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

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

A discussion regarding our financial condition and results of operations for fiscal 2019 compared to fiscal 2018 is presented under Results of Operations of this Form 10-K. Discussions regarding our financial condition and results of operations for fiscal 2018 compared to 2017 have been omitted from this Annual Report on Form 10-K, but can be found in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on February 28, 2019, which is available without charge on the SEC's website at www.sec.gov and on our investor relations website at investor.aligntech.com.

Overview

Our goals are to establish Invisalign clear aligners as the standard method for treating malocclusion which, to date, over 8 million people worldwide have been treated with our Invisalign System, and to establish the iTero intraoral scanner as the preferred scanning device for 3D digital scans, ultimately driving increased clear aligner and other product adoption by dental professionals. We intend to achieve these goals by continued focus and execution of our strategic growth drivers set forth in the Business Strategy section of this Annual Report on Form 10-K.

The successful execution of our business strategy in 2020 and beyond may be affected by a number of factors including:

•	New Invisalign Products and Feature Enhancements. We believe product innovation drives greater treatment predictability, clinical applicability and ease of use for the dental professionals we serve customers which supports adoption of Invisalign treatment in their practices. Our focus is to develop solutions and features to treat a wide range of cases from simple to complex.

•

We rolled out Invisalign treatment with Mandibular Advancement, the first clear aligner solution for Class II correction in growing tween and teen patients in multiple regions and countries throughout 2018. This offering combines the benefits of our clear aligner system with features for moving the lower jaw forward while simultaneously aligning the teeth without the need for elastics typically used to treat teen Class II patients.

•

In April 2018, we announced Invisalign Go product with more user-friendly iTero digital chairside experience and greater flexibility to treat a wider range of mild to moderate cases. Invisalign Go also incorporates new data-driven clinical protocols for predictable tooth movement and automated case assessments that leverages our Invisalign patients treated to date. These improvements make it easier for general practitioner (“GP”) dentists to tailor their treatment plans to the individual needs of each patient.

•

In July 2018, we announced Invisalign First clear aligners which are a treatment option designed with features specifically for younger patients with early mixed dentition with a mixture of primary/baby and permanent teeth. Phase 1 treatment is an early interceptive orthodontic treatment for young patients, traditionally done through arch expanders, or partial metal braces, before all permanent teeth have erupted, typically at ages seven through ten years. Invisalign First clear aligners are designed specifically to address a broad range of younger patients’ malocclusions, including shorter clinical crowns, management of erupting dentition and predictable dental arch expansion.

•	In October 2019, we launched the Invisalign Moderate Package for the treatment of mild to moderate malocclusion. The Invisalign Moderate treatment includes all the features of Invisalign treatment, plus additional features that address the orthodontic needs of teenage patients such as compliance indicators and compensation for tooth eruption.

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

•

In April 2018, we expanded the iTero Element portfolio with the launch of the iTero Element 2 and the iTero Element Flex scanners, building on the existing high precision, full-color imaging and fast scan times of the iTero Element portfolio while streamlining orthodontic and restorative workflows. The next-generation iTero Element 2 is designed for greater performance with 2X faster start-up and 25% faster scan processing time compared to the iTero Element. The new iTero Element Flex wand-only configuration is a portable scanner for easy transport from office to office.

As we continue to expand our global presence, we expect to seek regulatory approvals to offer our iTero portfolio products in more countries, thereby tapping potential growth opportunities in underserved markets

•

In February 2019, we announced the launch of iTero Element 5D Imaging System for comprehensive, preventative and restorative oral care. The iTero Element 5D Imaging System provides a new comprehensive approach to clinical applications, workflows and user experience that expands the suite of existing high-precision, full color imaging and fast scan times of the iTero Element portfolio. The iTero Element 5D Imaging System is available in the majority of EMEA and select APAC countries. The iTero Element 5D Imaging System is pending regulatory approval and is not yet available in the U.S. or LATAM countries.

•	In June 2019, we announced the launch of iTero Element Foundation intraoral scanner with restorative software. The iTero Element Foundation extends Align’s portfolio of intraoral scanners with powerful 3D visualization to better meet the needs of doctors, labs and patients. The iTero Element Foundation is available in North America and will also be available in other select countries in 2020.

We believe that over the longterm, clinical solutions and treatment tools will increase adoption of Invisalign and increase sales of our intraoral scanners; however, it is difficult to predict the rate of adoption which may vary by region and channel.

