately $370.2 million of the net proceeds from the issuance of the 2021 Notes to repurchase a portion of the outstanding 2020 Notes (see additional information below under “Trulia’s Convertible Senior Notes due 2020”) in privately negotiated transactions. In addition, the Company used approximately $36.6 million of the net proceeds from the issuance of the 2021 Notes to pay the cost of the capped call transactions with the initial purchaser of the 2021 Notes and two additional financial institutions (“Capped Call Confirmations”) as discussed further below. The Company used the remainder of the net proceeds for general corporate purposes.
Prior to the close of business on the business day immediately preceding September 1, 2021, the 2021 Notes are convertible at the option of the holders of the 2021 Notes only under certain conditions, none of which conditions have been satisfied as of September 30, 2018 . On or after September 1, 2021, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders of the 2021 Notes may convert their 2021 Notes at their option at the conversion rate then in effect, irrespective of these conditions. The Company will settle conversions of the 2021 Notes by paying or delivering, as the case may be, cash, shares of Class C capital stock, or a combination of cash and shares of Class C capital stock, at its election. The conversion rate will initially be 19.0985 shares of Class C capital stock per $1,000 principal amount of 2021 Notes (equivalent to an initial conversion price of approximately $52.36 per share of Class C capital stock). The conversion rate is subject to customary adjustments upon the occurrence of certain events. The Company may redeem for cash all or part of the 2021 Notes, at its option, on or after December 6, 2019, under certain circumstances at a redemption price equal to 100% of the principal amount of the 2021 Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date (as defined in the indenture governing the 2021 Notes). The conversion option does not meet the criteria for separate accounting as a derivative as it is indexed to our own stock.
If the Company undergoes a fundamental change (as defined in the indenture governing the 2021 Notes), holders of the 2021 Notes may require the Company to repurchase for cash all or part of their 2021 Notes at a repurchase price equal to 100% of the principal amount of the 2021 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date (as defined in the indenture governing the 2021 Notes). In addition, if certain fundamental changes occur, the Company may be required in certain circumstances to increase the conversion rate for any 2021 Notes converted in connection with such fundamental changes by a specified number of shares of its Class C capital stock. Certain events are also considered “Events of Default,” which may result in the acceleration of the maturity of the 2021 Notes, as described in the indenture governing the notes. There are no financial covenants associated with the 2021 Notes.
We may not redeem the 2021 Notes prior to December 6, 2019. We may redeem the 2021 Notes for cash, at our option, in whole or in part on or after December 6, 2019, if the last reported sale price per share of our Class C capital stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period.
Interest expense related to the 2021 Notes for the three months ended September 30, 2018 was $7.2 million , which is comprised of approximately $4.9 million related to the amortization of debt discount and debt issuance costs and $2.3 million for the contractual coupon interest. Interest expense related to the 2021 Notes for the nine months ended September 30, 2018 was $21.3 million , which is comprised of approximately $14.4 million related to the amortization of debt discount and debt issuance costs and $6.9 million for the contractual coupon interest. The effective interest rate on the liability component of the 2021 Notes for the three and nine months ended September 30, 2018 is 7.44% . Accrued interest related to the 2021 Notes as of September 30, 2018 and December 31, 2017 was $3.1 million and $0.8 million , respectively, and is recorded in accrued expenses and other current liabilities in the condensed consolidated balance sheet.
The following table presents the outstanding principal amount and carrying value of the 2021 Notes as of the dates presented (in thousands):
 
Outstanding
Principal
Amount
 
Unamortized
Debt Discount
and Debt
Issuance Costs
 
Carrying
Value
September 30, 2018
$
460,000

 
$
(70,332
)
 
$
389,668

December 31, 2017
$
460,000

 
$
(84,721
)
 
$
375,279


As of September 30, 2018 , the unamortized debt discount and debt issuance costs for the 2021 Notes will be amortized to interest expense over a remaining period of approximately 38 months.

