Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

Overview

Our goal is to establish Invisalign clear aligners as the standard method for treating malocclusion and to establish the iTero intraoral scanner as the preferred scanning device for 3D digital scans, ultimately driving increased product adoption by dental professionals. We intend to achieve this by continued focus and execution of our strategic growth drivers set forth in the Business Strategy section in this Annual Report on Form 10-K.

The successful execution of our business strategy in 2018 and beyond may be affected by a number of other factors including:

•

New Products, Feature Enhancements and Technology Innovation. Product innovation drives greater treatment predictability and clinical applicability and ease of use for our customers which supports adoption of Invisalign treatment in their practices. Our focus is to develop solutions and features to treat a wide range of cases from simple to complex. Most recently, in March 2017, we announced Invisalign Teen with mandibular advancement, the first clear aligner solution for Class II correction in growing tween and teen patients. This new offering combines the benefits of the most advanced clear aligner system in the world with features for moving the lower jaw forward while simultaneously aligning the teeth. Invisalign Teen with mandibular advancement is now available in Canada, and select Europe, Middle East and Africa ("EMEA"), Asia Pacific ("APAC") and Latin America ("LATAM") countries. Invisalign Teen with mandibular advancement is pending 510(k) clearance and is not yet available in the United States ("U.S."). We believe that over the long-term, clinical solutions and treatment tools will increase adoption of Invisalign and increase sales of our intraoral scanners; however, it is difficult to predict the rate of adoption which may vary by region and channel.

•	Invisalign Adoption. Our goal is to establish Invisalign as the treatment of choice for treating malocclusion ultimately driving increased product adoption and frequency of use by dental professionals, also known as "utilization rates." Our quarterly utilization rates for the last 9 quarters are as follows:

• Invisalign Utilization Rates = # of cases shipped divided by # of doctors cases were shipped to

◦	Total utilization in the fourth quarter of 2017 increased to 5.7 cases per doctor compared to 5.2 in the fourth quarter of 2016.

▪

North America: Utilization among our North American orthodontist customers reached an all time high in the fourth quarter of 2017 at 14.0 cases per doctor. Compared to 11.3 cases per doctor utilized in the fourth quarter of 2016, the increase in North America orthodontist utilization in the fourth quarter of 2017 reflects improvements in product and technology which continues to strengthen our doctors’ clinical confidence such that they now utilize Invisalign more often and on more complex cases, including their teenage patients.

▪	International: International doctor utilization of 5.2 cases per doctor in the fourth quarter of 2017 compared to 5.0 in the fourth quarter of 2016. The International utilization reflects growth in both the EMEA and APAC regions due to increasing adoption of the product due in part to its ability to treat more complex cases.

We expect that over the long-term our utilization rates will gradually improve as a result of advancements in product and technology, which continue to strengthen our doctors’ clinical confidence in the use of Invisalign. In addition, since the teenage market makes up 75% of the 10 million total orthodontic case starts each year and as we continue to drive adoption of teenage patients through sales and marketing programs, we expect our utilization rate to improve. In 2017, 25.5% of our volume was from teenagers starting treatment with Invisalign, an increase of 40.4% from 2016. Our utilization rates, however, may fluctuate from period to period due to a variety of factors, including seasonal trends in our business along with adoption rates of new products and features.

•	Number of New Invisalign Doctors Trained. We continue to expand our Invisalign customer base through the training of new doctors. In 2017, Invisalign growth was driven primarily by increased utilization across all regions as well as by the continued expansion of our customer base as we trained a total of 16,500 new Invisalign doctors, of which 67% were trained internationally.

•

International Invisalign Growth. We will continue to focus our efforts towards increasing Invisalign adoption by dental professionals in our direct international markets. On a year over year basis, international Invisalign volume increased 52.3% driven primarily by strong performance in our APAC and EMEA regions. We believe that the introduction of Invisalign Teen treatment with mandibular advancement is helping to raise visibility for Invisalign treatment of teenagers and contributed to some of the growth in the APAC market. In 2018, we are continuing to expand in our existing markets through targeted investments in sales coverage and professional marketing and education programs, along with consumer marketing in selected country markets. We expect international Invisalign clear aligner revenues to continue to grow at a faster rate than North America for the foreseeable future due to our continued investment in international market expansion, the size of the market opportunity, and our relatively low market penetration of these regions (Refer to Item 1A Risk Factors - “We are exposed to fluctuations in currency exchange rates, which could negatively affect our financial condition and results of operations.” for information on related risk factors).

•	Establish Regional Order Acquisition, Treatment Planning and Manufacturing Operations. We will continue to establish and expand additional order acquisition, treatment planning and manufacturing operations closer to our international customers in order to improve our operational efficiency and to provide doctors confidence in using Invisalign clear aligners to treat more patients and more often:

◦	In June 2017, we opened a new treatment planning facility in Chengdu, China which services and supports our customers within China. It also serves as a clinical education and training center for all of our customers across Asia Pacific.

◦	In August 2017, we opened a treatment planning facility in Cologne, Germany to support our customers located in Europe.

◦	In 2017, we purchased two buildings in Costa Rica for a total purchase price of approximately $51.7 million in order to support our expanding treatment planning and customer service needs.

◦	In November 2017, we entered into an Investment Agreement with the People’s Republic of China in which we have committed to invest a minimum of $46.0 million in Ziyang, China over five years to establish manufacturing operations.

Refer to Item 1A Risk Factors - “As we continue to grow, we are subject to growth related risks, including risks related to excess or constrained capacity at our existing facilities” for information on related risk factors and Refer to Note 9 "Commitments and Contingencies" of the Notes of Consolidated Financial Statements for more information on the Costa Rica purchase agreements and the China investment agreement.

