Zillow Group, Inc.
ZILLOW GROUP, INC. (Form: 10-Q, Received: 05/08/2018 11:49:32)
 
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 March 31, 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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
 
☐  (Do not check if a smaller reporting company)
 
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 May 1, 2018 , 57,322,533 shares of Class A common stock, 6,217,447 shares of Class B common stock, and 129,809,624 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 March 31, 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.

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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)
 
March 31,
2018
 
December 31,
2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
397,393

 
$
352,095

Short-term investments
425,593

 
410,444

Accounts receivable, net of allowance for doubtful accounts of $4,917 and $5,341 at March 31, 2018 and December 31, 2017, respectively
54,558

 
54,396

Prepaid expenses and other current assets
44,703

 
24,590

Total current assets
922,247

 
841,525

Contract cost assets
42,465

 

Property and equipment, net
114,828

 
112,271

Goodwill
1,931,076

 
1,931,076

Intangible assets, net
307,919

 
319,711

Other assets
25,602

 
25,934

Total assets
$
3,344,137

 
$
3,230,517

Liabilities and shareholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
5,194

 
$
3,587

Accrued expenses and other current liabilities
55,034

 
61,373

Accrued compensation and benefits
22,746

 
19,109

Deferred revenue
35,297

 
31,918

Deferred rent, current portion
2,426

 
2,400

Total current liabilities
120,697

 
118,387

Deferred rent, net of current portion
18,214

 
21,330

Long-term debt
389,624

 
385,416

Deferred tax liabilities and other long-term liabilities
47,161

 
44,561

Total liabilities
575,696

 
569,694

Commitments and contingencies (Note 16)

 

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; 57,288,985 and 56,629,103 shares issued and outstanding as of March 31, 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 March 31, 2018 and December 31, 2017
1

 
1

Class C capital stock, $0.0001 par value; 600,000,000 shares authorized; 129,437,894 and 127,268,598 shares issued and outstanding as of March 31, 2018 and December 31, 2017, respectively
13

 
13

Additional paid-in capital
3,340,387

 
3,254,146

Accumulated other comprehensive loss
(1,454
)
 
(1,100
)
Accumulated deficit
(570,512
)
 
(592,243
)
Total shareholders’ equity
2,768,441

 
2,660,823

Total liabilities and shareholders’ equity
$
3,344,137

 
$
3,230,517

See accompanying notes to condensed consolidated financial statements.

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Table of Contents

ZILLOW GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data, unaudited)
 
 
Three Months Ended
March 31,
 
2018
 
2017
Revenue
$
299,879

 
$
245,775

Costs and expenses:
 
 
 
Cost of revenue (exclusive of amortization) (1)
23,919

 
20,232

Sales and marketing
137,291

 
105,940

Technology and development
93,933

 
72,868

General and administrative
56,073

 
45,466

Acquisition-related costs
27

 
105

Total costs and expenses
311,243

 
244,611

Income (loss) from operations
(11,364
)
 
1,164

Other income
2,446

 
953

Interest expense
(7,073
)
 
(6,723
)
Loss before income taxes
(15,991
)
 
(4,606
)
Income tax expense
(2,600
)
 

Net loss
$
(18,591
)
 
$
(4,606
)
Net loss per share — basic and diluted
$
(0.10
)
 
$
(0.03
)
Weighted-average shares outstanding — basic and diluted
191,464

 
183,158

 ____________________
(1) Amortization of website development costs and intangible assets included in technology and development
$
22,549

 
$
23,261

See accompanying notes to condensed consolidated financial statements.


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Table of Contents

ZILLOW GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands, unaudited)
 
 
Three Months Ended
March 31,
 
2018
 
2017
Net loss
$
(18,591
)
 
$
(4,606
)
Other comprehensive loss:
 
 
 
Unrealized losses on investments
(332
)
 
(25
)
Currency translation adjustments
(22
)
 

Total other comprehensive loss
(354
)
 
(25
)
Comprehensive loss
$
(18,945
)
 
$
(4,631
)
See accompanying notes to condensed consolidated financial statements.

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Table of Contents

ZILLOW GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
 
Three Months Ended
March 31,
 
2018
 
2017
Operating activities
 
 
 
Net loss
$
(18,591
)
 
$
(4,606
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
26,906

 
27,135

Share-based compensation expense
30,741

 
26,395

Amortization of contract cost assets
9,296

 

Amortization of discount and issuance costs on 2021 Notes
4,708

 
4,353

Deferred income taxes
2,600

 

Loss on disposal of property and equipment
1,803

 
999

Bad debt expense
(267
)
 
718

Deferred rent
(3,090
)
 
190

Amortization of bond premium
(137
)
 
223

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
105

 
(2,059
)
Prepaid expenses and other assets
(19,923
)
 
4,737

Contract cost assets
(11,440
)
 

Accounts payable
1,672

 
53

Accrued expenses and other current liabilities
(6,747
)
 
4,683

Accrued compensation and benefits
3,637

 
2,539

Deferred revenue
3,379

 
1,598

Net cash provided by operating activities
24,652

 
66,958

Investing activities
 
 
 
Proceeds from maturities of investments
61,386

 
49,107

Purchases of investments
(76,729
)
 
(84,008
)
Purchases of property and equipment
(15,791
)
 
(14,163
)
Purchases of intangible assets
(1,098
)
 
(5,308
)
Proceeds from divestiture of a business

 
579

Cash paid for acquisition, net

 
(6,002
)
Net cash used in investing activities
(32,232
)
 
(59,795
)
Financing activities
 
 
 
Proceeds from exercise of stock options
52,906

 
11,006

Value of equity awards withheld for tax liability
(28
)
 
(237
)
Net cash provided by financing activities
52,878

 
10,769

Net increase in cash and cash equivalents during period
45,298

 
17,932

Cash and cash equivalents at beginning of period
352,095

 
243,592

Cash and cash equivalents at end of period
$
397,393

 
$
261,524

Supplemental disclosures of cash flow information
 
 
 
Noncash transactions:
 
 
 
Capitalized share-based compensation
$
2,120

 
$
2,868

Write-off of fully depreciated property and equipment
$
7,379

 
$
3,446

Write-off of fully amortized intangible assets
$
10,687

 
$
5,280

See accompanying notes to condensed consolidated financial statements.




ZILLOW GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1 . Organization and Description of Business
Zillow Group, Inc. operates the leading real estate and home-related information marketplaces on mobile and the web, with a complementary portfolio of brands and products to help consumers find vital information about homes and connect with local professionals. Zillow Group’s brands focus on all stages of the home lifecycle: renting, buying, selling and financing. The Zillow Group portfolio of consumer brands includes real estate and rental marketplaces Zillow, Trulia, StreetEasy, HotPads, Naked Apartments, RealEstate.com and OutEast.com. In addition, Zillow Group provides a comprehensive suite of marketing software and technology solutions to help real estate, rental and mortgage professionals maximize business opportunities and connect with millions of consumers. The Zillow Instant Offers marketplace provides homeowners with the opportunity to receive offers from buyers, including Zillow starting in April of 2018, in some metropolitan areas. When Zillow buys a home, it will make necessary updates and list 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; 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 March 31, 2018 , our results of operations, comprehensive loss and cash flows for the three month periods ended March 31, 2018 and 2017 . The results of the three month period ended March 31, 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.

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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 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.
Concentrations of Credit Risk
Financial instruments, which potentially subject us to concentrations of credit risk, consist primarily of cash and cash equivalents, investments and accounts receivable. We place cash and cash equivalents and investments with major financial institutions, which management assesses to be of high credit quality, in order to limit exposure of our investments.
Credit risk with respect to accounts receivable is dispersed due to the large number of customers. Further, our credit risk on accounts receivable is mitigated by the relatively short payment terms that we offer. Collateral is not required for accounts receivable. We maintain an allowance for doubtful accounts such that receivables are stated at net realizable value.
Cash and Cash Equivalents
Cash includes demand deposits with banks or financial institutions. Cash equivalents include short-term, highly liquid investments that are both readily convertible to known amounts of cash, and so near their maturity that they present minimal risk of changes in value because of changes in interest rates. Our cash equivalents include only investments with original maturities of three months or less. We regularly maintain cash in excess of federally insured limits at financial institutions.
Short-term Investments
Our investments consist of fixed income securities, which include U.S. and foreign government agency securities, corporate notes and bonds, commercial paper, municipal securities and certificates of deposit, and are classified as available-for-sale securities. As the investments are available to support current operations, our available-for-sale securities are classified as short-term investments. Available-for-sale securities are carried at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive loss in shareholders’ equity, while realized gains and losses and other-than-temporary impairments are reported as a component of net loss based on specific identification. An impairment charge is recorded in the consolidated statements of operations for declines in fair value below the cost of an individual investment that are deemed to be other than temporary. We assess whether a decline in value is temporary based on the length of time that the fair market value has been below cost, the severity of the decline and the intent and ability to hold or sell the investment. We did not identify any investments as other-than-temporarily impaired as of March 31, 2018 or December 31, 2017 .
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable represent our unconditional right to consideration. Accounts receivable are generally due within 30 days and are recorded net of the allowance for doubtful accounts. We consider accounts outstanding longer than the contractual terms past due. We review accounts receivable on a regular basis and estimate an amount of losses for uncollectible accounts based on our historical collections experience, age of the receivable, knowledge of the customer and the condition of the general economy and industry as a whole. We record changes in our estimate to the allowance for doubtful accounts through bad debt expense and relieve the allowance when accounts are ultimately determined to be uncollectible. Bad debt expense is included in general and administrative expenses.
Contract Cost Assets
We capitalize certain incremental costs of obtaining contracts with customers which we expect to recover. These costs relate to commissions paid to sales personnel, primarily for our Premier Agent and Premier Broker programs. As a practical expedient, we recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that we otherwise would have recognized is one year or less. Capitalized commission costs are recorded as contract cost assets in our condensed consolidated balance sheets. Contract cost assets are amortized to expense on a straight-line basis over a period that is consistent with the transfer to the customer of the products or services to which the asset relates, generally the estimated life of the customer relationship. Amortization expense related to contract cost assets is included in sales and marketing expenses in our condensed consolidated statements of operations. In determining the estimated life of our customer relationships, we consider quantitative and qualitative data, including, but not limited to, historical customer data, recent

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changes or expected changes in product or service offerings, and changes in how we monetize our products and services. The amortization period for capitalized contract costs related to our Premier Agent and Premier Broker programs ranges from two to three years.
Property and Equipment
Property and equipment is recorded at cost and depreciated using the straight-line method over the estimated useful lives of the related assets. The useful lives are as follows:
 