16


The estimated fair value of the 2021 Notes was $498.5 million and $509.0 million , respectively, as of September 30, 2018 and December 31, 2017 . The estimated fair value of the 2021 Notes was determined through consideration of quoted market prices. The fair value is classified as Level 3 due to the limited trading activity for the 2021 Notes.
The Capped Call Confirmations are expected generally to reduce the potential dilution of our Class C capital stock upon any conversion of 2021 Notes and/or offset the cash payments the Company is required to make in excess of the principal amount of the 2021 Notes in the event that the market price of the Class C capital stock is greater than the strike price of the Capped Call Confirmations (which initially corresponds to the initial conversion price of the 2021 Notes and is subject to certain adjustments under the terms of the Capped Call Confirmations), with such reduction and/or offset subject to a cap based on the cap price of the Capped Call Confirmations. The Capped Call Confirmations have an initial cap price of $69.19 per share, which represents a premium of approximately 85% over the closing price of the Company’s Class C capital stock on The Nasdaq Global Select Market on December 6, 2016, and is subject to certain adjustments under the terms of the Capped Call Confirmations. The Capped Call Confirmations will cover, subject to anti-dilution adjustments substantially similar to those applicable to the 2021 Notes, the number of shares of Class C capital stock that will underlie the 2021 Notes. In addition, the Capped Call Confirmations provide for the Company to elect, subject to certain conditions, for the Capped Call Confirmations to remain outstanding (with certain modifications) following its election to redeem the 2021 Notes, notwithstanding any conversions of 2021 Notes in connection with such redemption. The Capped Call Confirmations do not meet the criteria for separate accounting as a derivative as they are indexed to our own stock. The premiums paid for the Capped Call Confirmations have been included as a net reduction to additional paid-in capital within shareholders’ equity.
Trulia’s Convertible Senior Notes due in 2020
In connection with the February 2015 acquisition of Trulia, a portion of the total purchase price was allocated to Trulia’s Convertible Senior Notes due in 2020 (the “2020 Notes”), which are unsecured senior obligations. Pursuant to and in accordance with the Merger Agreement, Zillow Group entered into a supplemental indenture in respect of the 2020 Notes in the aggregate principal amount of $230.0 million , which supplemental indenture provides, among other things, that, at the effective time of the Trulia Merger, (i) each outstanding 2020 Note is no longer convertible into shares of Trulia common stock and is convertible solely into shares of Zillow Group Class A common stock, pursuant to, and in accordance with, the terms of the indenture governing the 2020 Notes, and (ii) Zillow Group guaranteed all of the obligations of Trulia under the 2020 Notes and related indenture. In December 2016, the Company used approximately $370.2 million of the net proceeds from the issuance of the 2021 Notes discussed above to repurchase $219.9 million aggregate principal of the 2020 Notes in privately negotiated transactions. The aggregate principal amount of the 2020 Notes is due on December 15, 2020 if not earlier converted or redeemed. Interest is payable on the 2020 Notes at the rate of 2.75% semi-annually on June 15 and December 15 of each year.
Holders of the 2020 Notes may convert all or any portion of their notes, in multiples of $1,000 principal amount, at their option at any time prior to the close of business on the business day immediately preceding the maturity date. Regarding the supplemental indenture in respect of the 2020 Notes, the conversion ratio immediately prior to the effective time of the Trulia Merger of 27.8303 shares of Trulia common stock per $1,000 principal amount of notes was adjusted to 12.3567 shares of our Class A common stock per $1,000 principal amount of notes based on the exchange ratio of 0.444  per the Merger Agreement. This was equivalent to an initial conversion price of approximately $80.93 per share of our Class A common stock. Regarding the August 2015 distribution of shares of our Class C capital stock as a dividend to our Class A and Class B common shareholders, the conversion ratio has been further adjusted to 41.4550 shares of Class A common stock per $1,000 principal amount of notes, which is equivalent to a conversion price of approximately $24.12 per share of our Class A common stock. The conversion ratio will be adjusted for certain dilutive events and will be increased in the case of corporate events that constitute a “Make-Whole Fundamental Change” (as defined in the indenture governing the notes). The conversion option of the 2020 Notes has no cash settlement provisions. The conversion option does not meet the criteria for separate accounting as a derivative as it is indexed to our own stock.
The holders of the 2020 Notes will have the ability to require us to repurchase the notes in whole or in part upon the occurrence of an event that constitutes a “Fundamental Change” (as defined in the indenture governing the notes, including such events as a “change in control” or “termination of trading”, subject to certain exceptions). In such case, the repurchase price would be 100% of the principal amount of the 2020 Notes plus accrued and unpaid interest, if any, to, but excluding, the Fundamental Change repurchase date. Certain events are also considered “Events of Default,” which may result in the acceleration of the maturity of the 2020 Notes, as described in the indenture governing the notes. There are no financial covenants associated with the 2020 Notes.
The 2020 Notes are redeemable, at our option, in whole or in part on or after December 20, 2018, if the last reported sale price per share of our Class A common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period.

