Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Quarterly Results of Operations

	Three Months Ended
	2013																2012
	31-Dec				30-Sept				30-June				31-Mar				31-Dec				30-Sept				30-June				31-Mar
	(in thousands, except per share data ) (unaudited )
Net revenues 1	$	178,292			$	164,506			$	163,828			$	153,580			$	142,840			$	136,496			$	145,626			$	135,079
Gross profit 2	136,476				125,090				123,691				112,849				106,478				100,350				108,800				100,760
Income (loss) from operations 3	52,923				41,464				37,901				(38,075		)		17,071				4,503				36,012				28,006
Net income (loss) 3 4	42,422				34,537				29,320				(41,983		)		9,559				(344		)		28,492				20,984
Net income (loss) per share:
Basic	$	0.53			$	0.43			$	0.36			$	(0.52	)		$	0.12			$	—			$	0.35			$	0.26
Diluted	$	0.51			$	0.42			$	0.36			$	(0.52	)		$	0.12			$	—			$	0.34			$	0.26
Shares used in computing net income per share:
Basic	80,432				79,967				80,576				81,248				81,043				81,437				80,384				79,235
Diluted	82,438				81,848				82,149				81,248				82,981				81,437				82,954				81,856

1

In the fourth quarter of 2012, we identified an error that the actual case refinement usage rate was lower than our estimate and, as a result, we recorded a net revenue release of $4.9 million previously deferred for case refinement of which $5.2 million was a correction of an error of which $4.5 million relates to the first three quarters for the fiscal year 2012 and $0.7 million relates to the fiscal year 2011. The adjustment was not material to any quarter within 2012. The net amount of $4.9 million is not material to the results of operations for twelve months ended December 31, 2012.

2

Gross profit for the quarter ended March 2012 included acquisition and integration related costs of $0.1 million, amortization of intangible assets of $0.3 million, and exit costs of $0.3 million. Gross profit for the quarter ended June 2012 included acquisition and integration related costs of $0.1 million, amortization of intangible assets of $0.2 million, and exit costs of $0.1 million. Gross profit for the quarter ended September 2012 included acquisition and integration related costs of $0.1 million, amortization of intangible assets of $0.2 million, and exit costs of $0.1 million. Gross profit for the quarter ended December 2012 amortization of intangible assets of $0.2 million.

3	Income (loss) from operations and net income (loss) included, net of taxes,:

•	$40.7 million and $26.3 million of goodwill and long-lived asset impairment, respectively, in March 2013.

•	Impairment of goodwill of $24.7 million for the quarter ended September 2012 and $11.9 million for the quarter ended December 2012.

•	Acquisition and integration related costs of $0.7 million for the quarter ended March 2012, $0.3 million for the quarter ended June 2012, and $0.2 million for the quarter ended September 2012.

•	Exit costs of $0.5 million for the quarter ended March 2012, $0.2 million for the quarter ended June 2012, and $0.1 million for the quarter ended September 2012.

4

In the fourth quarter of 2013, we recorded an out of period correction that resulted in decreases in cost of net revenues of approximately $1.3 million and operating expense of $1.5 million offset in part by an increase in the provision for income taxes of $0.6 million. The overall increase of $2.2 million in net income related to the out of period correction was not material to the consolidated financial statements for any quarter within 2012 or 2013.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page
Report of Management on Internal Control over Financial Reporting	54
Report of Independent Registered Public Accounting Firm	55
Consolidated Statements of Operations	56
Consolidated Statements of Comprehensive Income	57
Consolidated Balance Sheets	58
Consolidated Statements of Stockholders’ Equity	59
Consolidated Statements of Cash Flows	60
Notes to Consolidated Financial Statements	61

REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Align is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is designed by, or under supervision of, our CEO and CFO, and effected by the board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that:

•	pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Align;

•	provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of Align are being made only in accordance with authorizations of management and directors of Align; and

•	provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Align's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2013. In making this assessment, management used the criteria set forth in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

On April 30, 2013, we acquired ICA Holdings Pty Limited in a purchase business combination. We excluded the acquired business from management's annual assessment of the effectiveness of our internal control over financial reporting as of December 31, 2013. In the aggregate, this business represented approximately 1% of our total consolidated assets and approximately 4% of our total consolidated net revenues as of and for the year ended December 31, 2013.

Based on its assessment , management has concluded that, as of December 31, 2013, our internal control over financial reporting was effective based on criteria in Internal Control - Integrated Framework (1992) issued by the COSO.

The effectiveness of our internal control over financial reporting as of December 31, 2013 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.

/S/ THOMAS M. PRESCOTT
Thomas M. Prescott
President and Chief Executive Officer
February 28, 2014
/S/ DAVID L. WHITE
David L. White
Chief Financial Officer
February 28, 2014

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of Align Technology, Inc.:

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1), present fairly, in all material respects, the financial position of Align Technology, Inc. and its subsidiaries at December 31, 2013 and December 31, 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As described in the Report of Management on Internal Control over Financial Reporting, management has excluded ICA Holdings Pty Limited from its assessment of internal control over financial reporting as of December 31, 2013 because it was acquired by the Company in a purchase business combination during 2013. We have also excluded ICA Holdings Pty Limited from our audit of internal control over financial reporting. ICA Holdings Pty Limited is a wholly-owned subsidiary whose total consolidated assets and total consolidated net revenues represent approximately 1% and approximately 4%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2013.

/s/ PricewaterhouseCoopers LLP

San Jose, California

February 28, 2014

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

	Year Ended December 31,
	2013				2012				2011
Net revenues	$	660,206			$	560,041			$	479,741
Cost of net revenues	162,100				143,653				118,458
Gross profit	498,106				416,388				361,283
Operating expenses:
Sales and marketing	180,046				152,041				142,174
General and administrative	112,752				99,295				91,595
Research and development	44,083				42,869				37,154
Impairment of goodwill	40,693				36,591				—
Impairment of long lived assets	26,320				—				—
Total operating expenses	403,894				330,796				270,923
Income from operations	94,212				85,592				90,360
Other income (expense), net	(1,073		)		(1,296		)		(419		)
Net income before provision for income taxes	93,139				84,296				89,941
Provision for income taxes	28,844				25,605				23,225
Net income	$	64,295			$	58,691			$	66,716
Net income per share:
Basic	$	0.80			$	0.73			$	0.86
Diluted	$	0.78			$	0.71			$	0.83
Shares used in computing net income per share:
Basic	80,551				80,529				77,988
Diluted	82,589				83,040				80,294

The accompanying notes are an integral part of these consolidated financial statements.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME

(in thousands)

	Year Ended December 31,
	2013				2012				2011
Net income	$	64,295			$	58,691			$	66,716
Net change in cumulative translation adjustment	62				129				10
Change in unrealized gains (losses) on available-for sale securities, net of tax	29				28				(98		)
Other comprehensive income (loss)	91				157				(88		)
Comprehensive income	$	64,386			$	58,848			$	66,628

The accompanying notes are an integral part of these consolidated financial statements.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

	December 31,
	2013				2012
ASSETS
Current assets:
Cash and cash equivalents	$	242,953			$	306,386
Marketable securities, short-term	127,040				28,485
Accounts receivable, net of allowance for doubtful accounts and returns of $1,733 and $3,167, respectively	113,250				98,992
Inventories	13,968				15,122
Prepaid expenses and other current assets	47,465				36,808
Total current assets	544,676				485,793
Marketable securities, long-term	101,978				21,252
Property, plant and equipment, net	75,743				79,191
Goodwill	61,623				99,236
Intangible assets, net	23,739				45,777
Deferred tax assets	15,766				21,609
Other assets	8,622				3,454
Total assets	$	832,147			$	756,312
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	17,718			$	19,549
Accrued liabilities	80,345				74,247
Deferred revenues	77,275				61,975
Total current liabilities	175,338				155,771
Other long-term liabilities	22,839				19,224
Total liabilities	198,177				174,995
Commitments and contingencies (Notes 6 and 8)
Stockholders’ equity:
Preferred stock, $0.0001 par value (5,000 shares authorized; none issued)	—				—
Common stock, $0.0001 par value (200,000 shares authorized; 80,583 and 80,611 issued and outstanding at 2013 and 2012, respectively)	8				8
Additional paid-in capital	729,578				670,732
Accumulated other comprehensive income, net	294				203
Accumulated deficit	(95,910		)		(89,626		)
Total stockholders’ equity	633,970				581,317
Total liabilities and stockholders’ equity	$	832,147			$	756,312

The accompanying notes are an integral part of these consolidated financial statements.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the years ended December 31, 2013, 2012 and 2011

(in thousands)

	Common Stock							Additional Paid in Capital				Accumulated Other Comprehensive Income (Loss)				Accumulated Deficit				Total
	Shares			Amount
Balances at December 31, 2010	76,390			$	8			$	555,851			$	134			$	(178,246	)		$	377,747
Net income	—			—				—				—				66,716				66,716
Net change in unrealized gain from available-for sale securities	—			—				—				10				—				10
Net change in cumulative translation adjustment	—			—				—				(98		)		—				(98		)
Issuance of common stock relating to employee equity compensation plans	2,708			—				25,501				—				—				25,501
Tax withholdings related to net share settlement of restricted stock units	—			—				(1,897		)		—				—				(1,897		)
Common stock repurchased and retired	(322	)		—				(2,771		)		—				(4,983		)		(7,754		)
Excess tax provision from share based payment arrangements	—			—				11,391				—				—				11,391
Stock based compensation	—			—				19,165				—				—				19,165
Balances at December 31, 2011	78,776			8				607,240				46				(116,513		)		490,781
Net income	—			—				—				—				58,691				58,691
Net change in unrealized gain from available-for sale securities	—			—				—				28				—				28
Net change in cumulative translation adjustment	—			—				—				129				—				129
Issuance of common stock relating to employee equity compensation plans	3,565			—				42,327				—				—				42,327
Tax withholdings related to net share settlements of restricted stock units	—			—				(2,106		)		—				—				(2,106		)
Common stock repurchased and retired	(1,730	)		—				(15,399		)		—				(31,804		)		(47,203		)
Excess tax benefit from share based payment arrangements	—			—				17,187				—				—				17,187
Stock based compensation	—			—				21,483				—				—				21,483
Balances at December 31, 2012	80,611			8				670,732				203				(89,626		)		581,317
Net income	—			—				—				—				64,295				64,295
Net change in unrealized gain from available-for sale securities	—			—				—				29				—				29
Net change in cumulative translation adjustment	—			—				—				62				—				62
Issuance of common stock relating to employee equity compensation plans	2,694			—				34,196				—				—				34,196
Tax withholdings related to net share settlements of restricted stock units	—			—				(4,363		)		—				—				(4,363		)
Common stock repurchased and retired	(2,722	)		—				(24,528		)		—				(70,579		)		(95,107		)
Excess tax benefit from share based payment arrangements	—			—				27,103				—				—				27,103
Stock based compensation	—			—				26,438				—				—				26,438
Balances at December 31, 2013	80,583			$	8			$	729,578			$	294			$	(95,910	)		$	633,970