Computer equipment
2 to 3 years
Office equipment, furniture and fixtures
5 to 7 years
Leasehold improvements
Shorter of expected useful life or lease term
Maintenance and repair costs are charged to expense as incurred. Major improvements, which extend the useful life of the related asset, are capitalized. Upon disposal of a fixed asset, we record a gain or loss based on the difference between the proceeds received and the net book value of the disposed asset.
Website and Software Development Costs
The costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct and incremental and deemed by management to be significant, are capitalized in property and equipment and amortized on a straight-line basis over their estimated useful lives. Maintenance and enhancement costs, including those costs in the post-implementation stages, are typically expensed as incurred, unless such costs relate to substantial upgrades and enhancements to the website or software that result in added functionality, in which case the costs are capitalized and amortized on a straight-line basis over the estimated useful lives. Amortization expense related to capitalized website and software development costs is included in technology and development expense.
Capitalized development activities placed in service are amortized over the expected useful lives of those releases, currently estimated at one to three years. The estimated useful lives of website and software development activities are reviewed frequently and adjusted as appropriate to reflect upcoming development activities that may include significant upgrades and/or enhancements to the existing functionality.
Construction-in-progress primarily consists of website development costs that are capitalizable, but for which the associated applications had not been placed in service.
Recoverability of Goodwill and Indefinite-Lived Intangible Assets
Goodwill represents the excess of the cost of an acquired business over the fair value of the assets acquired at the date of acquisition, and is not amortized. We assess the impairment of goodwill on an annual basis, in our fourth quarter, or whenever events or changes in circumstances indicate that goodwill may be impaired. Typically, we choose to forgo the initial qualitative assessment and perform a quantitative analysis to assist in our annual evaluation. If impairment exists, the carrying value of the goodwill is reduced to fair value through an impairment charge recorded in our statements of operations.
Our indefinite-lived intangible asset is not amortized, and we assess the asset for impairment on an annual basis, in our fourth quarter, or whenever events or changes in circumstances indicate that the asset may be impaired. On an interim basis, we consider if there are any events and circumstances that could affect the significant inputs used to determine the fair value of the indefinite-lived intangible asset, including, but not limited to, costs that could have a negative effect on future expected earnings and cash flows, changes in certain key performance metrics, and changes in management, key personnel, strategy or customers. In our evaluation of our trade names and trademarks indefinite-lived intangible asset, we typically first perform a qualitative assessment to determine whether the fair value of the indefinite-lived intangible asset is more likely than not impaired. If so, we perform a quantitative assessment and an impairment charge is recorded in our statements of operations for the excess of the carrying value of the indefinite-lived intangible asset over its fair value.
Intangible Assets
We purchase and license data content from multiple data providers. This data content consists of U.S. county data about home details (e.g., the number of bedrooms, bathrooms, square footage) and other information relating to the purchase price of homes, both current and historical, as well as imagery, mapping and parcel data that is displayed on our mobile applications and websites. Our home details data not only provides information about a home and its related transactions which is displayed on our mobile applications and websites, but is also used in our proprietary valuation algorithms to produce Zestimates, Rent

7


Zestimates and Zillow Home Value Indexes. License agreement terms vary by vendor. In some instances, we retain perpetual rights to this information after the contract ends; in other instances, the information and data are licensed only during the fixed term of the agreement. Additionally, certain data license agreements provide for uneven payment amounts throughout the contract term.
We capitalize payments made to third parties for data licenses that we expect to provide future economic benefit through the recovery of the costs of these arrangements via the generation of our revenue and margins. For data license contracts that include uneven payment amounts, we capitalize the payments as they are made as an intangible asset and the total contract value is typically amortized on a straight-line basis over the term of the contract, which is equivalent to the estimated useful life of the asset. We evaluate data content contracts for potential capitalization at the inception of the arrangement as well as each time periodic payments to third parties are made.
The amortization period for the capitalized purchased content is based on our best estimate of the useful life of the asset, which is approximately five years. The determination of the useful life includes consideration of a variety of factors including, but not limited to, our assessment of the expected use of the asset and contractual provisions that may limit the useful life, as well as an assessment of when the data is expected to become obsolete based on our estimates of the diminishing value of the data over time. We evaluate the useful life of the capitalized purchased data content each reporting period to determine whether events and circumstances warrant a revision to the remaining useful life. If we determine the estimate of the asset’s useful life requires modification, the carrying amount of the asset is amortized prospectively over the revised useful life. The capitalized purchased data content is amortized on a straight-line basis as the pattern of delivery of the economic benefits of the data cannot reliably be determined because we do not have the ability to reliably predict future traffic to our mobile applications and websites.
Under certain other data agreements, the underlying data is obtained on a subscription basis with consistent monthly or quarterly recurring payment terms over the contractual period. Upon the expiration of such arrangements, we no longer have the right to access the related data, and therefore, the costs incurred under such contracts are not capitalized and are expensed as payments are made. We would immediately lose rights to data under these arrangements if we were to cancel the subscription and/or cease making payments under the subscription arrangements.
We also capitalize costs related to the license of certain internal-use software from third parties, including certain licenses of software in cloud computing arrangements. Additionally, we capitalize costs incurred during the application development stage related to the development of internal-use software and enterprise cloud computing services. We expense costs as incurred related to the planning and post-implementation phases of development. Capitalized internal-use software costs are amortized over the estimated useful life of the asset, which is currently one to three years, on a straight-line basis.
Intangibles-in-progress consist of purchased content and software that are capitalizable but have not been placed in service.
We also have intangible assets for developed technology, customer relationships, trade names and trademarks and advertising relationships which we recorded in connection with acquisitions. Purchased intangible assets with a determinable economic life are carried at cost, less accumulated amortization. These intangible assets are amortized over the estimated useful life of the asset on a straight-line basis.
Recoverability of Intangible Assets with Definite Lives and Other Long-Lived Assets
We evaluate intangible assets and other long-lived assets for impairment whenever events or circumstances indicate that they may not be recoverable. Recoverability is measured by comparing the carrying amount of an asset group to future undiscounted net cash flows expected to be generated. We group assets for purposes of such review at the lowest level for which identifiable cash flows of the asset group are largely independent of the cash flows of the other groups of assets and liabilities. If this comparison indicates impairment, the amount of impairment to be recognized is calculated as the difference between the carrying value and the fair value of the asset group.
Deferred Revenue
Deferred revenue consists of prepaid advertising fees received or billed in advance of satisfying our performance obligations and prepaid but unrecognized subscription revenue. Deferred revenue is recognized when or as we satisfy our obligations under contracts with customers.
Deferred Rent
For our operating leases, we recognize rent expense on a straight-line basis over the terms of the leases and, accordingly, we record the difference between cash rent payments and the recognition of rent expense as a deferred rent liability. For office

8


space under an operating lease that is subleased to a third party for which we intend to reoccupy the space at a future date, rent expense is recognized net of sublease income. Landlord-funded leasehold improvements are also recorded as deferred rent liabilities and are amortized as a reduction of rent expense over the non-cancelable term of the related operating lease.
Business Combinations
We recognize identifiable assets acquired and liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions for the purchase price allocation process to value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill to the extent that we identify adjustments to the preliminary purchase price allocation. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our condensed consolidated statements of operations. We recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined.
Revenue Recognition
We recognize revenue when (or as) we satisfy our performance obligations by transferring control of the 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.
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 are Premier Agent, Rentals, Mortgages and Other.
As a practical expedient, we do not adjust the promised amount of consideration for the effects of a significant financing component as the period between our transfer of a promised product or service to a customer and when the customer pays for that product or service is one year or less.
We do not disclose the transaction price related to remaining performance obligations for (i) contracts with an original expected duration of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for performance completed to date. The remaining duration of our performance obligations is generally less than one year.
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

9


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.
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.
Mortgages Revenue. Mortgages revenue primarily includes marketing products sold to mortgage professionals on a cost per lead basis, including our Long Form and Custom Quote services. For our Long Form 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. In Zillow Group’s Long Form 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. 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. Mortgages revenue also includes revenue generated by Mortech, which provides subscription-based mortgage software solutions, including a product and pricing engine and lead management platform, for which we recognize revenue on a straight-line basis during the contractual period over which the services are provided.
Other Revenue. Other revenue primarily includes revenue generated by new construction and display, as well as revenue from the sale of various other marketing and business products and services to real estate professionals. Our new construction marketing solutions allow home builders to showcase their available inventory to home shoppers. New construction revenue primarily includes revenue generated by advertising sold to builders on a cost per residential community basis, and revenue is recognized on a straight-line basis during the contractual period over which the communities are advertised on our mobile applications and websites. Consideration is billed in arrears. Display revenue primarily consists of graphical mobile and web advertising sold on a cost per thousand impressions or cost per click basis to advertisers promoting their brands on our mobile applications and websites. We recognize display revenue as clicks occur or as impressions are delivered to users interacting with our mobile applications or websites, which is the amount for which we have the right to invoice.
Cost of Revenue
Our cost of revenue consists of expenses related to operating our mobile applications and websites, including associated headcount expenses, such as salaries and benefits and share-based compensation expense and bonuses, as well as credit card fees, ad serving costs paid to third parties, revenue-sharing costs related to our commercial business relationships, depreciation expense and costs associated with the operation of our data center and mobile applications and websites.
Technology and Development
Technology and development expenses consist of headcount expenses, including salaries, benefits, share-based compensation expense and bonuses for salaried employees and contractors engaged in the design, development and testing of our mobile applications and websites, and equipment and maintenance costs. Technology and development expenses also include amortization costs related to capitalized website and development activities, amortization of software, amortization of certain intangibles and other data agreement costs related to the purchase of data used to populate our mobile applications and websites, amortization of intangible assets recorded in connection with acquisitions, including developed technology and customer relationships, amongst others, and depreciation expense.
Share-Based Compensation
We measure compensation expense for all share-based awards at fair value on the date of grant and recognize compensation expense over the service period on a straight-line basis for awards expected to vest.
We use the Black-Scholes-Merton option-pricing model to determine the fair value for option awards. In valuing our option awards, we make assumptions about risk-free interest rates, dividend yields, volatility, and weighted-average expected lives. We account for forfeitures as they occur. Risk-free interest rates are derived from U.S. Treasury securities as of the option award grant date. Expected dividend yield is based on our historical cash dividend payments, which have been zero to date. The

10


expected volatility for our Class A common stock and Class C capital stock is estimated using our historical volatility. The weighted-average expected life of the option awards is estimated based on our historical exercise data.
For issuances of restricted stock units and restricted units, we determine the fair value of the award based on the market value of our Class A common stock or Class C capital stock, as applicable, at the date of grant.
Advertising Costs
Advertising costs are expensed as incurred. Advertising costs are recorded in sales and marketing expenses.
Income Taxes
We use the asset and liability approach for accounting and reporting income taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement and tax bases of assets and liabilities at the applicable enacted tax rates. A valuation allowance against deferred tax assets would be established if, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50%) that some or all of the deferred tax assets are not expected to be realized.
We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit, new tax legislation or the change of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made. Interest and penalties related to unrecognized tax benefits are recorded as income tax expense.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation under the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code, including but not limited to: (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries; (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) eliminating the corporate alternative minimum tax (“AMT”) and how AMT credits are utilized; (5) the additional limitations on deducting executive compensation under IRC Section 162(m); and (6) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017 . Shortly after enactment, implementation guidance was released by the Securities and Exchange Commission that requires a company to reflect the income tax effects of those aspects of the Tax Act for which the accounting under the accounting rules is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but the company is able to determine a reasonable estimate, it should record a provisional estimate in the financial statements. Further, the implementation guidance also provides for a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete their accounting pursuant to the accounting rules.
Recently Adopted Accounting Standards
In December 2016, the Financial Accounting Standards Board (“FASB”) issued guidance to narrow the definition of a business. This guidance assists entities with evaluating when a set of transferred assets and activities is a business. This guidance is effective for interim and annual reporting periods beginning after December 15, 2017, and early adoption is permitted. This guidance must be applied prospectively to transactions occurring within the period of adoption. We adopted this guidance on January 1, 2018. The adoption of this guidance did not have an impact on our financial position, results of operations or cash flows.
In January 2016, the FASB issued guidance on the recognition and measurement of financial instruments. This guidance generally requires equity investments, except those accounted for under the equity method of accounting or those that result in consolidation of the investee, to be measured at fair value with changes in fair value recognized in net income (loss). An entity may elect to measure equity securities that do not have readily determinable fair values and do not qualify for the net asset value per share practical expedient at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The guidance also requires the separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements. This guidance is effective for interim and annual reporting periods beginning after December 15, 2017, early adoption is permitted, and the guidance must be applied prospectively to equity investments that exist as of the adoption date. We adopted this guidance, and the February 2018 amendment to this guidance, effective January 1, 2018. The adoption of this guidance did not have any impact on our financial position, results of operations or cash flows.