17


The carrying value of the 2020 Notes was $9.6 million and $10.1 million , respectively, as of September 30, 2018 and December 31, 2017 . The estimated fair value of the 2020 Notes was $16.7 million and $17.6 million , respectively, as of September 30, 2018 and December 31, 2017 . The estimated fair value of the 2020 Notes was determined through consideration of quoted market prices. The fair value is classified as Level 3 due to the limited trading activity for the 2020 Notes.
Note 13 . Income Taxes
We are subject to federal and state income taxes in the United States and in Canada. As of September 30, 2018 and December 31, 2017 , we have provided a valuation allowance against our net deferred tax assets that we believe, based on the weight of available evidence, are not more likely than not to be realized. Therefore, no material current tax liability or expense has been recorded in the condensed consolidated financial statements. We have accumulated federal tax losses of approximately $1,014.0 million as of December 31, 2017 , which are available to reduce future taxable income. We have accumulated state tax losses of approximately $21.4 million (tax effected) as of December 31, 2017 .
We recorded an income tax benefit of $14.7 million for the three months ended September 30, 2018 , which was calculated as the difference between the income tax benefit of $22.7 million recorded for the nine months ended September 30, 2018 and the income tax benefit of $8.0 million recorded for the six months ended June 30, 2018. The $22.7 million tax benefit recorded for the nine months ended September 30, 2018 is comprised of a $1.9 million income tax benefit, which was calculated using an estimate of our annual effective tax rate of 4.3% applied to our loss before income taxes of $44.9 million for the nine months ended September 30, 2018 and a $20.8 million discrete income tax benefit as a result of the treatment of stock compensation windfall deductions and the impact from the Tax Act related to IRC Section 162(m). Our estimated annual effective tax rate for the nine months ended September 30, 2018 is primarily impacted by the release in valuation allowance resulting from indefinite-lived deferred tax assets and their ability to offset indefinite-lived intangible deferred tax liabilities.
As of September 30, 2018 , we have completed our accounting for the income tax effects related to the deduction limitations on compensation under the Tax Act and have recorded a discrete tax benefit adjustment of $3.3 million during the three months ended September 30, 2018. The Internal Revenue Service has provided further guidance in applying the written binding contracts requirement under the Tax Act and certain of our executive compensation previously eligible to be deducted for tax purposes under Section 162(m) of the Internal Revenue Code will be considered grandfathered and, therefore, will continue to be deductible. Based on the clarification of these rules, the accounting related to the Section 162(m) limitation of the Internal Revenue Code is considered complete and we have recorded a $5.9 million discrete tax benefit adjustment related to this item for the nine months ended September 30, 2018 .
Note 14 . Shareholders’ Equity
Preferred Stock
Our board of directors has the authority to fix and determine and to amend the number of shares of any series of preferred stock that is wholly unissued or to be established and to fix and determine and to amend the designation, preferences, voting powers and limitations, and the relative, participating, optional or other rights, of any series of shares of preferred stock that is wholly unissued or to be established, subject in each case to certain approval rights of holders of our outstanding Class B common stock. There was no preferred stock issued and outstanding as of September 30, 2018 or December 31, 2017 .
Common and Capital Stock
Our Class A common stock has no preferences or privileges and is not redeemable. Holders of Class A common stock are entitled to one vote for each share.
Our Class B common stock has no preferences or privileges and is not redeemable. At any time after the date of issuance, each share of Class B common stock, at the option of the holder, may be converted into one share of Class A common stock, or automatically converted into Class A common stock upon the affirmative vote by or written consent of holders of a majority of the shares of the Class B common stock. During the nine months ended September 30, 2018 and the year ended December 31, 2017 , no shares of Class B common stock were converted into Class A common stock at the option of the holders. Holders of Class B common stock are entitled to 10  votes for each share.
Our Class C capital stock has no preferences or privileges, is not redeemable and, except in limited circumstances, is non -voting. On July 3, 2018, Zillow Group issued and sold  6,557,017  shares (of which  855,263  shares were related to the exercise of the underwriters’ option to purchase additional shares) of our Class C capital stock at a public offering price of  $57.00  per share. We received net proceeds of $360.3 million after deducting underwriting discounts and commissions and offering expenses payable by us.
Note 15 . Share-Based Awards
In connection with our February 2015 acquisition of Trulia, we assumed the obligations of Zillow and Trulia outstanding under pre-existing stock plans. We intend that future equity grants will be made under Zillow Group’s 2011 Amended and Restated Incentive Plan (as amended and/or restated from time to time, the “2011 Plan”) only (or a successor thereto).
Zillow Group, Inc. Amended and Restated 2011 Incentive Plan
On July 19, 2011, the 2011 Plan became effective. In addition to the share reserve of 18,400,000 shares, the number of shares available for issuance under the 2011 Plan automatically increases on the first day of each of our fiscal years by a number of shares equal to the least of (a)  3.5% of our outstanding Class A common stock, Class B common stock, and Class C capital stock on a fully diluted basis as of the end of our immediately preceding fiscal year, (b)  10,500,000 shares, and (c) a lesser amount determined by our board of directors; provided, however, that any shares from any increases in previous years that are not actually issued will continue to be available for issuance under the 2011 Plan. In addition, shares previously available for grant under Zillow, Inc.’s 2005 Equity Incentive Plan (the “2005 Plan”), but not issued or subject to outstanding awards under the 2005 Plan as of July 19, 2011, and shares subject to outstanding awards under the 2005 Plan that subsequently cease to be subject to such awards (other than by reason of exercise of the awards) are available for grant under the 2011 Plan. The 2011 Plan is administered by the compensation committee of the board of directors. Under the terms of the 2011 Plan, the compensation committee may grant equity awards, including incentive stock options, nonqualified stock options, restricted stock, restricted stock units or restricted units to employees, officers, directors, consultants, agents, advisers and independent contractors. The board of directors has also authorized certain senior executive officers to grant equity awards under the 2011 Plan, within limits prescribed by our board of directors. The 2011 Plan provides that in the event of a stock dividend, stock split or similar event, the maximum number and kind of securities available for issuance under the plan will be proportionally adjusted.
Options under the 2011 Plan are granted with an exercise price per share not less than 100% of the fair market value of our stock on the date of grant, with the exception of substituted option awards granted in connection with acquisitions, and are exercisable at such times and under such conditions as determined by the compensation committee. Any portion of an option that is not vested and exercisable on the date of a participant’s termination of service expires on such date. Employees generally forfeit their rights to exercise vested options 3 months following their termination of employment or 12 months following termination by reason of death, disability or retirement. Options granted under the 2011 Plan typically expire seven or ten years from the grant date and typically vest either 25% after 12 months and ratably thereafter over the next 36 months or quarterly over a period of four years , though certain options have been granted with alternative vesting schedules.
Restricted stock units granted under the 2011 Plan typically vest either 25% after 12 months and quarterly thereafter over the next three years , quarterly over a period of four years , or 12.5% after 6 months and quarterly thereafter for the next 3.5 years . Any portion of a restricted stock unit that is not vested on the date of a participant’s termination of service expires on such date.
Option Awards
The following table summarizes option award activity for the nine months ended September 30, 2018 :
 
Number
of Shares
Subject to
Existing
Options
 
Weighted-
Average
Exercise
Price Per
Share
 
Weighted-
Average
Remaining
Contractual
Life (Years)
 
Aggregate
Intrinsic
Value
(in thousands)
Outstanding at January 1, 2018
26,645,206

 
$
27.70

 
5.72
 
$
355,739

Granted
5,429,505

 
53.63

 
 
 
 
Exercised
(5,177,060
)
 
22.14

 
 
 
 
Forfeited or cancelled
(610,688
)
 
34.55

 
 
 
 
Outstanding at September 30, 2018
26,286,963

 
33.99

 
6.24
 
321,371

Vested and exercisable at September 30, 2018
14,128,452

 
29.07

 
4.76
 
220,974



18


The fair value of options granted is estimated at the date of grant using the Black-Scholes-Merton option-pricing model, assuming no dividends and with the following assumptions for the periods presented:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Expected volatility
42%
 
46%
 
42%-45%
 
46%-49%
Expected dividend yield
 
 
 
Risk-free interest rate
2.84%
 
1.70%
 
2.52%-2.84%
 
1.67%-1.84%
Weighted-average expected life
4.50 years
 
4.25 years
 
4.50-5.00 years
 
4.25-4.75 years
Weighted-average fair value of options granted
$19.21

$15.79
 
$20.89

$14.40


As of September 30, 2018 , there was a total of $179.9 million in unrecognized compensation cost related to unvested stock options.
Restricted Stock Units
The following table summarizes activity for restricted stock units for the nine months ended September 30, 2018 :
 
Restricted
Stock Units
 
Weighted-
Average Grant-
Date Fair
Value
Unvested outstanding at January 1, 2018
4,016,405

 
$
33.22

Granted
2,898,786

 
52.75

Vested
(1,288,746
)
 
35.07

Forfeited or cancelled
(524,952
)
 
38.50

Unvested outstanding at September 30, 2018
5,101,493

 
43.33


The fair value of outstanding restricted stock units will be recorded as share-based compensation expense over the vesting period. As of September 30, 2018 , there was $205.9 million of total unrecognized compensation cost related to unvested restricted stock units.
Share-Based Compensation Expense
The following table presents the effects of share-based compensation in our condensed consolidated statements of operations during the periods presented (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Cost of revenue
$
969

 
$
1,014

 
$
3,180

 
$
2,942

Sales and marketing
5,911

 
5,914

 
17,413

 
17,694

Technology and development
15,031

 
10,438

 
40,920

 
29,329

General and administrative
19,771

 
11,208

 
49,853

 
34,197

Total
$
41,682

 
$
28,574

 
$
111,366

 
$
84,162


Note 16 . Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of shares (including Class A common stock, Class B common stock and Class C capital stock) outstanding during the period. In the calculation of basic net income (loss) per share, undistributed earnings are allocated assuming all earnings during the period were distributed.