The use of iTero and other digital scanners for Invisalign case submission in place of PVS impressions continues to grow and remains a positive catalyst for Invisalign utilization. For the fourth quarter of 2019, total Invisalign cases submitted with a digital scanner in the Americas increased to 79.5%, up slightly from 78.8% in the third quarter of 2019. International scans increased to 64.7%, up from 62.6% in the third quarter of 2019. We believe that over the longterm, technology innovation and added features and functionality of our iTero scanners will increase adoption of Invisalign and increase sales of our intraoral scanners; however, it is difficult to predict the rate of adoption which may vary by region and channel.

•	Invisalign Adoption. Our goal is to establish Invisalign as the treatment of choice for treating malocclusion ultimately driving increased product adoption and frequency of use by dental professionals, also known as “utilization rates.” Our annual utilization rates for the last three fiscal years are as follows:

***** Invisalign utilization rates are calculated by the # of cases shipped divided by the # of doctors to whom cases were shipped. Our International region includes EMEA and APAC. LATAM is excluded from the above chart as it is immaterial.

◦	Total utilization in 2019 increased to 15.9 cases per doctor compared to 15.7 cases in 2018.

▪	North America: Utilization for both our North American orthodontist and GP customers increased in 2019 to 65.0 and 9.5 cases per doctor compared to 56.7 cases and 9.1 cases per doctor in 2018, respectively. The increase in utilization in 2019 reflects improvements in product and technology which continues to strengthen

our doctors’ clinical confidence such that they now utilize Invisalign more often and on more complex cases, including their teenage patients.

▪	International: International doctor utilization remained relatively flat at 13.8 cases per doctor in 2019 compared to 13.9 cases in 2018.

We expect our utilization rates to gradually improve as a result of advancements in product and technology, which continue to strengthen our doctors’ clinical confidence in the use of Invisalign clear aligners. In addition, since the teenage and younger market makes up 75% of the approximately 12 million total orthodontic case starts each year, and as we continue to drive adoption of teenage and younger patients through sales and marketing programs, we expect our utilization rates to improve. Our utilization rates, however, may fluctuate from period to period due to a variety of factors, including seasonal trends in our business along with adoption rates of new products and features.

•	Number of New Invisalign Doctors Trained. We continue to expand our Invisalign customer base through the training of new doctors. In 2019, we trained 22,270 new Invisalign doctors of which 9,765 were trained in the Americas region and 12,505 in the International region.

•

International Invisalign Growth. We continue to focus our efforts towards increasing Invisalign clear aligner adoption by dental professionals in the EMEA and APAC markets. On a year-over-year basis, our International Invisalign volume increased 34.0% driven primarily by increased adoption as well as expansion of our customer base in both the EMEA and APAC regions. However, beginning in the second quarter of 2019, we experienced slower growth rates than prior periods in China primarily due to the US-China trade war and resulting economic uncertainty which caused headwind for consumer demand especially for consumption of luxury goods and considered purchases. We also believe there has been increased competitive activity from wires and bracket manufacturers and clear aligner suppliers. In addition, in the first quarter of 2020, the outbreak of the Novel Coronavirus (2019 NCov) in China has caused increased uncertainty and disruption to our employees, doctors’ practices, their patients and consumers. We expect the impact of the Novel Coronavirus and related efforts by the Chinese government to contain its spread, including travel restrictions, extension of the Lunar New Year and discouraging non-essential medical and dental procedures to adversely impact sales and operations in China for a currently indeterminate period of time. Notwithstanding these current issues in China, we continue to see growth from our international orthodontists and GP customers and are seeing more positive traction in the GP channel as we continue to segment our sales and marketing resources and programs specifically around each customer channel. In 2019, we continued to expand in our existing markets through targeted investments in sales coverage and professional marketing and education programs, along with consumer marketing in select country markets. We expect International revenues to continue to grow at a faster rate than the Americas for the foreseeable future due to our continued investment in international market expansion, the size of the market opportunities and our relatively low market penetration of these regions. Our future growth is dependent upon the continued growth of Invisalign adoption and international market penetration.