•	Operating Expenses. We expect operating expenses to increase in 2018 due in part to:

◦	Investments in international expansion in new country markets;

◦	Investments in manufacturing to enhance our regional capabilities;

◦	Increases in legal expenses primarily related to the continued protection of our intellectual property rights, including our patents;

◦	Increases in sales, marketing and customer support resources; and

◦	Product and technology innovation to enhance product efficiency and operational productivity.

We believe that these investments will position us to increase our revenues and continue to grow our market share.

•

Stock Repurchases: April 2016 Repurchase Program. In 2017, we repurchased $50.0 million of our common stock through an accelerated stock repurchase agreement and repurchased $50.0 million on the open market. As of December 31, 2017, we had $200.0 million remaining under the April 2016 Repurchase Program. In February 2018, we repurchased $100.0 million of our common stock on the open market (Refer to Note 11 "Common Stock Repurchase Program" of the Notes to Consolidated Financial Statements for details on stock repurchase program).

•

U.S. Tax Cuts and Jobs Act. The U.S. Tax Cuts and Jobs Act (the “TCJA”) was enacted into law on December 22, 2017 and impacted our effective tax rate for the year ended December 31, 2017. The TCJA made significant changes to the Internal Revenue Code, including, but not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S. international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. We have estimated the impact of the TCJA and recorded a provisional amount of $84.3 million additional income tax expense in the fourth quarter of 2017. This provisional amount includes income tax expenses related to the remeasurement of certain deferred tax assets and liabilities of $10.4 million, and the one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings in the amount of $73.9 million. Additional work is necessary for a more detailed analysis of our deferred tax assets and liabilities and our historical foreign earnings as well as potential correlative adjustments. Any subsequent adjustment to these amounts will be recorded to tax expense in 2018 when the analysis is complete.

•

SmileDirectClub. In February 2018, we received a communication on behalf of SDC Financial LLC, SmileDirectClub LLC, and the Members of SDC Financial LLC other than Align (collectively, the "SDC Entities") alleging that the launch and operation of our Invisalign store pilot program constitutes a breach of non-compete provisions applicable to the members of SDC Financial LLC, including Align. As a result of this alleged breach, SDC Financial LLC has notified Align that its members (other than Align) seek to exercise a right to repurchase all of Align’s SDC Financial LLC membership interests for a purchase price equal to the current capital account balance of Align. The SDC Entities also allege that Align has breached confidentiality provisions applicable to the SDC Financial LLC members and demands that Align cease all activities related to the Invisalign store pilot project, close existing Invisalign stores and cease using SDC’s confidential information. Align disputes the allegations that it has breached its obligations to the SDC Entities, including the allegation that the SDC Entities are entitled to exercise a repurchase right. Pursuant to the parties’ agreement, the dispute will be arbitrated if it is not resolved through negotiations. We are currently evaluating the potential impact that this could have on our consolidated financial statements.

Results of Operations

Net Revenues by Reportable Segment Comparison for Year Ended December 31, 2017, 2016 and 2015:

We group our operations into two reportable segments: Clear Aligner segment and Scanner segment

•	Our Clear Aligner segment consists of Comprehensive Products, Non-Comprehensive Products and Non-Case revenues as defined below:

◦	Comprehensive Products include our Invisalign Full, Teen and Assist products.

◦	Non-Comprehensive Products include our Invisalign Express, Invisalign Lite, Invisalign i7 and Invisalign Go products in addition to revenues from the sale of aligners to SmileDirectClub (“SDC”) under our supply agreement. Revenue from SDC is recorded after eliminating outstanding intercompany transactions.

◦	Non-Case includes our Vivera retainers along with our training and ancillary products for treating malocclusion.

•	Our Scanner segment consists of intraoral scanning systems and additional services available with the intraoral scanners that provide digital alternatives to the traditional cast models. This segment includes our iTero scanner and OrthoCAD services.

Net revenues for our Clear Aligner segment and Scanner segment by region for the year ended December 31, 2017, 2016 and 2015 are as follows (in millions):

	Year Ended															Year Ended
Net Revenues	December 31, 2017				December 31, 2016				Change							December 31, 2016				December 31, 2015				Change
Clear Aligner revenues:
North America	$	744.6			$	568.7			$	175.9			30.9	%		$	568.7			$	498.7			$	70.0			14.0	%
International	483.0				326.6				156.4				47.9	%		326.6				250.1				76.5				30.6	%
Non-Case	81.7				63.0				18.7				29.7	%		63.0				51.4				11.6				22.6	%
Total Clear Aligner net revenues	$	1,309.3			$	958.3			$	351.0			36.6	%		$	958.3			$	800.2			$	158.1			19.8	%
Scanner net revenues	164.1				121.5				42.6				35.1	%		121.5				45.3				76.2				168.2	%
Total net revenues	$	1,473.4			$	1,079.8			$	393.6			36.5	%		$	1,079.8			$	845.5			$	234.3			27.7	%

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Clear Aligner Case Volume by Region

Case volume data which represents Clear Aligner case shipments by region, for the year ended December 31, 2017, 2016 and 2015 is as follows (in millions):

	Year Ended												Year Ended
Region	December 31, 2017			December 31, 2016			Change						December 31, 2016			December 31, 2015			Change
North America	621.9			464.5			157.4			33.9	%		464.5			398.4			66.1			16.6	%
International	354.5			244.7			109.8			44.9	%		244.7			184.8			59.9			32.4	%
Total case volume	976.4			709.2			267.2			37.7	%		709.2			583.2			126.0			21.6	%

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Fiscal Year 2017 compared to Fiscal Year 2016

Total net revenues increased by $393.6 million in 2017 as compared to 2016 primarily as a result of case volume growth across all regions and products as well as increased non-case revenue.