11


In May 2014, the 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 as of and for the three months ended March 31, 2018 is as follows (in thousands, except per share data):
 
 
New Guidance
 
Prior Guidance
 
Change
Condensed Consolidated Statement of Operations:
 
 
 
 
 
 
Sales and marketing
 
$
137,291

 
$
139,434

 
$
(2,143
)
Total costs and expenses
 
311,243

 
313,386

 
(2,143
)
Loss from operations
 
(11,364
)
 
(13,507
)
 
2,143

Loss before income taxes
 
(15,991
)
 
(18,134
)
 
2,143

Income tax expense
 
(2,600
)
 
(3,290
)
 
690

Net loss
 
(18,591
)
 
(21,424
)
 
2,833

Net loss per share - basic and diluted
 
(0.10
)
 
(0.11
)
 
0.01

Condensed Consolidated Balance Sheet:
 
 
 
 
 
 
Contract cost assets
 
42,465

 

 
42,465

Total assets
 
3,344,137

 
3,301,672

 
42,465

Deferred tax liabilities and other long-term liabilities
 
47,161

 
47,851

 
(690
)
Total liabilities
 
575,696

 
576,386

 
(690
)
Accumulated deficit
 
(570,512
)
 
(613,667
)
 
43,155

Total shareholders’ equity
 
2,768,441

 
2,725,286

 
43,155

Total liabilities and shareholders’ equity
 
3,344,137

 
3,301,672

 
42,465

Recently Issued Accounting Standards Not Yet Adopted
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.
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. We have not yet determined the impact the adoption of this guidance will have on our financial position, results of operations or cash flows.

12


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 and should be applied through a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, and early adoption is permitted. We expect to adopt this guidance on January 1, 2019. We anticipate this guidance will have a material impact on our financial position, 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. We continue to assess the potential impacts of this guidance, including the impact the adoption of this guidance 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.

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):
 
 
March 31, 2018
 
Total
 
Level 1
 
Level 2
Cash equivalents:
 
 
 
 
 
Money market funds
$
233,712

 
$
233,712

 
$

Commercial paper
7,483

 

 
7,483

U.S. government agency securities
3,999

 

 
3,999

Certificates of deposit
249

 

 
249

Short-term investments:
 
 
 
 
 
U.S. government agency securities
320,930

 

 
320,930

Commercial paper
40,264

 

 
40,264

Corporate notes and bonds
39,870

 

 
39,870

Municipal securities
15,616

 

 
15,616

Certificates of deposit
8,913

 

 
8,913

        Total
$
671,036

 
$
233,712

 
$
437,324

 

13


 
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 11 for the carrying amount and estimated fair value of the Company’s Convertible Senior Notes due in 2021 and Trulia’s Convertible Senior Notes due in 2020.
We did not have any Level 3 assets as of March 31, 2018 or December 31, 2017 . There were no liabilities measured at fair value on a recurring basis as of March 31, 2018 or December 31, 2017 .
Note 4 . Cash and Cash Equivalents and Short-term Investments
The following tables present the amortized cost, gross unrealized gains and losses, and estimated fair market value of our cash and cash equivalents and available-for-sale investments as of the dates presented (in thousands):
 
March 31, 2018
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Market
Value
Cash
$
151,950

 
$

 
$

 
$
151,950

Cash equivalents:
 
 
 
 
 
 
 
Money market funds
233,712

 

 

 
233,712

Commercial paper
7,483

 

 

 
7,483

U.S. government agency securities
3,999

 

 

 
3,999

Certificates of deposit
249

 

 

 
249

Short-term investments:
 
 
 
 
 
 
 
U.S. government agency securities
322,244

 

 
(1,314
)
 
320,930

Commercial paper
40,264

 

 

 
40,264

Corporate notes and bonds
39,972

 

 
(102
)
 
39,870

Municipal securities
15,677

 

 
(61
)
 
15,616

Certificates of deposit
8,914

 
1

 
(2
)
 
8,913

        Total
$
824,464

 
$
1

 
$
(1,479
)
 
$
822,986


14


 
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 March 31, 2018 (in thousands):
 
Amortized
Cost
 
Estimated Fair
Market Value
Due in one year or less
$
341,729

 
$
340,800

Due after one year through two years
85,342

 
84,793

Total
$
427,071

 
$
425,593


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
(267
)
Less: write-offs, net of recoveries and other adjustments
(157
)
Balance as of March 31, 2018
$
4,917


Note 6 . Contract Cost Assets
As of March 31, 2018 , we had $42.5 million of contract cost assets. During the three months ended March 31, 2018 , we recorded no impairment losses and $9.3 million of amortization expense related to contract cost assets.
Note 7 . Property and Equipment, net
The following table presents the detail of property and equipment as of the dates presented (in thousands):

15


 
March 31,
2018
 
December 31,
2017
Website development costs
$
137,479

 
$
130,072

Leasehold improvements
54,170

 
47,321

Computer equipment
28,267

 
30,071

Construction-in-progress
23,700

 
28,150

Office equipment, furniture and fixtures
23,406

 
22,887

Property and equipment
267,022

 
258,501

Less: accumulated amortization and depreciation
(152,194
)
 
(146,230
)
Property and equipment, net
$
114,828

 
$
112,271


We recorded depreciation expense related to property and equipment (other than website development costs) of $4.2 million and $3.9 million , respectively, during the three months ended March 31, 2018 and 2017 .

We capitalized $8.6 million and $12.5 million , respectively, in website development costs during the three months ended March 31, 2018 and 2017 . Amortization expense for website development costs included in technology and development expenses was $9.5 million and $10.1 million , respectively, during the three months ended March 31, 2018 and 2017 .
Note 8 . 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 March 31, 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. There have been no impairments or upward or downward adjustments as of March 31, 2018 that would impact the carrying amount of either investment. These investments are classified within other assets in the condensed consolidated balance sheet.

Note 9 . Intangible Assets, net
The following tables present the detail of intangible assets subject to amortization as of the dates presented (in thousands):
 
March 31, 2018
 
Cost
 
Accumulated
Amortization
 
Net
Purchased content
$
35,395

 
$
(22,980
)
 
$
12,415

Software
19,496

 
(9,985
)
 
9,511

Customer relationships
103,900

 
(50,038
)
 
53,862

Developed technology
111,980

 
(60,010
)
 
51,970

Trade names and trademarks
4,900

 
(4,208
)
 
692

Intangibles-in-progress
2,469

 

 
2,469

Total
$
278,140

 
$
(147,221
)
 
$
130,919


16


 
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

Amortization expense recorded for intangible assets for the three months ended March 31, 2018 and 2017 was $13.0 million and $13.1 million , respectively, and 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 March 31, 2018 and December 31, 2017 .

Note 10 . Deferred Revenue
The following table presents the changes in deferred revenue (in thousands):

Balance as of January 1, 2018
$
31,918

Deferral of revenue
238,121

Less: Revenue recognized
(234,742
)
Balance as of March 31, 2018
$
35,297


During the three months ended March 31, 2018 , we recognized as revenue a total of $28.2 million pertaining to amounts that were recorded in deferred revenue as of December 31, 2017 .
Note 11 . Convertible Senior Notes
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.
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.

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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 March 31, 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 March 31, 2018 was $7.0 million , which is comprised of approximately $4.7 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 three months ended March 31, 2017 was $6.7 million , which is comprised of approximately $4.4 million related to the amortization of debt discount and debt issuance costs and $2.3 million for the contractual coupon interest. The effective interest rate on the liability component of the 2021 Notes for the three months ended March 31, 2018 is 7.44% . Accrued interest related to the 2021 Notes as of March 31, 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
March 31, 2018
$
460,000

 
$
(80,013
)
 
$
379,987

December 31, 2017
$
460,000

 
$
(84,721
)
 
$
375,279


As of March 31, 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 44 months.
The estimated fair value of the 2021 Notes was $558.9 million and $509.0 million , respectively, as of March 31, 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

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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.
The carrying value of the 2020 Notes was $9.6 million and $10.1 million , respectively, as of March 31, 2018 and December 31, 2017 . The estimated fair value of the 2020 Notes was $16.7 million and $17.6 million , respectively, as of March 31, 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.

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Note 12 . Income Taxes
We are subject to federal and state income taxes in the United States and in Canada. As of March 31, 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 income tax expense of $2.6 million for the three months ended March 31, 2018 . Our income tax expense for the period was calculated using an estimate of our annual effective tax rate of (32.2)% applied to our loss before income taxes of $16.0 million for the three months ended March 31, 2018. This was partially offset by a discrete tax benefit of $2.6 million as a result of our estimated impact from the Tax Act. Our estimated annual effective tax rate for the three months ended March 31, 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 March 31, 2018 , we have not completed our accounting for the income tax effects related to the deduction limitations on compensation under the Tax Act, and we have recorded provisional adjustments where we were able to make reasonable estimates of the effects for which our analysis is not yet complete. The provisional adjustments relate to the grandfathering of our executive compensation under Section 162(m) of the Internal Revenue Code. We expect the Internal Revenue Service to provide further guidance in applying the written binding contracts requirement under the Tax Act. We believe the clarifications of this rule could impact our financial position and results of operations by an estimated $2.0 million to $5.0 million .
Note 13 . 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 March 31, 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 three months ended March 31, 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.
Note 14 . 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

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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. 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 three months ended March 31, 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
4,515,423

 
53.61

 
 
 
 
Exercised
(2,414,214
)
 
21.91

 
 
 
 
Forfeited or cancelled
(262,467
)
 
32.44

 
 
 
 
Outstanding at March 31, 2018
28,483,948

 
32.25

 
6.35
 
615,484

Vested and exercisable at March 31, 2018
13,868,461

 
26.69

 
4.59
 
376,592

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
March 31,
 
2018
 
2017
Expected volatility
43%-45%
 
48%-49%
Expected dividend yield
 
Risk-free interest rate
2.52%-2.65%
 
1.75%-1.84%
Weighted-average expected life
4.50-5.00 years
 
4.25-4.75 years
Weighted-average fair value of options granted
$20.88
 
$14.21

As of March 31, 2018 , there was a total of $214.6 million in unrecognized compensation cost related to unvested stock options.