•

Increasing Competition. Starting in the second quarter of 2019, we began experiencing slower adult case growth from North American orthodontists, reflecting a more competitive environment especially for the young adult demographic. Given increased awareness for direct to consumer clear aligners and heavy advertising spend from direct to consumer companies, case starts may be shifting away from traditional practices. We also believe that doctors are sampling alternative products and/or taking advantage of wires and brackets bundles that essentially give clear aligners away for free or at low prices. In the third quarter of 2019, we increased investment in consumer demand with a new advertising campaign for North America and expanding marketing programs such as our Concierge Service, which connects potential patients with Invisalign doctors increasing conversion and loyalty. In addition, we launched new sales tools and professional marketing materials and we also expect to see increased productivity from the approximate 100 sales representatives we added in the first quarter of 2019. If, however, we are unable to compete effectively with existing products or respond effectively to any products developed by new or existing competitors, our business could be harmed*.*

•

Establish Regional Order Acquisition, Treatment Planning and Manufacturing Operations. We expect to continue establishing and expanding additional order acquisition, treatment planning and manufacturing operations closer to our international customers in order to improve our operational efficiency and increase doctors' confidence in Invisalign clear aligners. In the fourth quarter of 2018, we began fabricating our aligners in our manufacturing facility in Ziyang, China, our first aligner fabrication facility outside of Juarez, Mexico. In the third quarter of 2019, we opened our new order acquisition and treatment facility in Wroclaw, Poland and new treatment facility in Yokohama, Japan.

•	Corporate Structure Reorganization. In January 2020, we reorganized our corporate structure and intercompany relationships to more closely align with the international nature of our business activities with the goal of achieving financial and operational efficiencies. As part of this corporate structure reorganization, our EMEA regional headquarters

was moved from Amsterdam, the Netherlands to Rotkreuz, Switzerland. As a result, we will continue to incur expenses in the near term and expect to realize the related benefits in subsequent years. The implementation of this reorganization plan has been disruptive to our business, and may not ultimately be more efficient or effective. Moreover, our reorganization activities, including any related expenses and the impact from affected employees, could have a material adverse effect on our business, operating results, financial condition and effective tax rates.

•	Expenses. We expect expenses to increase in 2020 due in part to:

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

▪	Investments in international expansion;

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

▪	Increase in sales, marketing and customer support resources including our new advertising campaign; and

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

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

•

Stock Repurchases. During the year ended December 31, 2019, we repurchased $200.0 million of our common stock on the open market at an average price of $264.93 per share. We also entered into an accelerated stock repurchase agreement to repurchase $200.0 million of our common stock and received a total of 1.1 million shares for an average share price of $176.61. As of December 31, 2019, we have $100.0 million available for repurchase under the $600.0 million repurchase program authorized by our Board of Directors in May 2018 (Refer to Note 12 “Common Stock Repurchase Programs” of the Notes to Consolidated Financial Statements for details on our stock repurchase programs).

Results of Operations

Net Revenues by Reportable Segment

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 Invisalign Comprehensive and Invisalign First.

•	Non-Comprehensive Products include, but are not limited to, Invisalign Moderate, Lite and Express packages and Invisalign Go, in addition to revenues from the sale of aligners to SmileDirectClub (“SDC”) under our supply agreement that expired on December 31, 2019.

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

•	Our Scanner segment consists of intraoral scanning systems, which includes a single hardware platform and restorative or orthodontic software options, additional services and ancillary products. This segment includes our iTero scanner and OrthoCAD services.

Net revenues for our Clear Aligner and Scanner segments by region for the year ended December 31, 2019, 2018 and 2017 are as follows (in millions):

		Year Ended December 31,															Year Ended December 31,
Net Revenues		2019				2018				Change							2018				2017				Change
Clear Aligner revenues:
Americas		$	1,022.1			$	903.3			$	118.8			13.2	%		$	903.3			$	754.1			$	149.2			19.8	%
International		881.4				684.2				197.2				28.8	%		684.2				473.5				210.7				44.5	%
Non-Case		122.3				104.0				18.3				17.6	%		104.0				81.7				22.3				27.3	%
Total Clear Aligner net revenues		$	2,025.8			$	1,691.5			$	334.3			19.8	%		$	1,691.5			$	1,309.3			$	382.2			29.2	%
Scanner net revenues		381.0				275.0				106.0				38.5	%		275.0				164.1				110.9				67.6	%
Total net revenues		$	2,406.8			$	1,966.5			$	440.3			22.4	%		$	1,966.5			$	1,473.4			$	493.1			33.5	%

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

Clear Aligner Case Volume by Region

Case volume data which represents Clear Aligner case shipments by region for the year ended December 31, 2019, 2018 and 2017 is as follows (in thousands):

		Year Ended December 31,												Year Ended December 31,
Region		2019			2018			Change						2018			2017			Change
Americas		867.3			780.7			86.6			11.1	%		780.7			631.6			149.1			23.6	%
International		669.8			499.9			169.9			34.0	%		499.9			344.8			155.1			45.0	%
Total case volume		1,537.1			1,280.6			256.5			20.0	%		1,280.6			976.4			304.2			31.2	%

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

Total net revenues increased by $440.3 million in 2019 as compared to 2018 primarily as a result of Invisalign case and scanner volume growth across all regions.

