Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Quarterly Results of Operations

	Three Months Ended
	2018																2017
	December 31, 2018				September 30, 2018				June 30, 2018				March 31, 2018				December 31, 2017				September 30, 2017				June 30, 2017				March 31, 2017
	(in thousands, except per share data) (unaudited )
Net revenues	$	534,020			$	505,289			$	490,259			$	436,924			$	421,323			$	385,267			$	356,482			$	310,341
Gross profit	383,096				371,781				365,582				327,408				317,917				292,488				270,917				235,625
Income from operations	120,473				125,208				122,691				98,192				109,606				98,763				83,569				61,673
Net income	97,392				100,872				106,105				95,866				10,264				82,555				69,179				69,420
Net income per share:
Basic	$	1.22			$	1.26			$	1.32			$	1.20			$	0.13			$	1.03			$	0.86			$	0.87
Diluted	$	1.20			$	1.24			$	1.30			$	1.17			$	0.13			$	1.01			$	0.85			$	0.85
Shares used in computing net income per share:
Basic	79,891				80,111				80,216				80,036				80,080				80,163				80,188				79,904
Diluted	80,943				81,359				81,471				81,628				81,863				81,789				81,631				81,534

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page
Report of Management on Internal Control over Financial Reporting	54
Report of Independent Registered Public Accounting Firm	55
Consolidated Statements of Operations for the year ended December 31, 2018, 2017 and 2016	57
Consolidated Statements of Comprehensive Income for the year ended December 31, 2018, 2017 and 2016	58
Consolidated Balance Sheets as of December 31, 2018 and 2017	59
Consolidated Statements of Stockholders’ Equity for the year ended December 31, 2018, 2017 and 2016	60
Consolidated Statements of Cash Flows for the year ended December 31, 2018, 2017 and 2016	61
Notes to Consolidated Financial Statements	62

REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

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

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

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

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

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

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2018. In making this assessment, management used the criteria set forth in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

Based on our assessment, management has concluded that, as of December 31, 2018, our internal control over financial reporting was effective based on criteria in Internal Control - Integrated Framework (2013) issued by the COSO.

The effectiveness of our internal control over financial reporting as of December 31, 2018 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.

/S/ JOSEPH M. HOGAN
Joseph M. Hogan
President and Chief Executive Officer
February 28, 2019
/S/ JOHN F. MORICI
John F. Morici
Chief Financial Officer and Senior Vice President, Global Finance
February 28, 2019

Report of Independent Registered Public Accounting Firm

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

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Align Technology, Inc. and its subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2018, including the related notes and financial statement schedule listed in the index appearing under Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

Change in Accounting Principle

As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for certain elements of its employee share-based payments in 2017.

Basis for Opinions

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the

company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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

/s/ PricewaterhouseCoopers LLP

San Jose, California

February 28, 2019

We have served as the Company's auditor since 1997.

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

	Year Ended December 31,
	2018				2017				2016
Net revenues	$	1,966,492			$	1,473,413			$	1,079,874
Cost of net revenues	518,625				356,466				264,580
Gross profit	1,447,867				1,116,947				815,294
Operating expenses:
Selling, general and administrative	852,404				665,777				490,653
Research and development	128,899				97,559				75,720
Total operating expenses	981,303				763,336				566,373
Income from operations	466,564				353,611				248,921
Interest income	8,576				6,948				4,213
Other income (expense), net	(8,489		)		4,240				(10,568		)
Net income before provision for income taxes and equity in losses of investee	466,651				364,799				242,566
Provision for income taxes	57,723				130,162				51,200
Equity in losses of investee, net of tax	8,693				3,219				1,684
Net income	$	400,235			$	231,418			$	189,682
Net income per share:
Basic	$	5.00			$	2.89			$	2.38
Diluted	$	4.92			$	2.83			$	2.33
Shares used in computing net income per share:
Basic	80,064				80,085				79,856
Diluted	81,357				81,832				81,484

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

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

	Year Ended December 31,
	2018				2017				2016
Net income	$	400,235			$	231,418			$	189,682
Net change in foreign currency translation adjustment	(3,631		)		1,741				(670		)
Change in unrealized gains (losses) on investments, net of tax	286				(232		)		712
Other comprehensive income (loss)	(3,345		)		1,509				42
Comprehensive income	$	396,890			$	232,927			$	189,724

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

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

	December 31,
	2018				2017
ASSETS
Current assets:
Cash and cash equivalents	$	636,899			$	449,511
Marketable securities, short-term	98,460				272,031
Accounts receivable, net of allowance for doubtful accounts of $2,378 and $5,814, respectively	439,009				324,189
Inventories	55,641				31,688
Prepaid expenses and other current assets	72,470				80,948
Total current assets	1,302,479				1,158,367
Marketable securities, long-term	9,112				39,948
Property, plant and equipment, net	521,329				348,793
Equity method investments	45,913				54,606
Goodwill and intangible assets, net	81,949				89,068
Deferred tax assets	64,689				49,334
Other assets	26,987				43,893
Total assets	$	2,052,458			$	1,784,009
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	64,256			$	36,776
Accrued liabilities	234,679				195,562
Deferred revenues	393,138				267,713
Total current liabilities	692,073				500,051
Income tax payable	78,008				114,091
Other long-term liabilities	29,486				15,579
Total liabilities	799,567				629,721
Commitments and contingencies (Notes 8 and 9)
Stockholders’ equity:
Preferred stock, $0.0001 par value (5,000 shares authorized; none issued)	—				—
Common stock, $0.0001 par value (200,000 shares authorized; 79,778 and 80,040 issued and outstanding, respectively)	8				8
Additional paid-in capital	877,514				886,435
Accumulated other comprehensive income (loss), net	(2,774		)		571
Retained earnings	378,143				267,274
Total stockholders’ equity	1,252,891				1,154,288
Total liabilities and stockholders’ equity	$	2,052,458			$	1,784,009

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

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

	Common Stock							Additional Paid-In Capital				Accumulated Other Comprehensive Income (Loss), Net				Retained Earnings				Total
	Shares			Amount
Balances at December 31, 2015	79,500			$	8			$	821,507			$	(980	)		$	27,391			$	847,926
Cumulative effect adjustment from adoption of ASU 2014-09	—			—				—				—				3,918				3,918
Net income	—			—				—				—				189,682				189,682
Net change in unrealized gains (losses) from investments	—			—				—				712				—				712
Net change in foreign currency translation adjustment	—			—				—				(670		)		—				(670		)
Issuance of common stock relating to employee equity compensation plans	1,163			—				13,778				—				—				13,778
Tax withholdings related to net share settlements of restricted stock units	—			—				(29,857		)		—				—				(29,857		)
Common stock repurchased and retired	(1,110	)		—				(10,593		)		—				(85,625		)		(96,218		)
Net tax benefits from stock-based awards	—			—				15,888				—				—				15,888
Stock-based compensation	—			—				54,148				—				—				54,148
Balances at December 31, 2016	79,553			8				864,871				(938		)		135,366				999,307
Cumulative effect adjustment from adoption of ASU 2016-16	—			—				—				—				(1,300		)		(1,300		)
Net income	—			—				—				—				231,418				231,418
Net change in unrealized gains (losses) from investments	—			—				—				(232		)		—				(232		)
Net change in foreign currency translation adjustment	—			—				—				1,741				—				1,741
Issuance of common stock relating to employee equity compensation plans	1,073			—				14,461				—				—				14,461
Tax withholdings related to net share settlements of restricted stock units	—			—				(46,168		)		—				—				(46,168		)
Common stock repurchased and retired	(586	)		—				(5,583		)		—				(98,210		)		(103,793		)
Stock-based compensation	—			—				58,854				—				—				58,854
Balances at December 31, 2017	80,040			8				886,435				571				267,274				1,154,288
Net income	—			—				—				—				400,235				400,235
Net change in unrealized gains (losses) from investments	—			—				—				286				—				286
Net change in foreign currency translation adjustment	—			—				—				(3,631		)		—				(3,631		)
Issuance of common stock relating to employee equity compensation plans	795			—				16,635				—				—				16,635
Tax withholdings related to net share settlements of restricted stock units	—			—				(86,067		)		—				—				(86,067		)
Common stock repurchased and retired	(1,057	)		—				(10,252		)		—				(289,750		)		(300,002		)
Stock-based compensation	—			—				70,763				—				—				70,763
Other	—			—				—				—				384				384
Balances at December 31, 2018	79,778			$	8			$	877,514			$	(2,774	)		$	378,143			$	1,252,891