Clear Aligner - North America

North America net revenues increased by $175.9 million in 2017 compared to 2016 primarily due to case volume growth across all channels and most products which increased net revenues by $192.6 million. This increase was offset in part by lower average selling price ("ASP") which decreased net revenues by $16.7 million. The ASP decline is a result of a shift in product mix towards Non-Comprehensive Products, primarily driven by increased SDC revenues which carry a lower ASP and higher Invisalign promotional discounts, which collectively reduced revenues by $58.4 million. These factors contributing to the decline in ASP were offset in part by price increases on our Comprehensive Products effective on April 1, 2017 which contributed $28.4 million to net revenues as well as an increase in additional aligner revenue which contributed $10.8 million to net revenues, among other factors.

Clear Aligner - International

International net revenues increased by $156.4 million in 2017 compared to 2016 primarily driven by case volume growth across all channels and products which increased net revenues by $146.7 million and, to a lesser extent, higher ASP which contributed approximately $9.7 million to the increase in net revenues. The increase in ASP was primarily due to price increases in our Comprehensive Products effective on July 1, 2017, as well as the impact from acquiring certain distributors as we now recognize direct sales at full ASP rather than the discounted ASP, which collectively contributed $24.7 million to net revenues. The factors contributing to an increase in ASP were offset in part by higher promotional discounts which decreased net revenues by $12.6 million as well as an increase in net revenue deferrals of $3.6 million, among other factors.

Clear Aligner - Non-Case

Non-case net revenues, consisting of training fees and ancillary product revenues, increased by $18.7 million in 2017 compared to 2016 primarily due to increased Vivera volume in both North America and International.

Scanner

Scanner net revenues increased by $42.6 million in 2017 compared to 2016 primarily as a result of an increase in the number of scanners recognized which increased net revenues by $29.7 million as well as higher CAD/CAM services resulting from a larger installed base of scanners which contributed $16.2 million to net revenues. These increases were offset in part by a decrease in scanner ASP which reduced net revenues by $3.3 million.

Fiscal Year 2016 compared to Fiscal Year 2015

Total net revenues increased by $234.3 million in 2016 as compared to 2015 primarily as a result of case volume growth across all regions and products as well as increased non-case revenue.

Clear Aligner - North America

North America net revenues increased by $70.0 million in 2016 compared to 2015 primarily due to case volume growth across all channels and products which increased net revenues by $82.7 million. This increase was offset in part by lower average selling price ("ASP") which decreased net revenues by $12.7 million. ASP declined in 2016 compared to 2015 as a result of higher promotional discounts of $21.9 million as well as an increase in net deferrals of $7.7 million primarily related to the full year effect of our new additional aligners product policy launched in July 2015. These declines were partially offset by price increases on our Comprehensive Products effective April 1, 2016 which contributed $17.7 million to net revenues.

Clear Aligner - International

International net revenues increased by $76.5 million in 2016 compared to 2015 primarily driven by case volume growth across all channels and products which increased net revenues by $80.9 million. This increase was offset in part by lower ASP which decreased net revenues by $4.4 million. ASP declined in 2016 compared to 2015 as a result of higher promotional discounts of $6.9 million as well as the unfavorable impact of changes in foreign exchange rates of $6.8 million. These declines were partially offset by the price increases on our Comprehensive products effective April 1, 2016 which contributed $5.7 million to net revenues, as well as an increase in additional aligner revenue of $3.5 million.

Clear Aligner - Non-Case

Non-case net revenues, consisting of training fees and ancillary product revenues, increased by $11.6 million in 2016 compared to 2015 primarily due to increased Vivera volume both in North America and International.

Scanner

Scanner net revenues increased by $76.2 million in 2016 compared to 2015 primarily as a result of an increase in the number of scanners recognized as we began shipping our next generation iTero Element scanner in September 2015, which contributed $43.3 million in net revenues and, to a lesser extent, an increase in ASP. which contributed $23.7 million to net revenues.

Cost of net revenues and gross profit (in millions):

	Year Ended												Year Ended
	December 31, 2017				December 31, 2016				Change				December 31, 2016				December 31, 2015				Change
Clear Aligner
Cost of net revenues	$	289.7			$	210.8			$	78.9			$	210.8			$	172.0			$	38.8
% of net segment revenues	22.1		%		22.0		%						22.0		%		21.5		%
Gross profit	$	1,019.6			$	747.5			$	272.1			$	747.5			$	628.2			$	119.3
Gross margin %	77.9		%		78.0		%						78.0		%		78.5		%
Scanner
Cost of net revenues	$	66.8			$	53.7			$	13.1			$	53.7			$	33.4			$	20.3
% of net segment revenues	40.7		%		44.2		%						44.2		%		73.7		%
Gross profit	$	97.4			$	67.8			$	29.6			$	67.8			$	11.9			$	55.9
Gross margin %	59.3		%		55.8		%						55.8		%		26.3		%
Total cost of net revenues	$	356.5			$	264.6			$	91.9			$	264.6			$	205.4			$	59.2
% of net revenues	24.2		%		24.5		%						24.5		%		24.3		%
Gross profit	$	1,116.9			$	815.3			$	301.6			$	815.3			$	640.1			$	175.2
Gross margin %	75.8		%		75.5		%						75.5		%		75.7		%

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Cost of net revenues for our Clear Aligner and Scanner segments includes personnel-related costs including payroll and stock-based compensation for staff involved in the production process, the cost of materials, packaging, shipping costs, depreciation on capital equipment and facilities used in the production process, amortization of acquired intangible assets and training costs.

