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 2019 and beyond may be affected by a number of other factors including:

•

New Invisalign Product Portfolio and Pricing. In July 2018, we launched a new expanded Invisalign product portfolio which includes new options and greater flexibility to treat a broader range of patients. The new Invisalign product portfolio offers doctors more choices by extending desirable features across the entire portfolio and creating new Invisalign treatment packages, as well as new options to treat young patients with early mixed dentition (with a mixture of primary/baby and permanent teeth). The new end-to-end Invisalign product portfolio includes clear aligner product offerings for almost every patient age group and case complexity to make it easier for our doctors to tailor treatment planning to the needs of each patient. Pricing and availability for the new Invisalign product offerings and the associated terms and conditions vary by region.

•	New Invisalign Products and Feature Enhancements. Product innovation drives greater treatment predictability, 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.

◦

In March 2017, we announced Invisalign treatment with Mandibular Advancement, the first clear aligner solution for Class II correction in growing tween and teen patients. This offering combines the benefits of our clear aligner system with features for moving the lower jaw forward while simultaneously aligning the teeth. Invisalign treatment with Mandibular Advancement is available in Canada, select Europe, Middle East and Africa (“EMEA”), Asia Pacific (“APAC”) and Latin America (“LATAM”) countries and, in the U.S. starting November 2018 as we received 510(k) clearance from the United States (“U.S.”) Food and Drug Administration in October 2018.

◦

Beginning July 2018, Invisalign First clear aligners, a treatment option designed with features specifically for younger patients with early mixed dentition, are available to Invisalign-trained doctors in the U.S., Canada, Australia, New Zealand, Japan, and the EMEA region. Invisalign First clear aligners are designed specifically to address a broad range of younger patients’ malocclusions, including shorter clinical crowns, management of erupting dentition and predictable dental arch expansion. Phase 1 treatment is an early interceptive orthodontic treatment for young patients, traditionally done through arch expanders, or partial metal braces, before all permanent teeth have erupted, typically at ages seven through ten years.

◦

In April 2018, we announced a new Invisalign Go product with more user-friendly iTero digital chairside experience and greater flexibility to treat a wider range of mild to moderate cases, such as crowded or gap teeth that require teeth straightening prior to restorative treatments. Invisalign Go is available to Invisalign-trained doctors in the U.S., the majority of European countries as well as in select APAC markets. Invisalign Go also incorporates new data-driven clinical protocols for predictable tooth movement and automated case assessments that leverages our Invisalign patients treated to date. These improvements make it easier for general practitioner dentists to tailor their treatment plans to the individual needs of each patient.

•	New iTero Products and Technology Innovation. The iTero scanner is an important component to our customer experience and is central to a digital approach as well as overall customer utilization of Invisalign.

◦	In April 2018, we expanded the iTero Element portfolio with the launch of the iTero Element 2 and the iTero Element Flex scanners, building on the existing high precision, full-color imaging and fast scan times of the

iTero Element portfolio while streamlining orthodontic and restorative workflows. The next-generation iTero Element 2 is designed for greater performance with 2X faster start-up and 25% faster scan processing time compared to the iTero Element. The new iTero Element Flex wand-only configuration is a portable scanner for easy transport from office to office. iTero Element 2 and iTero Element Flex scanners are available in the U.S., Canada, the majority of European countries as well as in select APAC markets. The existing iTero Element scanner continues to be available in all markets.

◦

In April 2018, we announced that we received market approval for the iTero Element intra-oral scanner from the China Food and Drug Administration, and we began offering this scanner in China. The iTero Element scanner launch in China not only supports growth of our base Invisalign clear aligner business but also represents a major milestone for digital dentistry in China. As we continue to expand into markets where we sell our intra-oral scanners, we expect continued growth for the foreseeable future due to the size of the market opportunities and our relatively low market penetration in these regions.

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.

The use of iTero and other digital scanners for Invisalign case submission in place of PVS impressions continues to grow and remains a positive catalyst for Invisalign utilization. For the fourth quarter of 2018, total Invisalign cases submitted with a digital scanner in the Americas increased to 72.6%, up from 71.0% in the third quarter of 2018. International scans increased to 57.5%, up from 53.9% in the third quarter of 2018. In China, Invisalign cases submitted using a digital scanner increased to 45.9% from close to 0% in only one year. We believe that over the long-term, technology innovation and added features and functionality of our iTero scanners 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 annual utilization rates for the last three fiscal years are as follows:

• Invisalign utilization rates = # of cases shipped divided by # of doctors cases were shipped to. Beginning in the first quarter of 2018, we report International region to include EMEA and APAC. LATAM is excluded from above chart as it is not material. Our historical utilization numbers have been recast to reflect this new classification.