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

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Year Ended December 31,
	2018				2017				2016
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	400,235			$	231,418			$	189,682
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred taxes	(15,680		)		17,572				(16,401		)
Depreciation and amortization	54,727				37,739				24,002
Stock-based compensation	70,763				58,854				54,148
Net tax benefits from stock-based awards	—				—				15,888
Excess tax benefit from share-based payment arrangements	—				—				(16,773		)
Equity in losses of investee	8,693				3,219				1,684
Other non-cash operating activities	17,252				13,847				12,031
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable	(109,224		)		(90,990		)		(95,808		)
Inventories	(24,109		)		(5,481		)		(7,663		)
Prepaid expenses and other assets	(9,122		)		(8,669		)		(9,390		)
Accounts payable	25,045				8,175				(3,395		)
Accrued and other long-term liabilities	36,250				24,235				31,371
Long-term income tax payable	(36,548		)		68,958				7,622
Deferred revenues	136,399				79,662				60,656
Net cash provided by operating activities	554,681				438,539				247,654
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment	(223,312		)		(195,695		)		(70,576		)
Purchase of marketable securities	(180,191		)		(390,244		)		(405,612		)
Proceeds from maturities of marketable securities	375,105				349,240				387,873
Proceeds from sales of marketable securities	9,560				39,536				216,119
Purchases of investments in privately held companies	(5,000		)		(12,764		)		(46,745		)
Loan advances to equity investee	—				(36,000		)		—
Loan repayment from equity investee	30,000				6,000				—
Acquisition, net of cash acquired	—				(8,953		)		—
Other investing activities	765				(2,597		)		(8,031		)
Net cash provided by (used in) investing activities	6,927				(251,477		)		73,028
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock	16,635				14,461				13,778
Common stock repurchases	(300,002		)		(103,793		)		(96,218		)
Excess tax benefit from share-based payment arrangements	—				—				16,773
Employees’ taxes paid upon the vesting of restricted stock units	(86,067		)		(46,168		)		(29,857		)
Net cash used in financing activities	(369,434		)		(135,500		)		(95,524		)
Effect 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
Cash, cash equivalents, and restricted cash at beginning of year	450,125				393,019				171,235
Cash, cash equivalents, and restricted cash at end of year	$	637,566			$	450,125			$	393,019

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

ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies

Business Description

Align Technology, Inc. (“We”, “Our”, or “Align”) was incorporated in April 1997 in Delaware. Align is a global medical device company engaged in the design, manufacture and marketing of Invisalign® clear aligners and iTero® intraoral scanners and services for orthodontics and restorative and aesthetic dentistry. Align’s products are intended primarily for the treatment of malocclusion or the misalignment of teeth and are designed to help dental professionals achieve the clinical outcomes that they expect. We are headquartered in San Jose, California with offices worldwide. Our Americas regional headquarters is located in Raleigh, North Carolina; our European regional headquarters is located in Amsterdam, the Netherlands; and our Asia Pacific regional headquarters is located in Singapore. We have two operating segments: (1) Clear Aligner, known as the Invisalign System, and (2) Scanners and Services ("Scanner"), known as the iTero intraoral scanner and OrthoCAD services.

Basis of Presentation and Preparation

The consolidated financial statements include the accounts of Align and our wholly-owned subsidiaries after elimination of intercompany transactions and balances.

During fiscal year 2018, we adopted Accounting Standards Codification (“ASC”) 606, “Revenues from Contracts with Customers,” using the full retrospective method and Accounting Standards Update (“ASU”) 2016-18, “Statement of Cash Flows - Restricted Cash,” on a retrospective basis. The Consolidated Balance Sheet as of December 31, 2017, Consolidated Statements of Cash Flow for the year ended December 31, 2017 and 2016, and Consolidated Statements of Stockholders' Equity for the year ended December 31, 2017 and 2016 have been recast to comply with the adoption of these standards.

Use of Estimates

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

Fair Value of Financial Instruments

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

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

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

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

Cash and Cash Equivalents

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

Restricted Cash

The restricted cash primarily consists of funds reserved for legal requirements. Restricted cash balances are included in other current assets and other assets within our Consolidated Balance Sheet.

Marketable Securities

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

Variable Interest Entities

We evaluate whether an entity in which we have made an investment is considered a variable interest entity (“VIE”). If we determine we are the primary beneficiary of a VIE, we would consolidate the VIE into our financial statements. In determining if we are the primary beneficiary, we evaluate whether we have the power to direct the activities that most significantly impact the VIE's economic performance and the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. Our evaluation includes identification of significant activities and an assessment of our ability to direct those activities based on governance provisions and arrangements to provide or receive product and process technology, product supply, operations services, equity funding, financing, and other applicable agreements and circumstances. Our assessments of whether we are the primary beneficiary of a VIE require significant assumptions and judgments. We have concluded that we are not the primary beneficiary of our VIE investments; therefore, we do not consolidate their results into our consolidated financial statements.

Investments in Privately Held Companies

Investments in privately held companies in which we can exercise significant influence but do not own a majority equity interest or otherwise control are accounted for under ASC 323, “Investments -Equity Method and Joint Ventures.” Equity securities qualified as equity method investments are reported on our Consolidated Balance Sheet as a single amount, and we record our share of their operating results within equity in losses of investee, net of tax, in our Consolidated Statement of Operations. Investments in privately held companies in which we cannot exercise significant influence and do not own a majority equity interest or otherwise control are accounted for under ASC 321, “Investments -Equity Securities.” The equity securities without readily determinable fair values are recorded at cost and adjusted for impairments and observable price changes with a same or similar security from the same issuer (“Measurement Alternative”). Equity securities under ASC 321 are reported on our Consolidated Balance Sheet as other assets, and we record a change in carrying value of our equity securities, if any, in other income (expense), net in our Consolidated Statement of Operations.

Equity securities are evaluated for impairment as events or circumstances indicate that there is an other-than-temporary loss in value. The decrease in value is recognized in the period the impairment occurs and recorded in other income (expense), net in the Consolidated Statement of Operations.

Derivative Financial Instruments

We enter into foreign currency forward contracts to minimize the short-term impact of foreign currency exchange rate fluctuations associated with certain assets and liabilities. These forward contracts are not designated as hedging instruments and do not subject us to material balance sheet risk due to fluctuations in foreign currency exchange rates. The gains and losses on these forward contracts are intended to offset the gains and losses in the underlying foreign currency denominated monetary assets

and liabilities being economically hedged. We do not enter into foreign currency forward contracts for trading or speculative purposes. The net gain or loss from the settlement of these foreign currency forward contracts is recorded in other income (expense), net in the Consolidated Statement of Operations.

Foreign Currency

For our international subsidiaries, we analyze on an annual basis or more often if necessary, if a significant change in facts and circumstances indicate that the functional currency has changed. For international subsidiaries where the local currency is the functional currency, adjustments from translating financial statements from the local currency to the U.S. dollar reporting currency are recorded as a separate component of accumulated other comprehensive income (loss), net in the stockholders’ equity section of the Consolidated Balance Sheet. This foreign currency translation adjustment reflects the translation of the balance sheet at period end exchange rates, and the income statement at an average exchange rate in effect during the period. The foreign currency revaluation that are derived from monetary assets and liabilities stated in a currency other than functional currency are included in other income (expense), net. For the year ended December 31, 2018, 2017 and 2016, we had foreign currency net gains (losses) of $(5.6) million, $9.0 million and $(8.0) million, respectively.

Certain Risks and Uncertainties

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

Our cash and investments are held primarily by three financial institutions. Financial instruments which potentially expose us to concentrations of credit risk consist primarily of cash equivalents and marketable securities. We invest excess cash primarily in money market funds, commercial paper, corporate bonds, U.S. government agency bonds, U.S. government treasury bonds and certificates of deposits. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to write down the value of our investments, which could adversely affect our results of operations and financial condition. Moreover, the performance of certain securities in our investment portfolio correlates with the credit condition of the U.S. economy.

We provide credit to customers in the normal course of business. Collateral is not required for accounts receivable, but ongoing evaluations of customers’ credit worthiness are performed. We maintain reserves for potential credit losses and such losses have been within management’s expectations. No individual customer accounted for 10% or more of our accounts receivable at December 31, 2018 or 2017, or net revenues for the year ended December 31, 2018, 2017 or 2016.

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

We have manufacturing facilities located outside the U.S. In Juarez, Mexico and Ziyang, China, we manufacture our clear aligners, distribute and repair our scanners and perform our computer-aided design/computer-aided manufacturing ("CAD/CAM") services. In Or Yehuda, Israel, we produce our handheld intraoral scanner wand and perform the final assembly of our iTero scanner. Our digital treatment plans using a sophisticated, internally developed computer-modeling program are located in multiple international locations to support our customers within the regions. Our reliance on international operations exposes us to related risks and uncertainties, including difficulties in staffing and managing international operations such as hiring and retaining qualified personnel; controlling production volume and quality of manufacture; political, social and economic instability; interruptions and limitations in telecommunication services; product and material transportation delays or disruption; trade restrictions and changes in tariffs; import and export license requirements and restrictions; fluctuations in foreign currency exchange rates; and potential adverse tax consequences. If any of these risks materialize, our international manufacturing operations, as well as our operating results, may be harmed.

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

Inventories

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

Property, Plant and Equipment

Property, plant and equipment are stated at historical cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. Construction in progress ("CIP") is related to the construction or development of property (including land) and equipment that have not yet been placed in service for their intended use. Upon sale or retirement, the asset’s cost and related accumulated depreciation are removed from the balance sheet and any related gains or losses are reflected in income from operations. Maintenance and repairs are expensed as incurred. Refer to Note 3 "Balance Sheet Components" of the Notes of Consolidated Financial Statements for details on estimated useful lives.

Goodwill and Finite-Lived Acquired Intangible Assets

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

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

Impairment of Goodwill and Long-Lived Assets

Goodwill

We evaluate goodwill for impairment at least annually on November 30th or more frequently if indicators are present, an event occurs or 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 units is based on relative synergies generated as a result of an acquisition.