The accompanying notes are an integral part of these consolidated financial statements.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Year Ended December 31,
	2013				2012				2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	64,295			$	58,691			$	66,716
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred taxes	21,204				17,783				5,842
Depreciation and amortization	13,887				13,440				12,112
Stock-based compensation	26,438				21,483				19,165
Amortization of intangibles	2,938				4,371				5,365
Excess tax benefit from share-based payment arrangements	(27,103		)		(17,187		)		(11,391		)
Impairment of goodwill	40,693				36,591				—
Impairment of long-lived assets	26,320				—				—
Other non-cash expenses	4,142				4,517				2,572
Changes in assets and liabilities, excluding the effects of business combinations:
Accounts receivable	(11,981		)		(11,666		)		(24,147		)
Inventories	1,158				(5,718		)		(4,058		)
Prepaid expenses and other assets	(392		)		(3,853		)		(2,681		)
Accounts payable	(186		)		(6		)		7,535
Accrued and other long-term liabilities	9,662				2,943				37,105
Deferred revenues	14,901				12,389				16,334
Net cash provided by operating activities	185,976				133,778				130,469
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition, net of cash acquired	(7,652		)		—				(187,588		)
Purchase of property, plant and equipment	(19,412		)		(38,333		)		(30,404		)
Purchase of marketable securities	(303,917		)		(67,511		)		—
Proceeds from maturities of marketable securities	90,917				24,901				8,915
Proceeds from sales of marketable securities	31,741				297				1,402
Other investing activities	(2,411		)		2,346				(3,931		)
Net cash used in investing activities	(210,734		)		(78,300		)		(211,606		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock	34,196				42,327				25,501
Common stock repurchase	(95,107		)		(47,203		)		(7,754		)
Excess tax benefit from share-based payment arrangements	27,103				17,187				11,391
Employees’ taxes paid upon the vesting of restricted stock units	(4,363		)		(2,106		)		(1,897		)
Net cash (used in) provided by financing activities	(38,171		)		10,205				27,241
Effect of foreign exchange rate changes on cash and cash equivalents	(504		)		28				(93		)
Net (decrease) increase in cash and cash equivalents	(63,433		)		65,711				(53,989		)
Cash and cash equivalents, beginning of year	306,386				240,675				294,664
Cash and cash equivalents, end of year	$	242,953			$	306,386			$	240,675

The accompanying notes are an integral part of these consolidated financial statements.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies

Business Description

Align Technology, Inc. (“We”, “Our”, or “Align”) was incorporated in April 1997 in Delaware and focuses on designing, manufacturing and marketing innovative, technology-rich products to help dental professionals achieve the clinical results they expect and deliver effective, convenient cutting-edge dental treatment options to their patients. We are headquartered in San Jose, California with offices worldwide. Our international headquarters are located in Amsterdam, the Netherlands. We have two operating segments, (1) Clear Aligner, known as the Invisalign System, and (2) Scanners and CAD/CAM Services ("SCCS"), known as the iTero intra-oral scanner and OrthoCAD services.

Basis of presentation and preparation

The consolidated financial statements include the accounts of Align and our wholly-owned subsidiaries after elimination of intercompany transactions and balances. Certain amounts within revenues and cost of revenues in prior periods have been reclassified to conform with the current period presentation. These reclassifications had no impact on previously reported gross profit or financial position.

In connection with the preparation of the consolidated financial statements, we evaluated events subsequent to the balance sheet date through the financial statement issuance date and determined that all material transactions have been recorded and disclosed properly.

Out of period adjustment

In 2013, we recorded an out of period correction that resulted in decreases in cost of net revenues of approximately $1.7 million and operating expense of $0.7 million offset in part by an increase in the provision for income taxes of $0.5 million. We do not believe the increase of $1.9 million to net income related to the out of period adjustment is material to the consolidated financial statements for the fiscal year ended December 31, 2013 or to any prior years' consolidated financial statements.

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S.”) requires our management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, we evaluate our estimates, including those related to the fair values of financial instruments, intangible assets and goodwill, useful lives of intangible assets and property and equipment, stock-based compensation, revenue recognition, income taxes, and contingent liabilities, among others. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

Fair value of financial instruments

The carrying amounts of our cash, accounts receivable, accounts payable and other current liabilities approximate their fair value.

We measure our cash equivalents, marketable securities, and our Israeli severance fund at fair value. Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

Level 1— Quoted (unadjusted) prices in active markets for identical assets or liabilities.

Level 2— Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Level 3 – Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.

Cash and cash equivalents

We consider currency on hand, demand deposits, time deposits, and all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash and cash equivalents. Cash and cash equivalents are held in various financial institutions in the U.S. and internationally.

Restricted cash

Our restricted cash balance as of December 31, 2013 was $4.0 million, included in Long Term Assets, and primarily consisted of funds reserved for legal requirements. The restricted cash balance as of December 31, 2012 was $1.6 million, included in Prepaid Expenses and Other Current Assets, and represented unclaimed merger consideration related to the acquisition of Cadent Holdings in April 2011.

Marketable securities

We invest primarily in money market funds, commercial paper, corporate bonds, U.S. dollar dominated foreign corporate bonds, U.S. government agencies and municipal bonds.

Marketable securities are classified as available-for-sale and are carried at fair value. Marketable securities classified as current assets have maturities of less than one year. Unrealized gains or losses on such securities are included in accumulated other comprehensive income (loss) in stockholders’ equity. Realized gains and losses from maturities of all such securities are reported in earnings and computed using the specific identification cost method. Realized gains or losses and charges for other-than-temporary declines in value, if any, on available-for-sale securities are reported in other income (expense) as incurred. We periodically evaluate these investments for other-than-temporary impairment.

Foreign currency

For our international subsidiaries where the U.S. dollar is the functional currency, we analyze on an annual basis or more often if necessary, if a significant change in facts and circumstances indicate that the primary economic currency has changed. Adjustments from translating certain European and Asia-Pacific subsidiaries’ financial statements from the local currency to the U.S. dollar are recorded as a separate component of accumulated other comprehensive income (loss), net in the stockholders’ equity section of the Consolidated Balance Sheets. This foreign currency translation adjustment reflects the translation of the balance sheet at period end exchange rates, and the income statement at an average exchange rate in effect during the period. As of December 31, 2013 and 2012, there were no material amounts in accumulated other comprehensive income, net related to the translation of our foreign subsidiaries’ financial statements.

Our other international entities operate in a U.S. dollar functional currency environment, and therefore, the foreign currency assets and liabilities are remeasured into the U.S. dollar at current exchange rates except for non-monetary assets and liabilities which are remeasured at historical exchange rates. Revenues and expenses are generally remeasured at an average exchange rate in effect during each period. Gains or losses from foreign currency remeasurement are included in other income (expense). For the year ended December 31, 2013 and 2012, foreign currency gains and losses were not significant.

Certain risks and uncertainties

Our operating results depend to a significant extent on our ability to market and develop our products. The life cycles of our products are difficult to estimate due, in part, to the effect of future product enhancements and competition. Our inability to successfully develop and market our products as a result of competition or other factors would have a material adverse effect on our business, financial condition and results of operations.

Our cash and investments are held primarily by two financial institutions. Financial instruments which potentially expose us to concentrations of credit risk consist primarily of cash equivalents, marketable securities and accounts receivable. We invest excess cash primarily in money market funds of major financial institutions, U.S. government agencies, U.S. dollar dominated foreign corporate bonds and domestic corporate bonds. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to write down the value of our investments, which could materially harm our results of operations and financial condition. Moreover, the performance of

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

certain securities in our investment portfolio correlates with the credit condition of the U.S. economy. We provide credit to customers in the normal course of business. Collateral is not required for accounts receivable, but ongoing evaluations of customers’ credit worthiness are performed. We maintain reserves for potential credit losses and such losses have been within management’s expectations. No individual customer accounted for 10% or more of our accounts receivable at December 31, 2013 or 2012, or net revenues for the year ended December 31, 2013, 2012, or 2011.

In the U.S., the Food and Drug Administration (“FDA”) regulates the design, manufacture, distribution, pre-clinical and clinical study, clearance and approval of medical devices. Products developed by us may require approvals or clearances from the FDA or other international regulatory agencies prior to commercialized sales. There can be no assurance that our products will receive any of the required approvals or clearances. If we were denied approval or clearance or such approval was delayed, it may have a material adverse impact on us.

We have manufacturing operations located outside the U.S. We currently rely on our manufacturing facility in Costa Rica to prepare digital treatment plans using a sophisticated, internally developed computer-modeling program. In addition, we manufacture our clear aligners and distribute our intra-oral scanners at our facility in Juarez, Mexico, and we produce our handheld scanner wand in Or Yehuda, Israel. Our reliance on international operations exposes us to related risks and uncertainties, including difficulties in staffing and managing international operations such as hiring and retaining qualified personnel; controlling production volume and quality of manufacture; political, social and economic instability, particularly as a result of increased levels of violence in Juarez, Mexico and Israel; interruptions and limitations in telecommunication services; product and material transportation delays or disruption; trade restrictions and changes in tariffs; import and export license requirements and restrictions; fluctuations in foreign currency exchange rates; and potential adverse tax consequences. If any of these risks materialize, our international manufacturing operations, as well as our operating results, may be harmed.

We purchase certain inventory from sole suppliers. Additionally, we rely on a limited number of hardware manufacturers. The inability of any supplier or manufacturer to fulfill our supply requirements could materially and adversely impact our future operating results.

Inventories

Inventories are valued at the lower of cost or market, with cost computed using either standard cost (which approximates actual cost) or average and actual cost on a first-in-first-out basis. Excess and obsolete inventories are determined primarily based on future demand forecasts, and write-downs of excess and obsolete inventories are recorded as a component of cost of revenues.

Property, plant and equipment

Property, plant and equipment are stated at historical cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, generally three to ten years. We amortize leasehold improvements over the shorter of the remaining lease term of up to five years or the estimated useful lives of the assets. We depreciate buildings over periods up to 20 years. Land is not depreciated. Construction in progress is related to the construction or development of property (including land) and equipment that have not yet been placed in service for their intended use. Upon sale or retirement, the asset’s cost and related accumulated depreciation are removed from the general ledger and any related gains or losses are reflected in operating expenses. Maintenance and repairs are expensed as incurred.

Goodwill and finite-lived acquired intangible assets

Goodwill represents the excess of the purchase price paid over the fair value of tangible and identifiable intangible net assets acquired in business combinations and is allocated to the respective reporting units based on relative synergies generated.

Our intangible assets primarily consist of intangible assets acquired as part of the Cadent acquisition. These assets are amortized using the straight-line method over their estimated useful lives of one to fifteen years, reflecting the period in which the economic benefits of the assets are expected to be realized.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Impairment of goodwill and long-lived assets

Goodwill

We evaluate goodwill for impairment at least annually on November 30th or more frequently if indicators are present, an event occurs or circumstances changes that suggest an impairment may exist and that it would more likely than not reduce the fair value of a reporting unit below its carrying amount. The allocation of goodwill to the respective reporting unit is based on relative synergies generated as a result of an acquisition.

We perform an initial assessment of qualitative factors to determine whether the existence of events and circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. In performing the qualitative assessment, we identify and consider the significance of relevant key factors, events, and circumstances that affect the fair value of our reporting units. These factors include external factors such as macroeconomic, industry, and market conditions, as well as entity-specific factors, such as our actual and planned financial performance. We also give consideration to the difference between the reporting unit fair value and carrying value as of the most recent date a fair value measurement was performed. If, after assessing the totality of relevant events and circumstances, we determine that it is more likely than not that the fair value of the reporting unit exceeds its carrying value and there is no indication of impairment, no further testing is performed; however, if we conclude otherwise, the first step of the two-step impairment test is performed by estimating the fair value of the reporting unit and comparing it with its carrying value, including goodwill.

Step one of the goodwill impairment test consists of a comparison of the fair value of a reporting unit against its carrying amount, including the goodwill allocated to each reporting unit. We determine the fair value of our reporting units based on the present value of estimated future cash flows under the income approach of the reporting units as well as various price or market multiples applied to the reporting unit's operating results along with the appropriate control premium under the marketing approach, both of which are classified as level 3 within the fair value hierarchy (as described in Note 2 in our consolidated financial statements). If the carrying amount of the reporting unit is in excess of its fair value, step two requires the comparison of the implied fair value of the reporting unit’s goodwill against the carrying amount of the reporting unit’s goodwill. Any excess of the carrying value of the reporting unit’s goodwill over the implied fair value of the reporting unit’s goodwill is recorded as an impairment loss.