◦	Total utilization in 2018 increased to 15.7 cases per doctor compared to 14.5 cases in 2017.

▪	North America: Utilization among our North American orthodontist customers increased in 2018 to 56.7 cases per doctor compared to 46.6 cases per doctor in 2017. The increase in North American

orthodontist utilization in 2018 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 was 13.9 cases per doctor in 2018 compared to 13.2 cases in 2017. The increase in International utilization reflects increased utilization and continued expansion of our customer base in both 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 and younger market makes up 75% of the approximately 12 million total orthodontic case starts each year, and as we continue to drive adoption of teenage and younger patients through sales and marketing programs, we expect our utilization rate to improve. 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 2018, we trained approximately 19,655 new Invisalign doctors of which 7,885 were trained in the Americas region and 11,770 in the International region.

•

International Invisalign Growth. We continue to focus our efforts towards increasing Invisalign clear aligner adoption by dental professionals in the EMEA and APAC markets. On a year-over-year basis, our international Invisalign volume increased 45.3% driven primarily by increased adoption as well as expansion of our customer base in both the EMEA and APAC regions. We continue to see growth from our international orthodontists and general practitioner (“GP”) customers and are seeing more positive traction in the GP channel from segmenting our sales and marketing resources and programs specifically around each customer channel. In addition, we believe that continuous product introductions and feature improvements, such as Invisalign treatment with mandibular advancement, provide our customers with continued confidence in treating complex cases as well as teen-aged patients with Invisalign clear aligners. In 2019, 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 select country markets. We expect International revenues to continue to grow at a faster rate than the Americas for the foreseeable future due to our continued investment in international market expansion, the size of the market opportunities, and our relatively low market penetration of these regions. Our future growth is dependent upon the continued growth of Invisalign adoption and international market penetration (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 the fourth quarter of 2018, we began fabricating our aligners in our new manufacturing facility in Ziyang, China, our first aligner fabrication facility outside of Juarez, Mexico. We expect that it will take several quarters to ramp this facility up to full capacity and as a result manufacturing labor and overhead in this facility will be underutilized during this transition period. (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).

•

Invisalign Experience Program. In 2018, we expanded the interactive brand experience that was piloted in 2017 and finished the year with a total of twelve Invisalign locations in major U.S. cities. The program expansion is designed to address the rapidly-evolving consumer market for clear aligners and connects consumers interested in Invisalign treatment with Invisalign doctors in their communities (Refer to Item 3 "Legal Proceedings" for details on SDC dispute which may impact the Invisalign locations).

•

Increased Sales Force. In order to provide more comprehensive sales and service coverage, in the fourth quarter of 2018, we increased our sales force in the Americas by adding approximately 100 sales team members. In the first quarter of 2019, we plan to add 50 new sales representatives in EMEA to cover GP dentist channel. (Refer to Item 1A Risk Factors - “We primarily rely on our direct sales force to sell our products, and any failure to maintain our direct sales force could harm our business" for information on related risk factors).

•	Expenses. We expect expenses to increase in 2019 due in part to:

◦	Investments in manufacturing capacity and facilities to enhance our regional capabilities;

◦	Investments in international expansion in new country markets;

◦	Investments in expansion of number of direct sales force personnel;

◦	Increases in sales, marketing and customer support resources;

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

◦	Increases in legal expenses, primarily related to the continued protection of our intellectual property rights including our patents along with the additional costs related to the planned corporate structure reorganization.

We believe that these investments will position us to increase our revenues and continue to grow our market share, but will negatively impact results of operations, particularly in the near term.

•	Stock Repurchases:

◦	April 2016 Repurchase Program. In 2018, we repurchased approximately $200.0 million of our common stock on the open market, completing the April 2016 Repurchase Program.

◦

May 2018 Repurchase Program. In May 2018, we announced that our Board of Directors had authorized a plan to repurchase up to $600.0 million of our common stock. In August 2018, we repurchased $50.0 million of our common stock on the open market. In November 2018, we entered into an accelerated share repurchase ("2018 ASR") to repurchase $50.0 million of our common stock which was completed in December 2018. As of December 31, 2018, we have $500.0 million remaining under the May 2018 Repurchase Program. In February 2019, we repurchased $50.0 million of our common stock on the open market (Refer to Note 11 "Common Stock Repurchase Programs" of the Notes to Consolidated Financial Statements for details on common stock repurchase programs).