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Restricted Stock Units
The following table summarizes activity for restricted stock units for the three months ended March 31, 2018 :
 
Restricted
Stock Units
 
Weighted-
Average Grant-
Date Fair
Value
Unvested outstanding at January 1, 2018
4,016,405

 
$
33.22

Granted
1,916,215

 
52.90

Vested
(394,844
)
 
31.60

Forfeited or cancelled
(191,376
)
 
36.70

Unvested outstanding at March 31, 2018
5,346,400

 
40.29

The fair value of outstanding restricted stock units will be recorded as share-based compensation expense over the vesting period. As of March 31, 2018 , there was $203.7 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
March 31,
 
2018
 
2017
Cost of revenue
$
955

 
$
903

Sales and marketing
5,162

 
5,530

Technology and development
11,542

 
8,491

General and administrative
13,082

 
11,471

Total
$
30,741

 
$
26,395

Note 15 . Net Loss Per Share
Basic net loss per share is computed by dividing net 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 loss per share, undistributed earnings are allocated assuming all earnings during the period were distributed.
Diluted net loss per share is computed by dividing net 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 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. 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 2021 Notes.
For the periods presented, the following Class A common stock and Class C capital stock equivalents were excluded from the calculations of diluted net loss per share because their effect would have been antidilutive (in thousands):

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Three Months Ended
March 31,
 
2018
 
2017
Weighted-average Class A common stock and Class C capital stock option awards outstanding
25,222

 
27,994

Weighted-average Class A common stock and Class C capital stock restricted stock units outstanding
4,346

 
4,042

Class A common stock issuable upon conversion of the 2020 Notes
403

 
444

Class C capital stock issuable related to conversion spread on the 2021 Notes
235

 

Total Class A common stock and Class C capital stock equivalents
30,206

 
32,480

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 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.
Note 16 . 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 March 31, 2018 and 2017 was $5.8 million and $5.0 million , respectively.
Purchase Commitments
We have entered into various non-cancelable purchase commitments for content related to our mobile applications and websites. See Note 2 under “Intangible Assets” for additional information regarding our purchase commitments.
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 $3.7 million as of March 31, 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

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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. We have recorded an estimated liability for approximately $4.1 million as of March 31, 2018 and December 31, 2017 . We do not believe there is a reasonable possibility that a material loss in excess of amounts accrued may be incurred.
In April 2017, we received a Civil Investigative Demand from the Consumer Financial Protection Bureau (“CFPB”) requesting information related to our March 2017 response to the CFPB’s February 2017 Notice and Opportunity to Respond and Advise (“NORA”) letter. The NORA letter notified us that the CFPB’s Office of Enforcement was considering whether to recommend that the CFPB take legal action against us, alleging that we violated Section 8 of the Real Estate Settlement Procedures Act (“RESPA”) and Section 1036 of the Consumer Financial Protection Act (“CFPA”). This notice stemmed from an inquiry that commenced in 2015 when we received and responded to an initial Civil Investigative Demand from the CFPB. Based on correspondence from the CFPB in August 2017, we understand that it has concluded its investigation. The CFPB invited us to discuss a possible settlement and indicated that it intended to pursue further action if those discussions do not result in a settlement. We continue to believe that our acts and practices are lawful and that our co-marketing program allows lenders and agents to comply with RESPA, and we will vigorously defend against any allegations to the contrary. Should the CFPB commence an action against us, it may seek restitution, disgorgement, civil monetary penalties, injunctive relief or other corrective action. We cannot provide assurance that the CFPB will not commence a legal action against us in this matter, nor are we able to predict the likely outcome of any such action. As of March 31, 2018 and December 31, 2017 , we have recorded an accrual for an immaterial amount in connection with this matter. There is a reasonable possibility that a loss in excess of amounts accrued may be incurred; however, the possible loss or range of loss is not estimable.
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. 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 March 31, 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 the court has ruled on our pending motion to dismiss 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 March 31, 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

24


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.
Note 17 . 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 $2.8 million and $ 2.0 million , respectively, as of March 31, 2018 and December 31, 2017 .
Note 18 . 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 March 31, 2018 and 2017 was $3.8 million and $2.9 million , respectively.
Note 19 . Segment Information and Revenue
We have one operating and reportable segment which has been identified based on how 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 on an entity-wide basis. There are no segment managers who are held accountable for operations, operating results or plans for levels or components.
The chief executive officer reviews information about our revenue categories. The following table presents the balances of our revenue categories during the periods presented (in thousands):
 
Three Months Ended
March 31,
 
2018
 
2017
Premier Agent
$
213,732

 
$
175,301

Rentals
29,063

 
21,545

Mortgages
19,023

 
20,270

Other
38,061

 
28,659

Total revenue
$
299,879

 
$
245,775


25


Note 20 . Subsequent Events
In April 2018, we announced Zillow Group’s participation as a purchaser of homes in the Instant Offers marketplace. Through Instant Offers, interested home sellers submit information about their home and receive investor offers for a sale alongside a real estate agent’s analysis of what the home might sell for on the open market. Each time Zillow Group purchases a home it intends to quickly update and resell the home on the open market. As a participant in the Instant Offers marketplace, Zillow Group began buying homes in May of 2018. Beginning in the second quarter of 2018, Zillow Group will report financial results for two reportable segments: the Internet, Media & Technology (“IMT”) segment and the Homes segment. The IMT segment will include the financial results for the Premier Agent, Rentals, Mortgages 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.
In April 2018, we entered into a lease agreement for additional office space for our corporate headquarters in Seattle, Washington. Pursuant to the terms of the lease, we will lease an additional 79,038 square feet, and we are obligated to make escalating monthly lease payments that begin in September 2019 and continue through December 2024. Future minimum payments under the operating lease for this new space are as follows (in thousands):
2018
$

2019
764

2020
2,318

2021
2,397

2022
2,477

All future years
5,190

Total future minimum lease payments
$
13,146


26



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 contained 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 leading real estate and home-related information marketplaces on mobile and the web, with a complementary portfolio of brands and products to help consumers find vital information about homes and connect with local professionals. Zillow Group’s brands focus on all stages of the home lifecycle: renting, buying, selling and financing. The Zillow Group portfolio of consumer brands includes real estate and rental marketplaces Zillow, Trulia, StreetEasy, HotPads, Naked Apartments, RealEstate.com and OutEast.com. The Zillow Instant Offers marketplace provides homeowners with the opportunity to receive offers from buyers, including Zillow starting in April of 2018, in some metropolitan areas. When Zillow buys a home, it will make necessary updates and list the home for resale on the open market. In addition, Zillow Group provides a comprehensive suite of marketing software and technology solutions to help real estate, rental and mortgage professionals maximize business opportunities and connect with millions of consumers. 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 75 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.
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 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 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.
During the three months ended March 31, 2018 , we generated revenue of $299.9 million , as compared to $245.8 million in the three months ended March 31, 2017 , an increase of 22%. This increase was primarily the result of a $38.4 million, or 22%, increase in Premier Agent revenue, a $7.5 million, or 35%, increase in Rentals revenue, and a $9.4 million, or 33%, increase in Other revenue. There were approximately 175.5 million average monthly unique users of our mobile applications and websites for the three months ended March 31, 2018 , representing year-over-year growth of 5%. Visits increased 15% to 1,764.8 million for the three months ended March 31, 2018 from 1,533.0 million for the three months ended March 31, 2017 .

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Net loss for the three months ended March 31, 2018 was $18.6 million, as compared to net loss for the three months ended March 31, 2017 of $4.6 million.
In April 2018, we announced Zillow Group’s participation as a purchaser of homes in the Instant Offers marketplace. Through Instant Offers, interested home sellers submit information about their home and receive investor offers for a sale alongside a real estate agent’s analysis of what the home might sell for on the open market. Each time Zillow Group purchases a home it intends to quickly repair and resell the home on the open market. As a participant in the Instant Offers marketplace, Zillow Group began buying homes in May of 2018. Beginning in the second quarter of 2018, Zillow Group will report financial results for two reportable segments: the Internet, Media & Technology (“IMT”) segment and the Homes segment. The IMT segment will include the financial results for the Premier Agent, Rentals, Mortgages 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 through the Instant Offers marketplace. Zillow Group’s preparation to participate in the Instant Offers marketplace did not have a material impact on our financial results for the three months ended March 31, 2018 . However, we do expect the Homes segment to have a material impact on our consolidated balance sheets, statements of operations and cash flows for the remainder of 2018. We expect to hold approximately 300 to 1,000 homes in inventory as of December 31, 2018 .
As of March 31, 2018 , we had 3,334 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, and our display revenue depends in part on the number of impressions delivered to our users. 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 advertising 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.
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 (as of June 2017) measure unique users with Google Analytics, and Trulia measures unique users with Adobe Analytics (formerly called Omniture analytical tools).  
 
Three Months Ended
March 31,
 
2017 to 2018
% Change
 
2018
 
2017
 
 
(in millions)
 
 
Average Monthly Unique Users
175.5

 
166.6

 
5
%
Visits
The number of visits is an important metric because it is an indicator of consumers’ level of engagement with our mobile applications and websites. 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.

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We define a visit as a group of interactions by users with the Zillow, Trulia, StreetEasy (as of March 2017) and RealEstate.com (as of June 2017) 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
March 31,
 
2017 to 2018
% Change
 
2018
 
2017
 
 
(in millions)
 
 
Visits
1,764.8

 
1,533.0

 
15
%
Basis of Presentation
Revenue
We recognize revenue when (or as) we satisfy our performance obligations by transferring control of the 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.

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 are Premier Agent, Rentals, Mortgages and Other.
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 distribution related to our auction-based pricing model whereby the share of voice purchased by Premier Agents and Premier Brokers will represent both the share of impressions delivered as

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advertisements and the proportion of validated connections a Premier Agent or Premier Broker receives. When consumers do not select a specific Premier Agent or Premier Broker advertisement, the validated connections will be distributed to Premier Agents and Premier Brokers in proportion to their share of voice. We believe distributing validated 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 in the future to apply this new form of lead distribution more broadly with full adoption by the end of 2018. We are unable to predict whether this change will have a material impact on revenue or other results of operations.
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.
Mortgages Revenue. Mortgages revenue primarily includes marketing products sold to mortgage professionals on a cost per lead basis, including our Long Form and Custom Quote services. For our Long Form 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. In Zillow Group’s Long Form 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. 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. Mortgages revenue also includes revenue generated by Mortech, which provides subscription-based mortgage software solutions, including a product and pricing engine and lead management platform, for which we recognize revenue on a straight-line basis during the contractual period over which the services are provided.
Other Revenue. Other revenue primarily includes revenue generated by new construction and display, as well as revenue from the sale of various other marketing and business products and services to real estate professionals. Our new construction marketing solutions allow home builders to showcase their available inventory to home shoppers. New construction revenue primarily includes revenue generated by advertising sold to builders on a cost per residential community basis, and revenue is recognized on a straight-line basis during the contractual period over which the communities are advertised on our mobile applications and websites. Consideration is billed in arrears. Display revenue primarily consists of graphical mobile and web advertising sold on a cost per thousand impressions or cost per click basis to advertisers promoting their brands on our mobile applications and websites. We recognize display revenue as clicks occur or as impressions are delivered to users interacting with our mobile applications or websites, which is the amount for which we have the right to invoice.
Costs and Expenses
Cost of Revenue. Our cost of revenue consists of expenses related to operating our mobile applications and websites, including associated headcount expenses, such as salaries, benefits, share-based compensation expense and bonuses, as well as credit card fees, ad serving costs paid to third parties, revenue-sharing costs related to our commercial business relationships, depreciation expense and costs associated with the operation of our data center and mobile applications and websites.
Sales and Marketing. Sales and marketing expenses consist of advertising costs and other sales expenses related to promotional and marketing activities, as well as headcount expenses, including salaries, commissions, benefits, share-based compensation expense and bonuses for sales, sales support, customer support, marketing and public relations employees, and depreciation expense.
 
Technology and Development. Technology and development expenses consist of headcount expenses, including salaries, benefits, share-based compensation expense and bonuses for salaried employees and contractors engaged in the design, development and testing of our mobile applications and websites, and equipment and maintenance costs. Technology and development expenses also include amortization costs related to capitalized website and development activities, amortization of software, amortization of certain intangibles and other data agreement costs related to the purchase of data used to populate our mobile applications and websites, and amortization of intangible assets recorded in connection with acquisitions, including developed technology and customer relationships, amongst others. Technology and development expenses also include depreciation expense.