During March 2013, changes in the competitive environment for intra-oral scanners, including announcements from our competitors of new low-priced scanners targeted at orthodontists and general practitioner dentists ("GP") in North America, caused us to lower our expectations for growth and profitability for our SCCS reporting unit. As a result, we determined that goodwill related only to our SCCS reporting unit should be tested for impairment as of March 2013 due to these facts and circumstances which would more likely than not reduce the fair value of our SCCS reporting unit below its carrying amount. There was no triggering event related to the Clear Aligner goodwill. Refer to Note 5 for details of the impairment analysis.

The remaining goodwill is entirely attributable to our Clear Aligner reporting unit. During the fourth quarter of fiscal 2013, we performed the annual goodwill impairment testing using the qualitative approach discussed above and found no impairment as the fair value of our Clear Aligner reporting unit was significantly in excess of the carrying value.

Finite-lived intangible assets and long-lived assets

We evaluate long-lived assets (including finite-lived intangible assets) for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. An asset or asset group is considered impaired if its carrying amount exceeds the future undiscounted net cash flows the asset or asset group is expected to generate. If an asset or asset group is considered to be impaired, the impairment to be recognized is calculated as the amount by which the carrying amount of the asset or asset group exceeds its fair market value. Our estimates of future cash flows attributable to our long-lived assets require significant judgment based on our historical and anticipated results and are subject to many factors. Factors we consider important which could trigger an impairment review include significant negative industry or economic trends, significant loss of customers and changes in the competitive environment. We use a DCF approach, utilizing harvest model, to estimate the fair value of a reporting unit, which we believe is the most reliable indicator of fair value of a business, and is most consistent with the approach of a marketplace participant would use. The estimation of fair value utilizing a DCF approach includes numerous uncertainties which require our significant judgment when making assumptions of expected growth rates and the selection of discount rates, as well as assumptions regarding general economic

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

and business conditions, and the structure that would yield the highest economic value, among other factors. Key assumptions used in measuring the fair values of SCCS reporting unit included the discount rate (based on the weighted-average cost of capital) and revenue growth. The fair value of SCCS’s trademark was determined using a risk-adjusted DCF model under the relief-from-royalty method. The royalty rate used was based on a consideration of market rates. The fair value of SCCS’s finite-lived customer relationships was determined using a DCF model under the multi-period excess earnings method. We recorded a long-lived asset impairment in the quarter ended March 31, 2013 due to changes in the competitive environment for our intra-oral scanners, including announcements from our competitors of new low-priced scanners targeted at orthodontists and general practitioner dentists in North America. There was no triggering event related to the Clear Aligner asset group. Refer to Note 5 for details of the impairment analysis.

There were no further triggering events in 2013 that would cause further impairments of our long-lived assets.

Development costs for internal use software

Costs relating to internal use software are accounted for in accordance with the provisions of accounting for the costs of computer software developed or obtained for internal use. Capitalized software costs are amortized over the estimated useful life of three years. Development costs for internal use software for the year ended December 31, 2013, 2012, or 2011 were not material.

Product Warranty

Clear Aligner

We warrant our Invisalign products against material defects until the Invisalign case is complete. We accrue for warranty costs in cost of net revenues upon shipment of products. The amount of accrued estimated warranty costs is primarily based on historical experience as to product failures as well as current information on replacement costs. Actual warranty costs could differ materially from the estimated amounts. We regularly review the accrued balances and update these balances based on historical warranty cost trends. As a result of our mid-course correction policy change in June 2013, we Have experienced a reduction in our warranty claims, which has decreased our warranty reserve.

Scanners and CAD/CAM Services

We warrant our intra-oral scanners for a period of one year, which include materials and labor. We accrue for these warranty costs based on average historical repair costs. An extended warranty may be purchased for additional fees.

Allowance for Doubtful Accounts and Returns

We maintain allowances for doubtful accounts, for customers that are not able to make payments, and for sales returns. We periodically review these allowances, including an analysis of the customers’ payment history and information regarding the customers’ creditworthiness, as well as historical sales returns as a percentage of revenue. Actual write-offs have not materially differed from the estimated allowance.

Revenue Recognition

We measure and allocate revenue according to the accounting guidance for multiple-deliverable revenue arrangements in Accounting Standards Update (“ASU”) 2009-13, Multiple-Deliverable Revenue Arrangements-a consensus of the Financial Accounting Standard Board (“FASB” )Emerging Issues Task Force.

Multiple-Element Arrangements (“MEAs”): Arrangements with customers may include multiple deliverables, including any combination of products/equipment and services. The deliverables included in the MEAs are separated into more than one unit of accounting when (i) the delivered product/equipment has value to the customer on a stand-alone basis, and (ii) delivery of the undelivered service element(s) is probable and substantially in our control. Arrangement consideration is then allocated to each unit, delivered or undelivered, based on the relative selling price (“RSP”) of each unit of accounting based first on vendor-specific objective evidence (“VSOE”) if it exists, second on third-party evidence (“TPE”) if it exists, and on best estimated selling price (“BESP”) if neither VSOE or TPE exist.

•	VSOE – In most instances, products are sold separately in stand-alone arrangements. Services are also sold separately through renewals of contracts with varying periods. We determine VSOE based on its pricing and discounting practices for the specific product or service when sold separately, considering geographical, customer,

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

and other economic or marketing variables, as well as renewal rates or stand-alone prices for the service element(s).

•	TPE – If we cannot establish VSOE of selling price for a specific product or service included in a multiple-element arrangement, we use third-party evidence of selling price. We determine TPE based on sales of comparable amount of similar products or service offered by multiple third parties considering the degree of customization and similarity of product or service sold.

•

BESP – The best estimated selling price represents the price at which we would sell a product or service if it were sold on a stand-alone basis. When VSOE or TPE do not exist for all elements, we determine BESP for the arrangement element based on sales, cost and margin analysis, as well as other inputs based on its pricing practices. Adjustments for other market and Company-specific factors are made as deemed necessary in determining BESP.

Provisions for discounts and rebates to customers are provided for in the same period that the related product sales are recorded based upon historical discounts and rebates.

Clear Aligner

We enter into arrangements (“treatment plans”) that involve multiple future product deliverables. Invisalign Full, Invisalign Teen and Invisalign Assist include up to 3 optional case refinements. Case refinement is a finishing tool used to adjust a patient's teeth to the desired final position. Case refinement may be elected by the dental professional at any time during treatment however it is generally ordered in the last stages of orthodontic treatment. Beginning June 15, 2013, Invisalign Full and Invisalign Teen also include up to three optional mid-course corrections. Mid-course correction is a treatment adjustment during active treatment if the case is not tracking to the original treatment plan or goals. Mid-course correction gives doctors the ability to "adjust course' based on the needs of the individual patient. Invisalign Teen also includes up to six optional replacement aligners in the price of the product and may be ordered any time throughout treatment.

We determined that our treatment plans, except Invisalign Assist with progress tracking, comprise the following deliverables which also represent separate units of accounting: single-batched aligners, case refinement mid-course correction and replacement aligners. We allocate revenue for each treatment plan based on each unit's relative selling price based on BESP and recognize the revenue upon the delivery of each unit in the treatment plan. We regularly review our estimates of selling price and maintain internal controls over the establishment and update of these estimates.

For Invisalign Assist with the progress tracking feature, aligners and services are provided to the dental professional every nine stages (“a batch”). Beginning January 1, 2011, we were able to reliably estimate the number of batches which are expected to be shipped for each case based upon our historical experience. The amounts allocated to this deliverable are recognized on a prorated basis as each batch is shipped.

Prior to 2013, the Vivera Retainer included four shipments per year, and revenue was recognized ratably as each shipment occurred. In the first quarter of 2013, we consolidated Vivera Retainer product shipments down to one shipment per year.

Scanners and CAD/CAM Services

We recognize revenues from the sales of iTero intra-oral scanners and CAD/CAM services. CAD/CAM services include scanning services, extended warranty for the intra-oral scanners, a range of iTero restorative services and OrthoCAD services such as OrthoCAD iRecord. We sell intra-oral scanners and services through both our direct sales force and distribution partners. The intra-oral scanner sales price includes one year of warranty, and for additional fees, the customer may select an unlimited scanning service agreement over a fixed period of time or extended warranty periods. Revenue is recognized when persuasive evidence of the arrangement exists, the price is fixed or determinable, collectability is reasonably assured, title and risk of loss has passed to customers based on the shipping terms, no significant obligations remain, and allowances for discounts, returns, and customer incentives can be reliably estimated. When intra-oral scanners are sold with either an unlimited scanning service agreement and/or extended warranty, we allocate revenue based on each element's relative selling price. We estimate the selling price of each element, as if it is sold on a stand-alone basis, taking into consideration historical prices as well as our discounting strategies. Scanner revenue, net of related discounts and allowances, is recognized when products or equipment have been shipped, installed and on-site training completed. For certain distributors who provide installation and training to the customer, we recognize scanner revenue when the intra-oral scanner is shipped to the distributor assuming all of the other revenue recognition criteria have been met.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Discounts are deducted from revenue at the time of sale or when the discount is offered, whichever is later and free cases or training is included as a deliverable in the multiple-element arrangement assessment. Returns of products, excluding warranty related returns, are infrequent and insignificant.

Service revenue, including iTero restorative and all OrthoCAD services are recognized upon delivery or ratably over the contract term as the specified services are performed. If a customer selects a pay per use basis for scanning service fees, the revenue is recognized as the service is provided.

We offer customers an option to purchase extended warranties on certain products. We recognize revenue on these extended warranty contracts ratably over the life of the contract. The costs associated with these extended warranty contracts are recognized when incurred.

Shipping and Handling Costs

Shipping and handling charges to customers are included in net revenues, and the associated costs incurred are recorded in cost of revenues.

Legal Proceedings and Litigations

We are involved in legal proceedings on an ongoing basis. If we believe that a loss arising from such matters is probable and can be reasonably estimated, we accrue the estimated liability in our financial statements. If only a range of estimated losses can be determined, we accrue an amount within the range that, in our judgment, reflect the most likely outcome; if none of the estimates within that range is a better estimate than any other amount, we accrue the low end of the range.

Research and development

Research and development expense is expensed as incurred and includes the costs associated with the research and development of new products and enhancements to existing products. These costs primarily include compensation costs, including stock-based compensation expense, outside consulting expenses , costs associated with conducting clinical and pre-commercialization trial and testing, allocations of corporate overhead expenses including facilities, IT and human resource costs, equipment costs and depreciation and amortization.

Advertising costs

The cost of advertising and media is expensed as incurred. For the years ended December 31, 2013, 2012 and 2011 advertising costs totaled $26.0 million, $23.6 million and $21.2 million, respectively.

Common stock repurchase

We repurchase our own common stock from time to time in the open market when our Board of Directors approve a stock repurchase program. We account for these repurchase under the accounting guidance for equity where we allocate the total repurchase value that are in excess over par between additional paid in capital and retained earnings. All shares repurchased are retired.

Operating leases

We currently lease office spaces, automobiles and equipment under operating leases with original lease periods of up to 9 years. Certain of these leases have free or escalating rent payment provisions and lease incentives provided by the landlord. We recognize rent expense under such leases on a straight-line basis over the term of the lease as certain leases have adjustments for market provisions.

Income taxes

We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.

As part of the process of preparing our Consolidated Financial Statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our current tax exposure under the

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

applicable tax laws and assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Consolidated Balance Sheets.

We account for uncertainty in income taxes pursuant to authoritative guidance based on a two-step approach to recognize and measure uncertain tax positions taken or expected to be taken in a tax return. The first step is to determine if the weight of available evidence indicates that it is more likely than not that the tax position will be sustained on audit based on its technical merits, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. We adjust reserves for our uncertain tax positions due to changing facts and circumstances, such as the closing of a tax audit, or refinement of estimates due to new information. To the extent that the final outcome of these matters is different than the amounts recorded, such differences will impact our tax provision in our Consolidated Statements of Operations in the period in which such determination is made.