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Diluted net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of shares (including Class A common stock, Class B common stock and Class C capital stock) outstanding during the period and potentially dilutive Class A common stock and Class C capital stock equivalents, except in cases where the effect of the Class A common stock or Class C capital stock equivalent would be antidilutive. Potential Class A common stock and Class C capital stock equivalents consist of Class A common stock and Class C capital stock issuable upon exercise of stock options and Class A common stock and Class C capital stock underlying unvested restricted stock units using the treasury stock method. Potential Class A common stock equivalents also include Class A common stock issuable upon conversion of the 2020 Notes using the if-converted method.
Since the Company expects to settle the principal amount of the outstanding 2021 Notes and 2023 Notes in cash, the Company uses the treasury stock method for calculating any potential dilutive effect of the conversion spread on diluted net income per share, if applicable. For the 2021 Notes, the conversion spread of approximately 8.8 million shares has a dilutive impact on diluted net income per share when the market price of the Company’s Class C capital stock at the end of a period exceeds the conversion price of $52.36 per share. For the 2023 Notes, the conversion spread of approximately 4.8 million shares has a dilutive impact on diluted net income per share when the market price of the Company’s Class C capital stock at the end of a period exceeds the conversion price of $78.37 per share.
For the periods presented, the following table reconciles the denominators used in the basic and diluted net income (loss) per share calculations (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Denominator for basic calculation
202,416

 
187,692

 
195,208

 
185,447

Effect of dilutive securities:
 
 
 
 
 
 
 
Option awards

 
7,401

 

 

Unvested restricted stock units

 
1,332

 

 

Denominator for dilutive calculation
202,416

 
196,425

 
195,208

 
185,447


For the periods presented, the following Class A common stock and Class C capital stock equivalents were excluded from the calculations of diluted net income (loss) per share because their effect would have been antidilutive (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Weighted-average Class A common stock and Class C capital stock option awards outstanding
21,766

 
6,542

 
23,508

 
28,671

Weighted-average Class A common stock and Class C capital stock restricted stock units outstanding
5,072

 
199

 
4,891

 
4,311

Class A common stock issuable upon conversion of the 2020 Notes
410

 
438

 
410

 
438

Total Class A common stock and Class C capital stock equivalents
27,248

 
7,179

 
28,809

 
33,420


In the event of liquidation, dissolution, distribution of assets or winding-up of the Company, the holders of all classes of common and capital stock have equal rights to receive all the assets of the Company after the rights of the holders of preferred stock have been satisfied. We have not presented net income (loss) per share under the two-class method for our Class A common stock, Class B common stock and Class C capital stock because it would be the same for each class due to equal dividend and liquidation rights for each class.

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Note 17 . Commitments and Contingencies
Lease Commitments
We have entered into various non-cancelable operating lease agreements for certain of our office space and equipment with original lease periods expiring between  2018  and 2024. We are committed to pay a portion of the related operating expenses under certain of these lease agreements. Certain of these arrangements have free rent periods or escalating rent payment provisions, and we recognize rent expense under such arrangements on a straight-line basis. Operating lease expense for the three months ended September 30, 2018 and 2017 was $5.8 million and $5.7 million , respectively. Operating lease expense for the nine months ended September 30, 2018 and 2017 was $17.2 million and $15.8 million , respectively.
Purchase Commitments
Purchase commitments primarily include various non-cancelable agreements to purchase content related to our mobile applications and websites as well as homes that the Company is under contract to purchase through Zillow Offers but that have not closed as of the respective date. As of September 30, 2018, the value of homes under contract that not have closed was $ 30.3 million .
Surety Bonds
In the course of business, we are required to provide financial commitments in the form of surety bonds to third parties as a guarantee of our performance on and our compliance with certain obligations. If we were to fail to perform or comply with these obligations, any draws upon surety bonds issued on our behalf would then trigger our payment obligation to the surety bond issuer. We have outstanding surety bonds issued for our benefit of approximately $3.5 million and $3.7 million , respectively, as of September 30, 2018 and December 31, 2017 .
Legal Proceedings
We are involved in a number of legal proceedings concerning matters arising in connection with the conduct of our business activities, some of which are at preliminary stages and some of which seek an indeterminate amount of damages. We regularly evaluate the status of legal proceedings in which we are involved to assess whether a loss is probable or there is a reasonable possibility that a loss or additional loss may have been incurred to determine if accruals are appropriate. We further evaluate each legal proceeding to assess whether an estimate of possible loss or range of loss can be made if accruals are not appropriate. For certain cases described below, management is unable to provide a meaningful estimate of the possible loss or range of possible loss because, among other reasons, (i) the proceedings are in preliminary stages; (ii) specific damages have not been sought; (iii) damages sought are, in our view, unsupported and/or exaggerated; (iv) there is uncertainty as to the outcome of pending appeals or motions; (v) there are significant factual issues to be resolved; and/or (vi) there are novel legal issues or unsettled legal theories presented. For these cases, however, management does not believe, based on currently available information, that the outcomes of these proceedings will have a material effect on our financial position, results of operations or cash flow.
In July 2015, VHT, Inc. (“VHT”) filed a complaint against us in the U.S. District Court for the Western District of Washington alleging copyright infringement of VHT’s images on the Zillow Digs site. In January 2016, VHT filed an amended complaint alleging copyright infringement of VHT’s images on the Zillow Digs site as well as the Zillow listing site. In December 2016, the court granted a motion for partial summary judgment that dismissed VHT’s claims with respect to the Zillow listing site. A federal jury trial began on January 23, 2017, and on February 9, 2017, the jury returned a verdict finding that the Company had infringed VHT’s copyrights in images displayed or saved to the Digs site. The jury awarded VHT $79,875 in actual damages and approximately $8.2 million in statutory damages. In March 2017, the Company filed motions in the district court seeking judgment for the Company on certain claims that are the subject of the verdict, and for a new trial on others. On June 20, 2017, the judge ruled and granted in part our motions, finding that VHT failed to present sufficient evidence to prove direct copyright infringement for a portion of the images, reducing the total damages to approximately $4.1 million . On October 26, 2017, the Company filed an appeal with the Ninth Circuit Court of Appeals seeking review of the final judgment and certain prior rulings entered by the district court. The oral hearing for the appeal took place on August 28, 2018. We have recorded an estimated liability for approximately $4.1 million as of September 30, 2018 and December 31, 2017 . We do no t believe there is a reasonable possibility that a material loss in excess of amounts accrued may be incurred.