Clear Aligner - Americas

Americas net revenues increased by $118.8 million in 2019 as compared to 2018 due to Invisalign case volume growth across all channels and products which contributed to the net revenue growth by $100.2 million and higher average selling prices ("ASP") which increased net revenues by $18.7 million. Higher ASP was mainly the result of price increases across most products which increased net revenues by $35.1 million and $23.4 million increase in net revenues driven by a product mix shift towards Comprehensive products and less SDC revenues, which carry a lower ASP. We no longer manufacture aligners for SDC as our supply agreement with SDC expired by its terms on December 31, 2019. These ASP increases were partially offset by a reduction in net revenues of $23.1 million from higher promotional discounts and $17.6 million reduction in net revenues as a result of higher net revenue deferrals and unfavorable foreign exchange rates.

Clear Aligner - International

International net revenues increased by $197.2 million in 2019 as compared to 2018 primarily driven by case volume growth across all channels and products which increased net revenues by $232.5 million. This increase was partially offset by lower ASP that reduced net revenues by $35.3 million. The ASP decline was mainly the result of higher promotional discounts which reduced net revenues by $45.0 million, unfavorable foreign exchange rates lowered net revenues by $37.2 million, and a product mix shift towards Non-comprehensive products reduced net revenues by $19.0 million. These ASP decreases were partially offset by a $47.8 million improvement in net revenues related to price increases across most products along with a benefit from going direct in several additional countries, and lower net revenue deferrals and sales credits that increased net revenues by $18.1 million.

Clear Aligner - Non-Case

Non-case net revenues, consisting of Vivera Retainers, training fees and other product revenues, increased by $18.3 million in 2019 compared to 2018 due to increased Vivera volume across all regions.

Scanner

Scanner and services net revenues increased by $106.0 million in 2019 as compared to 2018. This increase is primarily a result of scanner volume growth which increased net revenues by $58.4 million, and higher CAD/CAM services that increased net revenues by $37.7 million primarily due to a larger install base and increased scanner subscription services. Additionally, net revenues increased by $10.0 million due to an improvement in the scanner ASP mainly attributable to price increases in several regions.

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

		Year Ended December 31,												Year Ended December 31,
		2019				2018				Change				2018				2017				Change
Clear Aligner
Cost of net revenues		$	526.0			$	411.0			$	115.0			$	411.0			$	289.7			$	121.3
% of net segment revenues		26.0		%		24.3		%						24.3		%		22.1		%
Gross profit		$	1,499.7			$	1,280.5			$	219.2			$	1,280.5			$	1,019.6			$	260.9
Gross margin %		74.0		%		75.7		%						75.7		%		77.9		%
Scanner
Cost of net revenues		$	136.9			$	107.7			$	29.2			$	107.7			$	66.8			$	40.9
% of net segment revenues		35.9		%		39.1		%						39.1		%		40.7		%
Gross profit		$	244.2			$	167.4			$	76.8			$	167.4			$	97.4			$	70.0
Gross margin %		64.1		%		60.9		%						60.9		%		59.3		%
Total cost of net revenues		$	662.9			$	518.6			$	144.3			$	518.6			$	356.5			$	162.1
% of net revenues		27.5		%		26.4		%						26.4		%		24.2		%
Gross profit		$	1,743.9			$	1,447.9			$	296.0			$	1,447.9			$	1,116.9			$	331.0
Gross margin %		72.5		%		73.6		%						73.6		%		75.8		%

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

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

Clear Aligner

The gross margin percentage decreased in 2019 compared to 2018 primarily due to an increase in aligners per case driven by additional aligners.

Scanner

The gross margin percentage increased in 2019 compared to 2018 primarily driven by higher ASP and manufacturing efficiencies.

Selling, general and administrative (in millions):

		Year Ended December 31,												Year Ended December 31,
		2019				2018				Change				2018				2017				Change
Selling, general and administrative		$	1,072.1			$	852.4			$	219.7			$	852.4			$	665.8			$	186.6
% of net revenues		44.5		%		43.3		%						43.3		%		45.2		%

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

Selling, general and administrative expense includes personnel-related costs including payroll, commissions and stock-based compensation for our sales force, marketing and administration in addition to media and advertising expenses, clinical education, trade shows and industry events, product marketing, equipment and maintenance costs, legal and outside service costs, depreciation and amortization expense and allocations of corporate overhead expenses including facilities and Information Technology (“IT”).