We assess the likelihood that we will be able to realize our deferred tax assets. Should there be a change in our ability to realize our deferred tax assets, our tax provision would increase in the period in which we determine that it is more likely than not that we cannot realize our deferred tax assets. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If it is more likely than not that we will not realize our deferred tax assets, we will increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be realizable. The available positive evidence at December 31, 2013 included historical operating profits and a projection of future income sufficient to realize most of our remaining deferred tax assets. As of December 31, 2013, it was considered more likely than not that our deferred tax assets would be realized with the exception of certain foreign loss carryovers as we are unable to forecast sufficient future profits to realize the deferred tax assets.

As of December 31, 2013, U.S. income taxes and foreign withholding taxes associated with the repatriation of undistributed earnings of foreign subsidiaries were not provided for on a cumulative total of $186.4 million. We intend to reinvest these earnings indefinitely in our foreign subsidiaries. If these earnings were distributed in the form of dividends or otherwise, or if the shares of the relevant foreign subsidiaries were sold or otherwise transferred, we would be subject to additional U.S. income taxes subject to an adjustment for foreign tax credit, and foreign withholding taxes. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable.

Accounting guidance for stock-based compensation prohibits recognition of a deferred income tax asset for excess tax benefits due to stock option exercises that have not yet been realized through a reduction in income taxes payable. We follow the tax law ordering method to determine when excess tax benefits have been realized and consider only the direct impacts of awards when calculating the amount of windfalls or shortfalls.

Stock-based compensation

We recognize stock-based compensation cost for only those shares ultimately expected to vest on a straight-line basis over the requisite service period of the award. We estimate the fair value of market-performance based restricted stock units using a Monte Carlo simulation model which requires the input of assumptions, including expected term, stock price volatility and the risk-free rate of return. In addition, judgment is also required in estimating the number of stock-based awards that are expected to be forfeited. Forfeitures are estimated based on historical experience at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.

Medical Device Excise Taxes

In accordance with the Patient Protection and Affordable Care Act, effective January 1, 2013, we began to incur an excise tax on sales of medical devices in the U.S. We record the medical device excise tax in general and administrative expenses in the consolidated statement of operations. The medical excise tax expense was $7.1 million for the year ended December 31, 2013. Any future changes in the applicability of the medical device excise tax as it applies to us will be recorded as an additional expense or a credit to the consolidated statement of operations in the period in which it becomes probable and reasonably estimable.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Comprehensive income (loss)

Comprehensive income (loss) includes all changes in equity during a period from non-owner sources. Comprehensive income (loss), including unrealized gains and losses on available-for-sale securities and foreign currency translation adjustments, are reported net of their related tax effect.

Recent Accounting Pronouncements

In July 2013, Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-11, "Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force)." The amendments in this ASU provide guidance on the financial statements presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward with certain exceptions, in which case such an unrecognized tax benefit should be presented in the financial statements as a liability. The amendments in this ASU do not require new recurring disclosures and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. We are currently assessing the impact of this ASU on our consolidated financial statements.

Note 2. Marketable Securities and Fair Value Measurements

As of December 31, 2013 and 2012, the estimated fair value of our short-term and long-term investments, classified as available for sale, are as follows (in thousands):

Short-term

December 31, 2013	Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Commercial paper	$	54,318			$	10			$	—			$	54,328
Corporate bonds	29,079				10				(4		)		29,085
U.S. dollar dominated foreign corporate bonds	13,959				12				—				13,971
Municipal securities	7,006				11				(3		)		7,014
U.S. government agency bonds	16,693				10				—				16,703
Asset-backed securities	5,937				2				—				5,939
Total Marketable Securities, Short-Term	$	126,992			$	55			$	(7	)		$	127,040

Long-term

December 31, 2013	Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
U.S. government agency bonds	$	38,138			$	1			$	(21	)		$	38,118
Corporate bonds	23,308				14				(9		)		23,313
U.S. dollar dominated foreign corporate bonds	19,485				27				(17		)		19,495
U.S. government treasury bonds	6,916				3				—				6,919
Municipal securities	8,326				13				(8		)		8,331
Asset-backed securities	5,800				4				(2		)		5,802
Total Marketable Securities, Long-Term	$	101,973			$	62			$	(57	)		$	101,978

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Short-term

December 31, 2012	Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Commercial paper	$	4,646			$	1			$	—			$	4,647
Corporate bonds	18,767				7				(4		)		18,770
U.S. dollar dominated foreign corporate bonds	5,060				9				(1		)		5,068
Total Marketable Securities, Short-Term	$	28,473			$	17			$	(5	)		$	28,485

Long-term

December 31, 2012	Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Corporate bonds	$	16,132			$	16			$	(7	)		$	16,141
U.S. dollar dominated foreign corporate bonds	3,038				4				(1		)		3,041
U.S. government agency bonds	2,069				1				—				2,070
Total Marketable Securities, Long-Term	$	21,239			$	21			$	(8	)		$	21,252

For the years ended December 31, 2013 and 2012, realized losses were immaterial. Cash and cash equivalents were not included in the table above as the gross unrealized gains and losses were not material. We have no material short-term or long-term investments that have been in continuous unrealized loss positions for greater than twelve months as of December 31, 2013. Amounts reclassified to earnings from unrealized gain or losses were immaterial in 2013 and 2012.

Our fixed-income securities investment portfolio consists of corporate bonds, U.S. dollar dominated foreign corporate bonds, commercial paper, municipal securities, U.S. government agency bonds and asset-backed securities that have a maximum maturity of two years. The securities that we invest in are generally deemed to be low risk based on their credit ratings from the major rating agencies. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As interest rates increase, those securities purchased at a lower yield show a mark-to-market unrealized loss. The unrealized losses are due primarily to changes in credit spreads and interest rates. We expect to realize the full value of all these investments upon maturity or sale. The weighted average remaining duration of these securities was approximately 10 months as of December 31, 2013 and 2012.

As the carrying value approximates the fair value for our short-term and long-term marketable securities shown in the tables above, the following table summarizes the fair value of our short-term and long-term marketable securities classified by maturity as of December 31, 2013 and 2012 (in thousands):

		December 31,				December 31,
		2013				2012
One year or less		$	127,040			$	28,485
One year through two years		101,978				21,252
		$	229,018			$	49,737

Fair Value Measurements

We measure the fair value of our cash equivalents and marketable securities as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We use the U.S. GAAP fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. This hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value:

Level 1—Quoted (unadjusted) prices in active markets for identical assets or liabilities.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Our Level 1 assets consist of money market funds and commercial paper. We did not hold any Level 1 liabilities as of December 31, 2013 or 2012.

Level 2—Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Our Level 2 assets consist of commercial paper, corporate bonds, U.S. dollar denominated foreign corporate bonds, U.S. government agency bonds, and our Israeli funds that are mainly invested in insurance policies. We obtain these fair values for level 2 investments from our asset manager for each of our portfolios. Our custody bank and asset managers independently use professional pricing services to gather pricing data which may include quoted market prices for identical or comparable financial instruments, or inputs other than quoted prices that are observable either directly or indirectly, and we are ultimately responsible for these underlying estimates.

We did not hold any Level 2 liabilities as of December 31, 2013 or 2012.

Level 3—Unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow ("DCF") methodologies or similar valuation techniques, as well as significant management judgment or estimation.

We did not hold any Level 3 assets or liabilities as of December 31, 2013 or 2012.

Non-Recurring Fair Value Measurements

During 2013, we recorded an impairment charge to our long-lived assets and goodwill of $26.3 million and $40.7 million, respectively, related to our Scanner and CAD/CAM Services ("SCCS") reporting unit as an event occurred and circumstances changed that led us to perform an impairment analysis prior to our annual test which required us to determine the fair value of the SCCS reporting unit (Refer to Note 5). These fair value measurements were calculated using unobservable inputs, using the income approach which is classified as Level 3 within the fair value hierarchy. Inputs for the income approach includes the amount and timing of future cash flows based on our most recent operational budgets, strategic plans, terminal growth rates assumptions and other estimates.

During 2012, we recorded a goodwill impairment charge of $36.6 million related to our SCCS reporting unit as an event occurred or circumstances changed that led us to perform a goodwill impairment analysis between the annual test which required us to determine the fair value of the SCCS reporting unit (Refer to Note 5). These fair value measurements were calculated using unobservable inputs, using both the income and market approach, which are classified as Level 3 within the fair value hierarchy. Inputs for the income approach includes the amount and timing of future cash flows based on our most recent operational budgets, strategic plans, terminal growth rates assumptions and other estimates. The primary input for the market approach include market multiples for guideline companies that operate in a similar business environment.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table summarizes our financial assets measured at fair value on a recurring basis as of December 31, 2013and 2012 (in thousands):

Description	Balance as of December 31, 2013				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)
Cash equivalents:
Money market funds	$	143,540			$	143,540			$	—
Commercial paper	15,398				—				15,398
Short-term investments:
Commercial paper	54,328				—				54,328
Corporate bonds	29,085				—				29,085
U.S. dollar denominated foreign corporate bonds	13,971				—				13,971
Municipal securities	7,014				—				7,014
U.S. government agency bonds	16,703				—				16,704
Asset-backed securities	5,939				—				5,938
Long-term investments:
Corporate bonds	23,313				—				23,313
U.S. government agency bonds	38,118				—				38,118
U.S. dollar denominated foreign corporate bonds	19,495				—				19,495
U.S. government treasury bonds	6,919				6,919				—
Municipal securities	8,331				—				8,331
Asset-backed securities	5,802				—				5,802
Long-term other assets:
Israeli funds	2,193				—				2,193
	$	390,149			$	150,459			$	239,690

Description	Balance as of December 31, 2012				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)
Cash equivalents:
Money market funds	$	86,166			$	86,166			$	—
Commercial paper	950				—				950
Short-term investments:
Commercial paper	4,647				—				4,647
Corporate bonds	18,770				—				18,770
U.S. dollar denominated foreign corporate bonds	5,068				—				5,068
Long-term investments:
U.S. government agency bonds	2,070				—				2,070
Corporate bonds	16,141				—				16,141
U.S. dollar denominated foreign corporate bonds	3,041				—				3,041
Long-term other assets:
Israeli funds	2,218				—				2,218
	$	139,071			$	86,166			$	52,905

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Note 3. Balance Sheet Components

Inventories

Inventories consist of the following (in thousands):

	December 31,
	2013				2012
Raw materials	$	5,172			$	7,629
Work in process	4,241				3,889
Finished goods	4,555				3,604
Total Inventories	$	13,968			$	15,122

Work in process includes costs to produce our clear aligner and intra-oral scanner products. Finished goods primarily represent our intra-oral scanners and ancillary products that support our clear aligner products.

Property, plant and equipment

Property, plant and equipment consist of the following (in thousands):

		December 31,
	2013				2012
Clinical and manufacturing equipment		$	104,373			$	83,821
Computer hardware		24,851				22,706
Computer software		21,286				20,346
Furniture and fixtures		7,275				6,808
Leasehold improvements		14,996				12,388
Building		1,868				1,868
Land		1,162				1,162
Construction in progress		5,438				16,027
Total		181,249				165,126
Less: Accumulated depreciation and amortization and impairment charges 1		(105,506		)		(85,935		)
Total Property, plant and equipment, net		$	75,743			$	79,191

1

We recorded an impairment of our long-lived assets in 2013 which was a result of changes in the competitive environment for intra-oral scanners which included announcements of new low-priced scanners targeted at orthodontists and GPs in North America that caused us to lower our expectations for growth and profitability for our SCCS reporting unit. As a result, we determined that the carrying value of the long-lived assets was not recoverable and therefore recorded an impairment charge of $26.3 million, of which $7.0 million related to property and equipment. Refer to Note 5 for details of the impairment analysis.