21


In August and September 2017, two purported class action lawsuits were filed against us and certain of our executive officers, alleging, among other things, violations of federal securities laws on behalf of a class of those who purchased our common stock between February 12, 2016 and August 8, 2017. One of those purported class actions, captioned Vargosko v. Zillow Group, Inc. et al, was brought in the U.S. District Court for the Central District of California. The other purported class action lawsuit, captioned Shotwell v. Zillow Group, Inc. et al, was brought in the U.S. District Court for the Western District of Washington. The complaints allege, among other things, that during the period between February 12, 2016 and August 8, 2017, we issued materially false and misleading statements regarding our business practices. The complaints seek to recover, among other things, alleged damages sustained by the purported class members as a result of the alleged misconduct. In November 2017, an amended complaint was filed against us and certain of our executive officers in the Shotwell v. Zillow Group class action lawsuit, extending the beginning of the class period to November 17, 2014. In January 2018, the Vargosko v. Zillow Group purported class action lawsuit was transferred to the U.S. District Court for the Western District of Washington and consolidated with the Shotwell v. Zillow Group purported class action lawsuit. In February 2018, the plaintiffs filed a consolidated amended complaint, and in April 2018, we filed our motion to dismiss the consolidated amended complaint. In May 2018, the plaintiffs filed their opposition to our motion to dismiss the consolidated amended complaint. In June 2018, we filed our reply in support of our motion to dismiss the consolidated amended complaint. In October 2018, our motion to dismiss was granted, though the plaintiffs have 45 days to attempt to cure the defects in their consolidated amended complaint. We have denied the allegations of wrongdoing and intend to vigorously defend the claims in this lawsuit. We have not recorded an accrual related to this lawsuit as of September 30, 2018 and December 31, 2017 , as we do not believe a loss is probable.
In October and November 2017 and January and February 2018, four shareholder derivative lawsuits were filed in the U.S. District Court for the Western District of Washington and the Superior Court of the State of Washington, against certain of our executive officers and directors seeking unspecified damages on behalf of the Company and certain other relief, such as reform to corporate governance practices. The plaintiffs in the derivative suits (in which the Company is a nominal defendant) allege, among other things, the defendants breached their fiduciary duties in connection with oversight of public statements and legal compliance, and as a result of the breach of such fiduciary duties, the Company was damaged, and defendants were unjustly enriched. Certain of the plaintiffs also allege, among other things, violations of Section 14(a) of the Securities Exchange Act of 1934 and waste of corporate assets. All four of the shareholder derivative lawsuits have been stayed until after final resolution of pleading motions and related appeals, if any, in the consolidated securities class action lawsuit discussed above. The defendants intend to deny the allegations of wrongdoing and vigorously defend the claims in these lawsuits. We have not recorded an accrual related to these lawsuits as of September 30, 2018 and December 31, 2017 , as we do not believe a loss is probable.
In addition to the matters discussed above, from time to time, we are involved in litigation and claims that arise in the ordinary course of business. Although we cannot be certain of the outcome of any such litigation or claims, nor the amount of damages and exposure that we could incur, we currently believe that the final disposition of such matters will not have a material effect on our business, financial position, results of operations or cash flow. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.
Indemnifications
In the ordinary course of business, we enter into contractual arrangements under which we agree to provide indemnification of varying scope and terms to business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the breach of such agreements and out of intellectual property infringement claims made by third parties. In addition, we have agreements that indemnify certain issuers of surety bonds against losses that they may incur as a result of executing surety bonds on our behalf. For our indemnification arrangements, payment may be conditional on the other party making a claim pursuant to the procedures specified in the particular contract. Further, our obligations under these agreements may be limited in terms of time and/or amount, and in some instances, we may have recourse against third parties for certain payments. In addition, we have indemnification agreements with certain of our directors and executive officers that require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. The terms of such obligations may vary.

22


Note 18 . Self-Insurance
We are self-insured for medical benefits, and beginning on January 1, 2018 for dental benefits, for all qualifying Zillow Group employees. The medical plan carries a stop-loss policy which will protect when cumulative medical claims exceed 125% of expected claims for the plan year with a limit of $1.0 million and from individual claims during the plan year exceeding $150,000 . We record estimates of the total costs of claims incurred based on an analysis of historical data and independent estimates. Our liability for self-insured claims is included within accrued compensation and benefits in our condensed consolidated balance sheets and was $3.0 million and $ 2.0 million , respectively, as of September 30, 2018 and December 31, 2017 .
Note 19 . Employee Benefit Plan
We have a defined contribution 401(k) retirement plan covering Zillow Group employees who have met certain eligibility requirements (the “Zillow Group 401(k) Plan”). Eligible employees may contribute pretax compensation up to a maximum amount allowable under the Internal Revenue Service limitations. Employee contributions and earnings thereon vest immediately. We currently match up to 4% of employee contributions under the Zillow Group 401(k) Plan. The total expense related to the Zillow Group 401(k) Plan for the three months ended September 30, 2018 and 2017 was $4.1 million and $3.0 million , respectively. The total expense related to the Zillow Group 401(k) Plan for the nine months ended September 30, 2018 and 2017 was $11.9 million and $8.9 million , respectively.
Note 20 . Segment Information and Revenue
Beginning in the second quarter of 2018, we have two operating and reportable segments, which have been identified based on the way in which our chief operating decision-maker manages our business, makes operating decisions and evaluates operating performance. The chief executive officer acts as the chief operating decision-maker and reviews financial and operational information of the Internet, Media & Technology (“IMT”) and Homes segments.
The IMT segment includes the financial results for the Premier Agent, Rentals, Mortgages and new construction marketplaces, dotloop, and display, as well as revenue from the sale of various other marketing and business products and services to real estate professionals. The Homes segment includes the financial results from Zillow Group’s buying and selling of homes directly.
Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain costs incurred by one segment may benefit the other segment. These costs are generally headcount-related and are allocated to each segment based on the estimated effort attributable to each segment.
The chief executive officer reviews information about our revenue categories as well as statement of operations data inclusive of loss before income taxes by segment. This information is included in the following table for the periods presented (in thousands):