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

Step one of the goodwill impairment test consists of a comparison of the fair value of a reporting unit against its carrying amount, including the goodwill allocated to each reporting unit. We determine the fair value of our reporting units based on the present value of estimated future cash flows under the income approach of the reporting units as well as various price or market multiples applied to the reporting unit's operating results along with the appropriate control premium under the marketing approach, both of which are classified as level 3 within the fair value hierarchy as described in Note 2 "Marketable Securities and Fair Value

Measurements" of the Notes of Consolidated Financial Statements. If the carrying amount of the reporting unit is in excess of its fair value, step two requires the comparison of the implied fair value of the reporting unit’s goodwill against the carrying amount of the reporting unit’s goodwill. Any excess of the carrying value of the reporting unit’s goodwill over the implied fair value of the reporting unit’s goodwill is recorded as an impairment loss in the Consolidated Statements of Operations.

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 that the asset or asset group is expected to generate. 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. 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 assumptions. 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 the Notes of Consolidated Financial Statements for details on intangible long-lived assets.

Development Costs for Internal Use Software

Internally developed software includes enterprise-level business software that we customize to meet our specific operational needs. Such capitalized costs include external direct costs utilized in developing or obtaining the applications and payroll and payroll-related costs for employees, who are directly associated with the development of the applications. During the year ended December 31, 2018, we capitalized approximately $2.7 million of internally developed software costs. Internally developed software costs capitalized during the year ended December 31, 2017 was not material.

The costs to develop software that is marketed externally have not been capitalized as we believe our current software development process is essentially completed concurrent with the establishment of technological feasibility. As such, all related software development costs are expensed as incurred and included in research and development expense in our Consolidated Statement of Operations.

Product Warranty

Clear Aligner

We warrant our Invisalign products against material defects until the treatment plan is complete. We warrant clear aligners manufactured for SmileDirectClub, LLC (“SDC”) against material defects for one year. We accrue for warranty costs in cost of net revenues upon shipment of products. The estimated warranty costs liability is primarily based on historical experience as to product failures as well as current information on replacement costs. Actual warranty costs could differ materially from the estimated amounts. We regularly review our warranty liability and update these balances based on historical warranty cost trends.

Scanners and Services

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

Allowance for Doubtful Accounts

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

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 usages 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 ("FASB") 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.

Shipping and Handling Costs

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

Legal Proceedings and Litigations

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

Research and Development

Research and development expense is expensed as incurred and includes the costs associated with the research and development of new products and enhancements to existing products. These costs primarily include personnel-related costs, including payroll and stock-based compensation, outside consulting expenses and allocations of corporate overhead expenses including facilities and information technology (“IT”).

Advertising Costs

The cost of advertising and media is expensed as incurred. For the year ended December 31, 2018, 2017 and 2016, we incurred advertising costs of $88.4 million, $70.1 million and $36.0 million, respectively.

Common Stock Repurchase

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

Operating Leases

We lease office spaces, vehicles and equipment under operating leases with original lease periods of up to 10 years. Certain of these leases have free or escalating rent payment provisions and lease incentives provided by the landlord. We recognize rent expense under such leases on a straight-line basis over the term of the lease.

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 realizable. The available positive evidence at December 31, 2018 included historical operating profits and a projection of future income sufficient to realize most of our remaining deferred tax assets. As of December 31, 2018,

it was considered more likely than not that our deferred tax assets would be realized with the exception of certain foreign loss carryovers as we are unable to forecast sufficient future profits to realize the deferred tax assets.

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.

Stock-Based Compensation

We recognize stock-based compensation cost for shares expected to vest on a straight-line basis over the requisite service period of the award, net of estimated forfeitures. We use the Black-Scholes option pricing model to determine the fair value of stock awards 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 also required in estimating the number of stock-based awards that are expected to be forfeited. Forfeitures are estimated based on historical experience at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.

Comprehensive Income

Comprehensive income includes all changes in equity during a period from non-owner sources including unrealized gains and losses on investments and foreign currency translation adjustments, net of their related tax effect.

Recent Accounting Pronouncements

(i) New Accounting Updates Recently Adopted

In March 2016, the FASB issued Accounting Standards Update ("ASU") 2016-09, "Improvements to Employee Share-Based Payment Accounting" (Topic 718). We adopted the standard in the first quarter of fiscal year 2017. With this adoption, excess tax benefits related to stock-based compensation expense are reflected in our consolidated statement of operations as a component of the provision for income taxes instead of additional paid-in capital in our consolidated balance sheet. In addition, 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. During the fiscal year ended December 31, 2017, we recognized excess tax benefits of $30.0 million in our provision for income taxes. Excess tax benefits from share-based payment arrangements are classified as an operating activity in our consolidated statement of cash flows.

In May 2014, FASB released ASU 2014-09, “Revenue from Contracts with Customers,” (Topic 606) to supersede nearly all existing revenue recognition guidance under GAAP. The core principle of the standard is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for the goods or services. We adopted the guidance in the first quarter of fiscal year 2018 by applying the full retrospective method. The impact of adoption was primarily related to the Clear Aligner segment. Our disaggregation of revenues can be found in Note 16 “Segments and Geographical Information.” We elected to take the practical expedient to exclude from the transaction price all taxes assessed by a governmental authority. Prior periods have been retrospectively adjusted, and we recognized a $3.9 million cumulative effect of adopting the guidance as an adjustment to our opening balance of retained earnings as of January 1, 2016 in our Consolidated Statements of Stockholders’ Equity.

The adoption of ASU 2014-09 did not have a material impact on our Consolidated Statement of Operations, Consolidated Statements of Comprehensive Income or Consolidated Statements of Cash Flows. Consolidated Balance Sheet line items, which reflect the adoption of the ASU 2014-09 are as follows (in thousands):

		December 31, 2017
		As Previously Reported				Adjustment				As Adjusted
Asset Accounts:
Accounts receivable, net		$	322,825			$	1,364			$	324,189
Deferred tax assets		50,059				(725		)		49,334
Other assets		38,379				5,514				43,893
Liability and Stockholders’ Equity Accounts:
Accrued liabilities		$	194,198			$	1,364			$	195,562
Deferred revenues		266,842				871				267,713
Retained earnings		263,356				3,918				267,274

In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments,” which clarifies the presentation and classification of certain cash receipts and cash payments in the statements of cash flows. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2017. We adopted the standard in the first quarter of fiscal year 2018 on a retrospective basis, and it did not have an impact on our Consolidated Statements of Cash Flows.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows—Restricted Cash,” which provides guidance to address the classification and presentation of changes in restricted cash in the statements of cash flows. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2017 on a retrospective basis. We adopted the guidance in the first quarter of fiscal year 2018 on a retrospective basis and presented the changes in the total of cash, cash equivalents, and restricted cash in the Consolidated Statements of Cash Flows. Consolidated Statement of Cash Flows line items, which reflect the adoption of the ASU 2016-18, are as follows (in thousands):

		December 31, 2017
		As Previously Reported				Adjustment				As Adjusted
Cash Flows from Investing Activities
Other investing activities		$	567			$	(3,164	)		$	(2,597	)
Net cash used in investing activities		(248,313		)		(3,164		)		(251,477		)
Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash		5,510				34				5,544
Net increase in cash, cash equivalents, and restricted cash		60,236				(3,130		)		57,106
Cash, cash equivalents, and restricted cash at beginning of the period		389,275				3,744				393,019
Cash, cash equivalents, and restricted cash at end of the period		$	449,511			$	614			$	450,125

		December 31, 2016
		As Previously Reported				Adjustment				As Adjusted
Cash Flows from Investing Activities
Other investing activities		$	(8,211	)		$	180			$	(8,031	)
Net cash provided by investing activities		72,848				180				73,028
Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash		(3,417		)		43				(3,374		)
Net increase in cash, cash equivalents, and restricted cash		221,561				223				221,784
Cash, cash equivalents, and restricted cash at beginning of the period		167,714				3,521				171,235
Cash, cash equivalents, and restricted cash at end of the period		$	389,275			$	3,744			$	393,019

In May 2017, the FASB issued ASU 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting,” to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2017 on a prospective basis. We adopted the standard in the first quarter of fiscal year 2018 on a prospective basis which did not have an impact on our consolidated financial statements and related disclosures.

(ii) Recent Accounting Updates Not Yet Effective

In February 2016, the FASB issued ASU 2016-02, “Leases” (Topic 842) to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The updated guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. In July 2018, the FASB issued ASU 2018-11, “Leases- Targeted Improvements,” which provides an additional transition method by allowing entities to initially apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings. We will adopt this standard in the first quarter of fiscal year 2019 by electing the transition method issued in ASU 2018-11 and the package of practical expedients available in the standard. We are finalizing our implementation efforts related to policies, processes and internal controls to comply with the guidance. Upon adoption, based on our lease portfolio as of December 31, 2018, we anticipate recognizing right-of-use assets in the range of $67 million to $74 million and related lease liabilities in the range of $77 million to $86 million on our Consolidated Balance Sheet, with no material impact to our Consolidated Statement of Operations.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses” (Topic 326). The FASB issued this update to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this update replace the existing guidance of incurred loss impairment methodology with an approach that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. In November 2018, the FASB issued ASU 2018-19, “Codification Improvements to Topic 326, Financial Instruments - Credit Losses” which clarifies the scope of guidance in the ASU 2016-13. The updated guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption of the update is permitted in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are currently evaluating the impact of this guidance on our consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-04, “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,” to simplify the subsequent measurement of goodwill by eliminating step two from the goodwill impairment test. Under the amendments, an entity will recognize an impairment charge for the amount by which the carrying value exceeds the fair value. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2019 on a prospective basis and early adoption is permitted. We are currently evaluating the impact of this guidance on our consolidated financial statements and related disclosures.