Selling, general and administrative expense increased in 2019 compared to 2018 primarily due to higher compensation related costs of $121.2 million mainly from increased headcount resulting in higher salaries expense, incentive bonuses, fringe benefits, and stock-based compensation partially due to investments in sales coverage and international expansion. We also incurred higher expenses from advertising and marketing costs of $40.1 million, legal and outside service costs of $31.7 million, equipment, software and maintenance costs of $18.1 million and depreciation and amortization costs of $12.4 million.

Research and development (in millions):

		Year Ended December 31,												Year Ended December 31,
		2019				2018				Change				2018				2017				Change
Research and development		$	157.4			$	128.9			$	28.5			$	128.9			$	97.6			$	31.3
% of net revenues		6.5		%		6.6		%						6.6		%		6.6		%

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

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

Research and development expense increased in 2019 compared to 2018 primarily due to higher compensation costs mainly from increased headcount resulting in higher salaries expense, stock-based compensation, incentive bonuses and fringe benefits.

Impairments and other (gains) charges (in millions):

		Year Ended December 31,												Year Ended December 31,
		2019				2018				Change				2018			2017				Change
Impairments and other (gains) charges		$	23.0			$	—			$	23.0			—	%		$	—			$	—
% of net revenues		1.0		%		—		%						—	%		—		%

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

In 2019, we recorded impairments and other (gains) charges of $23.0 million which are comprised of operating lease right-of-use assets impairments of $14.2 million, store leasehold improvement and other fixed asset impairments of $14.3 million, and employee severance and other expenses of $1.3 million, partially offset by Invisalign store lease termination gains of $6.8 million (Refer to Note 8“Impairments and Other (Gains) Charges” and Note 9 “Legal Proceedings” of the Notes to Consolidated Financial Statements for more information).

Litigation settlement gain (in millions):

		Year Ended December 31,												Year Ended December 31,
		2019				2018				Change				2018				2017				Change
Litigation settlement gain		$	(51.0	)		$	—			$	(51.0	)		$	—			$	—			$	—
% of net revenues		(2.1		)%		—		%						—		%		—		%

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

In 2019, we recorded a gain of $51.0 million due to the litigation settlement with Straumann (Refer to Note 9 “Legal Proceedings” of the Notes to Consolidated Financial Statements for more information).

Income from operations (in millions):

		Year Ended December 31,												Year Ended December 31,
		2019				2018				Change				2018				2017			Change
Clear Aligner
Income from operations		$	836.0			$	712.4			$	123.6			$	712.4			$	564.6		$	147.8
Operating margin %		41.3		%		42.1		%						42.1		%		43.2		%
Scanner
Income from operations		$	137.7			$	99.0			$	38.7			$	99.0			$	49.6		$	49.4
Operating margin %		36.1		%		36.0		%						$	—			$	—
Total income from operations 1		$	542.5			$	466.6			$	75.9			$	466.6			$	353.6		$	113.0
Operating margin %		22.5		%		23.7		%						$	—			$	—

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

1 Refer to Note 17 “Segments and Geographical Information” of the Notes to Consolidated Financial Statements for details on unallocated corporate expenses and the reconciliation to Consolidated Income from Operations.

Clear Aligner

Operating margin percentage decreased in 2019 compared to 2018 primarily due to lower Clear Aligner gross margin percentage as a result of an increase in aligners per case combined with impairment charges on operating lease right-of-use assets, store leasehold improvement and other fixed assets. These decreases were partially offset by a gain recognized from the litigation settlement with Straumann.

Scanner

Operating margin percentage remained flat in 2019 compared to 2018 primarily due to manufacturing efficiencies and higher ASP partially offset by higher operating expenses.

Interest income (in millions):

		Year Ended December 31,												Year Ended December 31,
		2019				2018				Change				2018				2017				Change
Interest income		$	12.5			$	8.6			$	3.9			$	8.6			$	6.9			$	1.7

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

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

Interest income increased in 2019 compared to 2018 mainly due to a larger investment portfolio.

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

		Year Ended December 31,												Year Ended December 31,
		2019				2018				Change				2018				2017				Change
Other income (expense), net		$	7.7			$	(8.5	)		$	16.2			$	(8.5	)		$	4.2			$	(12.7	)

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

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

Other income (expense), net, increased in 2019 compared to 2018 primarily due to a $15.8 million gain from the sale of our investment in SDC. This increase was partially offset by a $4.0 million impairment of our equity investment in a privately held company along with foreign exchange losses (Refer to Note 9 “Legal Proceedings” of the Notes to Consolidated Financial Statements for details on SDC legal proceedings discussion).