As of December 31, 2013, construction in progress consisted primarily of costs for capital equipment to be placed in service in the next year. Depreciation and amortization was $13.9 million, $13.4 million, and $12.1 million, for the years ended December 31, 2013, 2012 and 2011, respectively.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Accrued liabilities

Accrued liabilities consist of the following (in thousands):

	December 31,
	2013				2012
Accrued payroll and benefits	$	43,029			$	39,621
Accrued sales rebate	10,100				8,333
Accrued sales tax and value added tax	6,215				5,253
Accrued sales and marketing expenses	3,893				4,088
Accrued warranty	3,104				4,050
Accrued accounts payable	2,764				2,866
Accrued professional fees	1,892				2,349
Accrued income taxes	1,205				572
Other accrued liabilities	8,143				7,115
Total Accrued Liabilities	$	80,345			$	74,247

Warranty

We regularly review the accrued balances and update these balances based on historical warranty trends. Actual warranty costs incurred have not materially differed from those accrued. However, future actual warranty costs could differ from the estimated amounts.

Clear Aligner

We warrant our Invisalign products against material defects until the Invisalign case is complete. We accrue for warranty costs in cost of net revenues upon shipment of products. The amount of accrued estimated warranty costs is primarily based on historical experience as to product failures as well as current information on replacement costs.

Scanners

We warrant our scanners for a period of one year from the date of training and installation. We accrue for these warranty costs which includes materials and labor based on estimated historical repair costs. Extended service packages may be purchased for additional fees.

Warranty accrual as of December 31, 2013 and 2012 consists of the following activity (in thousands):

Warranty accrual, December 31, 2011	$	3,177
Charged to cost of revenues	4,637
Actual warranty expenditures	(3,764		)
Warranty accrual, December 31, 2012	4,050
Charged to cost of revenues	2,850
Actual warranty expenditures	(3,796		)
Warranty accrual, December 31, 2013	$	3,104

Note 4. Business Combinations

Cadent

On April 29, 2011, we completed the acquisition of Cadent for an aggregate cash purchase price of approximately $187.6 million, acquiring all of Cadent's outstanding common and preferred stock. Cadent is a 3D digital scanning solution for orthodontics and dentistry. We believe that the combination of Align’s and Cadent’s technologies and capabilities creates

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

greater growth opportunities for Align by bringing innovative new Invisalign treatment tools to customers and by extending the value of intra-oral scanning in dental practices.

The following table summarizes the allocation of the purchase price as of April 29, 2011 (in thousands):

Assets	$	15,745
Property, plant and equipment	3,624
Acquired identifiable intangible assets:
Trademarks (one to fifteen year useful lives)	7,100
Existing technology (thirteen year useful life)	12,600
Customer relationships (eleven year useful life)	33,500
Goodwill	135,349
Liabilities assumed	(20,330		)
Total	$	187,588

In 2011, we incurred direct transaction costs of approximately $6.4 million that include investment banking, legal and accounting fees, and other external costs directly related to the acquisition. These costs were expensed as incurred as part of our operating expenses.

Goodwill of $135.3 million represents the excess of the purchase price over the fair value of the underlying net tangible and identifiable intangible assets, and represents the expected synergies of the transaction and the knowledge and experience of the workforce in place. None of the goodwill is deductible for tax purposes. In connection with the acquisition, we allocated approximately $77.3 million of the goodwill from the Cadent acquisition to our Scanner and CAD/CAM Services ("SCCS") reporting unit and approximately $58.0 million to our Clear Aligner reporting unit based on the expected relative synergies generated by the acquisition. During the third quarter of 2012, we determined that goodwill for our SCCS reporting unit should be tested for impairment between annual impairment tests since an event occurred or circumstances changed that would more likely than not reduce the fair value of our SCCS reporting unit below its carrying amount. We recorded a total impairment charge of $36.6 million for the SCCS for 2012 after finalizing step two of our analysis. Further, during March 2013, changes in the competitive environment for intra-oral scanners, including announcements from our competitors of new low-priced scanners targeted at orthodontists and general practitioner dentists in North America, caused us to lower our expectations for growth and profitability for our SCCS reporting unit. As a result, we determined that goodwill related only to our SCCS reporting unit should be tested for impairment as of March 2013 due to these facts and circumstances which would more likely than not reduce the fair value of our SCCS reporting unit below its carrying amount. Based on our analysis, there was no implied goodwill for the SCCS reporting unit; therefore, we recorded a goodwill impairment charge of $40.7 million in the three months ended March 31, 2013, which represents the remaining goodwill balance in the SCCS reporting unit. All remaining goodwill from the Cadent acquisition as of December 31, 2013 is attributable to the Clear Aligner segment. See Note 5 for discussion of our goodwill impairment.

For the year ended December 31, 2013 and 2012, Cadent contributed net revenues of $45.6 million, $43.5 million, respectively, and gross profit of $13.3 million and $10.4 million respectively. During the period of May 2011 through December 2011, Cadent contributed net revenues of approximately $28.0 million and gross profit of approximately $6.5 million. Sales, marketing, development and administrative activities for our Clear Aligner and SCCS reporting units were integrated during the post-acquisition period, therefore the operating results below gross profit are not available.

The following table presents the results of Align and Cadent for the year ended December 31, 2011. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of January 1, 2011 or results that may occur in the future (in thousands):

	Year Ended December 31,
	2011
Net revenues	$	492,468
Net income	$	62,116

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

ICA Holdings Pty Limited

On April 30, 2013, we completed the acquisition of ICA Holdings Pty Limited ("ICA") upon the expiration of the distribution agreement between certain subsidiaries of ICA and Align Technology B.V., for a total cash consideration of approximately $8.6 million, of which $7.4 million was attributed to assets acquired, $2.4 million in liabilities assumed and $3.6 million to goodwill. Goodwill as a result of this acquisition represents the excess of the purchase price over the fair value of the underlying net assets acquired and represents the knowledge and experience of the workforce in place. None of this goodwill will be deductible for tax purposes. Under the applicable accounting guidance, goodwill will not be amortized but will be tested for impairment on an annual basis or more frequently if certain indicators are present.

We believe that the transition from our distributor arrangement to a direct sales model as a result of the acquisition of ICA will increase our net revenues in the Asia Pacific region as we will experience higher average selling price(s) (“ASP”) as compared to our discounted ASP under the prior distribution agreement.

Pro forma results of operations for this acquisition have not been presented as it is not material to our results of operations, either individually or in aggregate, for the year ended December 31, 2013 or 2012 .

Note 5. Goodwill and Intangible Assets

Goodwill

The change in the carrying value of goodwill for the year ended December 31, 2013 by our reportable segments, which are also our reporting units, are as follows (in thousands):

	Clear Aligner				Scanners and CAD/CAM Services				Total
Balance as of December 31, 2011	$	58,445			$	76,938			$	135,383
Adjustment to goodwill 1	98				346				444
Impairment of goodwill	—				(36,591		)		(36,591		)
Balance as of December 31, 2012	58,543				40,693				99,236
Goodwill from ICA acquisition	3,558				—				3,558
Impairment of goodwill	—				(40,693		)		(40,693		)
Adjustments 2	(478		)		—				(478		)
Balance as of December 31, 2013	$	61,623			$	—			$	61,623

1

Pursuant to the accounting guidance for business combinations, we recorded goodwill adjustments for the effect on goodwill of changes to net assets acquired related our acquisition of Cadent during the measurement period (up to one year from April 29, 2011, the date of our acquisition of Cadent). Goodwill adjustments were not significant to our previously reported operating results or financial position.

2	The adjustments to goodwill during 2013 were a result of foreign currency translation.

Impairment of Goodwill

We evaluate goodwill for impairment at least annually on November 30th or more frequently if indicators are present, an event occurs or circumstances changes that suggest an impairment may exist and that it would more likely than not reduce the fair value of a reporting unit below its carrying amount. The allocation of goodwill to the respective reporting unit is based on relative synergies generated as a result of an acquisition.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

2012 Impairment

During the third quarter of 2012, we determined that the goodwill for our SCCS reporting unit should be tested for impairment between annual impairment tests since an event occurred/circumstances changed that would more likely than not reduce the fair value of our SCCS reporting unit below its carrying amount. These indicators included the termination of an exclusive distribution arrangement with Straumann for iTero intra-oral scanners in Europe, as well as the termination of their non-exclusive distribution arrangement for iTero intra-oral scanners in North America, together with market conditions and business trends within the SCCS reporting unit. While we continued to expect revenue growth in our SCCS business, our expectations for future growth and profitability rates projected for the SCCS reporting unit were lower than our previous estimates primarily driven by overall lower than expected financial results.

As a result, we performed step one analysis for our SCCS reporting unit, which consists of a comparison of the fair value of the SCCS reporting unit against its carrying amount, including the goodwill allocated to it. In deriving the fair value of the SCCS reporting unit, we utilized a combination of both the income and market approach, which are classified as level 3 within the fair value hierarchy. The income approach provides an estimate of fair value based on discounted expected future cash flows. The market approach provides an estimate of fair value using various prices or market multiples applied to the reporting unit's operating results and then applies an appropriate control premium in order to reconcile to our market capitalization. As a result of our step one analysis, we concluded that the fair value of the SCCS reporting unit was less than its carrying value, therefore, we proceeded to perform step two of the goodwill impairment analysis.

Step two of the goodwill impairment analysis measures the impairment charge by allocating the reporting unit's fair value to all of the assets and liabilities of the reporting unit in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination. This allocation process was performed only for the purposes of measuring the goodwill impairment, and not to adjust the carrying values of the recognized tangible assets and liabilities. Any excess of the carrying value of the reporting unit's goodwill over the implied fair value of the reporting unit's goodwill is recorded as an impairment loss. Based on our analysis, the implied fair value of goodwill was substantially lower than the carrying value of the goodwill for the SCCS reporting unit. We recorded a preliminary goodwill impairment charge during the third quarter of 2012 of $24.7 million and an additional $11.9 million during the fourth quarter of 2012, representing a change in estimate upon finalizing our 2013 annual budget process, for a total impairment charge of $36.6 million. None of the goodwill impairment charge was deductible for tax purposes.

2013 Impairment

During March 2013, changes in the competitive environment for intra-oral scanners, including announcements from our competitors of new low-priced scanners targeted at orthodontists and general practitioner dentists in North America, caused us to lower our expectations for growth and profitability for our SCCS reporting unit. As a result, we determined that goodwill related only to our SCCS reporting unit should be tested for impairment as of March 2013 due to these facts and circumstances which would more likely than not reduce the fair value of our SCCS reporting unit below its carrying amount. There was no triggering event related to the Clear Aligner goodwill.

We performed a step one analysis for our SCCS reporting unit which consists of a comparison of the fair value of the SCCS reporting unit against its carrying amount, including the goodwill allocated to it. In deriving the fair value of the SCCS reporting unit, we utilized the income approach which is classified as Level 3 within the fair value hierarchy. This approach provides an estimated fair value based on discounted expected future cash flows, which are based on management's estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used is based on a weighted average cost of capital adjusted for the relevant risk associated with the characteristics of the business and the projected cash flows.

As a result of our step one analysis, we concluded that the fair value of the SCCS reporting unit was less than its carrying value; therefore, we proceeded to step two of the goodwill impairment analysis. Step two of the goodwill impairment analysis measures the impairment charge by allocating the reporting unit's fair value to all of the assets and liabilities of the reporting unit in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination. This allocation process was performed only for the purposes of measuring the goodwill impairment and not to adjust the carrying values of the recognized tangible assets and liabilities. Any excess of the carrying value of the reporting unit's goodwill over the implied fair value of the reporting unit's goodwill is recorded as an

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

impairment loss. We use a discounted cash flow (“DCF”) approach to estimate the fair value of a reporting unit, utilizing harvest model, which we believe is the most reliable indicator of fair value of this business, and is most consistent with the approach a market place participant would use. Based on our analysis, there was no implied goodwill for the SCCS reporting unit; therefore, we recorded a goodwill impairment charge of $40.7 million in the three months ended March 31, 2013, which represents the remaining goodwill balance in the SCCS reporting unit. None of the goodwill impairment charge was deductible for tax purposes.