Fiscal Year 2017 compared to Fiscal Year 2016

Clear Aligner

The gross margin percentage declined slightly in 2017 compared to 2016 primarily due to an increase in aligners per case driven by additional aligners which was partially offset by higher absorption as a result of increased production volumes.

Scanner

The gross margin percentage increased in 2017 compared to 2016 primarily due to a favorable product mix shift to our lower cost iTero Element scanner. This was partially offset by a lower ASP.

Fiscal Year 2016 compared to Fiscal Year 2015

Clear Aligner

The gross margin percentage declined in 2016 compared to 2015 primarily driven by a higher number of aligners per case and lower ASP which was partially offset by higher absorption as a result of increased production volumes.

Scanner

The gross margin percentage increased in 2016 compared to 2015 due to a product mix shift to our iTero Element scanner which has a higher ASP along with lower costs per unit.

Selling, general and administrative (in millions):

	Year Ended												Year Ended
	December 31, 2017				December 31, 2016				Change				December 31, 2016				December 31, 2015				Change
Selling, general and administrative	$	665.8			$	490.7			$	175.1			$	490.7			$	390.2			$	100.5
% of net revenues	45.2		%		45.4		%						45.4		%		46.2		%

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Selling, general and administrative expense includes personnel-related costs including payroll, commissions and stock-based compensation for our sales force, marketing and administration in addition to media and advertising expenses, clinical education, trade shows and industry events, product marketing, outside consulting services, legal expenses, depreciation and amortization expense, the medical device excise tax ("MDET") and allocations of corporate overhead expenses including facilities and IT.

Selling, general and administrative expense increased in 2017 compared to 2016 primarily due to higher compensation related costs of $85.6 million mainly as a result of increased headcount resulting in higher salaries expense, incentive bonuses and fringe benefits. We also incurred higher expenses from advertising and marketing of $34.2 million, equipment and maintenance costs of $21.9 million, and outside services costs of $20.3 million.

Selling, general and administrative expense increased in 2016 compared to 2015 primarily due to higher compensation related costs of $47.1 million as a result of increased headcount resulting in higher salaries expense, incentive bonuses and fringe benefits. We also incurred higher expenses from advertising and marketing of $16.5 million, outside services costs of $12.2 million, equipment and material costs of $6.8 million, travel and related costs of $6.0 million and credit card processing fees of $4.2 million. In addition, during the first quarter of 2015, there was a refund of MDET taxes paid in 2014 of $6.8 million as our aligners are no longer subject to the excise tax.

Research and development (in millions):

	Year Ended												Year Ended
	December 31, 2017				December 31, 2016				Change				December 31, 2016				December 31, 2015				Change
Research and development	$	97.6			$	75.7			$	21.9			$	75.7			$	61.2			$	14.5
% of net revenues	6.6		%		7.0		%						7.0		%		7.2		%

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Research and development expense includes the personnel-related costs including stock-based compensation and outside consulting expenses associated with the research and development of new products and enhancements to existing products and allocations of corporate overhead expenses including facilities and IT.

Research and development expense increased in 2017 compared to 2016 primarily due to higher compensation costs as a result of increased headcount resulting in higher salaries expense, incentive bonuses and fringe benefits.

Research and development expense increased in 2016 compared to 2015 due to higher compensation costs as a result of increased headcount resulting in higher salaries expense, incentive bonuses and fringe benefits.

Income from operations (in millions):

	Year Ended												Year Ended
	December 31, 2017				December 31, 2016				Change				December 31, 2016				December 31, 2015				Change
Clear Aligner
Income from operations	$	564.6			$	411.8			$	152.8			$	411.8			$	371.1			$	40.7
Operating margin %	43.1		%		43.0		%						43.0		%		46.4		%
Scanner
Income (loss) from operations	$	49.6			$	37.5			$	12.1			$	37.5			$	(12.3	)		$	49.8
Operating margin %	30.2		%		30.9		%						30.9		%		(27.2		)%
Total income from operations(1)	$	353.6			$	248.9			$	104.7			$	248.9			$	188.6			$	60.3
Operating margin %	24.0		%		23.1		%						23.1		%		22.3		%

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

(1) Refer to Note 16 "Segments and Geographical Information" of the Notes to Consolidated Financial Statements for details on unallocated corporate expenses and the reconciliation to total income from operations.

Fiscal Year 2017 compared to Fiscal Year 2016

Clear Aligner

Operating margin percentage increased slightly in 2017 compared to 2016 as we leveraged our operating expenses on higher Clear Aligner revenues.

Scanner

Operating margin percentage decreased in 2017 compared to 2016 due to higher operating expenses and, to a lesser extent, lower ASP. This was partially offset by a favorable product mix shift to our lower cost iTero Element scanner.

Fiscal Year 2016 compared to Fiscal Year 2015

Clear Aligner

Operating margin percentage declined in 2016 compared to 2015 primarily due to higher compensation costs as a result of increased headcount, higher number of aligners manufactured per case and lower ASP.

Scanner

Operating margin percentage increased in 2016 compared to 2015 due to a product mix shift to our iTero Element scanner resulting in a higher ASP and lower costs per unit. We also incurred lower operating expenses as a percentage of revenues as we leveraged our operating expenses on higher revenues.