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

		Year Ended December 31,												Year Ended December 31,
		2019				2018				Change				2018				2017				Change
Equity in losses of investee, net of tax		$	7.5			$	8.7			$	(1.2	)		$	8.7			$	3.2			$	5.5

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

Equity in losses of investee, net of tax decreased in 2019 compared to 2018 since we tendered our SDC equity interest on April 3, 2019, and thus, we no longer record our share of SDC's losses (Refer to Note 5 “Equity Method Investments” of the Notes to Consolidated Financial Statements for details on equity method investments).

Provision for income taxes (in millions):

		Year Ended December 31,												Year Ended December 31,
		2019				2018				Change				2018				2017				Change
Provision for income taxes		$	112.3			$	57.7			$	54.6			$	57.7			$	130.2			$	(72.5	)
Effective tax rates		20.0		%		12.4		%						12.4		%		35.7		%

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

The increase in effective tax rate for the year ended December 31, 2019 compared to the same period in 2018 is primarily attributable to tax benefits recorded last year as a result of expiration of statute limitations that did not recur in 2019 and reduced excess tax benefits from stock-based compensation mainly due to non-deductible officers’ compensation. For the year ended December 31, 2019 and December 31, 2018, we recognized tax benefits in our provision for income taxes of $1.6 million and $22.5 million, respectively, related to expiration of statute of limitations and $13.4 million and $26.5 million, respectively, related to stock-based compensation.

Effective January 1, 2020, as a result of the relocation of our EMEA regional headquarters from Amsterdam, the Netherlands to Rotkreuz, Switzerland, our tax rate for the first quarter of 2020 and for the rest of the year, will reflect a significant one-time tax benefit of up to $1.6 billion associated with the recognition of a deferred tax asset related to the intra-entity transfer of certain intellectual property rights. We continue to assess the realizability of this deferred tax asset as we take into account new information, including the profitability of our Swiss headquarters and ongoing communication with the Swiss tax authorities.

Liquidity and Capital Resources

We fund our operations from product sales. As of December 31, 2019 and 2018, we had the following cash and cash equivalents, and short-term and long-term marketable securities (in thousands):

	Year Ended December 31,
	2019				2018
Cash and cash equivalents	$	550,425			$	636,899
Marketable securities, short-term	318,202				98,460
Marketable securities, long-term	—				9,112
Total	$	868,627			$	744,471

As of December 31, 2019, we had $868.6 million in cash, cash equivalents, and marketable securities. Cash equivalents and marketable securities are comprised of money market funds and highly liquid debt instruments which primarily include commercial paper, corporate bonds, U.S. government agency bonds, U.S. government treasury bonds, and certificates of deposit.

As of December 31, 2019, approximately $278.5 million of cash, cash equivalents and marketable securities was held by our foreign subsidiaries. We repatriated $350.0 million to the U.S. during the year ended December 31, 2019 under the Global Intangible Low-Taxed Income (“GILTI”) provisions of the U.S. Tax Cuts and Jobs Act (the “TCJA”) and substantially all of the earnings previously determined to be not indefinitely reinvested have been repatriated. Our intent is to permanently reinvest our earnings from our international operations going forward, and our current plans do not require us to repatriate them to fund our U.S. operations as we generate sufficient domestic operating cash flow and have access to external funding under our current revolving line of credit.

Cash flows (in thousands):

		Year Ended December 31,
		2019				2018				2017
Net cash provided by (used in):
Operating activities		$	747,270			$	554,681			$	438,539
Investing activities		(350,444		)		6,927				(251,477		)
Financing activities		(485,540		)		(369,434		)		(135,500		)
Effects of foreign exchange rate changes on cash, cash equivalents, and restricted cash		2,282				(4,733		)		5,544
Net increase in cash, cash equivalents, and restricted cash		$	(86,432	)		$	187,441			$	57,106

Operating Activities

For the year ended December 31, 2019, cash flows from operations of $747.3 million was primarily comprised of our net income of approximately $442.8 million as well as the following:

Significant non-cash activities

•	Stock-based compensation of $88.2 million related to equity awards granted to employees and directors;

•	Depreciation and amortization of $79.0 million related to our investments in property, plant and equipment and intangible assets;

•	Impairment charges of $28.5 million related to decreases in the fair value of certain assets related to the closure of our Invisalign stores;

•	Non-cash operating lease costs of $18.5 million; and

•	Gain from the sale of equity method investment of $15.8 million.