In February 2018, the FASB issued ASU 2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” which gives entities the option to reclassify to retained earnings the tax effects resulting from the U.S. Tax Cuts and Jobs Act (the “TCJA”) related to items in

accumulated other comprehensive income. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2018 on a retrospective basis and early adoption is permitted. We do not expect that the guidance will have a material impact on our consolidated financial statements and related disclosures.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement,” to modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2019 on a prospective basis and early adoption is permitted. We are currently evaluating the impact of this guidance on our related disclosures.

In August 2018, the FASB issued ASU 2018-15, “Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40) Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract,” to clarify the guidance on the costs of implementing a cloud computing hosting arrangement that is a service contract. Under the amendments, the entity is required to follow the guidance in Subtopic 350-40, Internal-Use Software, to determine which implementation costs under the service contract to be capitalized as an asset and which costs to expense. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2019 either on a retrospective or prospectively basis and early adoption is permitted. We are currently evaluating the impact of this guidance on our consolidated financial statements and related disclosures.

Note 2. Investments and Fair Value Measurements

As of December 31, 2018 and 2017, the estimated fair value of our short-term and long-term marketable securities, classified as available for sale, are as follows (in thousands):

Short-term

December 31, 2018		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Commercial paper		$	17,793			$	—			$	—			$	17,793
Corporate bonds		45,100				—				(48		)		45,052
U.S. government agency bonds		19,981				—				(77		)		19,904
U.S. government treasury bonds		15,292				—				(1		)		15,291
Certificates of deposit		420				1				(1		)		420
Total marketable securities, short-term		$	98,586			$	1			$	(127	)		$	98,460

Long-term

December 31, 2018		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Corporate bonds		$	4,957			$	5			$	(2	)		$	4,960
U.S. government agency bonds		1,399				8				—				1,407
U.S. government treasury bonds		2,235				9				—				2,244
Certificates of deposit		500				1				—				501
Total marketable securities, long-term		$	9,091			$	23			$	(2	)		$	9,112

Short-term

December 31, 2017		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Commercial paper		$	58,503			$	—			$	(1	)		$	58,502
Corporate bonds		145,728				3				(174		)		145,557
U.S. government agency bonds		3,013				—				(7		)		3,006
U.S. government treasury bonds		60,650				—				(70		)		60,580
Certificates of deposit		4,386				—				—				4,386
Total marketable securities, short-term		$	272,280			$	3			$	(252	)		$	272,031

Long-term

December 31, 2017		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
U.S. government agency bonds		$	15,023			$	—			$	(68	)		$	14,955
Corporate bonds		25,067				2				(76		)		24,993
Total marketable securities, long-term		$	40,090			$	2			$	(144	)		$	39,948

Cash equivalents are not included in the tables above as the gross unrealized gains and losses are not material. We have no short-term or long-term investments that have been in a continuous material unrealized loss position for greater than twelve months as of December 31, 2018 and 2017. Amounts reclassified to earnings from accumulated other comprehensive income (loss), net related to unrealized gains or losses were not material in 2018 and 2017. For the year ended December 31, 2018, 2017 and 2016, realized gains or losses were not material.

Our fixed-income securities investment portfolio consists of investments that have a maximum effective maturity of 40 months on any individual security. The securities that we invest in are generally deemed to be low risk based on their credit ratings from the major rating agencies. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As interest rates increase, those securities purchased at a lower yield show a mark-to-market unrealized loss. The unrealized losses are due primarily to changes in credit spreads and interest rates. We expect to realize the full value of all these investments upon maturity or sale. The weighted average remaining duration of these securities was approximately four months and six months as of December 31, 2018 and 2017, respectively.

As the carrying value approximates the fair value for our short-term and long-term marketable securities shown in the tables above, the following table summarizes the fair value of our short-term and long-term marketable securities classified by contractual maturity as of December 31, 2018 and 2017 (in thousands):

		December 31,
		2018				2017
One year or less		$	98,460			$	272,031
Due in greater than one year		9,112				39,948
Total marketable securities		$	107,572			$	311,979

Investments in Privately Held Companies

Our investments in privately held companies as of December 31, 2018 and December 31, 2017 are as follows (in thousands):

	December 31,
	2018				2017
Equity securities under the equity method investment 1	$	45,913			$	54,606
Equity securities without readily determinable fair values 2	$	9,862			$	—

1	Refer to Note 4 “Equity Method Investments” of the Notes to Consolidated Financial Statements for more information

2

In April 2018, $4.9 million of convertible short term notes receivable (recurring Level 3 investment) was converted into equity securities as a result of qualified financing secured by the private company in accordance with ASC 321, “Investments—Equity Securities.” The equity securities issued upon conversion are reported as a nonrecurring investment within other assets in our Consolidated Balance Sheet. During the year ended December 31, 2018, there were no fair value adjustments to equity securities without readily determinable fair values.

Fair Value Measurements

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

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

Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability. We obtain fair values for our Level 2 investments. Our custody bank and asset managers independently use professional pricing services to gather pricing data which may include quoted market prices for identical or comparable financial instruments, or inputs other than quoted prices that are observable either directly or indirectly, and we are ultimately responsible for these underlying estimates.

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

The following tables summarize our financial assets measured at fair value on a recurring basis as of December 31, 2018 and 2017 (in thousands):

Description		Balance as of December 31, 2018				Level 1				Level 2
Cash equivalents:
Money market funds		$	431,081			$	431,081			$	—
Commercial paper		4,681				—				4,681
U.S. government treasury bonds		2,195				2,195				—
Corporate bonds		3,880				—				3,880
Short-term investments:
Commercial paper		17,793				—				17,793
Corporate bonds		45,052				—				45,052
U.S. government agency bonds		19,904				—				19,904
U.S. government treasury bonds		15,291				15,291				—
Certificates of deposit		420				—				420
Long-term investments:
U.S. government agency bonds		1,407				—				1,407
Corporate bonds		4,960				—				4,960
U.S. government treasury bonds		2,244				2,244				—
Certificate of deposit		501				—				501
Prepaid expenses and other current assets:
Israeli funds		3,047				—				3,047
		$	552,456			$	450,811			$	101,645

Description		Balance as of December 31, 2017				Level 1				Level 2				Level 3
Cash equivalents:
Money market funds		$	253,155			$	253,155			$	—			$	—
Commercial paper		7,246				—				7,246				—
Corporate bonds		2,016				—				2,016				—
Short-term investments:
Commercial paper		58,502				—				58,502				—
Corporate bonds		145,557				—				145,557				—
U.S. government agency bonds		3,006				—				3,006				—
U.S. government treasury bonds		60,580				60,580				—				—
Certificates of deposit		4,386				—				4,386				—
Long-term investments:
U.S. government agency bonds		14,955				—				14,955				—
Corporate bonds		24,993				—				24,993				—
Prepaid expenses and other current assets:
Israeli funds		3,075				—				3,075				—
Short-term notes receivable		4,476				—				—				4,476
		$	581,947			$	313,735			$	263,736			$	4,476

Derivative Financial Instruments

In March 2018, we began entering into foreign currency forward contracts to minimize the short-term impact of foreign currency exchange rate fluctuations on certain trade and intercompany receivables and payables. These forward contracts are classified within Level 2 of the fair value hierarchy. The gain from the settlement of foreign currency forward contracts during 2018 was $9.9 million. As of December 31, 2018, the fair value of foreign exchange forward contracts outstanding was not material.

The following table presents the gross notional value of all our foreign exchange forward contracts outstanding as of December 31, 2018 (in thousands):

	December 31, 2018
	Local Currency Amount		Notional Contract Amount (USD)
Euro	€62,000		$	71,095
Chinese Yuan	¥375,000		54,515
Brazilian Real	R$81,000		20,858
Canadian Dollar	C$27,000		19,808
British Pound	£13,000		16,635
Japanese Yen	¥1,700,000		15,357
Australian Dollar	A$3,000		2,114
			$	200,382

Note 3. Balance Sheet Components

Inventories

Inventories consist of the following (in thousands):

	December 31,
	2018				2017
Raw materials	$	26,119			$	12,721
Work in process	13,784				12,157
Finished goods	15,738				6,810
Total inventories	$	55,641			$	31,688

Other Assets

Other assets consist of the following (in thousands):

	December 31,
	2018				2017
Capitalized commissions 1	$	9,185			$	5,514
Equity securities	9,862				—
Security deposits	5,162				3,557
Loan receivable from equity investee	—				30,000
Other long-term assets	2,778				4,822
Total other assets	$	26,987			$	43,893

(1) December 31, 2017 balance has been recasted to reflect the adoption of ASU 2014-09 (Refer to Note 1“Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements for more information).

Property, Plant and Equipment, Net

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

			December 31,
	Generally Used Estimated Useful Life		2018				2017
Clinical and manufacturing equipment	Up to 10 years		$	236,179			$	183,392
Computer hardware	3 years		34,297				24,933
Computer software	3 years		59,617				54,756
Furniture and fixtures	5 years		33,436				16,271
Leasehold improvements	Lease term (1)		77,168				37,756
Building	20 years		139,315				63,887
Land	—		17,630				17,630
CIP	—		95,414				85,976
Total			693,056				484,601
Less: Accumulated depreciation and amortization and impairment charges			(171,727		)		(135,808		)
Total property, plant and equipment, net			$	521,329			$	348,793

(1) Shorter of remaining lease term or estimated useful lives of asset

Depreciation and amortization was $54.7 million, $37.7 million and $24.0 million for the year ended December 31, 2018, 2017 and 2016, respectively.

Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

	December 31,
	2018				2017
Accrued payroll and benefits	$	127,109			$	103,004
Accrued expenses	39,323				27,318
Accrued customer credits and deposits	12,439				5,373
Accrued warranty	8,551				5,929
Accrued property, plant and equipment	8,193				11,362
Accrued professional fees	6,752				6,316
Accrued sales return reserve 1	6,534				1,364
Accrued sales tax and value added tax	6,276				5,503
Accrued income taxes	5,752				12,405
Accrued sales rebate	5,668				11,209
Other accrued liabilities	8,082				5,779
Total accrued liabilities	$	234,679			$	195,562

(1) December 31, 2017 balance has been reclassified from accounts receivable, net to reflect the adoption of ASU 2014-09 (Refer to Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements for more information).

Warranty

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

Warranty as of December 31, 2018 and 2017 consists of the following activity (in thousands):

Accrued warranty as of December 31, 2016	$	3,841
Charged to cost of net revenues	7,195
Actual warranty expenditures	(5,107		)
Accrued warranty as of December 31, 2017	5,929
Charged to cost of net revenues	15,059
Actual warranty expenditures	(12,437		)
Accrued warranty as of December 31, 2018	$	8,551

Deferred Revenues

Deferred revenues consist of the following (in thousands):

	December 31,
	2018				2017
Deferred revenues - current	$	393,138			$	267,713
Deferred revenues - long-term 1	17,051				4,588

1 Included in other long-term liabilities within our Consolidated Balance Sheet

During the year ended December 31, 2018 and 2017, we recognized $2.0 billion and $1.5 billion of revenue, respectively, of which $180.6 million and $119.0 million was included in the deferred revenues balance at December 31, 2017 and December 31, 2016, respectively.

Note 4. Equity Method Investments

On July 25, 2016, we acquired a 17% equity interest1, on a fully diluted basis, in SDC for $46.7 million. The investment is accounted for under an equity method investment, and the investee, SDC, is considered a related party. The investment is reported in our Consolidated Balance Sheet under equity method investments, and we record our proportional share of SDC's losses within equity in losses of investee, net of tax, in our Consolidated Statement of Operations. On July 24, 2017, we purchased an additional 2% equity interest in SDC for $12.8 million. As of December 31, 2018 and 2017, the balance of our equity method investments was $45.9 million and $54.6 million, respectively.

Concurrently with the investment on July 25, 2016, we also entered into a supply agreement with SDC to manufacture clear aligners for SDC's doctor-led, at-home program for simple teeth straightening. The term of the supply agreement expires on December 31, 2019. We commenced supplying aligners to SDC in October 2016. The sale of aligners to SDC and the income from the supply agreement are reported in our Clear Aligner business segment. We eliminate unrealized profit on outstanding intercompany transactions. As of December 31, 2018 and 2017, the balance of accounts receivable due from SDC was $16.3 million and $14.3 million, respectively. For the year ended December 31, 2018 and 2017, net revenues recognized from SDC were $27.9 million and $24.1 million, respectively.

On July 25, 2016, we entered into a Loan and Security Agreement (the "Loan Agreement") with SDC and amended on July 24, 2017 where we agreed to provide SDC a loan of up to $30.0 million in one or more advances. On February 7, 2018, $30.0 million of outstanding advances and related accrued interest were repaid in full, and the Loan Agreement was terminated (Refer to Note 9 "Commitments and Contingencies" of the Notes to Consolidated Financial Statements for information on the Loan and Security Agreement with SDC).

1 Our ownership percentage may change depending on SDC's equity share activities

Note 5. Business Combinations

During the first quarter of 2017, we completed the acquisitions of certain of our distributors for the total estimated cash consideration of approximately $9.5 million including cash acquired. We recorded $1.9 million of net tangible liabilities, $8.2 million of identifiable intangible assets and $3.2 million of goodwill. The goodwill is primarily related to the benefit we expect

to obtain from direct sales as we believe that the transition from our distributor arrangements to a direct sales model will increase our net revenues in the region as we will experience higher average sales prices (“ASP”) compared to our discounted ASP under the distribution agreements. The goodwill is not deductible for tax purposes.

Pro forma results of operations for these acquisitions have not been presented as they were not material to our results of operations, either individually or in aggregate, for the year ended December 31, 2017.

Note 6. Goodwill and Intangible Assets

Goodwill

The change in the carrying value of goodwill for the year ended December 31, 2018, all attributable to our Clear Aligner reporting unit, is as follows (in thousands):

	Total
Balance as of December 31, 2016	$	61,044
Goodwill from distributor acquisitions	3,247
Adjustments (1)	323
Balance as of December 31, 2017	64,614
Adjustments (1)	(585		)
Balance as of December 31, 2018	$	64,029

(1) The adjustments to goodwill during the period were related to foreign currency translation and/or purchase accounting adjustments within the measurement period.

Based on the qualitative assessments performed, there were no impairments to goodwill in 2018 and 2017.

Intangible Long-Lived Assets

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

There were no triggering events in 2018 and 2017 that would cause impairments of our long-lived assets.

Acquired intangible long-lived assets are being amortized as follows (in thousands):

	Weighted Average Amortization Period (in years)		Gross Carrying Amount as of December 31, 2018				Accumulated Amortization				Accumulated Impairment Loss				Net Carrying Value as of December 31, 2018
Trademarks	15		$	7,100			$	(1,907	)		$	(4,179	)		$	1,014
Existing technology	13		12,600				(5,268		)		(4,328		)		3,004
Customer relationships	11		33,500				(16,542		)		(10,751		)		6,207
Reacquired rights	3		7,500				(4,341		)		—				3,159
Patents	8		6,796				(2,334		)		—				4,462
Other	2		618				(544		)		—				74
Total intangible assets			$	68,114			$	(30,936	)		$	(19,258	)		$	17,920

	Weighted Average Amortization Period (in years)		Gross Carrying Amount as of December 31, 2017				Accumulated Amortization				Accumulated Impairment Loss				Net Carrying Value as of December 31, 2017
Trademarks	15		$	7,100			$	(1,769	)		$	(4,179	)		$	1,152
Existing technology	13		12,600				(4,704		)		(4,328		)		3,568
Customer relationships	11		33,500				(14,681		)		(10,751		)		8,068
Reacquired rights	3		7,500				(1,356		)		—				6,144
Patents	8		6,798				(1,504		)		—				5,294
Other	2		618				(390		)		—				228
Total intangible assets			$	68,116			$	(24,404	)		$	(19,258	)		$	24,454

The total estimated annual future amortization expense for these acquired intangible assets as of December 31, 2018 is as follows (in thousands):

Fiscal Year		Amortization
2019		$	6,134
2020		3,847
2021		3,389
2022		2,116
2023		1,495
Thereafter		939
Total		$	17,920

Amortization expense was $6.0 million, $6.2 million and $3.2 million for the year ended December 31, 2018, 2017 and 2016, respectively.

Note 7. Credit Facility

On February 27, 2018, we enter into a credit facility that provides 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 previous credit facility which provided for a $50.0 million revolving line of credit with a $10.0 million letter of credit. The credit facility requires us to comply with specific financial conditions and performance requirements. The loans bear interest, at our option, at either a rate based on the reserve adjusted LIBOR for the applicable interest period or a base rate, in each case plus a margin. The base rate is the highest of the credit facility’s publicly announced prime rate, the federal funds rate plus 0.50% and one month LIBOR plus 1.0%. The margin ranges from 1.25% to 1.75% for LIBOR loans and 0.25% to 0.75% for base rate loans. Interest on the loans is payable quarterly in arrears with respect to base rate loans and at the end of an interest period (and at three month intervals if the interest period exceeds three months) in the case of LIBOR loans. Principal, together with accrued and unpaid interest, is due on the maturity date. As of December 31, 2018, we had no outstanding borrowings under this credit facility and were in compliance with the conditions and performance requirements.

Note 8. Legal Proceedings

Securities Class Action Lawsuit

On November 5, 2018, a class action lawsuit against Align, and three of our executive officers, was filed in the U.S. District Court for the Northern District of California on behalf of a purported class of purchasers of our common stock between July 25, 2018 and October 24, 2018. The complaint generally alleges claims under the federal securities laws and seeks monetary damages in an unspecified amount and costs and expenses incurred in the litigation. On December 12, 2018, a similar lawsuit was filed in the same court on behalf of a purported class of purchasers of our common stock between April 25, 2018 and October 24, 2018 (together with the first lawsuit, the “Securities Actions”). Motions for appointment as lead plaintiff were filed on January 4, 2019. Align believes the plaintiffs’ claims are without merit and intends to vigorously defend itself. Align is currently unable to predict the outcome of these lawsuits and therefore cannot determine the likelihood of loss nor estimate a range of possible loss.