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Table of Contents

General and Administrative. General and administrative expenses consist of headcount expenses, including salaries, benefits, share-based compensation expense and bonuses for executive, finance, accounting, legal, human resources, recruiting, corporate information technology costs and other administrative support. General and administrative expenses also include legal settlement costs, legal, accounting and other third-party professional service fees, rent expense, depreciation expense and bad debt expense.
Acquisition-related Costs. Acquisition-related costs consist of investment banking, legal, accounting, tax, and regulatory filing fees associated with acquisitions.
Other Income
Other income consists primarily of interest income earned on our cash, cash equivalents and short-term investments.
Interest Expense
Interest expense consists of interest on the 2020 Notes we guaranteed in connection with our February 2015 acquisition of Trulia and interest on the 2021 Notes we issued in December 2016. Interest is payable on the 2020 Notes at the rate of 2.75% semi-annually on June 15 and December 15 of each year. Interest is payable on the 2021 Notes at the rate of 2.00% semi-annually on June 1 and December 1 of each year.
Income Taxes
We are subject to federal and state income taxes in the United States and in Canada. As of March 31, 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 .
On December 22, 2017, the U.S. government enacted comprehensive tax legislation under the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code, including but not limited to: (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) requiring companies to pay a one-time transition tax on certain untaxed earnings of foreign subsidiaries; (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) eliminating the corporate alternative minimum tax (“AMT”) and how AMT credits are utilized; (5) the additional limitations on deducting executive compensation under IRC Section 162(m); and (6) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017 . Shortly after enactment, implementation guidance was released by the Securities and Exchange Commission that requires a company to reflect the income tax effects of those aspects of the Tax Act for which the accounting under the accounting rules is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but the company is able to determine a reasonable estimate, it should record a provisional estimate in the financial statements. Further, the implementation guidance also provides for a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete their accounting pursuant to the accounting rules.
We recorded income tax expense of $2.6 million for the three months ended March 31, 2018 . Our income tax expense for the period was calculated using an estimate of our annual effective tax rate of (32.2)% applied to our loss before income taxes of $16.0 million for the three months ended March 31, 2018 . This was partially offset by a discrete tax benefit of $2.6 million as a result of our estimated impact from the Tax Act. Our estimated annual effective tax rate for the three months ended March 31, 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 March 31, 2018 , we have not completed our accounting for the income tax effects related to the deduction limitations on compensation under the Tax Act, and we have recorded provisional adjustments where we were able to make reasonable estimates of the effects for which our analysis is not yet complete. The provisional adjustments relate to the grandfathering of our executive compensation under Section 162(m) of the Internal Revenue Code. We expect the Internal Revenue Service to provide further guidance in applying the written binding contracts requirement under the Tax Act. We believe the clarifications of this rule could impact our financial position and results of operations by an estimated $2.0 million to $5.0 million.
Results of Operations
The following tables present our results of operations for the periods indicated and as a percentage of total revenue:

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Table of Contents


 
Three Months Ended
March 31,
 
2018
 
2017
 
(in thousands, except per share data, unaudited)
Statements of Operations Data:
 
 
 
Revenue
$
299,879

 
$
245,775

Costs and expenses:
 
 
 
Cost of revenue (exclusive of amortization) (1)(2)
23,919

 
20,232

Sales and marketing (1)
137,291

 
105,940

Technology and development (1)
93,933

 
72,868

General and administrative (1)
56,073

 
45,466

Acquisition-related costs
27

 
105

Total costs and expenses
311,243

 
244,611

Income (loss) from operations
(11,364
)
 
1,164

Other income
2,446

 
953

Interest expense
(7,073
)
 
(6,723
)
Loss before income taxes
(15,991
)
 
(4,606
)
Income tax expense
(2,600
)
 

Net loss
$
(18,591
)
 
$
(4,606
)
Net loss per share — basic and diluted
$
(0.10
)
 
$
(0.03
)
Weighted-average shares outstanding — basic and diluted
191,464

 
183,158

Other Financial Data:
 
 
 
Adjusted EBITDA (3)
$
46,310

 
$
54,799

 
Three Months Ended
March 31,
 
2018
 
2017
 
(in thousands, unaudited)
(1) Includes share-based compensation as follows:
 
 
 
Cost of revenue
$
955

 
$
903

Sales and marketing
5,162

 
5,530

Technology and development
11,542

 
8,491

General and administrative
13,082

 
11,471

Total
$
30,741

 
$
26,395

(2) Amortization of website development costs and intangible assets included in technology and development
$
22,549

 
$
23,261

(3) See “Adjusted EBITDA” below for more information and for a reconciliation of Adjusted EBITDA to net loss, the most directly comparable financial measure calculated and presented in accordance with U.S. generally accepted accounting principles, or GAAP.


32


 
Three Months Ended
March 31,
 
2018
 
2017
 
(unaudited)
Percentage of Revenue:
 
 
 
Revenue
100
 %
 
100
 %
Costs and expenses:
 
 
 
Cost of revenue (exclusive of amortization)
8

 
8

Sales and marketing
46

 
43

Technology and development
31

 
30

General and administrative
19

 
18

Acquisition-related costs

 

Total costs and expenses
104

 
100

Income (loss) from operations
(4
)
 

Other income
1

 

Interest expense
(2
)
 
(3
)
Loss before income taxes
(5
)
 
(2
)
Income tax expense
(1
)
 
0

Net loss
(6
)%
 
(2
)%
Adjusted EBITDA
To provide investors with additional information regarding our financial results, we have disclosed Adjusted EBITDA within this Quarterly Report on Form 10-Q, a non-GAAP financial measure. We have provided a reconciliation below of Adjusted EBITDA to net loss, the most directly comparable GAAP financial measure.
We have included Adjusted EBITDA in this Quarterly Report on Form 10-Q as it is a key metric used by our management and board of directors to measure operating performance and trends and to prepare and approve our annual budget. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates operating performance comparisons on a period-to-period basis.
Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
Adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments;
Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
Adjusted EBITDA does not consider the potentially dilutive impact of share-based compensation;
Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
Adjusted EBITDA does not reflect acquisition-related costs;
Adjusted EBITDA does not reflect interest expense or other income;
Adjusted EBITDA does not reflect income taxes; and
Other companies, including companies in our own industry, may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.
Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net loss and our other GAAP results.
The following table presents a reconciliation of Adjusted EBITDA to net loss for each of the periods presented:
 

33


 
Three Months Ended
March 31,
 
2018
 
2017
 
(in thousands, unaudited)
Reconciliation of Adjusted EBITDA to Net Loss:
 
 
 
Net loss
$
(18,591
)
 
$
(4,606
)
Other income
(2,446
)
 
(953
)
Depreciation and amortization expense
26,906

 
27,135

Share-based compensation expense
30,741

 
26,395

Acquisition-related costs
27

 
105

Interest expense
7,073

 
6,723

Income tax expense
2,600

 

Adjusted EBITDA
$
46,310

 
$
54,799


The Homes Segment
As discussed above, Zillow Group began purchasing homes as a participant in the Instant Offers marketplace in the second quarter of 2018 and, as a result, Zillow Group will report financial results for two reportable segments: the IMT segment and the Homes segment, beginning in the second quarter of 2018. The Homes segment will include the financial results from Zillow Group’s buying of homes through the Instant Offers marketplace, updating the homes and reselling them to homebuyers.
Zillow Group’s preparation to participate in the Instant Offers marketplace did not have a material impact on our financial results for the three months ended March 31, 2018 . We do, however, expect the Homes segment to have a material impact on our consolidated balance sheets, statements of operations and cash flows for the remainder of 2018. Though we expect the Homes segment to contribute to total revenue, we also expect cost of revenue, sales and marketing expense, and other costs and expenses will increase, including in connection with transaction costs associated with each purchase and sale and the cost of renovating the homes we purchase. Due to differences between the operational requirements and accounting treatment, among other factors, of the Homes segment as compared with the IMT segment, historical financial results may not be indicative of future financial performance on a consolidated basis.
Three Months Ended March 31, 2018 Compared to Three Months Ended March 31, 2017
Revenue
 
Three Months Ended
March 31,
 
2017 to 2018
% Change
 
2018
 
2017
 
 
(in thousands, unaudited)
 
 
Revenue:
 
 
 
 
 
Premier Agent
$
213,732

 
$
175,301

 
22
 %
Rentals
29,063

 
21,545

 
35
 %
Mortgages
19,023

 
20,270

 
(6
)%
Other
38,061

 
28,659

 
33
 %
Total revenue
$
299,879

 
$
245,775

 
22
 %
 

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Three Months Ended
March 31,
 
2018
 
2017
 
(unaudited)

Percentage of Total Revenue:
 
 
 
Premier Agent
71
%
 
71
%
Rentals
10

 
9

Mortgages
6

 
8

Other
13

 
12

Total revenue
100
%
 
100
%
Total revenue increased by $54.1 million, or 22%, for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 . There were approximately 175.5 million average monthly unique users of our mobile applications and websites for the three months ended March 31, 2018 compared to 166.6 million average monthly unique users for the three months ended March 31, 2017 , representing year-over-year growth of 5%. This increase in unique users increased the number of impressions, leads, clicks and other events we monetized across our revenue categories.
Premier Agent revenue grew to $213.7 million for the three months ended March 31, 2018 from $175.3 million for the three months ended March 31, 2017 , an increase of $38.4 million, or 22%. Premier Agent revenue represented 71% of total revenue for the three months ended March 31, 2018 and 2017 . Premier Agent revenue was positively impacted by an increase in visits. Visits increased 15% to 1,764.8 million for the three months ended March 31, 2018 from 1,533.0 million for the three months ended March 31, 2017 . This increase in visits increased the number of impressions we could monetize in our Premier Agent marketplace. Premier Agent revenue per visit increased by 6% to $0.121 for the three months ended March 31, 2018 from $0.114 for the three months ended March 31, 2017 . We calculate Premier Agent revenue per visit by dividing the revenue generated by our Premier Agent and Premier Broker programs in the period by the number of visits in the period. We believe Premier Agent revenue was also positively impacted by market forces taking effect within the auction-based pricing method we deployed for our Premier Agent and Premier Broker products in 2016 and 2017, which may have increased demand for our advertising platform. The three months ended March 31, 2017 represented the first quarterly period in which we implemented this pricing method for all agent advertisers.
In April 2018, we began testing a new method of consumer lead distribution to our Premier Agent and Premier Broker advertisers related to our auction-based pricing model. With this new method of consumer lead distribution, the share of voice, or an agent advertiser’s share of total advertising purchased in a particular zip code, purchased by Premier Agents and Premier Brokers will represent both the share of impressions delivered as advertisements (as it did previously) and, now, the proportion of validated consumer connections a Premier Agent or Premier Broker receives. A validated consumer connection is made when a consumer does not select a specific Premier Agent or Premier Broker with whom they want to connect through one of our mobile applications or websites. Applying the new model, these validated connections will be distributed to Premier Agents and Premier Brokers in proportion to their share of voice. We believe distributing validated 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 with full adoption by the end of 2018. We are unable to predict whether this change will have a material impact on revenue or other results of operations.