•

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 the Company (collectively, the SDC Entities) alleging that the launch and operation of the Invisalign locations 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 notified us 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. The SDC Entities’ communication also alleged that we breached confidentiality provisions applicable to the SDC Financial LLC members and demanded that we cease all activities related to the Invisalign pilot project, close existing Invisalign locations and cease using SDC’s confidential information. In April 2018, the SDC Entities served a Demand for Arbitration alleging that we breached the non-compete clause and confidentiality clause, misused the SDC Entities’ alleged trade secrets, and violated fiduciary duties to SDC Financial LLC. The SDC Entities seek through the arbitration the rights to repurchase all of Align’s SDC Financial LLC membership interests for a purchase price equal to the current capital account balance as defined by the Internal Revenue Service which likely is significantly below the current fair market value of such investment, an injunction requiring us to close our Invisalign locations and to cease using the SDC Entities’ confidential information, and financial damages in an unspecified amount. We filed a response in which we denied the SDC Entities’ allegations and denied that the SDC Entities are entitled to any relief. In April 2018 the SDC Entities also filed a motion for preliminary injunction in the Tennessee Court of Chancery seeking to enjoin Align from opening additional Invisalign locations until the arbitration is completed. In June 2018, the Tennessee court denied the SDC Entities’ motion for a preliminary injunction. In December 2018, the parties participated in binding arbitration proceedings and presented closing arguments on January 23, 2019. The arbitrator’s decision is due on or before March 4, 2019. This dispute does not impact Align’s existing supply agreement with SDC which remains in place through 2019. We do not intend to renew this agreement. We are currently unable to predict the outcome of this dispute and therefore cannot determine the likelihood of loss, if any, nor estimate a range of possible loss. (Refer to Note 8 "Legal Proceedings" of the Notes to Consolidated Financial Statements for details on SDC dispute).

Results of Operations

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, but not limited to, Invisalign Comprehensive (formerly known as Invisalign Full and Invisalign Teen), Invisalign Assist and Invisalign First.

◦	Non-Comprehensive Products include, but not limited to, Invisalign Express 10, Invisalign Express 5, Express Package, Lite Package and Invisalign Go in addition to revenues from the sale of aligners to SmileDirectClub (“SDC”) under our supply agreement.

◦	Non-Case includes, but not limited to, Vivera retainers along with our training and ancillary products for treating malocclusion.

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

Effective in the first quarter of 2018, Americas region includes North America and LATAM. International region includes EMEA and APAC. Historical data has been recasted to reflect the change.

Net Revenues for Reportable Segments by Region

Net revenues for our Clear Aligner and Scanner segments by region for the year ended December 31, 2018, 2017 and 2016 are as follows (in millions):

	Year Ended															Year Ended
Net Revenues	December 31, 2018				December 31, 2017				Change							December 31, 2017				December 31, 2016				Change
Clear Aligner revenues:
Americas	$	903.3			$	754.1			$	149.2			19.8	%		$	754.1			$	571.6			$	182.5			31.9	%
International	684.2				473.5				210.7				44.5	%		473.5				323.7				149.8				46.3	%
Non-Case	104.0				81.7				22.3				27.3	%		81.7				63.0				18.7				29.7	%
Total Clear Aligner net revenues	$	1,691.5			$	1,309.3			$	382.2			29.2	%		$	1,309.3			$	958.3			$	351.0			36.6	%
Scanner net revenues	275.0				164.1				110.9				67.6	%		164.1				121.5				42.6				35.1	%
Total net revenues	$	1,966.5			$	1,473.4			$	493.1			33.5	%		$	1,473.4			$	1,079.8			$	393.6			36.5	%

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, 2018, 2017 and 2016 is as follows (in thousands):

	Year Ended												Year Ended
Region	December 31, 2018			December 31, 2017			Change						December 31, 2017			December 31, 2016			Change
Americas	780.7			631.6			149.1			23.6	%		631.6			469.4			162.2			34.6	%
International	499.9			344.8			155.1			45.0	%		344.8			239.8			105.0			43.8	%
Total case volume	1,280.6			976.4			304.2			31.2	%		976.4			709.2			267.2			37.7	%

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

Fiscal Year 2018 compared to Fiscal Year 2017

Total net revenues increased by $493.1 million in 2018 as compared to 2017 primarily as a result of Clear Aligner case and scanner volume growth across all regions.