23


 
Three Months Ended
September 30, 2018
 
Nine Months Ended
September 30, 2018
 
IMT
 
Homes
 
Consolidated
 
IMT
 
Homes
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Premier Agent
$
232,703

 
$

 
$
232,703

 
$
677,320

 
$

 
$
677,320

Rentals
37,319

 

 
37,319

 
99,670

 

 
99,670

Mortgages
18,438

 

 
18,438

 
56,766

 

 
56,766

Other
43,616

 

 
43,616

 
123,445

 

 
123,445

Homes

 
11,018

 
11,018

 

 
11,018

 
11,018

Total revenue
332,076

 
11,018

 
343,094

 
957,201

 
11,018

 
968,219

Costs and expenses:
 
 
 
 
 
 
 
 
 
 
 
Cost of revenue
26,386

 
10,286

 
36,672

 
75,832

 
10,286

 
86,118

Sales and marketing
123,755

 
4,979

 
128,734

 
405,525

 
8,227

 
413,752

Technology and development
99,570

 
5,744

 
105,314

 
286,983

 
12,640

 
299,623

General and administrative
65,156

 
5,587

 
70,743

 
172,756

 
14,639

 
187,395

Impairment costs
10,000

 

 
10,000

 
10,000

 

 
10,000

Acquisition-related costs
1,405

 

 
1,405

 
2,064

 

 
2,064

Integration costs
523

 

 
523

 
523

 

 
523

Total costs and expenses
326,795

 
26,596

 
353,391

 
953,683

 
45,792

 
999,475

Income (loss) from operations
5,281

 
(15,578
)
 
(10,297
)
 
3,518

 
(34,774
)
 
(31,256
)
Other income
7,773

 

 
7,773

 
13,308

 

 
13,308

Interest expense
(12,236
)
 
(432
)
 
(12,668
)
 
(26,496
)
 
(432
)
 
(26,928
)
Income (loss) before income taxes
$
818

 
$
(16,010
)
 
$
(15,192
)
 
$
(9,670
)
 
$
(35,206
)
 
$
(44,876
)
We have not presented the comparable 2017 periods in the table above because we had one operating and reportable segment prior to 2018.
Note 21 . Subsequent Events
Acquisition of Mortgage Lenders of America
On October 31, 2018, Zillow Group’s wholly owned subsidiary, ZGM Holdco, Inc., acquired Mortgage Lenders of America, L.L.C. (“MLOA”), a national mortgage lender headquartered in Overland Park, Kansas for approximately $65.0 million in cash, subject to certain adjustments. The purchase price will be allocated to the assets acquired and liabilities assumed, including identifiable intangible assets, based on their respective fair values at the acquisition date. We are currently performing the procedures necessary to determine the purchase price allocation and will record estimated fair values during the fourth quarter of 2018.

24


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results may differ materially from those described in or implied by any forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, including in the section titled “Note Regarding Forward-Looking Statements,” and also those factors discussed in Part II, Item 1A (Risk Factors) of this report.
Overview of our Business
Zillow Group, Inc. operates the largest portfolio of real estate and home-related brands on mobile and the web which focus on all stages of the home lifecycle: renting, buying, selling and financing. Zillow Group is committed to empowering consumers with unparalleled data, inspiration and knowledge around homes, and connecting them with great real estate professionals. The Zillow Group portfolio of consumer brands includes real estate and rental marketplaces Zillow, Trulia, StreetEasy, HotPads, Naked Apartments, RealEstate.com and Out East. In addition, Zillow Group provides a comprehensive suite of marketing software and technology solutions to help real estate professionals maximize business opportunities and connect with millions of consumers. Beginning in April of 2018, Zillow Offers provides homeowners in certain metropolitan areas with the opportunity to receive offers to purchase their home from Zillow. When Zillow buys a home, it makes certain repairs and updates and lists the home for resale on the open market. We also own and operate a number of business brands for real estate, rental and mortgage professionals, including Mortech, dotloop, Bridge Interactive and New Home Feed.
Our living database of approximately 110 million U.S. homes, including homes for sale, homes for rent and homes not currently on the market, attracts an active and vibrant community of users. Individuals and businesses that use Zillow’s mobile applications and websites have updated information on more than 80 million homes, creating exclusive home profiles not available anywhere else. These profiles include detailed information about homes, including property facts, listing information and purchase and sale data. We provide this information to our users where, when and how they want it, through our industry-leading mobile applications and websites. Using complex, proprietary automated valuation models, we provide current home value estimates, or Zestimates, and current rental price estimates, or Rent Zestimates, on approximately 100 million U.S. homes.
As of the second quarter of 2018, Zillow Group has two reportable segments: the Internet, Media & Technology (“IMT”) segment, our historical operating and reportable segment, and the Homes segment. In connection with our IMT segment, we generate revenue from the sale of advertising services and our suite of marketing software and technology solutions to businesses and professionals primarily associated with the residential real estate, rental and mortgage industries. These professionals include real estate, rental and mortgage professionals and brand advertisers. Our four primary revenue categories within our IMT segment are Premier Agent, Rentals, Mortgages and Other.
Premier Agent revenue is generated by the sale of advertising under our Premier Agent and Premier Broker programs, which offer a suite of marketing and business technology products and services to help real estate agents and brokers achieve their advertising goals, while growing and managing their businesses and brands. We offer our Premier Agent and Premier Broker advertising products on a cost per impression basis. Impressions are delivered when a sold advertisement appears on pages viewed by users of our mobile applications and websites. Rentals revenue primarily includes advertising sold to property managers and other rental professionals on a cost per lead, cost per click or cost per lease generated basis. Mortgages revenue primarily includes advertising sold to mortgage lenders and other mortgage professionals on a cost per lead basis, including our Connect (formerly known as Long Form) and Custom Quote services, as well as revenue generated by Mortech, which provides subscription-based mortgage software solutions, including a product and pricing engine and lead management platform. Other revenue primarily includes revenue generated by new construction and display, as well as revenue from the sale of various other advertising and business software solutions and services and technology solutions for real estate professionals, including dotloop. New construction revenue primarily includes advertising services sold to home builders on a cost per residential community basis. Display revenue primarily consists of graphical mobile and web advertising sold to advertisers promoting their brands on our mobile applications and websites.
In our Homes segment, we generate revenue from the resale of homes on the open market through our Zillow Offers program. In April 2018, we announced Zillow Group’s direct purchase and sale of homes through the Zillow Offers program. We began selling homes in July of 2018.