Annual Impairment Test

The remaining goodwill is entirely attributable to our Clear Aligner reporting unit. During the fourth quarter of fiscal 2013, we performed the annual goodwill impairment testing and found no impairment events as the fair value of our Clear Aligner reporting unit was significantly in excess of the carrying value.

Acquired Intangible Assets

We amortize our intangible assets over their estimated useful lives. We evaluate long-lived assets, which includes property, plant and equipment and intangible assets, for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. The carrying value is not recoverable if it exceeds the undiscounted cash flows resulting from the use of the asset and its eventual disposition. Our estimates of future cash flows attributable to our long-lived assets require significant judgment based on our historical and anticipated results and are subject to many factors. Factors we consider important which could trigger an impairment review include significant negative industry or economic trends, significant loss of customers and changes in the competitive environment of our intra-oral scanning business.

During March 2013, changes in the competitive environment for intra-oral scanners, including announcements from our competitors of new low-priced scanners targeted at orthodontists and general practitioner dentists in North America, that caused us to lower our expectations for growth and profitability for our SCCS reporting unit. As a result, we determined that the carrying value of the SCCS long-lived assets was not recoverable as compared to the value of the undiscounted cash flows of our revised projections for the asset group. In order to determine the impairment amount of our long-lived assets, we fair valued each key component of our long-lived assets within the asset group, which involved the use of significant estimates and assumptions including replacement costs, revenue growth rates, operating margins, and plant and equipment cost trends. We use a DCF approach, utilizing the harvest model, to estimate the fair value of a reporting unit, which we believe is the most reliable indicator of fair value of a business, and is most consistent with the approach of a marketplace participant would use. The estimation of fair value utilizing a DCF approach includes numerous uncertainties which require our significant judgment when making assumptions of expected growth rates and the selection of discount rates, as well as assumptions regarding general economic and business conditions, and the structure that would yield the highest economic value, among other factors. Key assumptions used in measuring the fair values of SCCS reporting unit included the discount rate (based on the weighted-average cost of capital) and revenue growth. The fair value of SCCS’s trademark was determined using a risk-adjusted DCF approach under the relief-from-royalty method. The royalty rate used was based on a consideration of market rates. The fair value of SCCS’s finite-lived customer relationships was determined using a DCF approach under the multi-period excess earnings method. We determined our long-lived asset group within the SCCS reporting unit to be primarily finite-lived intangible assets, plant and equipment. Upon completion of this analysis, we recorded a total impairment charge of $26.3 million of which $19.3 million represented the impairment related to our SCCS intangible assets and $7.0 million related to plant and equipment. There was no triggering event related to the Clear Aligner asset group.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Intangible assets arising either as a direct result from the Cadent acquisition or individually acquired are being amortized as follows (in thousands):

	Weighted Average Amortization Period (in years)		Gross Carrying Amount as of December 31, 2013				Accumulated Amortization				Impairment Charge				Net Carrying Value as of December 31, 2013
Trademarks	15		$	7,100			$	(1,100	)		$	(4,179	)		$	1,821
Existing technology	13		12,600				(2,236		)		(4,328		)		6,036
Customer relationships	11		33,500				(7,112		)		(10,751		)		15,637
Other	8		285				(40		)		—				245
Total Intangible Assets			$	53,485			$	(10,488	)		$	(19,258	)		$	23,739

	Weighted Average Amortization Period (in years)		Gross Carrying Amount as of December 31, 2012				Accumulated Amortization				Net Carrying Value as of December 31, 2012
Trademarks	15		$	7,100			$	(895	)		$	6,205
Existing technology	13		12,600				(1,642		)		10,958
Customer relationships	11		33,500				(5,002		)		28,498
Other	8		125				(9		)		116
Total Intangible Assets			$	53,325			$	(7,548	)		$	45,777

The total estimated annual future amortization expense for these acquired intangible assets as of December 31, 2013 is as follows (in thousands):

Fiscal Year
2014	$	3,053
2015	2,600
2016	2,600
2017	2,600
2018	2,600
Thereafter	10,286
Total	$	23,739

Note 6. Legal Proceedings

Securities Class Action Lawsuit

On November 28, 2012, plaintiff City of Dearborn Heights Act 345 Police & Fire Retirement System filed a lawsuit against Align, Thomas M. Prescott (“Mr. Prescott”), Align's President and Chief Executive Officer, and Kenneth B. Arola (“Mr. Arola”), Align's former Vice President, Finance and Chief Financial Officer, in the United States District Court for the Northern District of California on behalf of a purported class of purchasers of our common stock between April 23, 2012 and October 17, 2012 (the "Securities Action"). On July 11, 2013, an amended complaint was filed, which named the same defendants, on behalf of a purported class of purchasers of our common stock between January 31, 2012 and October 17, 2012. The amended complaint alleged that Align, Mr. Prescott and Mr. Arola violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and that Mr. Prescott and Mr. Arola violated Section 20(a) of the Securities Exchange Act of 1934. Specifically, the amended complaint alleged that during the purported class period defendants failed to take an appropriate goodwill impairment charge related to the April 29, 2011 acquisition of Cadent Holdings, Inc. in the fourth quarter

of 2011, the first quarter of 2012 or the second quarter of 2012, which rendered our financial statements and projections of future earnings materially false and misleading and in violation of U.S. GAAP. The amended complaint sought monetary damages in an unspecified amount, costs and attorney's fees. On December 9, 2013, the judge granted our motion to dismiss with leave for plaintiff to file a second amended complaint. Plaintiff filed a second amended complaint on January 8, 2014 on behalf of the same purported class. The second amended complaint state the same claims as the first amended complaint. We filed a motion to dismiss the second amended complaint on February 7, 2014. Align intends to vigorously defend itself against these allegations. Align is currently unable to predict the outcome of this complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible loss.

Shareholder Derivative Lawsuit

On February 1, 2013, plaintiff Gary Udis filed a shareholder derivative lawsuit against several of Align's current and former officers and directors in the Superior Court of California, County of Santa Clara. The complaint alleges that our reported income and earnings were materially overstated because of a failure to timely write down goodwill related to the April 29, 2011 acquisition of Cadent Holdings, Inc., and that defendants made allegedly false statements concerning our forecasts. The complaint asserts various state law causes of action, including claims of breach of fiduciary duty, unjust enrichment, and insider trading, among others. The complaint seeks unspecified damages on behalf of Align, which is named solely as nominal defendant against whom no recovery is sought. The complaint also seeks an order directing Align to reform and improve its corporate governance and internal procedures, and seeks restitution in an unspecified amount, costs, and attorney's fees. On July 8, 2013, an Order was entered staying this derivative lawsuit until an initial ruling on our first motion to dismiss the Securities Action. On January 15, 2014, an order was entered staying this derivative lawsuit until an initial ruling on our second motion to dismiss the Securities Action discussed above. Align intends to vigorously defend itself against these allegations. Align is currently unable to predict the outcome of this complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible losses.

In addition, in the course of Align's operations, Align is involved in a variety of claims, suits, investigations, and proceedings, including actions with respect to intellectual property claims, patent infringement claims, government investigations, labor and employment claims, breach of contract claims, tax, and other matters. Regardless of the outcome, these proceedings can have an adverse impact on us because of defense costs, diversion of management resources, and other factors. Although the results of complex legal proceedings are difficult to predict and Align's view of these matters may change in the future as litigation and events related thereto unfold; Align currently does not believe that these matters, individually or in the aggregate, will materially affect Align's financial position, results of operations or cash flows.

Note 7. Credit Facilities

On March 22, 2013, we entered into a credit facility with Wells Fargo Bank. The credit facility provides for a $50.0 million revolving line of credit, with a $10.0 million letter of credit sublimit, and has a maturity date on March 22, 2016. The credit facility also requires us to maintain a minimum unrestricted cash balance of $50.0 million and comply with specific financial conditions and performance requirements. The loans bear interest, at our option, at a fluctuating rate per annum equal to the daily one-month adjusted LIBOR rate plus a spread of 1.75% or an adjusted LIBOR rate (based on one, three, six or twelve-month interest periods) plus a spread of 1.75%. As of December 31, 2013, we had no outstanding borrowings under this credit facility and were in compliance with the conditions and performance requirements.

Note 8. Commitments and Contingencies

Operating leases

We lease our facilities and certain equipment and automobiles under non-cancelable operating lease arrangements that expire at various dates through 2022 and provide for pre-negotiated fixed rental rates during the terms of the lease. The terms of some of our leases provide for rental payments on a graduated scale. We recognize rent expense on a straight-line basis over the lease period and accrue for any rent expense incurred but not paid. Total rent expense was $7.3 million, $6.9 million and $6.1 million, for the years ended December 31, 2013, 2012 and 2011, respectively.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Minimum future lease payments for non-cancelable leases as of December 31, 2013, are as follows (in thousands):

Fiscal Year	Operating leases
2014	$	7,878
2015	7,463
2016	6,708
2017	4,316
2018	1,483
Thereafter	425
Total minimum lease payments	$	28,273

Off-balance Sheet Arrangements

As of December 31, 2013, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.

Indemnification Provisions

In the normal course of business to facilitate transactions in our services and products, we indemnify certain parties: customers, vendors, lessors, and other parties with respect to certain matters, including, but not limited to, services to be provided by us and intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will 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. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim.

It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of December 31, 2013, we did not have any material indemnification claims that were probable or reasonably possible.

Note 9. Stockholders’ Equity

Preferred Stock Rights Agreement

The Preferred Stock Rights Agreement (the “Rights Agreement”) is intended to protect stockholders from unfair or coercive takeover practices. In accordance with the Rights Agreement, the Board of Directors declared a dividend distribution of one preferred stock purchase right (a “Right”) for each outstanding share of our common stock to stockholders of record on November 22, 2005. Each Right entitles stockholders to buy one one-thousandth of a share of our Series A Participating Preferred Stock, par value $0.0001 per share, at an exercise price of $37.00, subject to adjustment. Rights will become exercisable upon the occurrence of certain events, including a person or group acquiring or the announcing the intention to acquire beneficial ownership of 15% or more of the then outstanding common stock without the approval of the Board of Directors. Each holder of a Right will have the right to receive, upon exercise, shares of common stock having a value equal to two times the purchase price. The Rights will expire on November 22, 2015 or upon the exercise of the Rights, whichever occurs earlier.

Common Stock

The holders of common stock are entitled to receive dividends whenever funds are legally available and when and if declared by the Board of Directors. We have never declared or paid dividends on our common stock.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Stock-based Compensation Plans

Our 2005 Incentive Plan, as amended, provides for the granting of incentive stock options, non-statutory stock options, restricted stock units, market stock units, stock appreciation rights, performance units and performance shares to employees, non-employee directors, and consultants. Shares granted on or after May 16, 2013 as an award of restricted stock, restricted stock unit, market stock units, performance share or performance unit ("full value awards") are counted against the authorized share reserve as one and nine-tenths (1 9/10) shares for every one (1) share subject to the award, and any shares canceled that were counted as one and nine-tenths against the plan reserve will be returned at the same ratio. Full value awards granted prior to May 16, 2013 were counted against the authorized share reserve as one and one half (1 1/2) share for every one (1) share subject to the award, and any shares canceled that were counted as one and one half against the plan reserve will be returned at this same ratio.

On May 16, 2013, the Stockholders approved an increase of 7,000,000 shares to the 2005 Incentive Plan (as amended) for a total reserve of 23,283,379 shares for issuance, plus up to an aggregate of 5,000,000 shares that would have been returned to our 2001 Stock Incentive Plan as a result of termination of options on or after March 28, 2005.