Clear Aligner - Americas

Americas net revenues increased by $149.2 million in 2018 as compared to 2017, primarily due to case volume growth across all channels and products which increased net revenues by $177.9 million. This increase was offset in part by lower average selling prices ("ASP"), which was mainly the result of higher promotional discounts, which reduced net revenues by $44.7 million, and increased net revenue deferrals by $3.0 million. This decline was partially offset by higher prices from the new products introduced in July 2018, which increased net revenues by $19.2 million.

Clear Aligner - International

International net revenues increased by $210.7 million in 2018 as compared to 2017, primarily driven by case volume growth across all channels and products which increased net revenues by $213.0 million. This increase was slightly offset by lower ASP which reduced net revenues by $2.3 million. The ASP decline was mainly the result of increased net revenue deferrals mostly for additional aligners, which reduced net revenues by $20.1 million, and higher promotions discounts, which reduced net revenues by $17.4 million. These were partially offset by the favorable foreign exchange rates of $20.8 million and the higher prices of $18.3 million related to our new products effective July 2018.

Clear Aligner - Non-Case

Non-case net revenues, consisting of Vivera Retainers, training fees and other product revenues, increased by $22.3 million in 2018 compared to 2017. This was primarily due to increased Vivera volume across all regions, which increased revenue by $14.4 million, and training revenues across all regions, which increased revenue by $6.5 million.

Scanner

Scanner and services net revenues increased by $110.9 million in 2018 as compared to 2017. This increase is primarily due to an increase in the number of scanners recognized, which increased revenues $87.8 million. Additionally, a larger scanner install base resulted in higher computer-aided design/computer-aided manufacturing ("CAD/CAM") services which increased net revenues by $21.3 million and higher disposable sleeve volume which increased net revenue by $6.9 million. These factors were offset in part by a decrease in scanner ASP mostly due to increased promotional discounts, which reduced net revenues by $5.5 million.

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 Clear Aligner case volume growth across all regions and products as well as increased non-case revenue.

Clear Aligner - Americas

Americas net revenues increased by $182.5 million in 2017 compared to 2016 primarily due to case volume growth across all channels and most products which increased net revenues by $195.5 million. This increase was offset in part by lower ASP which decreased net revenues by $13.1 million. The ASP decline was 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 partially 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 $149.8 million in 2017 compared to 2016 primarily driven by case volume growth across all channels and products which increased net revenues by $142.9 million and, to a lesser extent, higher ASP which contributed approximately $6.8 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 $24.4 million to net revenues. The factors contributing to an increase in ASP were partially offset in part by higher promotional discounts which decreased net revenues by $13.7 million as well as an increase in net revenue deferrals of $3.0 million, among other factors.

Clear Aligner - Non-Case

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

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

	Year Ended												Year Ended
	December 31, 2018				December 31, 2017				Change				December 31, 2017				December 31, 2016				Change
Clear Aligner
Cost of net revenues	$	411.0			$	289.7			$	121.3			$	289.7			$	210.8			$	78.9
% of net segment revenues	24.3		%		22.1		%						22.1		%		22.0		%
Gross profit	$	1,280.5			$	1,019.6			$	260.9			$	1,019.6			$	747.5			$	272.1
Gross margin %	75.7		%		77.9		%						77.9		%		78.0		%
Scanner
Cost of net revenues	$	107.7			$	66.8			$	40.9			$	66.8			$	53.7			$	13.1
% of net segment revenues	39.1		%		40.7		%						40.7		%		44.2		%
Gross profit	$	167.4			$	97.4			$	70.0			$	97.4			$	67.8			$	29.6
Gross margin %	60.9		%		59.3		%						59.3		%		55.8		%
Total cost of net revenues	$	518.6			$	356.5			$	162.1			$	356.5			$	264.6			$	91.9
% of net revenues	26.4		%		24.2		%						24.2		%		24.5		%
Gross profit	$	1,447.9			$	1,116.9			$	331.0			$	1,116.9			$	815.3			$	301.6
Gross margin %	73.6		%		75.8		%						75.8		%		75.5		%

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 2018 compared to Fiscal Year 2017

Clear Aligner

The gross margin percentage decreased in 2018 compared to 2017 primarily due to higher manufacturing spend driven by operational expansion activities and an increase in aligners per case driven by additional aligners.

Scanner

The gross margin percentage increased in 2018 compared to 2017 primarily driven by manufacturing efficiencies offset in part by a lower ASP.

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.