Shareholder Derivative Lawsuit

In January 2019, three derivative lawsuits were also filed in the U.S. District Court for the Northern District of California, purportedly on behalf of Align, naming as defendants the members of our Board of Directors along with certain of our executive officers. The allegations in the complaints are similar to those presented in the Securities Action, but the complaints assert various state law causes of action, including for breaches of fiduciary duty, insider trading, and unjust enrichment, among others. The complaints seek unspecified monetary damages on behalf of Align, which is named solely as a nominal defendant against whom no recovery is sought, as well as disgorgement and the costs and expenses associated with the litigation, including attorneys’ fees. Align is currently unable to predict the outcome of these lawsuits and therefore cannot determine the likelihood of loss nor estimate a range of possible loss.

Patent Infringement and Related Lawsuits

On November 14, 2017, Align filed six patent infringement lawsuits asserting 26 patents against 3Shape, a Danish corporation, and a related U.S. corporate entity, asserting that 3Shape’s Trios intraoral scanning system and Dental System software infringe Align patents. Align filed two Section 337 complaints with the U.S. International Trade Commission (“ITC”) alleging that 3Shape violates U.S. trade laws by selling for importation and importing its infringing Trios intraoral scanning system and Dental System software. Align’s ITC complaints seek cease and desist orders and exclusion orders prohibiting the importation of 3Shape’s Trios scanning system and Dental System software products into the U.S. Align also filed four separate complaints in the U.S. District Court for the District of Delaware alleging patent infringement by 3Shape’s Trios intraoral scanning system and Dental System software.

On May 9, 2018, 3Shape filed a complaint in the U.S. District Court for the District of Delaware alleging patent infringement by Align’s iTero Element scanner of a single 3Shape patent. On June 14, 2018, 3Shape filed another complaint in the U.S. District Court for the District of Delaware alleging patent infringement by Align’s iTero Element scanner of a single 3Shape patent.

On August 28, 2018, 3Shape filed a complaint against Align in the U.S. District Court for the District of Delaware alleging antitrust violations and seeking monetary damages and injunctive relief relating to Align’s market activities, including Align’s assertion of its patent portfolio, in the clear aligner and intraoral scanning markets.

On December 10, 2018, Align filed three additional patent infringement lawsuits asserting 10 additional patents against 3Shape. Align filed one Section 337 complaint with the ITC alleging that 3Shape violates U.S. trade laws through unfair competition by selling for importation and importing the infringing TRIOS intraoral scanning system, Trios Lab Scanners and TRIOS software, TRIOS Module software, Dental System software, and Ortho System Software. On December 11, 2018, Align filed two separate complaints in the U.S. District Court for the District of Delaware alleging patent infringement by 3Shape's Trios intraoral scanning system, Lab Scanners and Dental and Ortho System Software.

Except for 3Shape’s antitrust complaint, each of the District Court complaints seek monetary damages and injunctive relief against further infringement. 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.

SDC Dispute

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 locations 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.

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

Note 9. Commitments and Contingencies

Operating Leases

We lease our facilities and certain equipment and automobiles under non-cancelable operating lease arrangements that expire at various dates through 2029 and provide for pre-negotiated fixed rental rates during the terms of the lease. The terms of some of our leases provide for rental payments on a graduated scale. We recognize rent expense on a straight-line basis over the lease period. Total rent expense was $16.5 million, $13.8 million and $9.9 million for the year ended December 31, 2018, 2017 and 2016, respectively. Sublease income is not material and excluded from the table below.

Minimum future lease payments for non-cancelable leases as of December 31, 2018, are as follows (in thousands):

Fiscal Year	Operating Leases
2019	$	21,429
2020	20,483
2021	18,897
2022	15,096
2023	12,400
Thereafter	18,371
Total minimum lease payments	$	106,676

Other Commitments

On July 25, 2016, we entered into a Loan and Security Agreement (the “Loan Agreement”) with SDC and subsequently amended on July 24, 2017 to provide a loan of up to $30.0 million in one or more advances to SDC (the “Loan Facility”). On February 7, 2018, $30.0 million of outstanding advances and related accrued interest were repaid in full, and the Loan Agreement was terminated (Refer to Note 4 “Equity Method Investments” of the Notes to Consolidated Financial Statements for more information on our investments in SDC).

On November 9, 2017, we entered into an Investment Agreement with the People’s Republic of China (“China Government”) where we have committed to invest a minimum of $46.0 million in Ziyang, China over five years to establish manufacturing operations.

On November 27, 2017, we entered into a Purchase Agreement with one of our existing single source suppliers. Under the terms of the original agreement, we are required to purchase a minimum of approximately $305.2 million of aligner materials over the next four years. On May 29, 2018, we entered into an amendment to the Purchase Agreement with the existing single source

supplier to increase the original term of the agreement to five years and total minimum purchase amount to approximately of $425.9 million.

On January 15, 2019, we entered into a Purchase Agreement to purchase five floors of a building under construction in Petach Tivka, Israel (the "Property") for a purchase price of approximately $27.0 million with an option to purchase additional three floors. The purchase price will be paid in six installments according to construction milestones and the delivery of the Property throughout 2019 and 2020.

On January 29, 2019, we entered into a Purchase and Sale Agreement to purchase our currently leased building located in Morrisville, North Carolina for a purchase price of $58.1 million. On January 30, 2019, we paid a $2.0 million deposit related to the Purchase and Sale Agreement and an additional $56.1 million will be paid on or before the closing date which is expected to occur on April 8, 2019.

Off-Balance Sheet Arrangements

As of December 31, 2018, we had no material off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources other than certain items disclosed in Other Commitments section above.

Indemnification Provisions

In the normal course of business to facilitate transactions in our services and products, we indemnify certain parties: customers, vendors, lessors, and other parties with respect to certain matters, including, but not limited to, services to be provided by us and intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and our executive 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.

Note 10. Stockholders’ Equity

Common Stock

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

Stock-Based Compensation Plans

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

As of December 31, 2018, the 2005 Incentive Plan (as amended) has a total reserve of 27,783,379 shares for issuance of which 6,060,265 shares are available for issuance. We issue new shares from our pool of authorized but unissued shares to satisfy the exercise and vesting obligations of our stock-based compensation plans.

Stock-Based Compensation

Stock-based compensation is based on the estimated fair value of awards, net of estimated forfeitures, and recognized over the requisite service period. Estimated forfeitures are based on historical experience at the time of grant and may be revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The stock-based compensation related to all of our stock-based awards and employee stock purchases for the year ended December 31, 2018, 2017 and 2016 is as follows (in thousands):

	For the Year Ended December 31,
	2018				2017				2016
Cost of net revenues	$	3,695			$	3,330			$	3,966
Selling, general and administrative	56,422				46,550				42,612
Research and development	10,646				8,974				7,570
Total stock-based compensation	$	70,763			$	58,854			$	54,148

Stock Options

We have not granted options since 2011 and all outstanding options were fully vested and associated stock-based compensation expense was recognized as of December 31, 2015. Activity for the year ended December 31, 2018, under the stock option plans is set forth below:

	Number of Shares Underlying Stock Options (in thousands)			Weighted Average Exercise Price per Share				Weighted Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)
Outstanding as of December 31, 2017	75			$	11.36
Exercised	(67	)		11.76
Cancelled or expired	—			—
Outstanding as of December 31, 2018	8			$	8.07			0.16		$	1,649
Vested at December 31, 2018	8			$	8.07			0.16		$	1,649
Exercisable at December 31, 2018	8			$	8.07			0.16		$	1,649

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between our closing stock price on the last trading day in 2018 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on the last trading day of 2018. This amount will fluctuate based on the fair market value of our stock. The total intrinsic value of stock options exercised for the year ended December 31, 2018, 2017 and 2016 was $17.6 million, $18.1 million and $18.2 million, respectively.

Restricted Stock Units ("RSUs")

The fair value of RSUs is based on our closing stock price on the date of grant. A summary for the year ended December 31, 2018, is as follows:

	Number of Shares Underlying RSUs (in thousands)			Weighted Average Grant Date Fair Value				Weighted Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)
Nonvested as of December 31, 2017	1,341			$	82.30
Granted	235			262.58
Vested and released	(562	)		75.22
Forfeited	(83	)		112.33
Nonvested as of December 31, 2018	931			$	129.42			1.04		$	194,950

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (calculated by multiplying our closing stock price on the last trading day of 2018 by the number of nonvested RSUs) that would have been received by the unit holders had all RSUs been vested and released as of the last trading day of 2018. This amount will fluctuate based on the fair

market value of our stock. During 2018, of the 561,692 shares vested and released, 178,324 shares vested were withheld for employee statutory tax obligations, resulting in a net issuance of 383,368 shares.

The total intrinsic value of RSUs vested and released during 2018, 2017 and 2016 was $146.7 million, $99.5 million and $59.8 million, respectively. The total fair value of RSUs vested during the year ended December 31, 2018, 2017 and 2016 was $42.2 million, $46.2 million and $39.1 million, respectively. The weighted average grant date fair value of RSUs granted during 2018, 2017 and 2016 was $262.58, $118.77 and $67.82, respectively. As of December 31, 2018, there was $80.7 million of total unamortized compensation costs, net of estimated forfeitures, related to RSUs and these costs are expected to be recognized over a weighted average period of 1.9 years.

Market-Performance Based Restricted Stock Units ("MSUs")

We grant MSUs to our executive officers. Each MSU represents the right to one share of Align’s common stock. The actual number of MSUs which will be eligible to vest will be based on the performance of Align’s stock price relative to the performance of a stock market index over the vesting period, and certain MSU grants are also based on Align's stock price at the end of the performance period. Generally, the vesting period of MSUs is three years. For MSUs granted during the year ended December 31, 2018, the maximum number of MSUs which will be eligible to vest are between 250% to 300% of the MSUs initially granted.