Interest and other income (expense), net (in millions):

	Year Ended												Year Ended
	December 31, 2017				December 31, 2016				Change				December 31, 2016				December 31, 2015				Change
Interest and other income (expense), net	$	11.2			$	(6.4	)		$	17.6			$	(6.4	)		$	(2.5	)		$	(3.9	)

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Interest and other income (expense), net, includes foreign currency revaluation gains and losses, interest income earned on cash, cash equivalents and investment balances, gains and losses on foreign currency forward contracts and other miscellaneous charges.

Interest and other income (expense), net, increased in 2017 compared to 2016 mainly due to higher foreign exchange gains as a result of the Euro strengthening to the U.S. dollar.

Interest and other income (expense), net, decreased in 2016 compared to 2015 mainly due to higher foreign exchange losses as a result of the Euro weakening to the U.S. dollar.

Equity in losses of investee, net of tax (in millions):

	Year Ended												Year Ended
	December 31, 2017				December 31, 2016				Change				December 31, 2016				December 31, 2015			Change
Equity in losses of investee, net of tax	$	3.2			$	1.7			$	1.5			$	1.7			—			$	1.7

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

We acquired a 17% equity interest in SDC in July 2016 and an additional 2% in July 2017 for combined equity interest of 19% on a fully diluted basis. We account for this investment based on the equity method of accounting. In 2017, equity in losses of investee, net of tax increased compared to the same period in 2016 due to a full year of losses attributable to equity method investments as well as a higher share due to our additional investment (Refer to Note 4 "Equity Method Investments" of the Notes to Consolidated Financial Statements for details on equity method investments).

Provision for income taxes (in millions):

	Year Ended												Year Ended
	December 31, 2017				December 31, 2016				Change				December 31, 2016				December 31, 2015				Change
Provision for income taxes	$	130.2			$	51.2			$	79.0			$	51.2			$	42.1			$	9.1
Effective tax rates	35.7		%		21.1		%						21.1		%		22.6		%

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Our provision for income taxes was $130.2 million, $51.2 million and $42.1 million for the year ended December 31, 2017, 2016 and 2015, respectively, representing effective tax rates of 35.7%, 21.1% and 22.6%, respectively.

The U.S. Tax Cuts and Jobs Act (the “TCJA”) was enacted into law on December 22, 2017 and impacted our effective tax rate for the year ended December 31, 2017. The TCJA made significant changes to the Internal Revenue Code, including, but not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S. international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. We have estimated the impact of the TCJA and recorded a provisional amount of $84.3 million of additional income tax expense in the fourth quarter of 2017. This provisional amount includes income tax expenses related to the remeasurement of certain deferred tax assets and liabilities of $10.4 million, and the one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings in the amount of $73.9 million. The provisional impact of the TCJA is discussed further in Note 13 "Income Taxes" of the Notes to Consolidated Financial Statements.

Our effective tax rate differs from the statutory federal income tax rate of 35% primarily due to certain foreign earnings, most significantly from the Netherlands and Costa Rica, being taxed at lower tax rates and excess tax benefits related to stock-based compensation recognized as a reduction of income tax expense, partially offset by certain one-time tax charges recorded as a result of the TCJA. The increase in the effective tax rate in 2017 compared to 2016 was primarily attributable to tax charges recorded as a result of the TCJA and the tax benefit recognized pursuant to the release of valuation allowance against our Israel deferred tax assets in 2016 that did not recur this year, partially offset by excess tax benefits related to stock-based compensation recognized as a reduction of income tax expense in accordance with ASU 2016-09 and increased tax benefits from foreign earnings being taxed at lower tax rates. The increase in the effective rate for the year ended December 31, 2016 compared to 2015 was primarily related to our international corporate restructuring as explained below.

On July 1, 2016, we implemented a new international corporate structure. This changed the structure of our international procurement and sales operations, as well as realigned the ownership and use of intellectual property among our wholly-owned subsidiaries. We continue to anticipate that an increasing percentage of our consolidated pre-tax income will be derived from, and reinvested in our foreign operations. We believe that income taxed in certain foreign jurisdictions at a lower rate relative to the U.S. federal statutory rate will have a beneficial impact on our worldwide effective tax rate over time. Although the license of

intellectual property rights between consolidated entities did not result in any gain in the consolidated financial statements, the Company generated taxable income in certain jurisdictions in 2016 resulting in a tax expense of $34.3 million. Additionally, as a result of the restructuring, we reassessed the need for a valuation allowance against our deferred tax assets considering all available evidence. Given the current earnings and anticipated future earnings of our subsidiary in Israel, we concluded that we have sufficient positive evidence to release the valuation allowance against our Israel operating loss carryforwards of $31.4 million, which resulted in an income tax benefit in 2016.

In June 2017, the Costa Rica Ministry of Foreign Trade, an agency of the Government of Costa Rica, granted an extension of certain income tax incentives for an additional twelve year period. Under these incentives, all of the income in Costa Rica is subject to a reduced tax rate. In order to receive the benefit of these incentives, we must hire a specified number of employees and maintain certain 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 2017, 2016 and 2015. As a result of these incentives, our income taxes were reduced by $1.8 million, $19.1 million and $32.7 million in the year ended December 31, 2017, 2016 and 2015 respectively, representing a benefit to diluted net income per share of $0.02, $0.23 and $0.40 in the year ended December 31, 2017, 2016 and 2015, respectively (Refer to Note 13 "Income Taxes" of the Notes to Consolidated Financial Statements for details on income taxes).