Selling, general and administrative (in millions):

	Year Ended												Year Ended
	December 31, 2018				December 31, 2017				Change				December 31, 2017				December 31, 2016				Change
Selling, general and administrative	$	852.4			$	665.8			$	186.6			$	665.8			$	490.7			$	175.1
% of net revenues	43.3		%		45.2		%						45.2		%		45.4		%

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, equipment and maintenance costs, outside service costs, legal costs, depreciation and amortization expense and allocations of corporate overhead expenses including facilities and Information Technology ("IT").

Fiscal Year 2018 compared to Fiscal Year 2017

Selling, general and administrative expense increased in 2018 compared to 2017 primarily due to higher compensation related costs of $110.9 million mainly from increased headcount resulting in higher salaries expense, incentive bonuses and fringe benefits as a result of investments in sales coverage and international expansion. We also incurred higher expenses from equipment, software and maintenance costs of $27.0 million from investments in facilities to enhance our regional capabilities, advertising and marketing of $24.3 million and $22.3 million of legal and outside services costs.

Fiscal Year 2017 compared to Fiscal Year 2016

Selling, general and administrative expense increased in 2017 compared to 2016 primarily due to higher compensation related costs of $85.6 million mainly from 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.

Research and development (in millions):

	Year Ended												Year Ended
	December 31, 2018				December 31, 2017				Change				December 31, 2017				December 31, 2016				Change
Research and development	$	128.9			$	97.6			$	31.3			$	97.6			$	75.7			$	21.9
% of net revenues	6.6		%		6.6		%						6.6		%		7.0		%

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 payroll and 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 for both periods primarily due to higher compensation costs mainly from increased headcount resulting in higher salaries expense, incentive bonuses and fringe benefits.

Income from operations (in millions):

	Year Ended												Year Ended
	December 31, 2018				December 31, 2017				Change				December 31, 2017				December 31, 2016				Change
Clear Aligner
Income from operations	$	712.4			$	564.6			$	147.8			$	564.6			$	411.8			$	152.8
Operating margin %	42.1		%		43.1		%						43.1		%		43.0		%
Scanner
Income from operations	$	99.0			$	49.6			$	49.4			$	49.6			$	37.5			$	12.1
Operating margin %	36.0		%		30.2		%						30.2		%		30.9		%
Total income from operations 1	$	466.6			$	353.6			$	113.0			$	353.6			$	248.9			$	104.7
Operating margin %	23.7		%		24.0		%						24.0		%		23.1		%

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 Consolidated Income from Operations.

Fiscal Year 2018 compared to Fiscal Year 2017

Clear Aligner

Operating margin percentage decreased in 2018 compared to 2017 due to higher manufacturing spend driven by operational expansion activities and an increase in aligners per case driven by additional aligners partially offset by leveraged spend of operating expenses on higher Clear Aligner revenues.

Scanner

Operating margin percentage increased in 2018 compared to 2017 due to leveraged spend of operating expenses on higher Scanner revenues and manufacturing efficiencies partially offset by a lower ASP.

Fiscal Year 2017 compared to Fiscal Year 2016

Clear Aligner

Operating margin percentage increased slightly in 2017 compared to 2016 due to leveraged spend of 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.

Interest income (in millions):

	Year Ended												Year Ended
	December 31, 2018				December 31, 2017				Change				December 31, 2017				December 31, 2016				Change
Interest income	$	8.6			$	6.9			$	1.7			$	6.9			$	4.2			$	2.7

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

Interest includes interest income earned on cash, cash equivalents and investment balances.

Fiscal Year 2018 compared to Fiscal Year 2017

Interest income increased in 2018 compared to 2017 mainly due to higher interest rates.

Fiscal Year 2017 compared to Fiscal Year 2016

Interest income increased in 2017 compared to 2016 mainly due to a larger investment portfolio.

Other income (expense), net (in millions):

	Year Ended												Year Ended
	December 31, 2018				December 31, 2017				Change				December 31, 2017				December 31, 2016				Change
Other income (expense), net	$	(8.5	)		$	4.2			$	(12.7	)		$	4.2			$	(10.6	)		$	14.8

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

Other income (expense), net, includes foreign exchange gains and losses, gains and losses on foreign currency forward contracts, interest expense and other miscellaneous charges.

Fiscal Year 2018 compared to Fiscal Year 2017

Other income (expense), net, decreased in 2018 compared to 2017 mainly due to foreign exchange losses partially offset by gains on foreign currency forward contracts.

Fiscal Year 2017 compared to Fiscal Year 2016

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.