As of December 31, 2013, we have a total of 23,283,379 shares authorized and reserved, of which 9,119,512 shares are available for issuance. This includes 2,384,516 shares that have been transferred from the 2001 Stock Incentive Plan. We issue new shares from our pool of authorized but unissued shares to satisfy the exercise and vesting obligations of our stock-based compensation plans.

Stock-based Compensation

Stock-based compensation is based on the estimated fair value of awards, net of estimated forfeitures, and recognized over the requisite service period. Estimated forfeitures are based on historical experience at the time of grant and may be revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The stock-based compensation related to all of our stock-based awards and employee stock purchases for the year ended December 31, 2013, 2012 and 2011 is as follows (in thousands):

	For the Year Ended December 31,
	2013				2012				2011
Cost of net revenues	$	2,565			$	1,843			$	1,818
Sales and marketing	7,093				5,581				5,495
General and administrative	13,261				10,361				9,096
Research and development	3,519				3,698				2,756
Total stock-based compensation	$	26,438			$	21,483			$	19,165

Stock Options

Options are granted for terms not to exceed seven years and generally vest over four years with 25% vesting one year from the date of grant and 1/48th each month thereafter. Activity for the year ended December 31, 2013, under the stock option plans are set forth below (in thousands, except years and per share amounts):

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

	Stock Options
	Number of Shares Underlying Stock Options			Weighted Average Exercise Price per Share				Weighted Average Remaining Contractual Term (in years )		Aggregate Intrinsic Value
Outstanding as of December 31, 2012	3,276			15.21
Granted	—			—
Exercised	(1,863	)		14.57
Cancelled or expired	(92	)		15.35
Outstanding as of December 31, 2013	1,321			$	16.08			3.61		$	54,231
Vested and expected to vest at December 31, 2013	1,317			$	16.06			3.61		$	54,102
Exercisable at December 31, 2013	1,205			$	15.65			3.59		$	49,996

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between our closing stock price on the last trading day in 2013 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2013. This amount will fluctuate based on the fair market value of our stock. The total intrinsic value of stock options exercised for the years ended December 31, 2013, 2012 and 2011 was $46.7 million, $50.9 million and $23.7 million, respectively. The total fair value of the options vested during the years ended December 31, 2013, 2012 and 2011 was $3.7 million, $5.0 million and $9.2 million, respectively. There were no stock options granted in 2013.

The fair value of stock options granted was estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:

	2013				2012				2011
Stock options 1:
Expected term (in years)	—				—				4.4
Expected volatility	—		%		—		%		60.6		%
Risk-free interest rate	—		%		—		%		1.7		%
Expected dividends	—				—				—
Weighted average fair value at grant date	$	—			$	—			$	10.87

1 There were no stock options granted in 2013 or 2012.

The expected term of stock options represents the weighted-average period the stock options are expected to remain outstanding. We used a mid-point model to determine the expected term of stock options based on our historical exercise, post-vesting cancellation experience, and the remaining contractual term of our outstanding options.

We use our own historical volatility.

The risk-free interest rate is based on the implied yield on a U.S. Treasury zero-coupon issue with a remaining term equal to the expected term of the option.

We have not paid any cash dividends since inception and do not anticipate paying cash dividends in the foreseeable future, therefore we used an expected dividend of zero.

As of December 31, 2013, there was $1.3 million, net of estimated forfeitures, of total unamortized compensation costs related to stock options and these costs are expected to be recognized over a weighted average period of 0.9 years. For the year ended December 31, 2013, the total recognized tax effect from exercised options was $0.9 million.

Restricted Stock Units

The fair value of nonvested restricted stock units (“RSUs”) is based on our closing stock price on the date of grant. A summary for the year ended December 31, 2013, is as follows (in thousands, except years and per share amounts):

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

	Shares Underlying RSUs			Average Grant Date Fair Value Price per Share				Weighted Remaining Vesting Period (in years)		Aggregate Intrinsic Value
Nonvested as of December 31, 2012	1,500			$	23.95
Granted	1,289			36.38
Vested and released	(573	)		22.90
Forfeited	(172	)		26.37
Nonvested as of December 31, 2013	2,044			$	31.88			1.44		$	116,818

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (calculated by multiplying our closing stock price on the last trading day of 2013 by the number of nonvested RSUs) that would have been received by the unit holders had all RSUs been vested and released on December 31, 2013. This amount will fluctuate based on the fair market value of our stock. During 2013, of the 572,815 shares vested and released, approximately 80,435 vested shares were withheld for executive RSUs minimum statutory tax obligations, resulting in a net issuance of 492,380 shares. Total payments to tax authorities for payroll taxes related to RSUs, including market-performance based restricted stock units, that vested during the period for executive officers were $4.4 million, $2.1 million and $1.9 million in 2013, 2012 and 2011, respectively, reflected as a financing activity in the Consolidated Statements of Cash Flows.

The total intrinsic value of RSUs vested and released during 2013, 2012 and 2011 was $20.3 million, $12.5 million and $8.9 million, respectively. The total fair value RSUs vested during the years ended December 31, 2013, 2012, and 2011 was $13.2 million, $7.8 million, and $5.8 million, respectively. As of December 31, 2013, there was $46.9 million of total unamortized compensation costs, net of estimated forfeitures, related to RSUs, and these costs are expected to be recognized over a weighted average period of 2.6 years.

On an annual basis, we grant market-performance based restricted stock units (“MSUs”) to our executive officers. Each MSU represents the right to one share of Align’s common stock and will be issued through our amended 2005 Incentive Plan. The actual number of MSUs which will be eligible to vest will be based on the performance of Align’s stock price relative to the performance of the NASDAQ Composite Index over the vesting period, generally two to three years, up to 150% of the MSUs initially granted.

The following table summarizes the MSU performance as of December 31, 2013:

	Number of Shares Underlying MSUs (in thousands)			Weighted Average Remaining Vesting Period (in years )		Aggregate Intrinsic Value (in thousands)
Nonvested as of December 31, 2012	266
Granted	225
Vested and released	(96	)
Forfeited	(88	)
Nonvested as of December 31, 2013	307			1.57		$	17,556

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (calculated by multiplying our closing stock price on the last trading day of 2013 by the number of non-vested MSUs) that would have been received by the unit holders had all MSUs been vested and released on December 31, 2013. This amount will fluctuate based on the fair market value of our stock. During 2013, of the 95,502 shares vested and released, approximately 45,119 vested shares were withheld for executive MSU tax payments, resulting in a net issuance of 50,383 shares.

The total intrinsic value of MSUs vested and released during 2013 was $3.2 million. The total fair value MSUs vested during the years ended December 31, 2013 was $1.5 million. As of December 31, 2013, we expect to recognize $5.8 million of total unamortized compensation cost, net of estimated forfeitures, related to MSU over a weighted average period of 1.6 years.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The fair value of the MSUs is estimated at the grant date using a Monte Carlo simulation that includes factors for market conditions. The following weighted-average assumptions used in the Monte Carlo simulation were as follows:

	Year Ended December 31,
	2013				2012				2011
Expected term (in years)	3				3				3
Expected volatility	47.0		%		54.0		%		58.4		%
Risk-free interest rate	0.4		%		0.4		%		1.3		%
Expected dividends	—				—				—
Weighted average fair value per share at grant date	$	35.49			$	29.45			$	22.12

Employee Stock Purchase Plan

In May 2010, our shareholders approved the 2010 Employee Stock Purchase Plan (the “2010 Purchase Plan”), replacing our 2001 Employee Stock Purchase Plan, which consists of consecutive overlapping twenty-four month offering periods with four six-month purchase periods in each offering period. Employees purchase shares at 85% of the fair market value of the common stock at either the beginning of the offering period or the end of the purchase period, whichever is lower. The 2010 Purchase Plan will continue until terminated by either the Board or its administrator. The maximum number of shares available for issuance under the 2010 Purchase Plan is 2,400,000 shares. During the year ended December 31, 2013, 2012 and 2011, we issued 288,675, 336,382, and 482,542 shares, respectively, at average prices of $21.96, $17.98, and $10.63, respectively. As of December 31, 2013, 1,611,170 shares remain available for future issuance.

The fair value of the option component of the Purchase Plan shares was estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:

	December 31,
	2013				2012				2011
Employee Stock Purchase Plan:
Expected term (in years)	1.2				1.2				1.5
Expected volatility	44.9		%		49.7		%		43.2		%
Risk-free interest rate	0.2		%		0.2		%		0.4		%
Expected dividends	—				—				—
Weighted average fair value at grant date	$	11.69			$	11.10			$	7.29

We recognized stock-based compensation expense of $3.4 million, $2.0 million and $3.1 million related to our employee stock purchase plans for the years ended December 31, 2013, 2012 and 2011, respectively. As of December 31, 2013, there was $1.9 million of total unamortized compensation costs related to employee stock purchases. These costs are expected to be recognized over a weighted average period of 0.6 years.

Note 10. Common Stock Repurchase Program

On October 27, 2011, we announced that our Board of Directors approved a stock repurchase program pursuant to which we may repurchase up to $150.0 million of common stock. Purchases under the stock repurchase program were made from time to time in the open market.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

During 2012, we repurchased approximately 1.7 million shares of common stock at an average price of $27.28 per share for an aggregate purchase price of approximately $47.2 million, including commissions. The common stock repurchases reduced additional paid-in capital by approximately $15.4 million and increased accumulated deficit by $31.8 million. During 2013, we repurchased approximately 2.7 million shares of our common stock at an average price of $34.95 per share, including commissions, for an aggregate purchase price of approximately $95.1 million. The common stock retirements reduced additional paid-in capital by approximately $24.5 million and increased accumulated deficit by $70.6 million. All repurchased shares were retired. No further authorization for repurchases remains outstanding as we completed the repurchases under this program as of December 31, 2013.

Note 11. Employee Benefit Plans

401(k) Plan

In January 1999, we adopted a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code for our U.S. employees. This plan covers substantially all U.S. employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis. In 2009, our Board of Directors authorized us to match 50% of our employee’s salary deferral contributions up to a 6% of the employee’s eligible compensation effective 2010. We contributed approximately $2.1 million, $1.9 million and $1.8 million to the 401(k) plan during 2013, 2012 and 2011, respectively.

Israeli Funds

Under the Israeli severance fund law, we are required to make payments to dismissed employees and employees leaving employment in certain circumstances. The funding is calculated based on the salary of the employee multiplied by the number of years of employment as of the applicable balance sheet date. Our Israeli employees are entitled to one month’s salary for each year of employment, or a pro-rata portion thereof. We fund the liability through monthly deposits into funds, and the values of these contributions are recorded in other long-term current assets.

As of December 31, 2013 and 2012, the accrued funds liability was approximately $2.4 million and $2.7 million, respectively.

Note 12. Income Taxes

Income before provision for income taxes consisted of the following (in thousands):

	Year ended December 31,
	2013				2012				2011
Domestic	$	31,993			$	32,341			$	52,184
Foreign	61,146				51,955				37,757
Total Income before provision for income taxes	$	93,139			$	84,296			$	89,941

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The provision for income taxes consisted of the following (in thousands):

	Year Ended December 31,
	2013				2012				2011
Federal
Current	$	26			$	—			$	65
Deferred	24,262				22,382				21,026
	24,288				22,382				21,091
State
Current	1,235				438				224
Deferred	1,158				1,486				1,394
	2,393				1,924				1,618
Foreign
Current	3,113				1,173				1,263
Deferred	(950		)		126				(747		)
	2,163				1,299				516
Provision for income taxes	$	28,844			$	25,605			$	23,225

The differences between income taxes using the federal statutory income tax rate of 35% and our effective tax rate were as follows:

	Year Ended December 31,
	2013			2012			2011
U.S. federal statutory income tax rate	35.00	%		35.00	%		35.00	%
State income taxes, net of federal tax benefit	2.54			2.36			1.58
Impact of differences in foreign tax rates	(20.41	)		(20.00	)		(14.99	)
Goodwill Impairment	15.29			15.19			—
Stock-based compensation	0.47			(1.15	)		1.67
Non-deductible transaction fees	—			—			1.29
Valuation allowance release	—			—			(0.14	)
Other items not individually material	(1.92	)		(1.02	)		1.41
	30.97	%		30.38	%		25.82	%

As of December 31, 2013, U.S. income taxes and foreign withholding taxes associated with the repatriation of undistributed earnings of foreign subsidiaries were not provided for on a cumulative total of $186.4 million. We intend to reinvest these earnings indefinitely in our foreign subsidiaries. If these earnings were distributed in the form of dividends or otherwise, or if the shares of the relevant foreign subsidiaries were sold or otherwise transferred, we would be subject to additional U.S. income taxes and foreign withholding taxes, net of related foreign tax credits. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable.