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During the three months ended September 30, 2018 , we generated revenue of $343.1 million , as compared to $281.8 million in the three months ended September 30, 2017 , an increase of 22%. This increase was primarily the result of a $35.6 million, or 18%, increase in Premier Agent revenue, an $11.0 million increase in Homes revenue, an $8.9 million, or 31%, increase in rentals revenue and an $8.1 million, or 23%, increase in other revenue. This increase was partially offset by a decrease in mortgages revenue of $2.4 million, or 12%, as compared with the three months ended September 30, 2017 . There were approximately 186.6 million average monthly unique users of our mobile applications and websites for the three months ended September 30, 2018 , representing year-over-year growth of 7%. Visits increased 13% to 1,888.9 million for the three months ended September 30, 2018 from 1,667.1 million for the three months ended September 30, 2017 . Net loss for the three months ended September 30, 2018 was $0.5 million , as compared to net income for the three months ended September 30, 2017 of $9.2 million .
On October 31, 2018, we completed the acquisition of Mortgage Lenders of America, L.L.C. (“MLOA”), a national mortgage lender. This acquisition is consistent with our strategy of moving further down funnel and closer to the real estate transaction to create better consumer experiences. The total purchase price for the acquisition of MLOA is approximately $65.0 million in cash. Beginning with the Quarterly Report on Form 10-Q for the quarterly period ending March 31, 2019, Zillow Group expects to report financial results for three reportable segments: the IMT segment, the Homes segment and the Mortgages segment. The IMT segment will include the financial results for the Premier Agent, Rentals and new construction marketplaces, as well as dotloop, display and other advertising and business software solutions. The Homes segment will include the financial results from Zillow Group’s buying and selling of homes directly. The Mortgages segment will include the financial results for advertising sold to mortgage lenders and other mortgage professionals, mortgage originations through MLOA and Mortech mortgage software solutions. We expect the Mortgages segment, with the inclusion of MLOA, to have a material impact on our consolidated balance sheets, statements of operations and cash flows in 2019.
On July 3, 2018, we closed underwritten public offerings of (1) 6,557,017 shares of Class C capital stock of Zillow Group, which includes 855,263 shares sold pursuant to the underwriters’ option to purchase additional shares; and (2) $373.8 million aggregate principal amount of Convertible Senior Notes due 2023 (the “2023 Notes”), which includes $48.8 million principal amount of 2023 Notes sold pursuant to the underwriters’ option to purchase additional 2023 Notes. The net proceeds from the offering of Class C capital stock and the issuance of the 2023 Notes were approximately $360.3 million and $364.0 million, respectively, after deducting underwriting discounts and commissions and offering expenses payable by Zillow Group. We used $29.4 million of the net proceeds from the issuance of the 2023 Notes to pay the cost of capped call confirmations. We intend to use the remainder of the net proceeds for general corporate purposes, which may include general and administrative matters and capital expenditures. Additionally, we may choose to use a portion of the net proceeds to expand our current business through acquisitions of, or investments in, other businesses, products or technologies.
As of September 30, 2018 , we had 3,809 full-time employees compared to 3,181 full-time employees as of December 31, 2017 .
Key Metrics
Management has identified unique users and visits as relevant to investors’ and others’ assessment of our financial condition and results of operations.
Unique Users
Measuring unique users is important to us because much of our Premier Agent, Rentals, Mortgages and other advertising revenue depends in part on our ability to enable real estate, rental and mortgage professionals to connect with our users, our display revenue depends in part on the number of impressions delivered to our users, and our Homes revenue depends in part on users accessing our mobile applications and websites to engage in the sale and purchase of homes with Zillow Group on the open market. Growth in consumer traffic to our mobile applications and websites increases the number of impressions, clicks, leads and other events we can monetize to generate revenue. In addition, our community of users improves the quality of our living database of homes with their contributions, which in turn attracts more users.

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Table of Contents

We count a unique user the first time an individual accesses one of our mobile applications using a mobile device during a calendar month and the first time an individual accesses one of our websites using a web browser during a calendar month. If an individual accesses our mobile applications using different mobile devices within a given month, the first instance of access by each such mobile device is counted as a separate unique user. If an individual accesses more than one of our mobile applications within a given month, the first access to each mobile application is counted as a separate unique user. If an individual accesses our websites using different web browsers within a given month, the first access by each such web browser is counted as a separate unique user. If an individual accesses more than one of our websites in a single month, the first access to each website is counted as a separate unique user since unique users are tracked separately for each domain. Zillow, StreetEasy, HotPads, Naked Apartments and RealEstate.com measure unique users with Google Analytics, and Trulia measures unique users with Adobe Analytics (formerly called Omniture analytical tools).  
 