Significant changes in working capital

•	Increase of $189.1 million in deferred revenues corresponding to the increase in case volume;

•	Increase of $121.0 million in accounts receivable which is primarily a result of the increase in net revenues; and

•	Increase of $60.2 million in accrued and other long-term liabilities due to timing of payment and activities.

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

Significant non-cash activities

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

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

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

Significant changes in working capital

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

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

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

Investing Activities

Net cash used in investing activities was $350.4 million for the year ended December 31, 2019, which primarily consisted of purchases of marketable securities of $693.3 million, purchases of property, plant and equipment of $149.7 million and other investing activities of $14.7 million. These outflows were partially offset by maturities and sales of marketable securities of $485.4 million and payments of $21.8 million received on an unsecured promissory note issued by SDC in exchange for tendering our shares to them.

For 2020, we expect to invest $180 million to $200 million in capital expenditures related to building purchases and improvements as well as additional manufacturing capacity to support our international expansion. Although we believe our current investment portfolio has little risk of impairment, we cannot predict future market conditions or market liquidity and can provide

no assurance that our investment portfolio will remain unimpaired (Refer to Note 10 “Commitments and Contingencies” of the Notes to Consolidated Financial Statements for details on the purchases of buildings in Petach Tivka, Israel and San Jose, California).

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

Financing Activities

Net cash used in financing activities was $485.5 million for the year ended December 31, 2019 primarily consisted of common stock repurchases of $400.0 million, payroll taxes paid for equity awards through share withholdings of $57.7 million and the purchase of a building that we previously leased under a finance lease of $45.8 million. These outflows were offset in part by $17.9 million proceeds from the issuance of common stock.

Net cash used in financing activities was $369.4 million for the year ended December 31, 2018 primarily consisted of common stock repurchases of $300.0 million and payroll taxes of $86.1 million paid for vesting of RSUs through share withholdings. These outflows were offset in part by $16.6 million from proceeds from the issuance of common stock.

Common Stock Repurchases

Refer to Note 12 "Common Stock Repurchase Programs" of the Notes to Consolidated Financial Statements for details.

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

•	May 2018 Repurchase Program. In May 2018, we announced that our Board of Directors had authorized a plan to repurchase up to $600.0 million of our common stock. We repurchased $100.0 million and $400.0 million of our common stock in 2018 and 2019, respectively, and as of December 31, 2019, we have $100.0 million remaining under this program.

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

Credit Facility

On February 27, 2018, we entered into a new credit facility for a $200.0 million revolving line of credit, with a $50.0 million letter of credit sublimit, and a maturity date of February 27, 2021. As of December 31, 2019, we had no outstanding borrowings under this credit facility (Refer to Note 7 "Credit Facility" of the Notes to Consolidated Financial Statements for details of the credit facility).

Contractual Obligations / Off Balance Sheet Arrangements

The impact that our contractual obligations as of December 31, 2019 are expected to have on our liquidity and cash flows in future periods is as follows (in thousands):

					Payments Due by Period
	Total				Less than 1 Year				1-3 Years				4-5 Years				More than 5 Years
Operating leases obligations 1	$	64,483			$	18,354			$	29,904			$	10,772			$	5,453
Unconditional purchase obligations	523,652				309,686				210,470				3,496				—
Total contractual cash obligations	$	588,135			$	328,040			$	240,374			$	14,268			$	5,453

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

Our contractual obligations table above excludes approximately $42.7 million of non-current uncertain tax benefits which are included in other long-term obligations and deferred tax assets on our balance sheet as of December 31, 2019. We have not included this amount because we cannot make a reasonably reliable estimate regarding the timing of settlements with taxing authorities, if any.

As of December 31, 2019, we had additional operating leases that have not yet commenced of $7.9 million. These operating leases will commence between 2020 through 2021 with lease terms of 2 years to 4 years.

We had no material off-balance sheet arrangements as defined in Regulation S-K Item 303(a) (4) as of December 31, 2019 other than certain items disclosed in Note 10 "Commitments and Contingencies" of the Notes to Consolidated Financial Statements.

Indemnification Provisions

In the normal course of business to facilitate transactions in our services and products, we indemnify 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, 2019, we did not have any material indemnification claims that were probable or reasonably possible.

Critical Accounting Policies and Estimates

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

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

Revenue Recognition

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

We identify a performance obligation as distinct if both of the following criteria are met: 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”), allocation of consideration from the contract to the individual performance obligations and the appropriate timing of revenue recognition, is the result of significant qualitative and quantitative judgments. 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 First, Invisalign Moderate, and Lite and Express Packages, include optional additional aligners at no charge for a certain period of time ranging from six months 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.