Liquidity and Capital Resources

We fund our operations from product sales. As of December 31, 2017 and 2016, we had the following cash and cash equivalents, and short-term and long-term marketable securities (in thousands):

	Year Ended December 31,
	2017				2016
Cash and cash equivalents	$	449,511			$	389,275
Marketable securities, short-term	272,031				250,981
Marketable securities, long-term	39,948				59,783
Total	$	761,490			$	700,039

Cash flows (in thousands):

	Year Ended December 31,
	2017				2016				2015
Net cash provided by (used in):
Operating activities	$	438,539			$	247,654			$	237,997
Investing activities	(248,313		)		72,848				(166,361		)
Financing activities	(135,500		)		(95,524		)		(100,786		)
Effects of foreign exchange rate changes on cash and cash equivalents	5,510				(3,417		)		(3,007		)
Net increase (decrease) in cash and cash equivalents	$	60,236			$	221,561			$	(32,157	)

As of December 31, 2017, we had $761.5 million in cash, cash equivalents, and short-term and long-term marketable securities. Cash equivalents and marketable securities are comprised of money market funds and highly liquid debt instruments which primarily include commercial paper, corporate bonds, U.S. government agency bonds, U.S. government treasury bonds and certificates of deposit.

As of December 31, 2017, approximately $490.1 million of cash, cash equivalents and short-term and long-term marketable securities was held by our foreign subsidiaries. The TCJA enacted into law on December 22, 2017 included a one-time transition tax on the mandatory deemed repatriation of foreign earnings, and, as a result, we recorded a provisional amount of additional income tax expense of $73.9 million, which will be paid over the next eight years. We may repatriate cash and cash equivalents and marketable securities back to the U.S. to invest in market expansion opportunities, provide additional working capital, and have greater flexibility to fund our stock repurchase program (Refer to Note 13 "Income Taxes" of the Notes to Consolidated Financial Statements for details).

Operating Activities

For the year ended December 31, 2017, cash flows from operations of $438.5 million resulted primarily from our net income of approximately $231.4 million as well as the following:

Significant non-cash activities

•	Stock-based compensation was $58.9 million related to equity incentive compensation granted to employees and directors,

•	Depreciation and amortization of $37.7 million related to our fixed assets and acquired and purchased intangible assets, and

•	Net change in deferred tax assets of $17.6 million.

Significant changes in working capital

•	Increase of $91.0 million in accounts receivable which is a result of the increase in net revenues,

•	Increase of $79.7 million in deferred revenues corresponding to the increases in case shipments,

•	Increase of $69.0 million in long-term income tax payable due to the new U.S.Tax Cut and Jobs Act enacted on December 22, 2017, and

•	Increase of $24.2 million in accrued and other long-term liabilities due to timing of payments and activities.

For the year ended December 31, 2016, cash flows from operations of $247.7 million resulted primarily from our net income of approximately $189.7 million as well as the following:

Significant non-cash activities

•	Stock-based compensation was $54.1 million related to equity incentive compensation granted to employees and directors,

•	Depreciation and amortization of $24.0 million related to our fixed assets and acquired and purchased intangible assets,

•	Excess tax benefits from our share-based compensation arrangements of $16.8 million,

•	Net change in deferred tax assets of $16.4 million, and

•	Net tax benefits from stock based compensation of $15.9 million.

Significant changes in working capital

•	Increase of $94.4 million in accounts receivable which is a result of the increase in net revenues,

•	Increase of $60.7 million in deferred revenues corresponding to the increases in case shipments and full year effect of our additional aligner product policy effective in July 2015, and

•	Increase of $37.6 million in accrued and other long-term liabilities due to timing of payments and activities.

For the year ended December 31, 2015, cash flows from operations of $238.0 million resulted primarily from our net income of approximately $144.0 million as well as the following:

Significant non-cash activities

•	Stock-based compensation was $52.9 million related to our equity incentive compensation granted to employees and directors,

•	Depreciation and amortization of $18.0 million related to our fixed assets and acquired and purchased intangible assets, and

•	Excess tax benefits from our share-based compensation arrangements of $10.4 million.

Significant changes in working capital

•	Increase of $41.9 million in deferred revenues corresponding to higher product sales along with the increased deferrals as a result of the change to our new additional aligner product policy in July 2015,

•	Increase of $40.8 million in accounts receivable which is a result of the increase in net revenues, and

•	Increase of $19.5 million in accrued and other long-term liabilities primarily due to an increase in income tax payable along with other accruals due to timing of payment.

Investing Activities

Net cash used in investing activities was $248.3 million for the year ended December 31, 2017, which primarily consisted of purchases of marketable securities of $390.2 million, property, plant and equipment purchases of $195.7 million for additional manufacturing capacity and to purchase our new headquarters, $30.0 million of loan advances to equity investee, net of repayments and $12.8 million related to our equity interest investment in SmileDirectClub, LLC ("SDC"). These outflows were partially offset by maturities and sales of marketable securities of $388.8 million.

For 2018, we expect to invest $200.0 million to $230.0 million on capital expenditures primarily related to operational expansion and ongoing growth of the business.

Net cash provided by investing activities was $72.8 million for the year ended December 31, 2016, which primarily consisted of maturities and sales of our marketable securities of $604.0 million. These inflows were partially offset by purchases of marketable securities of $405.6 million, property, plant and equipment purchases of $70.6 million including the implementation of our new ERP system and $46.7 million related to our equity interest investment in SDC.

Net cash used in investing activities was $166.4 million for the year ended December 31, 2015, which primarily consisted of purchases of marketable securities of $447.1 million and property, plant and equipment purchases of $53.5 million for additional manufacturing capacity and infrastructure including the project to implement a new ERP system which we started in late 2014. These uses were partially offset by $334.1 million of maturities and sales of our marketable securities.