Rentals revenue was $29.1 million for the three months ended March 31, 2018 compared to $21.5 million for the three months ended March 31, 2017 , an increase of $7.5 million, or 35%. The increase in rentals revenue was partially attributable to an increase in the number of average monthly rental listings on our mobile applications and websites, which increased 86% to 35,247 average monthly rental listings for the three months ended March 31, 2018 from 18,926 average monthly rental listings for the three months ended March 31, 2017 . Average monthly rental listings include the average monthly monetized, deduplicated rental listings for the period, which are displayed across all of our mobile applications and websites. An increase in rental listings on our mobile applications and websites increases the likelihood that a consumer will contact a rental professional, which in turn increases the likelihood of a lead, click, or lease that we monetize. The increase in average monthly rental listings was primarily a result of our monetization of rental listings on our StreetEasy brand mobile application and website beginning in the third quarter of 2017. The revenue per average monthly rental listing decreased 28% to approximately $825 for the three months ended March 31, 2018 from approximately $1,138 for the three months ended March 31, 2017 , due primarily from the monetization of rental listings on StreetEasy beginning in the third quarter of 2017, which typically generate less revenue per listing than larger rental properties. We calculate revenue per average monthly rental listing by dividing total rentals revenue for the period by the average monthly deduplicated rental listings for the period. The increase in rentals revenue was also driven in part by the 15% increase in visits to 1,764.8 million for the three months ended March 31, 2018 , which s

35


imilarly increases the likelihood a consumer will contact a rental professional, which in turn increases the likelihood of a lead, click, or lease that we monetize.
Mortgages revenue was $19.0 million for the three months ended March 31, 2018 compared to $20.3 million for the three months ended March 31, 2017 , a decrease of $1.2 million, or 6%. The decrease in mortgages revenue was primarily a result of decreased revenue generated by our Long Form and Custom Quote services. During the three months ended March 31, 2018 , we began testing and implementation of a new consumer lead distribution model, called Connect, in select markets. Following full implementation of Connect, we expect to deliver fewer, more transaction-ready consumer connections to our advertising lenders, which we believe will result in a more efficient experience for all participants. We believe the decrease in revenue generated by Long Form was primarily a result of the fewer, higher quality consumer leads delivered in connection with our testing and initial implementation of Connect in select markets, and other product iterations across our sites which also led to a decrease in leads.
In addition, we believe rising mortgage interest rates in the United States have contributed to a decrease in monetization events, primarily for our Custom Quote service, where we experienced lower refinance volumes than expected. We are uncertain how interest rates will impact mortgages revenue in future periods. The number of mortgage loan information requests submitted by consumers increased 8% to 7.1 million for the three months ended March 31, 2018 from 6.6 million mortgage loan information requests submitted by consumers for the three months ended March 31, 2017 . This resulted in a 13% decrease in our average revenue per loan information request for the three months ended March 31, 2018 compared to the three months ended March 31, 2017 . The growth in loan information requests submitted by consumers increases the likelihood of a monetization event, but there is not a direct correlation between the number of loan requests and mortgage revenue because loan information requests do not always result in revenue recognition.
Other revenue was $38.1 million for the three months ended March 31, 2018 compared to $28.7 million for the three months ended March 31, 2017 , an increase of $9.4 million, or 33%. The increase in other revenue was primarily a result of a 69% increase in revenue generated by our new construction marketing solutions. Growth in new construction revenue was primarily attributable to increases in adoption by and advertising sales to new home builders through our new construction platform.
Cost of Revenue
Cost of revenue was $23.9 million for the three months ended March 31, 2018 compared to $20.2 million for the three months ended March 31, 2017 , an increase of $3.7 million, or 18%. The increase in cost of revenue was primarily attributable to a $1.8 million increase in credit card and ad serving fees, a $1.4 million increase in data center and connectivity costs, and a $0.4 million increase in headcount-related expenses, including share-based compensation expense. We expect our cost of revenue to increase in absolute dollars in future years as we continue to incur more expenses that are associated with growth in revenue, including a significant amount of costs expected to be incurred in future periods related to our Homes segment.
Sales and Marketing
Sales and marketing expenses were $137.3 million for the three months ended March 31, 2018 compared to $105.9 million for the three months ended March 31, 2017 , an increase of $31.4 million, or 30%. The increase in sales and marketing expenses was primarily attributable to increased marketing and advertising expenses of $20.4 million, primarily related to advertising spend to attract consumers across online and offline channels, which supports our growth initiatives.
In addition to the increases in marketing and advertising expenses, headcount-related expenses increased $8.0 million, including share-based compensation expense, due primarily to significant growth in the size of our sales team. The increase in sales and marketing expenses was also attributable to a $0.8 million increase in consulting costs to support our advertising initiatives, and a $0.5 million increase in tradeshows and conferences expense and related travel costs. We expect our sales and marketing expenses to increase in absolute dollars in future years as we continue to expand our sales team and invest more resources in extending our audience through marketing and advertising initiatives. We also expect to incur a significant amount of sales and marketing expenses in future periods related to our Homes segment.
Technology and Development
Technology and development expenses, which include research and development costs, were $93.9 million for the three months ended March 31, 2018 compared to $72.9 million for the three months ended March 31, 2017 , an increase of $21.1 million, or 29%. Approximately $16.1 million of the increase related to growth in headcount-related expenses, including share-

36


based compensation expense, as we continue to grow our engineering teams to support current and future product initiatives. In addition, there was a $4.1 million increase in other non-capitalizable data content expense.
Amortization expense included in technology and development for capitalized website development costs and software was $10.9 million for the three months ended March 31, 2018 and 2017 . Other data content expense was $10.5 million and $6.4 million, respectively, for the three months ended March 31, 2018 and 2017 . Amortization expense included in technology and development related to intangible assets recorded in connection with acquisitions was $9.2 million and $9.9 million, respectively, for the three months ended March 31, 2018 and 2017 . Amortization expense included in technology and development for purchased data content intangible assets was $2.5 million for the three months ended March 31, 2018 and 2017 . We expect our technology and development expenses to increase in absolute dollars over time as we continue to build new mobile and website functionality, including as related to our Homes segment.
General and Administrative
General and administrative expenses were $56.1 million for the three months ended March 31, 2018 compared to $45.5 million for the three months ended March 31, 2017 , an increase of $10.6 million, or 23%. The increase in general and administrative expenses was primarily due to a $5.8 million increase in headcount-related expenses, including share-based compensation expense, driven primarily by growth in headcount in shared corporate services to support our engineering and other teams, a $2.4 million increase in software and hardware costs, a $1.5 million increase in travel and meals expense, a $1.0 million increase in professional services fees, a $0.8 million increase in city and state taxes, a $0.7 million increase in building lease-related expenses including rent, utilities and insurance, partially offset by a $1.0 million decrease in bad debt expense and a $0.6 million decrease in miscellaneous expenses. We expect general and administrative expenses to increase over time in absolute dollars as we continue to expand our business, including as related to the Homes segment.
Liquidity and Capital Resources
As of March 31, 2018 and December 31, 2017 , we had cash, cash equivalents, and investments of $823.0 million and $762.5 million, respectively. Cash and cash equivalents balances consist of operating cash on deposit with financial institutions, money market funds, corporate notes and bonds, commercial paper, U.S. government agency securities and certificates of deposit with original maturities of three months or less. Investments as of March 31, 2018 and December 31, 2017 consist of fixed income securities, which include U.S. government agency securities, corporate notes and bonds, commercial paper, municipal securities, certificates of deposit and foreign government securities. Amounts on deposit with third-party financial institutions exceed the Federal Deposit Insurance Corporation and the Securities Investor Protection Corporation insurance limits, as applicable. We believe that cash from operations and cash, cash equivalents and investment balances will be sufficient to meet our ongoing operating activities, working capital, capital expenditures and other capital requirements for at least the next 12 months.
The implementation and expansion of Zillow Group’s participation as a buyer of homes in the Instant Offers marketplace and a seller of homes to homebuyers will likely have a significant impact on our liquidity and capital resources as a cash and inventory intensive initiative. Initially, we will use cash from our balance sheet to fund the purchases of homes and related costs. We expect to use debt financing in the future to fund a portion of the purchase price of homes and certain related costs, though we cannot guarantee we will be able to obtain financing on favorable terms or at all.
We have outstanding $ 9.6 million aggregate principal of 2020 Notes as of March 31, 2018 . The 2020 Notes were guaranteed by Zillow Group in connection with our February 2015 acquisition of Trulia, Inc. The aggregate principal amount of the 2020 Notes is due on December 15, 2020 if not earlier converted or redeemed. The 2020 Notes are convertible into shares of Zillow Group Class A common stock. 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. The 2020 Notes are redeemable, at our option, in whole or in part on or after December 20, 2018, under certain circumstances. For additional information regarding the 2020 Notes, see Note 11 to our condensed consolidated financial statements.
In December 2016, Zillow Group issued $460.0 million aggregate principal amount of 2021 Notes. 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. 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 March 31, 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 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). For additional information regarding the 2021 Notes, see Note 11 to our condensed consolidated financial statements.

37


The following table presents selected cash flow data for the periods presented:
 
Three Months Ended
March 31,
 
2018
 
2017
 
(in thousands, unaudited)
Cash Flow Data:
 
 
 
Net cash provided by operating activities
$
24,652

 
$
66,958

Net cash used in investing activities
(32,232
)
 
(59,795
)
Net cash provided by financing activities
52,878

 
10,769

Cash Flows Provided By Operating Activities
Our operating cash flows result primarily from cash received from real estate professionals, rental professionals, mortgage professionals and brand advertisers. Our primary uses of cash from operating activities include payments for marketing and advertising activities and employee compensation and benefits. Additionally, uses of cash from operating activities include costs associated with operating our mobile applications and websites and other general corporate expenditures.
For the three months ended March 31, 2018 , net cash provided by operating activities was $24.7 million . This was primarily driven by a net loss of $18.6 million, adjusted by share-based compensation expense of $30.7 million, depreciation and amortization expense of $26.9 million, amortization of contract cost assets of $9.3 million, amortization of the discount and issuance costs on the 2021 Notes of $4.7 million, a non-cash change in our deferred income taxes of $2.6 million, a loss on disposal of property and equipment of $1.8 million, and a change in deferred rent of $3.1 million. Changes in operating assets and liabilities decreased cash provided by operating activities by $29.3 million. The changes in operating assets and liabilities are primarily due to a $19.9 million increase in prepaid expenses and other assets and a $6.7 million decrease in accrued expenses and other current liabilities driven primarily by the timing of payments, and an $11.4 million increase in contract cost assets due primarily to the capitalization of contract cost assets.
For the three months ended March 31, 2017 , net cash provided by operating activities was $67.0 million . This was primarily driven by a net loss of $4.6 million , adjusted by depreciation and amortization expense of $27.1 million , share-based compensation expense of $26.4 million , amortization of the discount and issuance costs on the 2021 Notes of $4.4 million , a loss on disposal of property and equipment of $1.0 million and an increase in bad debt expense of $0.7 million . Changes in operating assets and liabilities increased cash provided by operating activities by $11.6 million. The increase in operating assets and liabilities is primarily due to a $4.7 million increase in accrued expenses and other current liabilities due primarily to interest accrued on the 2021 Notes and the timing of payments related to various expenses, and a $4.7 million increase in prepaid expenses and other assets driven primarily by the timing of payments.
Cash Flows Used In Investing Activities
Our primary investing activities include the purchase and sale or maturity of investments, the purchase of property and equipment and intangible assets, and cash paid in connection with acquisitions.
For the three months ended March 31, 2018 , net cash used in investing activities was $32.2 million . This was primarily the result of $16.9 million of purchases for property and equipment and intangible assets and $15.3 million of net purchases of investments.
For the three months ended March 31, 2017 , net cash used in investing activities was $59.8 million . This was primarily the result of $34.9 million of net purchases of investments, $19.5 million of purchases for property and equipment and intangible assets, and $6.0 million paid in connection with an acquisition, partially offset by $0.6 million in proceeds from our August 2016 sale of our Diverse Solutions business.
Cash Flows Provided By Financing Activities
For the three months ended March 31, 2018 and 2017 , our financing activities primarily related to the exercise of employee option awards. The proceeds from the exercise of option awards for the three months ended March 31, 2018 and 2017 were $52.9 million and $11.0 million , respectively.

38


Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements other than outstanding surety bonds issued for our benefit of approximately $3.7 million as of March 31, 2018 . We do not believe that the surety bonds will have a material effect on our liquidity, capital resources, market risk support or credit risk support. For additional information regarding the surety bonds, see Note 16 to our condensed consolidated financial statements under the subsection titled “Surety Bonds”.
Contractual Obligations and Other Commitments
There have been no material changes outside the ordinary course of business in our commitments under contractual obligations as previously disclosed in our Annual Report on Form 10-K for the year ended  December 31, 2017 .
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 $3.7 million as of March 31, 2018 .
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.
We believe that the assumptions and estimates associated with revenue recognition, the 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, have the greatest potential impact on our condensed consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates.
Revenue Recognition
We recognize revenue when (or as) we satisfy our performance obligations by transferring control of the 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.
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 are Premier Agent, Rentals, Mortgages and Other.
As a practical expedient, we do not adjust the promised amount of consideration for the effects of a significant financing component as the period between our transfer of a promised product or service to a customer and when the customer pays for that product or service is one year or less.
We do not disclose the transaction price related to remaining performance obligations for (i) contracts with an original expected duration of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for performance completed to date.
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.