In June 2009, the Costa Rica Ministry of Foreign Trade, an agency of the Government of Costa Rica, granted a twelve year extension of certain tax incentives, which were previously granted in 2002. The incentive tax rates will expire in various years beginning in 2017. Under these incentives, all of the income in Costa Rica during these twelve year incentive periods is subject to reduced rates of Costa Rica income tax. In order to receive the benefit of the incentives, we must hire specified numbers of employees and maintain minimum levels of fixed asset investment in Costa Rica. If we do not fulfill these conditions for any reason, our incentive could lapse and our income in Costa Rica would be subject to taxation at higher rates, which could have a negative impact on our operating results. The Costa Rica corporate income tax rate that would apply, absent the incentives, is 30% for 2013. As a result of these incentives, income taxes were reduced by $27.7 million, $21.8 million, and $15.4 million in 2013, 2012, and 2011, respectively. The benefit of the tax holiday on net income per share (diluted) was $0.34, $0.26, $0.19 in 2013, 2012 and 2011, respectively.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

As of December 31, 2013 and December 31, 2012, the significant components of our deferred tax assets and liabilities were (in thousands):

	Year Ended December 31,
	2013				2012
Deferred tax assets:
Net operating loss and capital loss carryforwards	$	39,978			$	37,183
Credit carryforwards	9,362				8,806
Reserves and accruals	26,729				19,703
Translation gains	48				43
Stock-based compensation	9,100				9,908
	85,217				75,643
Deferred tax liabilities:
Prepaid expenses	557				345
Depreciation and amortization	5,320				9,903
	5,877				10,248
Net deferred tax assets before valuation allowance	79,340				65,395
Valuation allowance	(35,108		)		(27,056		)
Net deferred tax assets	$	44,232			$	38,339

We assess the likelihood that we will be able to realize our deferred tax assets. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If it is more likely than not that we do not expect to realize our deferred tax assets, we will increase our provision for income taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be realizable. As of December 31, 2013, we believed, except for the items noted in the subsequent paragraph, that it was more likely than not that the amount of deferred tax assets recorded on the balance sheet will be realized.

The $35.1 million total valuation allowance provided against our deferred tax assets at December 31, 2013 relates primarily to foreign net operating loss carryforwards. The valuation allowance increased by a net $8.0 million, due to a $9.8 million increase related to foreign net operating loss carryforwards, offset by a decrease of $1.8 million due to the statute of limitations having lapsed with respect to certain operating loss carryforward deferred tax assets.

At December 31, 2013, we had net operating loss carryforwards of approximately $42.4 million for federal purposes and $56.7 million for California state tax purposes. If not utilized, these carryforwards will begin to expire in 2026 for federal purposes and 2014 for California purposes. In addition, we had foreign net operating loss carryforwards of approximately $36.7 million, which, if not utilized will expire beginning in 2014.

Our net operating loss carryforwards associated with the exercise of employee stock options totaled $25.2 million as of December 31, 2013. Our income taxes payable for federal purposes have been reduced by the tax benefits associated with the exercise of employee stock options during the fiscal year, and utilization of net operating loss carryover applicable to stock options. The benefits applicable to stock options were credited directly to stockholders’ equity when realized. We follow the tax law ordering method to determine when excess tax benefits have been realized and consider only the direct impacts of awards when calculating the amount of windfalls or shortfalls.

We have research credit carryforwards of approximately $5.9 million for federal purposes and $3.6 million for California state tax purposes. If not utilized, the federal credit carryforwards will begin to expire in 2020. The California state credit can be carried forward indefinitely.

In the event of a change in ownership, as defined under federal and state tax laws, our net operating loss and tax credit carryforwards may be subject to annual limitations. The annual limitations may result in the expiration of the net operating loss and tax credit carryforwards before utilization.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The changes in the balance of gross unrecognized tax benefits, which exclude interest and penalties, for fiscal year ended December 31, 2013, 2012, and 2011, is as follows (in thousands):

Unrecognized tax benefit as of December 31, 2011	$	15,472
Tax positions related to current year:
Additions for uncertain tax positions	5,087
Tax positions related to prior year:
Additions for uncertain tax positions	80
Unrecognized tax benefit as of December 31, 2012	20,639
Tax positions related to current year:
Additions for uncertain tax positions	6,110
Tax positions related to prior year:
Decreases for uncertain tax positions	(81		)
Unrecognized tax benefit as of December 31, 2013	$	26,668

We account for uncertain tax issues pursuant to authoritative guidance based on a two-step approach to recognize and measure uncertain tax positions taken or expected to be taken in a tax return. We first determine whether it is more likely than not that a tax position will be sustained upon audit based on its technical merits. If a tax position meets the more-likely-than-not recognition threshold it is then measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is more than 50 percent likely to be realized upon ultimate settlement. We adjust reserves for our uncertain tax positions due to changing facts and circumstances, such as the closing of a tax audit, or refinement of estimates due to new information. To the extent the final outcome of these matters is different than the amounts recorded, such differences will impact our tax provision in our Consolidated Statements of Operations in the period in which such determination is made.

During fiscal year 2013, the amount of gross unrecognized tax benefits increased by $6.0 million. The total amount of unrecognized tax benefits was $26.7 million as of December 31, 2013, all of which would impact our effective tax rate if recognized. We have elected to recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. The penalties and interest accrued as of December 31, 2013 and 2012 are immaterial. We do not expect any significant changes to the amount of unrecognized tax benefits within the next twelve months.

We are subject to taxation and audits in the U.S. and various states and foreign jurisdictions. All of our tax years will be open to examination by the U.S. federal and most state tax authorities due to our net operating loss and overall credit carryforward position. With few exceptions, we are no longer subject to examination by foreign tax authorities for years before 2006.

Note 13. Net Income per Share

Basic net income per share is computed using the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed using the weighted average number of shares of common stock, adjusted for the dilutive effect of potential common stock. Potential common stock, computed using the treasury stock method, includes options, RSUs, MSUs and our employee stock purchase plan.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table sets forth the computation of basic and diluted net income per share attributable to common stock (in thousands, except per share amounts):

	Year Ended December 31,
	2013				2012				2011
Numerator:
Net income	$	64,295			$	58,691			$	66,716
Denominator:
Weighted-average common shares outstanding, basic	80,551				80,529				77,988
Dilutive effect of potential common stock	2,038				2,511				2,306
Total shares, diluted	82,589				83,040				80,294
Net income per share, basic	$	0.80			$	0.73			$	0.86
Net income per share, diluted	$	0.78			$	0.71			$	0.83

For the years ended December 31, 2013, 2012 and 2011 stock options, RSUs, MSUs and our employee stock purchase plan totaling 0.1 million, 0.1 million and 1.6 million, respectively, were excluded from diluted net income per share because of their anti-dilutive effect.

Note 14. Supplemental Cash Flow Information

The supplemental cash flow information consists of the following (in thousands):

	Year Ended December 31,
	2013				2012				2011
Taxes paid	$	4,125			$	2,825			$	1,953
Non-cash investing and financing activities:
Fixed assets acquired with accounts payable or accrued liabilities	$	2,308			$	940			$	1,611
Unclaimed merger consideration liability	$	—			$	1,575			$	—

Note 15. Segments and Geographical Information

Segment Information

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (“CODM”), or decision-making group, in deciding how to allocate resources and in assessing performance. Our CODM is our Chief Executive Officer. We report segment information based on the management approach. The management approach designates the internal reporting used by CODM for decision making and performance assessment as the basis for determining our reportable segments. The performance measures of our reportable segments include net revenues and gross profit.

We have grouped our operations into two reportable segments which are also our reporting units: Clear Aligner segment and SCCS segment.

•	Our Clear Aligner segment consists of our Invisalign System which includes Invisalign Full, Express/Lite, Teen, Assist, Vivera Retainers, along with our training and ancillary products for treating malocclusion.

•	Our SCCS segment consists of intra-oral scanning systems and additional services available with the intra-oral scanners that provide digital alternatives to the traditional cast models. This segment includes our iTero scanner and OrthoCAD services and was the result of our acquisition of Cadent on April 29, 2011.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

These reportable operating segments are based on how our CODM views and evaluates our operations as well as allocation of resources. The following information relates to these segments (in thousands):

	For the Year Ended December 31,
Net Revenues	2013				2012				2011
Clear Aligner
Invisalign Full	$	382,054			$	338,600			$	302,391
Invisalign Express/Lite	72,418				51,486				42,509
Invisalign Teen	84,850				67,127				54,529
Invisalign Assist	30,603				28,705				27,527
Invisalign non-case revenues	44,724				30,663				24,757
SCCS
Scanners	23,698				20,059				13,383
CAD/CAM Services	21,859				23,401				14,645
Total net revenues	$	660,206			$	560,041			$	479,741
Gross Profit
Clear Aligner	$	484,835			$	405,970			$	354,700
SCCS	13,271				10,418				6,583
Total gross profit	$	498,106			$	416,388			$	361,283

Geographical Information

Net revenues and long-lived assets are presented below by geographic area (in thousands):

	For the Year Ended December 31,
	2013				2012				2011
Net revenues 1:
United States	$	491,410			$	427,929			$	359,936
the Netherlands	127,769				105,942				97,910
Other international	41,027				26,170				21,895
Total net revenues	$	660,206			$	560,041			$	479,741

	As of December 31,
	2013				2012				2011
Long-lived assets 2:
United States	$	61,439			$	60,098			$	43,868
Mexico	6,291				6,473				4,673
the Netherlands	1,630				1,383				343
Other international	6,383				11,237				5,081
Total long-lived assets	$	75,743			$	79,191			$	53,965

1	Net revenues are attributed to countries based on location of where revenue is recognized.

2	Long-lived assets are attributed to countries based on entity that owns the assets.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Note 16. Exit Activities

In October 2012, we completed the consolidation of our CAD/CAM services and intra-oral scanner-related activities for our SCCS segment based in Carlstadt, New Jersey with our existing manufacturing and shared services organizations in order to optimize efficiency, consolidate customer-facing functions, and reduce operating costs. All existing intra-oral scanner research and development and manufacturing operations remain in Or Yehuda, Israel. The transition included the following activities:

•	Consolidation of customer care for CAD/CAM services and intra-oral scanners into our existing shared services organization in San Jose, Costa Rica;

•	Transition of CAD/CAM services and intra-oral scanner distribution and repair to our Treat operations in San Jose, Costa Rica and our new manufacturing facility in Juarez, Mexico; and

•	Consolidation of accounting and finance functions at our corporate headquarters in San Jose, California.

The consolidation of our New Jersey operations, which began in the fourth quarter of 2011, resulted in a total reduction of 119 full time headcount in Carlstadt, New Jersey.

During 2012, we incurred approximately $0.8 million in exit costs of which approximately $0.5 million were recorded in our cost of revenue and $0.3 million in operating expenses. There were no exit costs in 2013.