Financing Activities

Net cash used by financing activities was $135.5 million for the year ended December 31, 2017 primarily resulting from common stock repurchases of $103.8 million (Refer to Note 11 "Common Stock Repurchase Program" of the Notes to Consolidated Financial Statements for details on the stock repurchase program) and payroll taxes paid for vesting of restricted stock units ("RSUs") through share withholdings of $46.2 million. These outflows were offset in part by $14.5 million from proceeds from the issuance of common stock.

Net cash used by financing activities was $95.5 million for the year ended December 31, 2016 primarily resulting from common stock repurchases of $96.2 million (Refer to Note 11 "Common Stock Repurchase Program" of the Notes to Consolidated Financial Statements for details on the stock repurchase program) and $29.9 million of payroll taxes paid for vesting of RSUs through share withholdings, partially offset by excess tax benefit from our share-based compensation arrangements of $16.8 million and proceeds from issuance of common stock of $13.8 million.

Net cash used by financing activities was $100.8 million for the year ended December 31, 2015 resulting from repurchases of our common stock of $101.8 million and $20.7 million of payroll taxes paid for our employees' vesting of RSUs through share withholdings, partially off-set by proceeds from issuance of common stock of $11.3 million and $10.4 million from excess tax benefit from our share-based compensation arrangements.

As restricted stock units are taxable to the individuals when they vest, the number of shares we issue to each of our employees will be net of applicable withholding taxes which will be paid by us on their behalf. During 2017, 2016 and 2015, we paid $46.2 million, $29.9 million and $20.7 million, respectively, for taxes related to RSUs that vested during the periods.

Stock Repurchases

Refer to Note 11"Common Stock Repurchase Program" of the Notes to Consolidated Financial Statements for details on stock repurchase program.

◦	April 2014 Repurchase Program. In 2017, we repurchased shares of our common stock on the open market for an aggregate purchase price of approximately $3.8 million, completing the April 2014 Repurchase Program.

◦	April 2016 Repurchase Program. In 2017, we repurchased, $50.0 million of our common stock through an accelerated stock repurchase agreement and $50.0 million on the open market.

◦

Remaining Available Repurchases. As of December 31, 2017, we have $200.0 million remaining under the April 2016 Repurchase Program. In February 2018, we repurchased approximately 0.4 million shares on the open market for an aggregate purchase price of $100 million, at an average share price of $252.24 (Refer to Note 10 "Common Stock Repurchase Program" of the Notes to Consolidated Financial Statements for details on stock repurchase program).

We believe that our current cash and cash equivalents and marketable securities combined with our positive cash flows from operations will be sufficient to fund our operations and stock repurchases for at least the next 12 months. If we are unable to generate adequate operating cash flows, we may need to suspend our stock repurchase program, utilize our credit facility, or seek additional sources of capital through equity or debt financing, collaborative or other arrangements with other companies, bank financing and other sources in order to realize our objectives and to continue our operations. There can be no assurance that we will be able to obtain additional debt or equity financing on terms acceptable to us, or at all. If adequate funds are not available, we may need to make business decisions that could adversely affect our operating results such as modifications to our pricing policy, business structure or operations. Accordingly, the failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our business, results of operations and financial condition.

Credit Facility

On March 22, 2013, we entered into a credit facility for a $50.0 million revolving line of credit, with a $10.0 million letter of credit, and a maturity date of March 22, 2018. On February 27, 2018, we entered into a new credit facility for a $200.0 million revolving line of credit, with a $50.0 million letter of credit, and a maturity date of February 27, 2021, replacing existing credit facility (Refer to Note 7 "Credit Facility" of the Notes to Consolidated Financial Statements for details of the credit facility).

Contractual Obligations/Off Balance Sheet Arrangements

The impact that our contractual obligations as of December 31, 2017 are expected to have on our liquidity and cash flows in future periods is as follows (in thousands):

					Payments Due by Period
	Total				Less than 1 Year				1-3 Years				3-5 Years				More than 5 Years
Operating lease obligations (1)	$	61,555			$	14,799			$	23,019			$	14,164			$	9,573
Unconditional purchase obligations	683,242				414,726				173,663				94,853				—
Total contractual cash obligations	$	744,797			$	429,525			$	196,682			$	109,017			$	9,573

(1) Sublease income is not material and excluded from the table below.

Our contractual obligations table above excludes approximately $38.1 million of non-current uncertain tax benefits which are included in other long-term obligations and deferred tax assets on our balance sheet as of December 31, 2017. We have not included this amount because we cannot make a reasonably reliable estimate regarding the timing of settlements with taxing authorities, if any.

We had no material off-balance sheet arrangements as defined in Regulation S-K Item 303(a) (4) as of December 31, 2017 other than certain items disclosed in Note 9 "Commitments and Contingencies" of the Notes to Consolidated Financial Statements.

Indemnification Provisions

In the normal course of business to facilitate transactions in our services and products, we indemnify 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, 2017, we did not have any material indemnification claims that were probable or reasonably possible.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses and disclosures at the date of the financial statements. We evaluate our estimates on an on-going basis, including those related to revenue recognition, stock-based compensation, goodwill and finite-lived assets and related impairment, and income taxes. We use authoritative pronouncements, historical experience and other assumptions as the basis for making estimates. Actual results could differ from those estimates.

We believe the following critical accounting policies and estimates affect our more significant judgments used in the preparation of our consolidated financial statements. For further information on all of our significant accounting policies, see Note 1 "Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements under Item 8.