39


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. 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.
In April 2018, we began testing a new form of lead distribution related to our auction-based pricing model whereby the share of voice purchased by Premier Agents and Premier Brokers will represent both the share of impressions delivered as advertisements and the proportion of validated connections a Premier Agent or Premier Broker receives. When consumers do not select a specific Premier Agent or Premier Broker advertisement, the validated connections will be distributed to Premier Agents and Premier Brokers in proportion to their share of voice. We believe distributing validated 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 in the future to apply this new form of lead distribution more broadly with full adoption by the end of 2018. We are unable to predict whether this change will have a material impact on revenue or other results of operations.
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.
Mortgages Revenue. Mortgages revenue primarily includes marketing products sold to mortgage professionals on a cost per lead basis, including our Long Form and Custom Quote services. For our Long Form 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. In Zillow Group’s Long Form 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. 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. Mortgages revenue also includes revenue generated by Mortech, which provides subscription-based mortgage software solutions, including a product and pricing engine and lead management platform, for which we recognize revenue on a straight-line basis during the contractual period over which the services are provided.
Other Revenue. Other revenue primarily includes revenue generated by new construction and display, as well as revenue from the sale of various other marketing and business products and services to real estate professionals. Our new construction marketing solutions allow home builders to showcase their available inventory to home shoppers. New construction revenue primarily includes revenue generated by advertising sold to builders on a cost per residential community basis, and revenue is recognized on a straight-line basis during the contractual period over which the communities are advertised on our mobile applications and websites. Display revenue primarily consists of graphical mobile and web advertising sold on a cost per thousand impressions or cost per click basis to advertisers promoting their brands on our mobile applications and websites. We recognize display revenue as clicks occur or as impressions are delivered to users interacting with our mobile applications or websites, which is the amount for which we have the right to invoice.
Contract Cost Assets
We capitalize certain incremental costs of obtaining contracts with customers which we expect to recover. These costs relate to commissions paid to sales personnel, primarily for our Premier Agent and Premier Broker programs. As a practical expedient, we recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that we otherwise would have recognized is one year or less. Capitalized commission costs are recorded as contract cost assets in our condensed consolidated balance sheets. Contract cost assets are amortized to expense on a straight-line basis

40


over a period that is consistent with the transfer to the customer of the products or services to which the asset relates, generally the estimated life of the customer relationship. Amortization expense related to contract cost assets is included in sales and marketing expenses in our condensed consolidated statements of operations. Our determination of the estimated life of the customer relationship involves significant judgment. In determining the estimated life of our customer relationships, we consider quantitative and qualitative data, including, but not limited to, historical customer data, recent changes or expected changes in product or service offerings, and changes in how we monetize our products and services. The amortization period for our Premier Agent and Premier Broker programs ranges from two to three years.
Website and Software Development Costs
The costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct and incremental and deemed by management to be significant, are capitalized in property and equipment and amortized on a straight-line basis over their estimated useful lives. Maintenance and enhancement costs, including those costs in the post-implementation stages, are typically expensed as incurred, unless such costs relate to substantial upgrades and enhancements to the website or software that result in added functionality, in which case the costs are capitalized and amortized on a straight-line basis over the estimated useful lives. Amortization expense related to capitalized website and software development costs is included in technology and development expense.
Capitalized development activities placed in service are amortized over the expected useful lives of those releases, currently estimated at one to three years. The estimated useful lives of website and software development activities are reviewed frequently and adjusted as appropriate to reflect upcoming development activities that may include significant upgrades and/or enhancements to the existing functionality.
We exercise judgment in determining the point at which various projects may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the estimated useful lives over which the costs are amortized. To the extent that we change the manner in which we develop and test new features and functionalities related to our mobile applications and websites, assess the ongoing value of capitalized assets, or determine the estimated useful lives over which the costs are amortized, the amount of website and software development costs we capitalize and amortize could change in future periods.
Recoverability of Intangible Assets with Definite Lives and Other Long-Lived Assets
We evaluate intangible assets and other long-lived assets for impairment whenever events or circumstances indicate that they may not be recoverable. Recoverability is measured by comparing the carrying amount of an asset group to future undiscounted net cash flows expected to be generated. We group assets for purposes of such review at the lowest level for which identifiable cash flows of the asset group are largely independent of the cash flows of the other groups of assets and liabilities. If this comparison indicates impairment, the amount of impairment to be recognized is calculated as the difference between the carrying value and the fair value of the asset group.
Unforeseen events, changes in circumstances and market conditions and material differences in estimates of future cash flows could adversely affect the fair value of our assets and could result in an impairment charge. Fair value can be estimated utilizing a number of techniques including quoted market prices, prices for comparable assets, or other valuation processes involving estimates of cash flows, multiples of earnings or revenues, and we may make various assumptions and estimates when performing our impairment assessments, particularly as it relates to cash flow projections. Cash flow estimates are by their nature subjective and include assumptions regarding factors such as recent and forecasted operating performance, revenue trends and operating margins. These estimates could also be adversely impacted by changes in federal, state, or local regulations, economic downturns or developments, or other market conditions affecting our industry.
Share-Based Compensation
We measure compensation expense for all share-based awards at fair value on the date of grant and recognize compensation expense over the service period for awards expected to vest. We use the Black-Scholes-Merton option-pricing model to determine the fair value for option awards and recognize compensation expense on a straight-line basis over the option awards’ vesting period. For restricted stock units and restricted units, we use the market value of our Class A common stock and Class C capital stock, as applicable, on the date of grant to determine the fair value of the award, and we recognize compensation expense on a straight-line basis over the awards’ vesting period.
Determining the fair value of option awards at the grant date requires judgment. If any of the assumptions used in the Black-Scholes-Merton model changes significantly, share-based compensation expense for future option awards may differ materially compared with the awards granted previously. In valuing our option awards, we make assumptions about risk-free interest rates, dividend yields, volatility, and weighted-average expected lives. We account for forfeitures as they occur.

41


Risk-free interest rate.  Risk-free interest rates are derived from U.S. Treasury securities as of the option award’s grant date.
Expected dividend yields.  Expected dividend yields are based on our historical dividend payments, which have been zero to date.
Volatility.  The expected volatility for our Class A common stock and Class C capital stock is estimated using our historical volatility.
Expected term.  The weighted-average expected life of the option awards is estimated based on our historical exercise data.
We will continue to use judgment in evaluating the expected volatility and expected terms utilized for our share-based compensation expense calculations on a prospective basis. Actual results, and future changes in estimates, may differ substantially from management’s current estimates. As we continue to accumulate additional data related to our Class A common stock and Class C capital stock, we may have refinements to the estimates of our expected volatility and expected terms, which could materially impact our future share-based compensation expense. In future periods, we expect our share-based compensation expense to increase as a result of our existing, unrecognized share-based compensation that will be recognized as the awards vest, and as we grant additional share-based awards to attract and retain employees.
Income Taxes
We use the asset and liability approach for accounting and reporting income taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement and tax bases of assets and liabilities at the applicable enacted tax rates. A valuation allowance against deferred tax assets would be established if, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50%) that some or all of the deferred tax assets are not expected to be realized.
Our assumptions, judgments, and estimates relative to the value of our deferred tax assets take into account predictions of the amount and category of future taxable income, such as income from operations or capital gains income. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments, and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments, and estimates mentioned above could cause our actual income tax obligations to differ from our estimates, thus materially impacting our financial position and results of operations.
Since inception, we have typically incurred annual operating losses, and accordingly, we have generally not recorded a material current provision for income taxes, though we have historically in certain instances recorded income tax benefits in connection with acquisitions.
We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit, new tax legislation or the change of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation under the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code, including but not limited to: (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) requiring companies to pay a one-time transition tax on certain untaxed earnings of foreign subsidiaries; (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) eliminating the corporate alternative minimum tax (“AMT”) and how AMT credits are utilized; (5) the additional limitations on deducting executive compensation under IRC Section 162(m); and (6) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017 . Shortly after enactment, implementation guidance was released by the Securities and Exchange Commission that requires a company to reflect the income tax effects of those aspects of the Tax Act for which the accounting under the accounting rules is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but the company is able to determine a reasonable estimate, it should record a provisional estimate in the financial statements. Further, the implementation guidance also provides for a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete their accounting pursuant to the accounting rules.
As of March 31, 2018 , we have not completed our accounting for the income tax effects related to the deduction limitations on compensation under the Tax Act, and we have recorded provisional adjustments where we were able to make reasonable estimates of the effects for which our analysis is not yet complete. The provisional adjustments relate to the

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grandfathering of our executive compensation under Section 162(m) of the Internal Revenue Code. We expect the Internal Revenue Service to provide further guidance in applying the written binding contracts requirement under the Tax Act. We believe the clarifications of this rule could impact our financial position and results of operations by an estimated $2.0 million to $5.0 million.
For the year ending December 31, 2018 , we expect an overall statutory tax rate (including federal, state and foreign taxes) of approximately 24%, but in the absence of the Tax Act we would have expected an overall tax rate of approximately 38%. In 2018, we expect to record income tax benefits to the extent we generate additional operating loss carryforwards.
Business Combinations
We recognize identifiable assets acquired and liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions for the purchase price allocation process to value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill to the extent that we identify adjustments to the preliminary purchase price allocation. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our condensed consolidated statements of operations. We recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined.
Recoverability of Goodwill and Indefinite-Lived Intangible Assets
Goodwill represents the excess of the cost of an acquired business over the fair value of the assets acquired at the date of acquisition, and is not amortized. We assess the impairment of goodwill on an annual basis, in our fourth quarter, or whenever events or changes in circumstances indicate that goodwill may be impaired. Typically, we choose to forgo the initial qualitative assessment and perform a quantitative analysis to assist in our annual evaluation. If impairment exists, the carrying value of the goodwill is reduced to fair value through an impairment charge recorded in our statements of operations.
For our most recent goodwill impairment assessment performed as of October 1, 2017, we chose to forgo the initial qualitative assessment and performed a quantitative analysis whereby we determined that our market capitalization is well in excess of the book value of our common stock, and therefore, we concluded that the fair value of goodwill exceeds its carrying value.
Our indefinite-lived intangible asset is not amortized, and we assess the asset for impairment on an annual basis, in our fourth quarter, or whenever events or changes in circumstances indicate that the asset may be impaired. On an interim basis, we consider if there are any events and circumstances that could affect the significant inputs used to determine the fair value of the indefinite-lived intangible asset, including, but not limited to, costs that could have a negative effect on future expected earnings and cash flows, changes in certain key performance metrics, and changes in management, key personnel, strategy or customers. In our evaluation of our trade names and trademarks indefinite-lived intangible asset, we typically first perform a qualitative assessment to determine whether the fair value of the indefinite-lived intangible asset is more likely than not impaired. If so, we perform a quantitative assessment and an impairment charge is recorded in our statements of operations for the excess of the carrying value of the indefinite-lived intangible assets over their fair value.
Recently Adopted Accounting Standards and Recently Issued Accounting Standards Not Yet Adopted
For information about our recently adopted accounting standards and recently issued accounting standards not yet adopted, see Note 2 of the accompanying notes to our condensed consolidated financial statements included within this report.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks in the ordinary course of our business. These risks primarily consist of fluctuations in interest rates.
Interest Rate Risk
Under our current investment policy, we invest our excess cash in money market funds, certificates of deposit, U.S. government agency securities, commercial paper, foreign government securities, municipal securities, and corporate notes and bonds. Our current investment policy seeks first to preserve principal, second to provide liquidity for our operating and capital needs and third to maximize yield without putting our principal at risk.
Our investments are exposed to market risk due to the fluctuation of prevailing interest rates that may reduce the yield on our investments or their fair value. As our investment portfolio is short-term in nature, we do not believe an immediate 10% increase in interest rates would have a material effect on the fair market value of our portfolio.
As of March 31, 2018 , we have outstanding $460.0 million aggregate principal Convertible Senior Notes due in 2021 (the “2021 Notes”). The 2021 Notes were issued in December 2016 and carry a fixed interest rate of 2.00% per year. As of March 31, 2018 , we also have outstanding $9.6 million aggregate principal Convertible Senior Notes due in 2020 (the “2020 Notes”). The 2020 Notes were guaranteed by Zillow Group in connection with our February 2015 acquisition of Trulia, Inc. The 2020 Notes carry a fixed interest rate of 2.75% per year. Since the 2020 Notes and 2021 Notes bear interest at fixed rates, we have no direct financial statement risk associated with changes in interest rates. However, the fair values of the 2020 Notes and 2021 Notes change primarily when the market price of our stock fluctuates or interest rates change.
For these reasons, we do not expect that our results of operations or cash flows would be materially affected by a sudden change in market interest rates.
Inflation Risk
We do not believe that inflation has had a material effect on our business, results of operations or financial condition. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, results of operations and financial condition.
Foreign Currency Exchange Risk
We do not believe that foreign currency exchange risk has had a material effect on our business, results of operations or financial condition. As we do not maintain a significant balance of foreign currency, we do not believe an immediate 10% increase or decrease in foreign currency exchange rates relative to the U.S. dollar would have a material effect on our business, results of operations or financial condition.  