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

	Year Ended												Year Ended
	December 31, 2018				December 31, 2017				Change				December 31, 2017				December 31, 2016				Change
Equity in losses of investee, net of tax	$	8.7			$	3.2			$	5.5			$	3.2			$	1.7			$	1.5

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

Fiscal Year 2018 compared to Fiscal Year 2017

Equity in losses of investee, net of tax increased in 2018 compared to 2017 due to higher losses attributable from our equity method investments including a higher proportional share of the losses due to our additional investment made in the third quarter of 2017.

Fiscal Year 2017 compared to Fiscal Year 2016

Equity in losses of investee, net of tax increased in 2017 compared 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 made in the third quarter of 2017 (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, 2018				December 31, 2017				Change				December 31, 2017				December 31, 2016				Change
Provision for income taxes	$	57.7			$	130.2			$	(72.5	)		$	130.2			$	51.2			$	79.0
Effective tax rates	12.4		%		35.7		%						35.7		%		21.1		%

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

Our provision for income taxes was $57.7 million, $130.2 million and $51.2 million for the year ended December 31, 2018, 2017 and 2016, respectively, representing effective tax rates of 12.4%, 35.7% and 21.1%, respectively.

The decrease in effective tax rate for the year ended December 31, 2018 compared to the same period in 2017 is mainly driven by the provisional amounts recorded in 2017 related to the TCJA that did not recur in 2018, the recognition of tax benefits related to a statute of limitations expiration and the increase in excess tax benefits related to stock-based compensation, offset in part by the unfavorable tax impact of the TCJA including non-deductible officers' compensation and reduced tax benefits from foreign earnings being taxed at a lower rate. For the year ended December 31, 2018, the excess tax benefits related to stock-based compensation we recognized in our provision for income taxes was $26.5 million.

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 specified numbers 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 2018, 2017 and 2016. As a result of these incentives, our income taxes were reduced by $2.4 million, $1.8 million and $19.1 million in the year ended December 31, 2018, 2017 and 2016, respectively, representing a benefit to diluted net income per share of $0.03, $0.02 and $0.23 in the year ended December 31, 2018, 2017 and 2016, respectively (Refer to Note 13 "Accounting for Income Taxes" of the Notes to Consolidated Financial Statements for details on income taxes).

Liquidity and Capital Resources

We fund our operations from product and services sales. As of December 31, 2018 and 2017, we had the following cash and cash equivalents, and short-term and long-term marketable securities (in thousands):

	Year Ended December 31,
	2018				2017
Cash and cash equivalents	$	636,899			$	449,511
Marketable securities, short-term	98,460				272,031
Marketable securities, long-term	9,112				39,948
Total	$	744,471			$	761,490

As of December 31, 2018, we had $744.5 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, 2018, approximately $312.0 million of cash, cash equivalents and short-term and long-term marketable securities was held by our foreign subsidiaries. We repatriated $360.0 million to the U.S. during the year ended December 31, 2018 and we may further repatriate funds in the future to invest in market expansion opportunities, provide additional working capital, and have greater flexibility to fund our stock repurchase programs (Refer to Note 13 "Income Taxes" of the Notes to Consolidated Financial Statements for details).

Cash flows (in thousands):

	Year Ended December 31,
	2018				2017				2016
Net cash provided by (used in):
Operating activities	$	554,681			$	438,539			$	247,654
Investing activities	6,927				(251,477		)		73,028
Financing activities	(369,434		)		(135,500		)		(95,524		)
Effects of foreign exchange rate changes on cash, cash equivalents, and restricted cash	(4,733		)		5,544				(3,374		)
Net increase in cash, cash equivalents, and restricted cash	$	187,441			$	57,106			$	221,784

Operating Activities

For the year ended December 31, 2018, cash flows from operations of $554.7 million resulted primarily from our net income of approximately $400.2 million as well as the following:

Significant non-cash activities

•	Stock-based compensation was $70.8 million related to equity incentive compensation granted to employees and directors;

•	Depreciation and amortization of $54.7 million related to our investments in property, plant and equipment and intangible assets; and

•	Net change in deferred tax assets of $15.7 million.

Significant changes in working capital

•	Increase of $136.4 million in deferred revenues corresponding to the increase in case volume;

•	Increase of $109.2 million in accounts receivable which is primarily a result of the increase in net revenues; and

•	Decrease of $36.5 million in long-term income tax payable due to timing of payments made to IRS.

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 investments in property, plant and equipment and 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 volume;

•	Increase of $69.0 million in long-term income tax payable due to the new TCJA 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 our equity incentive compensation granted to employees and directors;

•	Depreciation and amortization of $24.0 million related to our investments in property, plant and equipment and 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 $95.8 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 volume and full year effect of our additional aligner product policy effective in July 2015; and

•	Increase of $31.4 million in accrued and other long-term liabilities due to timing of payments and activities.