The following table summarizes the MSU performance for the year ended December 31, 2018:

	Number of Shares Underlying MSUs (in thousands)			Weighted Average Grant Date Fair Value				Weighted Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in thousands)
Nonvested as of December 31, 2017	428			$	78.53
Granted	208			266.78
Vested and released	(312	)		62.41
Forfeited	—			—
Nonvested as of December 31, 2018	324			$	215.07			1.16		$	67,897

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (calculated by multiplying our closing stock price on the last trading day of 2018 by the number of nonvested MSUs) that would have been received by the unit holders had all MSUs been vested and released as of the last trading day of 2018. This amount will fluctuate based on the fair market value of our stock. During 2018, of the 312,300 shares vested and released, 130,697 shares were withheld for tax payments, resulting in a net issuance of 181,603 shares.

The total intrinsic value of MSUs vested and released during 2018, 2017 and 2016 was $92.7 million, $28.8 million and $17.4 million, respectively. The total fair value of MSUs vested during the year ended December 31, 2018, 2017 and 2016 was $19.5 million, $15.0 million and $9.9 million, respectively. As of December 31, 2018, we expect to recognize $39.6 million of total unamortized compensation cost, net of estimated forfeitures, related to MSUs over a weighted average period of 1.2 years.

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

	Year Ended December 31,
	2018				2017				2016
Expected term (in years)	3.0				3.0				3.0
Expected volatility	31.9		%		28.9		%		34.0		%
Risk-free interest rate	2.5		%		1.5		%		0.9		%
Expected dividends	—				—				—
Weighted average fair value per share at grant date	$	470.75			$	120.39			$	68.88

Total payments to tax authorities for payroll taxes related to RSUs, including MSUs, that vested during the period were $86.1 million, $46.2 million and $29.9 million during the year ended December 31, 2018, 2017 and 2016, respectively, and are reflected as a financing activity in the Consolidated Statement of Cash Flows.

Employee Stock Purchase Plan ("ESPP")

In May 2010, our shareholders approved the 2010 Employee Stock Purchase Plan (the “2010 Purchase Plan”), which consists of consecutive overlapping twenty-four month offering periods with four six-month purchase periods in each offering period. Employees purchase shares at 85% of the lower of the fair market value of the common stock at either the beginning of the offering period or the end of the purchase period. The 2010 Purchase Plan will continue until terminated by either the Board of Directors or its administrator. The maximum number of shares available for issuance under the 2010 Purchase Plan is 2,400,000 shares.

The following table summarizes the ESPP shares issued:

	Year Ended December 31,
	2018				2017				2016
Number of shares issued (in thousands)	164				202				197
Weighted average price	$	96.95			$	59.93			$	48.65

As of December 31, 2018, 571,778 shares remain available for future issuance.

The fair value of the option component of the 2010 Purchase Plan shares was estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:

	Year Ended December 31,
	2018				2017				2016
Expected term (in years)	1.3				1.2				1.2
Expected volatility	35.2		%		26.8		%		30.5		%
Risk-free interest rate	2.2		%		1.0		%		0.7		%
Expected dividends	—				—				—
Weighted average fair value at grant date	$	94.71			$	31.36			$	22.23

We recognized stock-based compensation expense related to our employee stock purchase plan of $5.6 million, $5.4 million and $2.7 million for the year ended December 31, 2018, 2017 and 2016, respectively. As of December 31, 2018, there was $2.1 million of total unamortized compensation costs related to future employee stock purchases which we expect to be recognized over a weighted average period of 0.4 years.

Note 11. Common Stock Repurchase Programs

April 2014 Repurchase Program

In April 2014, we announced that our Board of Directors had authorized a plan to repurchase up to $300.0 million of our common stock ("April 2014 Repurchase Program").

Prior to 2017, we entered into accelerated share purchase agreements to repurchase $190 million of our common stock and received a total of approximately 3.2 million shares. In addition, we repurchased on the open market approximately 1.6 million shares of our common stock for an aggregate purchase price of approximately $106.2 million.

In 2017, we repurchased on the open market approximately 0.04 million shares of our common stock at an average price of $96.37 per share, including commission for an aggregate purchase price of approximately $3.8 million, completing the April 2014 Repurchase Program.

April 2016 Repurchase Program

In April 2016, we announced that our Board of Directors had authorized a plan to repurchase up to $300.0 million of our common stock ("April 2016 Repurchase Program").

In 2017, we entered into an accelerated share repurchase agreement ("2017 ASR") to repurchase $50.0 million of our common stock. The 2017 ASR was completed in August 2017. We received a total of approximately 0.4 million shares for an average share price of $146.48. During 2017, we repurchased on the open market approximately 0.2 million shares of our common stock at an average price of $243.40 per share, including commissions, for an aggregate purchase price of approximately $50.0 million.

In 2018, we repurchased on the open market approximately 0.7 million shares of our common stock at an average price of $293.21 per share, including commission for an aggregate purchase price of approximately $200.0 million, 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 ("May 2018 Repurchase Program").

In 2018, we repurchased on the open market approximately 0.1 million shares of our common stock at an average price of $356.54 per share, including commissions, for an aggregate purchase price of approximately $50.0 million. In November 2018, we entered into an accelerated stock repurchase agreement to repurchase $50.0 million of our common stock which was completed in December 2018. We received a total of approximately 0.2 million shares for an average share price of $213.18. As of December 31, 2018, we have $500.0 million remaining under the May 2018 Repurchase Program.

In February 2019, we purchased on the open market approximately 0.2 million shares of our common stock at an average price of $243.42 per share, including commission for an aggregate purchase price of approximately of $50.0 million.

Note 12. Employee Benefit Plans

401(k) Plan

We have defined contribution retirement plan under Section 401(k) of the Internal Revenue Code for our U.S. employees which covers substantially all U.S. employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis. We match 50% of our employee’s salary deferral contributions up to a 6% of the employee’s eligible compensation effective 2010. We contributed approximately $5.2 million, $4.3 million and $3.4 million to the 401(k) plan during the year ended December 31, 2018, 2017 and 2016, respectively.

Israeli Funds

Under the Israeli severance fund law, we are required to make payments to dismissed employees and employees leaving employment in certain circumstances. The funding requirement is calculated based on the salary of the employee multiplied by the number of years of employment as of the applicable balance sheet date. Our Israeli employees are entitled to one month’s salary for each year of employment, or a pro-rata portion thereof. We fund the liability through monthly deposits into funds, and the values of these contributions are recorded in other current assets in the Consolidated Balance Sheet. As of December 31, 2018 and 2017, the balance of the fund liability was approximately $3.3 million and $3.2 million, respectively.

Note 13. Income Taxes

The TCJA was enacted into law on December 22, 2017 and impacted our effective tax rate for the year ended December 31, 2017 and 2018. 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. As of December 31, 2017, we recorded a provisional tax charge for the estimated impact of the TCJA of $84.3 million, of which $73.9 million was related to a provisional transition tax liability on the mandatory deemed repatriation of foreign earnings and $10.4 million was related to the remeasurement of certain deferred tax assets and liabilities. As of December 31, 2018, we have finalized our assessment of the impact of the TCJA

on our 2017 financial statements and recorded additional charges of $3.0 million in 2018, all of which relate to the transition tax on the mandatory deemed repatriation of foreign earnings.

The TCJA also includes provisions for certain foreign-sourced earnings, referred to as Global Intangible Low-Taxed Income (“GILTI”), which impose 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.

Net income before provision for income taxes and equity in losses of investee consists of the following (in thousands):

	Year ended December 31,
	2018				2017				2016
Domestic	$	171,658			$	123,696			$	118,871
Foreign	294,993				241,103				123,695
Net income before provision for income taxes and equity in losses of investee	$	466,651			$	364,799			$	242,566

The provision for (benefit from) income taxes consists of the following (in thousands):

	Year Ended December 31,
	2018				2017				2016
Federal
Current	$	35,788			$	91,214			$	40,235
Deferred	(5,989		)		15,724				24,794
	29,799				106,938				65,029
State
Current	9,568				2,580				2,603
Deferred	(3,274		)		2,677				2,636
	6,294				5,257				5,239
Foreign
Current	22,753				15,285				8,964
Deferred	(1,123		)		2,682				(28,032		)
	21,630				17,967				(19,068		)
Provision for income taxes	$	57,723			$	130,162			$	51,200

The differences between income taxes using the federal statutory income tax rate of 21% for 2018 and 35% for 2017 and 2016 and our effective tax rate are as follows:

	Year Ended December 31,
	2018			2017			2016
U.S. federal statutory income tax rate	21.0	%		35.0	%		35.0	%
State income taxes, net of federal tax benefit	1.3			1.4			2.1
U.S. tax on foreign earnings	4.1			1.5			0.2
Impact of U.S. Tax Cuts and Jobs Act (“TCJA”)	2.1			23.1			—
Impact of differences in foreign tax rates	(6.7	)		(18.0	)		(6.3	)
Impact of expiration of statute of limitations	(6.2	)		—			—
Stock-based compensation	(3.4	)		(6.3	)		1.2
Other items not individually material	0.2			(1.0	)		1.8
Valuation allowance release for Israel	—			—			(12.9	)
	12.4	%		35.7	%		21.1	%

As of December 31, 2018, undistributed earnings of the Company's foreign subsidiaries totaled $533.5 million. As a result of the TCJA, during the year ended December 31, 2017, we provided for U.S. income taxes on undistributed foreign earnings through December 31, 2017, and we have reassessed our capital needs and investment strategy with regard to the indefinite reinvestment, determining that certain of those are no longer indefinitely reinvested. Of the total undistributed foreign earnings as of December 31, 2018, the amount that is not indefinitely reinvested is $239.2 million. The remaining amount of undistributed foreign earnings of approximately $294.3 million continues to be indefinitely reinvested in our international operations. Since U.S. income taxes have already been provided under the GILTI provisions of the TCJA, the additional tax impact of the distribution of such foreign earnings to the U.S. parent company would be limited to withholding taxes and is not significant.