Three Months Ended
September 30,
 
2017 to 2018
% Change
 
2018
 
2017
 
 
(in millions)
 
 
Average Monthly Unique Users
186.6

 
175.2

 
7
%
Visits
The number of visits is an important metric because it is an indicator of consumers’ level of engagement with our mobile applications, websites and other services. We believe highly engaged consumers are more likely to be transaction-ready real estate market participants and therefore more sought-after by our agent and other real estate professional advertisers or more likely to participate in our Zillow Offers program.
We define a visit as a group of interactions by users with the Zillow, Trulia, StreetEasy and RealEstate.com mobile applications and websites, as we monetize our Premier Agent and Premier Broker products on these mobile applications and websites. A single visit can contain multiple page views and actions, and a single user can open multiple visits across domains, web browsers, desktop or mobile devices. Visits can occur on the same day, or over several days, weeks or months.
Zillow, StreetEasy and RealEstate.com measure visits with Google Analytics, and Trulia measures visits with Adobe Analytics. Visits to Trulia end after thirty minutes of user inactivity. Visits to Zillow, StreetEasy and RealEstate.com end either: (i) after thirty minutes of user inactivity or at midnight; or (ii) through a campaign change. A visit ends through a campaign change if a visitor arrives via one campaign or source (for example, via a search engine or referring link on a third-party website), leaves the mobile application or website, and then returns via another campaign or source.
 
Three Months Ended
September 30,
 
2017 to 2018
% Change
 
2018
 
2017
 
 
(in millions)
 
 
Visits
1,888.9

 
1,667.1

 
13
%

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Table of Contents

Basis of Presentation
Revenue
We recognize revenue when (or as) we satisfy our performance obligations by transferring control of promised products or services to our customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those products or services.
In our IMT segment, we generate revenue from the sale of advertising services and our suite of marketing software and technology solutions to businesses and professionals primarily associated with the residential real estate, rental and mortgage industries. These professionals include real estate, rental and mortgage professionals and brand advertisers. Our four primary revenue categories within our IMT segment are Premier Agent, Rentals, Mortgages and Other.
In our Homes segment, we generate revenue from the resale of homes on the open market through our Zillow Offers program.
Premier Agent Revenue. Premier Agent revenue is derived from our Premier Agent and Premier Broker programs. Our Premier Agent and Premier Broker programs offer a suite of marketing and business technology products and services to help real estate agents and brokers achieve their advertising goals, while growing and managing their businesses and brands. All Premier Agents and Premier Brokers receive access to a dashboard portal on our mobile application or website that provides individualized program performance analytics, our customer relationship management, or CRM, tool that captures detailed information about each contact made with a Premier Agent or Premier Broker through our mobile and web platforms and our account management tools. We have concluded that the marketing and business technology products and services promised to Premier Agents and Premier Brokers represent distinct performance obligations.
We offer our Premier Agent and Premier Broker advertising products on a cost per impression basis. Payment is received prior to the delivery of impressions. Impressions are delivered when a sold advertisement appears on pages viewed by users of our mobile applications and websites. We determine the cost per impression delivered in each zip code using an auction-based pricing method in consideration of the total amount spent by Premier Agents and Premier Brokers to purchase impressions in the zip code during the month. A Premier Agent’s or Premier Broker’s share of voice in a zip code is determined by their proportional monthly budgeted spend in that zip code as a percentage of the total monthly budgeted spend of all Premier Agents and Premier Brokers in that zip code. The cost per impression that we charge is dynamic - as demand for impressions in a zip code increases or decreases, the cost per impression in that zip code may be increased or decreased accordingly. The price paid for each impression is representative of the price at which we would sell an impression separately to a customer, or the stand-alone selling price.
We have not allocated the transaction price to each performance obligation as the amounts recognized would be the same irrespective of any allocation. As such, we recognize revenue related to the Premier Agent and Premier Broker products and services based on the contractual spend recognized on a straight-line basis during the contractual period over which the products and services are provided. This methodology best depicts how we satisfy our performance obligations to customers, as we continuously transfer control of the performance obligations to the customer throughout the contractual period.
In April 2018, we began testing a new form of lead validation and distribution related to our auction-based pricing model whereby the share of voice purchased by Premier Agents and Premier Brokers represents both the share of impressions delivered as advertisements appearing on pages viewed by users of our mobile applications and websites, as well as the proportion of validated consumer connections a Premier Agent or Premier Broker receives. When consumers who are interested in connecting with a real estate professional do not select a specific Premier Agent or Premier Broker advertisement on one of Zillow Group’s mobile applications or websites, the validated consumer leads will be distributed to Premier Agents and Premier Brokers in proportion to their share of voice. We believe distributing validated consumer connection leads on the basis of share of voice creates better experiences for consumers and further strengthens our partnerships with real estate professionals. We expect to apply this new form of lead distribution more broadly in the future, with nationwide adoption by the end of 2018.
Rentals Revenue.  Rentals revenue includes our rentals marketplace and suite of tools for rental professionals. Rentals revenue primarily includes revenue generated by advertising sold to property managers and other rental professionals on a cost per lead, cost per click or cost per lease generated basis. We recognize revenue as leads or clicks are provided to rental professionals, which is the amount for which we have the right to invoice. The number of leases generated through our rentals marketplace during the period is accounted for as variable consideration, and we estimate these amounts based on the expected number of qualified leases secured during the period. We do not believe that a significant reversal in the amount of cumulative revenue recognized will occur once the uncertainty related to the number of leases secured is subsequently resolved.

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Mortgages Revenue. Mortgages revenue primarily includes marketing products sold to mortgage professionals on a cost per lead basis, including our Custom Quote and a portion of our Connect services, and on a subscription basis, including a portion of our Connect service. For our Connect and Custom Quote cost per lead mortgage marketing products, participating qualified mortgage professionals typically make a prepayment to gain access to consumers interested in connecting with mortgage professionals. Mortgage professionals who exhaust their initial prepayment prepay additional funds to continue to participate in the marketplace. For our Connect subscription mortgage marketing product, participating qualified mortgage professionals generally prepay a monthly subscription fee, which they then allocate to desired geographic counties. In Zillow Group’s Connect platform, consumers answer a series of questions to find a local lender, and mortgage professionals receive consumer contact information, or leads, when the consumer chooses to share their information with a lender. Consumers who request rates for mortgage loans in Custom Quotes are presented with customized quotes from participating mortgage professionals.
For our cost per lead mortgages products, we recognize revenue when a user contacts a mortgage professional through Zillow Group’s mortgages platform, which is the amount for which we have the right to invoice. For our subscription product, the opportunity to receive a consumer contact is based on the mortgage professional’s relative share of voice in a geographic county. When a consumer submits a contact, Zillow Group contacts a group of subscription mortgage professionals via text message, and the first mortgage professional to respond receives the consumer contact information