Our treatment plans comprise the following performance obligations that also represent distinct deliverables: initial aligners, additional aligners, case refinement, and replacement aligners. We 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. Management considers a variety of factors such as historical sales, costs, and gross margin, which may vary over time depending upon the unique facts and circumstances related to each performance obligation in making these estimates. We also consider usage rates, which is the number of times a customer is expected to order additional aligners. Our process for estimating usage rates requires significant judgment and evaluation of inputs, including historical usage data by region, country and channel. We 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 consider whether a significant financing component exists; however, as the delivery of the performance obligations are at the customer’s discretion, we conclude 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 of 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.

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.

Unfulfilled Performance Obligations for Clear Aligners and Scanners

Our unfilled performance obligations, including deferred revenues and backlog, as of December 31, 2019 and the estimated revenues expected to be recognized in the future related to these performance obligations are $610.3 million. This includes performance obligations from the Clear Aligner segment, primarily the shipment of additional aligners, which are fulfilled over six months to five years. Also included are the performance obligations from the iTero scanner segment, primarily services and support, which are fulfilled over one to five years, and contracted deliveries of additional scanners. 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 generally varying from net 30 to net 180 days. Contract liabilities are recorded as deferred revenue balances, which are generated based upon timing of invoices and recognition patterns, not payments. If the revenue recognition exceeds the billing, the exceeded amount is considered unbilled receivable and a contract asset. Conversely, if the billing occurs prior to the revenue recognition, the amount is considered deferred revenue and a contract liability.

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

Goodwill

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

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

We perform an initial assessment of qualitative factors to determine whether the existence of events and circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. In performing the qualitative assessment, we identify and consider the significance of relevant key factors, events, and circumstances that affect the fair value of our reporting units. These factors include external factors such as macroeconomic, industry, and market conditions, as well as entity-specific factors, such as our actual and planned financial performance. We also give consideration to the difference between the reporting unit fair value and carrying value as of the most recent date a fair value measurement was performed. If, after assessing the totality of relevant events and circumstances, we determine that it is more likely than not that the fair value of the reporting unit exceeds its carrying value and there is no indication of impairment, no further testing is performed; however, if we conclude otherwise, the first step of the two-step impairment test is performed by estimating the fair value of the reporting unit and comparing it with its carrying value, including goodwill. Refer to Note 6 "Goodwill and Intangible Assets" of Notes to Consolidated Financial Statements for details on goodwill.

Finite-Lived Intangible Assets and Long-Lived Assets

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

We evaluate long-lived assets (including finite-lived intangible assets) for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. An asset or asset group is considered impaired if its carrying amount exceeds the future undiscounted net cash flows the asset or asset group is expected to generate. If an asset or asset group is considered to be impaired, the impairment to be recognized is calculated as the amount by which the carrying amount of the asset or asset group exceeds its fair market value. Our estimates of future cash flows attributable to our long-lived assets require significant judgment based on our historical and anticipated results and are subject to many factors. Factors we consider important which could trigger an impairment review include significant negative industry or economic trends, significant loss of customers and changes in the competitive environment. The estimation of fair value utilizing a discounted cash flow approach includes numerous uncertainties which require our significant judgment when making assumptions of expected growth rates and the selection of discount rates, as well as assumptions regarding general economic and business conditions, and the structure that would yield the highest economic value, among other factors. Refer to Note 6 "Goodwill and Intangible Assets" of Notes to Consolidated Financial Statements for details of the impairment analysis.

Accounting for Income Taxes

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

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our current tax exposure under the applicable tax laws and assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities which are included in our Consolidated Balance Sheet.

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

information. To the extent that the final outcome of these matters is different than the amounts recorded, such differences will impact our tax provision in our Consolidated Statement of Operation in the period in which such determination is made.

We assess the likelihood that we will be able to realize our deferred tax assets. Should there be a change in our ability to realize our deferred tax assets, our tax provision would increase in the period in which we determine that it is more likely than not that we cannot realize our deferred tax assets. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If it is more likely than not that we will not realize our deferred tax assets, we will increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be realized.

The U.S. Tax Cuts and Jobs Act includes provisions for certain foreign-sourced earnings referred to as Global Intangible Low-Taxed Income (“GILTI”) which imposes a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. We have made the election to record GILTI tax using the period cost method.

Recent Accounting Pronouncements

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