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, we generated taxable income in certain jurisdictions in 2016 resulting in a tax expense of $34.3 million. Additionally, as a result of the restructuring in 2016, we reassessed the need for a valuation allowance against our deferred tax assets considering all available evidence. Given the earnings in 2016 and anticipated future earnings of our subsidiary in Israel, we concluded that we had 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 of the same amount.

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 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.

As of December 31, 2018 and 2017, the significant components of our deferred tax assets and liabilities are (in thousands):

		Year Ended December 31,
		2018				2017
Deferred tax assets:
Net operating loss and capital loss carryforwards		$	25,410			$	24,971
Reserves and accruals		24,769				12,547
Stock-based compensation		8,571				10,074
Deferred revenue		14,285				10,811
Net translation losses		1,158				1,928
Credit carryforwards		115				792
		74,308				61,123
Deferred tax liabilities:
Depreciation and amortization		8,320				7,522
Prepaid expenses		902				751
Unremitted foreign earnings		612				3,305
		9,834				11,578
Net deferred tax assets before valuation allowance		64,474				49,545
Valuation allowance		(251		)		(278		)
Net deferred tax assets		$	64,223			$	49,267

The total valuation allowance as of December 31, 2018 was not material. During the year ended December 31, 2018, the valuation allowance decreased by a nominal amount which was mainly related to foreign currency translation adjustments.

As of December 31, 2018, we have fully utilized California net operating loss carryforwards. As of December 31, 2018, we have California research credit carryforwards of approximately $1.9 million which can be carried forward indefinitely. In addition, we have foreign net operating loss carryforwards of approximately $105.7 million, the majority of which can be carried forward indefinitely, and a minor portion of which, if not utilized, will expire beginning after 2023.

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

The changes in the balance of gross unrecognized tax benefits, which exclude interest and penalties, for the year ended December 31, 2018, 2017 and 2016, are as follows (in thousands):

Unrecognized tax benefit as of December 31, 2015	$	39,413
Tax positions related to current year:
Additions for uncertain tax positions	6,971
Unrecognized tax benefit as of December 31, 2016	46,384
Tax positions related to current year:
Additions for uncertain tax positions	1,819
Tax positions related to prior year:
Additions for uncertain tax positions	1,809
Decreases for uncertain tax positions	(826		)
Settlements with tax authorities	(1,527		)
Reductions due to lapse of applicable statute of limitations	(3		)
Unrecognized tax benefit as of December 31, 2017	47,656
Tax positions related to current year:
Additions for uncertain tax positions	14,519
Tax positions related to prior year:
Additions for uncertain tax positions	80
Reductions due to lapse of applicable statute of limitations	(28,993		)
Unrecognized tax benefit as of December 31, 2018	$	33,262

As of December 31, 2018, $29.9 million of our unrecognized tax benefits would impact our effective tax rate if recognized.

We file U.S. federal, U.S. state, and non-U.S. income tax returns. Our major tax jurisdictions include U.S. federal, the State of California and the Netherlands. For U.S. federal and state tax returns, we are no longer subject to tax examinations for years before 2015. We are currently under examination by the Internal Revenue Service for tax years 2015 and 2016. With few exceptions, we are no longer subject to examination by foreign tax authorities for years before 2010.

We have elected to recognize interest and penalties related to unrecognized tax benefits as a component of income taxes. For the year ended December 31, 2018 and 2017, interest and penalties included in tax expense was a benefit of $1.5 million and an expense of $0.8 million, respectively. Our total interest and penalties accrued as of December 31, 2018 and 2017 was $0.9 million and $2.9 million, respectively. The timing and resolution of income tax examinations is uncertain, and the amounts ultimately paid, if any, upon resolution of issues raised by the taxing authorities may differ materially from the amounts accrued for each year. Although it is possible that our balance of gross unrecognized tax benefits could materially change in the next 12 months, given the uncertainty in the development of ongoing income tax examinations, we are unable to estimate the full range of possible adjustments to this balance.

Note 14. Net Income per Share

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

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

	Year Ended December 31,
	2018				2017				2016
Numerator:
Net income	$	400,235			$	231,418			$	189,682
Denominator:
Weighted average common shares outstanding, basic	80,064				80,085				79,856
Dilutive effect of potential common stock	1,293				1,747				1,628
Total shares, diluted	81,357				81,832				81,484
Net income per share, basic	$	5.00			$	2.89			$	2.38
Net income per share, diluted	$	4.92			$	2.83			$	2.33

For the year ended December 31, 2018, 2017 and 2016, potentially anti-dilutive shares excluded from diluted net income per share related to RSUs, MSUs, stock options and ESPP were not material.

Note 15. Supplemental Cash Flow Information

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

	Year Ended December 31,
	2018				2017				2016
Taxes paid	$	114,601			$	51,231			$	47,289
Non-cash investing activities:
Fixed assets acquired with accounts payable or accrued liabilities	$	15,069			$	15,105			$	4,434
Conversion of convertible notes receivable into equity securities	$	4,862			$	—			$	—
Fair value of option to purchase property	$	—			$	3,936			$	—

Note 16. Segments and Geographical Information

Segment Information

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (“CODM”), or decision-making group, in deciding how to allocate resources and in assessing performance. Our CODM is our Chief Executive Officer. We report segment information based on the management approach. The management approach designates the internal reporting used by CODM for decision making and performance assessment as the basis for determining our reportable segments. The performance measures of our reportable segments include net revenues, gross profit and income from operations. Income from operations for each segment includes all geographic revenues, related cost of net revenues and operating expenses directly attributable to the segment. Certain operating expenses are attributable to operating segments and each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Costs not specifically allocated to segment income from operations include various corporate expenses such as stock-based compensation and costs related to IT, facilities, human resources, accounting and finance, legal and regulatory, and other separately managed general and administrative costs outside the operating segments.

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, our Invisalign Comprehensive (formerly known as Invisalign Full and Invisalign Teen), Invisalign Assist and Invisalign First.

•	Non-Comprehensive Products include, Invisalign Express 10, Invisalign Express 5, Express Package, Lite Package and Invisalign Go products in addition to revenues from the sale of aligners to 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.

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

	For the Year Ended December 31,
	2018				2017				2016
Net revenues
Clear Aligner	$	1,691,467			$	1,309,262			$	958,327
Scanner	275,025				164,151				121,547
Total net revenues	$	1,966,492			$	1,473,413			$	1,079,874
Gross profit
Clear Aligner	$	1,280,495			$	1,019,563			$	747,494
Scanner	167,372				97,384				67,800
Total gross profit	$	1,447,867			$	1,116,947			$	815,294
Income from operations
Clear Aligner	$	712,439			$	564,648			$	411,817
Scanner	98,998				49,613				37,498
Unallocated corporate expenses	(344,873		)		(260,650		)		(200,394		)
Total income from operations	$	466,564			$	353,611			$	248,921
Depreciation and amortization
Clear Aligner	$	29,001			$	21,581			$	13,742
Scanner	4,965				4,385				3,871
Unallocated corporate expenses	20,761				11,773				6,389
Total depreciation and amortization	$	54,727			$	37,739			$	24,002

The following table reconciles total segment income from operations in the table above to net income before provision for income taxes and equity in losses of investee (in thousands):

	For the Year Ended December 31,
	2018				2017				2016
Total segment income from operations	$	811,437			$	614,261			$	449,315
Unallocated corporate expenses	(344,873		)		(260,650		)		(200,394		)
Total income from operations	466,564				353,611				248,921
Interest income	8,576				6,948				4,213
Other income (expense), net	(8,489		)		4,240				(10,568		)
Net income before provision for income taxes and equity in losses of investee	$	466,651			$	364,799			$	242,566

Geographical Information

Net revenues are presented below by geographic area (in thousands):

	For the Year Ended December 31,
	2018				2017				2016
Net revenues (1):
United States (2)	$	1,023,559			$	836,200			$	692,254
The Netherlands (2)	610,039				456,108				286,911
China	155,790				81,661				46,480
Other International	177,104				99,444				54,229
Total net revenues	$	1,966,492			$	1,473,413			$	1,079,874

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

(2) Effective July 2016, we implemented a new international corporate structure. This changed the structure of our international procurement and sales operations.

Tangible long-lived assets are presented below by geographic area (in thousands):

	As of December 31,
	2018				2017
Long-lived assets (3):
The Netherlands	$	206,679			$	143,673
United States	139,239				128,171
Costa Rica	80,218				30,738
China	36,249				5,480
Mexico	33,240				25,090
Other International	25,704				15,641
Total long-lived assets	$	521,329			$	348,793

(3) Long-lived assets are attributed to countries based on entity that owns the assets.