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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended). Management, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b) as of March 31, 2018 . Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that these disclosure controls and procedures were effective as of March 31, 2018 .
Changes in Internal Control Over Financial Reporting
Except for the implementation of certain internal controls related to our January 1, 2018 adoption of guidance issued by the Financial Accounting Standards Board on revenue from contracts with customers, there were no other changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the three months ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION
Item 1. Legal Proceedings
For information regarding legal proceedings in which we are involved, see Note 16 under the subsection titled “Legal Proceedings” in our Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.

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Item 1A. Risk Factors
Our business is subject to numerous risks. You should carefully consider the following risk factors, as any of these risks could harm our business, results of operations, and future financial performance. Recovery pursuant to our insurance policies may not be available due to policy definitions of covered losses or other factors, and available insurance may be insufficient to compensate for damages, expenses, fines, penalties, and other losses we may incur as a result of these and other risks. In addition, risks and uncertainties not currently known to us or that we currently deem to be immaterial may materially adversely affect our business, financial condition and operating results. If any of these risks occur, the trading price of our common and capital stock could decline, and you could lose all or part of your investment. The following is an update to the risk factors set forth in Part I, Item 1A (Risk Factors) in our Annual Report on Form 10-K for the year ended December 31, 2017 .

Risks Related to Our Business and Industry

If Real Estate, Rental and Mortgage Professionals, Home Builders or Other Advertisers Reduce or End Their Advertising Spending With Us or if We Are Unable to Effectively Manage Advertising Inventory or Pricing, Our Business Would Be Harmed.

Our current financial model depends on revenue generated primarily through sales of advertising products and services to real estate agents and brokerages, rental professionals, mortgage professionals, home builders, and other advertisers in categories relevant to real estate. Our ability to attract and retain advertisers, and ultimately to generate advertising revenue, depends on a number of factors, including how successfully we can:
increase the number of consumers who use our products and services, provide them with tools to promote engagement between real estate market participants, and enhance their user experience so we can retain them;
offer an attractive return on investment to our advertisers for their advertising spending with us;
continue to develop our advertising products and services to increase adoption by and engagement with advertising customers;
keep pace with and anticipate changes in technology to provide industry-leading products and services to advertisers and consumers; and
compete effectively for advertising dollars with other online media companies.

Premier Agent revenue, derived from our Premier Agent and Premier Broker programs, accounted for 71% of total revenue for the three months ended March 31, 2018. This level of revenue concentration suggests that even modest decreases in individual agent advertiser spending across the advertiser population, caused by actual or perceived decreases to return on investment, preference for a competitive service, or other factors, could have a significant negative impact on our results of operations. We do not have long-term contracts with most of our advertisers. Our advertisers could choose to modify or discontinue their relationships with us with little or no advance notice. For example, our self-serve account interface for Premier Agent advertisers allows agent advertisers to independently control the duration of their advertising commitments. We may not succeed in retaining existing advertisers’ spending or capturing a greater share of such spending if we are unable to convince advertisers of the effectiveness or superiority of our products as compared to alternatives, including traditional offline advertising media such as television and newspapers. In addition, we continually evaluate and utilize various pricing and value delivery strategies in order to better align our revenue opportunities with the growth in usage of our mobile and web platforms. In 2016, for example, we implemented a new auction-based pricing method for our Premier Agent products, and in the second quarter of 2018, we will begin testing new ways to connect our users and agent advertisers. Future changes to our pricing or lead delivery methodologies for advertising services or product offerings may cause advertisers to reduce or end their advertising with us or negatively impact our ability to manage revenue opportunities. If advertisers reduce or end their advertising spending with us, or if we are unable to effectively manage inventory and pricing, our advertising revenue and business, results of operations and financial condition would be harmed.

If We Do Not Innovate or Provide High-Quality Products and Services on Mobile and the Web That Are Attractive to Our Users and to Our Advertisers, Our Business Could Be Harmed.

Our success depends on our continued innovation to provide new, and improve upon existing, products and services that make our mobile applications, websites and other tools useful for consumers and real estate, rental and mortgage professionals, and attractive to our advertisers. As a result, we must continually invest significant resources in research and development to improve the attractiveness and comprehensiveness of our products and services, adapt to changes in technology, and support new devices and operating systems. If we are unable to provide products and services that users, including real estate professionals, want to use, on the devices they prefer, then users may become dissatisfied and use competitors’ mobile applications, websites and tools. If consumers begin to access real estate through other media and we fail to innovate, our business may be negatively impacted. If we are unable to continue offering high-quality, innovative products and services, we

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may be unable to attract additional users and advertisers or retain our current users and advertisers, which could harm our business, results of operations and financial condition.

We Face Competition for Consumers in the Real Estate Category, Which Could Impair Our Ability to Attract Users of Our Mobile Applications and Websites, Which Would Harm Our Business, Results of Operations and Financial Condition.

Our business model depends on our ability to continue to attract consumers to our mobile applications and websites and enhance their engagement with our products and services in a cost-effective manner. New entrants continue to join the category at an increasingly rapid pace. Our existing and potential competitors include companies that operate, or could develop, national and local real estate, rental, new construction and mortgage mobile applications and websites. Such competitors range from companies offering traditional offline advertising media, like newspapers, to new mobile- or web-only technology companies. These companies could devote greater financial, technical and other resources than we have available to sales, advertising, or research and development, have a more accelerated time frame for deployment, or leverage their existing user bases and proprietary technologies to provide products and services that consumers might view as superior to our offerings. Any of our future or existing competitors may introduce different solutions that attract consumers or provide solutions similar to our own but with better branding or marketing resources. If we are not able to continue to attract consumers to our mobile applications and websites, our business, results of operations and financial condition would be harmed.

We May Not Be Able to Compete Successfully Against Our Existing or Future Competitors in Attracting Advertisers, Which Could Harm Our Business, Results of Operations and Financial Condition.

We face intense competition from traditional and online or mobile media sources to attract advertisers. Online and on mobile, we compete against websites dedicated to providing real estate, rental, new construction, and mortgage information and services to real estate professionals and consumers, major internet portals, general search engines, e-commerce, and social media sites, as well as other technology and media companies. We also compete for a share of advertisers’ overall marketing budgets with traditional media such as television, magazines, newspapers and home/apartment guide publications, particularly with respect to advertising dollars spent at the local level by real estate professionals to advertise their qualifications and listings. Large companies with significant brand recognition have large numbers of direct sales personnel and substantial proprietary advertising inventory and web traffic, which may provide a competitive advantage. To compete successfully for advertisers against future and existing competitors, we must continue to invest resources in developing our advertising platform and proving the effectiveness and relevance of our advertising products and services. Pressure from competitors seeking to acquire a greater share of our advertisers’ overall marketing budget could adversely affect our pricing and margins, lower our revenue, and increase our research and development and marketing expenses. If we are unable to compete successfully against our existing or future competitors, our business, results of operations or financial condition would be harmed.

We Compete in a Dynamic Industry, and We May Invest Significant Resources to Pursue Strategies and Develop New Products and Services That Do Not Prove Effective.

The industry for residential real estate technology, information marketplaces, services, and advertising is dynamic, and the expectations and behaviors of consumers and professionals shift constantly and rapidly. We continue to learn a great deal about the behaviors and objectives of residential real estate market participants as the industry evolves and are investing significant resources to develop, test, and launch products and services to address the needs of the market and improve the homebuying, selling, financing, building, and renting experience. Changes or additions to our products and services may not attract or engage our users, and may reduce confidence in our products and services, negatively impact the quality of our brands, upset other industry participants, expose us to increased market or legal risks, subject us to new laws and regulations, or otherwise harm our business. Our product Zillow Instant Offers, for example, which allows home sellers to receive a comparative market analysis from a Premier Agent alongside non-binding offers from institutional buyers, may not engage home sellers as we think it will. Further, if we do not realize the benefits we expect from strategic relationships we enter into, including for example, the generation of additional advertising revenue opportunities, our business could be harmed. We may not successfully anticipate or keep pace with industry changes, and we may invest considerable financial, personnel, and other resources to pursue strategies that do not, ultimately, prove effective such that our results of operations and financial condition may be harmed.

The Company’s Participation in Zillow Instant Offers Could Fail to Achieve Expected Results and Cause Harm to Our Financial Results, Operations, and Reputation.

In April 2018, we announced testing of the Company’s participation in Zillow Instant Offers pursuant to which Zillow will purchase homes, make certain repairs and updates, and attempt to sell the homes back into the market (the “Homes business”). This initiative may expose us to a variety of financial, legal, and reputational risks. The success of the Homes

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business depends in part on our ability to efficiently acquire, renovate, and sell properties. In determining whether to purchase a property, we may make assumptions, including the estimated time from purchase to sale, update costs, market conditions and potential resale proceeds, closing costs, and holding costs. These assumptions may be inaccurate. Our estimates of what homes are worth, and the algorithms and other data points used to inform those estimates, may not be accurate and we may pay more for homes than the price at which we are able to resell them. In addition, we may not timely discover latent home construction or environmental hazards or other issues which may decrease the value of properties we own. As a result, we may overpay for properties we acquire, and we may not be able to resell them for the price we anticipated or at all. We plan to use third party service providers to make upgrades to and perform maintenance on homes we acquire and, as a result, we may not be able to effectively control the timing and costs of those projects. Further, homes we purchase may suffer decreases in value due to natural disasters, catastrophic events, or other forces outside of our control. The homes we own may not be insured against all damages and losses.

The supply of and demand for homes, and the amounts prospective homebuyers are willing to pay for properties, are impacted by the strength of the overall economy, employment levels, availability of credit, tax or other governmental incentives that encourage homeownership, and regulation of mortgage interest rates, among other factors. Changes to these factors may negatively impact our ability to purchase a sufficient number of properties to realize benefits of scale and sell properties at the amounts we anticipated, if at all.