Investing Activities

Net cash provided by investing activities was $6.9 million for the year ended December 31, 2018, which primarily consisted of maturities and sales of our marketable securities of $384.7 million and loan repayment from equity investee of $30.0 million. These inflows were partially offset by purchases property, plant and equipment of $223.3 million, purchases of marketable securities of $180.2 million and purchases of investments in privately held companies of $5.0 million.

For 2019, we expect to invest $250.0 million to $260.0 million on capital expenditures primarily related to operational expansion and ongoing growth of the business.

Net cash used in investing activities was $251.5 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 SDC. These outflows were partially offset by maturities and sales of marketable securities of $388.8 million.

Net cash provided by investing activities was $73.0 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.

Financing Activities

Net cash used in financing activities was $369.4 million for the year ended December 31, 2018 primarily consisted of common stock repurchases of $300.0 million (Refer to Note 11 "Common Stock Repurchase Programs" of the Notes to Consolidated Financial Statements for details on stock repurchase programs) and payroll taxes of $86.1 million paid for vesting of restricted stock units ("RSUs") through share withholdings. These outflows were offset in part by $16.6 million from proceeds from the issuance of common stock.

Net cash used in 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 Programs" of the Notes to Consolidated Financial Statements for details on stock repurchase programs) and payroll taxes of $46.2 million paid for vesting of RSUs through share withholdings. These outflows were offset in part by $14.5 million from proceeds from the issuance of common stock.

Net cash used in 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 Programs" of the Notes to Consolidated Financial Statements for details on stock repurchase programs) and payroll taxes of $29.9 million 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.

Common Stock Repurchases

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

◦	April 2016 Repurchase Program. In 2018, we repurchased approximately $200.0 million of our common stock on the open market, completing the April 2016 Repurchase Program.

◦

May 2018 Repurchase Program. In May 2018, we announced that our Board of Directors had authorized a plan to repurchase up to $600.0 million of our common stock. In August 2018, we repurchased $50.0 million of our common stock on the open market. In November 2018, we entered into an accelerated share repurchase ("2018 ASR") to repurchase $50.0 million of our common stock which was completed in December 2018. As of December 31, 2018, we have $500.0 million remaining under the May 2018 Repurchase Program

We believe that our current cash, cash equivalents and short-term marketable securities combined with our existing borrowing capacity will be sufficient to fund our operations for at least the next 12 months. If we are unable to generate adequate operating cash flows and need more funds beyond our available liquid investments and those available under our credit facility, we may need to suspend our stock repurchase programs 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 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 sublimit, and a maturity date of February 27, 2021, replacing the existing credit facility which provided for a $50.0 million revolving line of credit with a $10.0 million letter of credit. As of December 31, 2018, we had no outstanding borrowings under this 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, 2018 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)	$	106,676			$	21,429			$	39,380			$	27,496			$	18,371
Unconditional purchase obligations	476,904				166,701				189,523				120,680				—
Total contractual cash obligations	$	583,580			$	188,130			$	228,903			$	148,176			$	18,371

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

Our contractual obligations table above excludes approximately $28.2 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, 2018. 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, 2018 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, 2018, 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

Our revenues are derived primarily from the sale of aligners, scanners, and services from our Clear Aligner and Scanner segments. We enter into sales contracts that may consist of multiple distinct performance obligations where certain performance obligations of the sales contract are not delivered in one reporting period. We measure and allocate revenues according to ASC 606-10, “Revenues from Contracts with Customers.”

We identify a performance obligation as distinct if both of the following criteria are true: the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer and the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. Determining the standalone selling price (“SSP”) and allocation of consideration from a contract to the individual performance obligations, and the appropriate timing of revenue recognition, is the result of significant qualitative and quantitative judgments. Management considers a variety of factors such as historical sales, usage rates (the number of times a customer is expected to order additional aligners), costs, and expected margin, which may vary over time depending upon the unique facts and circumstances related to each performance obligation in making these estimates. Further, our process for estimating usage rates require significant judgment and evaluation of inputs, including historical data and forecasted usages. While changes in the allocation of the SSP between performance obligations will not affect the amount of total revenues recognized for a particular contract, any material changes could impact the timing of revenue recognition, which would have a material effect on our financial position and result of operations. This is because the contract consideration is allocated to each performance obligation, delivered or undelivered, at the inception of the contract based on the SSP of each distinct performance obligation.