Revenue Recognition

We enter into sales arrangements that may consist of multiple deliverables of our products and services where certain elements of the sales arrangement are not delivered in one reporting period. We measure and allocate revenue according to the accounting guidance for multiple-element revenue arrangements in Accounting Standards Codification (“ASC”) 605-25, "Revenue Recognition – Multiple-Element Arrangements."

Each element within a multiple-element arrangement is accounted for as a separate unit of accounting provided the following criteria are met: the delivered products or services have value to the customer on a standalone basis; and for an arrangement that includes a general right of return relative to the delivered products or services, delivery or performance of the undelivered product or service is considered probable and is substantially controlled by us. We consider a deliverable to have standalone value if the product or service is sold separately by us or another vendor or could be resold by the customer. Further, our revenue arrangements generally do not include a general right of return relative to the delivered products. The arrangement consideration is allocated to each element, delivered or undelivered, at the inception of the arrangement based on the relative selling price of each unit of accounting. We use a hierarchy to determine the fair value to be used for allocating revenue to elements, based first on vendor-specific objective evidence (“VSOE”) if it exists, second on third-party evidence (“TPE”) if it exists, or on best estimated selling price (“BESP”) if neither VSOE nor TPE exist (a description as to how we determine VSOE, TPE and BESP is provided below).

•	VSOE - In most instances, this applies to products and services that are sold separately in stand-alone arrangements. We determine VSOE based on pricing and discounting practices for the specific product or service when sold separately, considering geographical, customer, 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 does 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 our pricing practices. Adjustments for other market and company specific factors are made as deemed necessary in determining BESP. We regularly review our estimates of selling price and maintain internal controls over the establishment and update of these estimates.

Revenue recognition for multiple-element arrangements requires judgment to determine if multiple elements exist, whether elements can be accounted for as separate units of accounting, and if so, the fair value for each of the elements, and the manner in which revenue should be allocated among the accounting units. Our process for determining BESPs requires judgment and considers multiple factors that may vary over time depending upon the unique facts and circumstances related to each deliverable. Further, while changes in the allocation of the best estimated selling price between the accounting units will not affect the amount of total revenue recognized for a particular arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could have a material effect on our financial position and results of operations.

Clear Aligner

We enter into arrangements (“treatment plan(s)”) that involve multiple future product deliverables. Invisalign Full, Invisalign Teen, and Invisalign Assist products include optional additional aligners at no charge for a period of up to five years after initial shipment and Invisalign Go includes optional additional aligners at no charge for a period of up to two years after initial shipment. Invisalign Teen also includes up to six optional replacement aligners in the price of the product and may be ordered by the dental professional any time throughout treatment. Invisalign Lite includes one optional case refinement in the price of the product. Case refinement is a finishing tool used to adjust a patient's teeth to the desired final position and may be elected by the dental professional at any time during treatment; however, it is generally ordered in the last stages of orthodontic treatment.

We determined that our treatment plans, except Invisalign Assist with progress tracking, comprise the following deliverables which also represent separate units of accounting: initial aligners, additional aligners, case refinement, 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 shipment of each unit in the treatment plan.

For Invisalign Assist with the progress tracking feature, aligners and services are provided to the dental professional every nine stages (a "batch”). We are 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.

Scanners and Services

We sell intraoral scanners and CAD/CAM services through both our direct sales force and distribution partners. The intraoral scanner sales price includes one year of warranty, and unlimited scanning services. The customer may, for additional fees, also select extended warranty and unlimited scanning services for periods beyond the initial year. When intraoral scanners are sold with 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.

Stock-Based Compensation Expense

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 use the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase plan shares. 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 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. We adopted the ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting" (Topic 718) in the first quarter of fiscal year 2017 and we elected to continue to estimate expected forfeitures rather than as they occur to determine the amount of compensation cost to be recognized in each period.

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. For the year ended December 31, 2017 and 2016, all goodwill is attributed to our Clear Aligner reporting unit.

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

Impairment of Goodwill, Finite-Lived Acquired Intangible Assets 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 changes in circumstances 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. Refer to Note 6 "Goodwill and Intangible Assets" of Notes to Consolidated Financial Statements for details on intangible long-lived assets.

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. The estimation of fair value utilizing a discounted cash flow 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. Refer to Note 6 "Goodwill and Intangible Assets" of Notes to Consolidated Financial Statements for details of the impairment analysis.

Accounting for 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 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 Statement 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 realized.

The TCJA was enacted into law on December 22, 2017 and impacted our effective tax rate for the year ended December 31, 2017. The TCJA made significant changes to the Internal Revenue Code, including, but not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S. international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017.

On December 22, 2017, Staff Accounting Bulletin No. 118 ("SAB 118") was issued to address the application of GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the TCJA. We recorded an additional income tax expense of $84.3 million in the fourth quarter of 2017, which represents the provisional amount of the impact of the TCJA. This provisional amount includes income tax expenses related to the remeasurement of certain deferred tax assets and liabilities of $10.4 million, and the one-time transition tax on the mandatory deemed repatriation of cumulative foreign earning in the amount of $73.9 million. Additional work is necessary for a more detailed analysis of our deferred tax assets and liabilities and our historical foreign earnings as well as potential correlative adjustments. Any subsequent adjustment to these amounts will be recorded to tax expense in 2018 when the analysis is complete. Refer to Note 13 "Income Taxes" of the Notes of Consolidated Financial Statements for details on provision impact of the TCJA.

Recent Accounting Pronouncements

See Note 1 “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements in Item 8 for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition, which is incorporated herein.