Clear Aligner

We enter into contracts (“treatment plan(s)”) that involve multiple future performance obligations. Invisalign Comprehensive, Invisalign Full, Invisalign Teen, Invisalign First, Invisalign Express 10, Invisalign Express 5, Express Package, Lite Package and Invisalign Assist products include optional additional aligners at no charge for a certain period of time ranging from one 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.

We determined that our treatment plans comprise the following performance obligations that also represent distinct deliverables: initial aligners, additional aligners, case refinement, and replacement aligners. We elected to take the practical expedient to consider shipping and handling costs as activities to fulfill the performance obligation. We allocate revenues for each treatment plan based on each unit’s SSP and recognize the revenues upon shipment, as the customers obtain physical possession and we have enforceable rights to payment. As we collect most consideration upfront, we considered whether a significant financing component exists; however, as the delivery of the performance obligations are at the customer’s discretion, we concluded that no significant financing component exists.

Scanner

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 also select, for additional fees, 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 revenues based on the respective SSPs of the scanner and the subscription service. We estimate the SSP of each element, taking into consideration historical prices as well as our discounting strategies. Revenues are then recognized over time as the monthly services are rendered and upon shipment for the scanner, as that is when we deem the customer to have obtained control. Most consideration is collected upfront and in cases where there are payment plans, consideration is collected by the one year mark and, therefore, there are no significant financing components.

Warranties

For both Clear Aligner and Scanner segments, we offer an assurance warranty which provides the customer assurance that the product will function as the parties intended because it complies with agreed-upon specifications, and thus is not treated as a separate performance obligation and will continue to be accrued in accordance with the Financial Accounting Standards Board guidance on guarantees.

Volume Discounts

In certain situations, we offer promotions in which the discount will increase depending upon the volume purchased over time. We concluded that in these situations, the promotions can represent either variable consideration or options, depending upon the specifics of the promotion. In the event the promotion contains an option, the option is considered a material right and, therefore, included in the accounting for the initial arrangement. We estimate the average anticipated discount over the lifetime of the promotion or contract, and apply that discount to each unit as it is sold. On a quarterly basis, we review our estimates and, if needed, updates are made and changes are applied prospectively.

Accrued Sales Return Reserve

We accrue for sales return reserve based on historical sales returns as a percentage of revenue.

Costs to Obtain a Contract

We offer a variety of commission plans to our salesforce; each plan has multiple components. To match the costs to obtain a contract to the associated revenue, we evaluate the individual components and capitalize the eligible components, recognizing the costs over the treatment period.

Unfulfilled Performance Obligations for Clear Aligners and Scanners

Our unfilled performance obligations as of December 31, 2018 and the estimated revenues expected to be recognized in the future related to these performance obligations are $431.8 million. This includes performance obligations from the Clear Aligner segment, primarily the shipment of additional aligners, which are fulfilled over one to five years, and performance obligations from the iTero scanner segment, primarily support, and contracted deliveries of additional scanners, which are fulfilled over one to five years. The estimate includes both product and service unfulfilled performance obligations and the time range reflects our best estimate of when we will transfer control to the customer and may change based on customer usage patterns, timing of shipments, readiness of customers' facilities for installation, and manufacturing availability.

Contract Balances

The timing of revenue recognition results in deferred revenues being recognized on our Consolidated Balance Sheet. For both aligners and scanners, we usually collect the total consideration owed prior to all performance obligations being performed with payment terms varying from net 30 to net 180 days. Contract liabilities are recorded as deferred revenue balances, which are generated based upon timing of invoices and recognition patterns, not payments. If the revenue recognition exceeds the billing, the exceeded amount is considered unbilled receivable and a contract asset. Conversely, if the billing occurs prior to the revenue recognition, the amount is considered deferred revenue and a contract liability.

Goodwill and Finite-Lived Acquired Intangible Assets and Long-Lived Assets

Goodwill

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.

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 goodwill.

Finite-Lived Intangible Assets and Long-Lived Assets

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.

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 Sheet.

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 Operation 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 U.S. Tax Cuts and Jobs Act was enacted into law on December 22, 2017 which included provisions for certain foreign-sourced earnings referred to as Global Intangible Low-Taxed Income (“GILTI”). GILTI imposes a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. FASB guidance issued in January 2018 allows companies to make an accounting policy election to either (i) account for GILTI as a component of tax expense in the period in which the tax is incurred (the “period cost method”), or (ii) account for GILTI in the measurement of deferred taxes (the “deferred method”). We have made the election to record GILTI tax using the period cost method.

Recent Accounting Pronouncements

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