Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Quarterly Results of Operations

	Three Months Ended
	2019																2018
	December 31, 2019				September 30, 2019				June 30, 2019				March 31, 2019				December 31, 2018				September 30, 2018				June 30, 2018				March 31, 2018
	(in thousands, except per share data) (unaudited )
Net revenues	$	649,787			$	607,341			$	600,697			$	548,971			$	534,020			$	505,289			$	490,259			$	436,924
Gross profit	471,958				437,554				432,289				402,096				383,096				371,781				365,582				327,408
Income from operations	151,150				127,152				176,490				87,701				120,473				125,208				122,691				98,192
Net income	121,262				102,524				147,142				71,848				97,392				100,872				106,105				95,866
Net income per share:
Basic	$	1.54			$	1.29			$	1.84			$	0.90			$	1.22			$	1.26			$	1.32			$	1.20
Diluted	$	1.53			$	1.28			$	1.83			$	0.89			$	1.20			$	1.24			$	1.30			$	1.17
Shares used in computing net income per share:
Basic	78,578				79,332				79,943				79,860				79,891				80,111				80,216				80,036
Diluted	79,137				79,825				80,590				80,687				80,943				81,359				81,471				81,628

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page
Report of Management on Internal Control over Financial Reporting	47
Report of Independent Registered Public Accounting Firm	48
Consolidated Statements of Operations for the year ended December 31, 2019, 2018 and 2017	50
Consolidated Statements of Comprehensive Income for the year ended December 31, 2019, 2018 and 2017	51
Consolidated Balance Sheets as of December 31, 2019 and 2018	52
Consolidated Statements of Stockholders’ Equity for the year ended December 31, 2019, 2018 and 2017	53
Consolidated Statements of Cash Flows for the year ended December 31, 2019, 2018 and 2017	54
Notes to Consolidated Financial Statements	55

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, 2019. 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, 2019, 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, 2019 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, 2020
/S/ JOHN F. MORICI
John F. Morici
Chief Financial Officer and Senior Vice President, Global Finance
February 28, 2020

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, 2019 and 2018, 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, 2019, 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, 2019, 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, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 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, 2019, 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 leases in 2019.

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.

Critical Audit Matters

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Revenue Recognition - Determination of Standalone Selling Price of Distinct Performance Obligations in Clear Aligner Contracts

As described in Notes 1 and 17 to the consolidated financial statements, the Company recognized net revenues of $2 billion from its Clear Aligner segment for the year ended December 31, 2019. The Company enters into contracts (“treatment plans”) that involve multiple future performance obligations. Management identifies 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, 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. 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. Management also considers usage rates, which is the number of times a customer is expected to order additional aligners. Management’s process for estimating usage rates requires significant judgment and evaluation of inputs, including historical usage data by region, country and channel.

The principal considerations for our determination that performing procedures related to revenue recognition and the determination of standalone selling price of distinct performance obligations in Clear Aligner contracts is a critical audit matter are there was significant judgment by management in determining the standalone selling price, which includes significant assumptions related to usage rates for each distinct performance obligation. This in turn led to significant judgment, subjectivity, and effort in applying audit procedures to evaluate the judgments made by management in determining the estimates of standalone selling price and usage rates for each distinct performance obligation.

Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to revenue recognition, including controls over the determination of standalone selling price for each distinct performance obligation in the Company’s Clear Aligner contracts. These procedures also included, among others, (i) testing management’s process for determining the estimate of standalone selling price, which included testing the completeness and accuracy of inputs used and evaluating the reasonableness of factors considered by management, such as historical sales, usage rates, costs, and gross margin, and (ii) testing management’s process for estimating usage rates, which included evaluating the reasonableness of inputs evaluated by management, including historical usage data by region, country and channel.

/s/ PricewaterhouseCoopers LLP

San Jose, California

February 28, 2020

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,
	2019				2018				2017
Net revenues	$	2,406,796			$	1,966,492			$	1,473,413
Cost of net revenues	662,899				518,625				356,466
Gross profit	1,743,897				1,447,867				1,116,947
Operating expenses:
Selling, general and administrative	1,072,053				852,404				665,777
Research and development	157,361				128,899				97,559
Impairments and other (gains) charges	22,990				—				—
Litigation settlement gain	(51,000		)		—				—
Total operating expenses	1,201,404				981,303				763,336
Income from operations	542,493				466,564				353,611
Interest income	12,482				8,576				6,948
Other income (expense), net	7,676				(8,489		)		4,240
Net income before provision for income taxes and equity in losses of investee	562,651				466,651				364,799
Provision for income taxes	112,347				57,723				130,162
Equity in losses of investee, net of tax	7,528				8,693				3,219
Net income	$	442,776			$	400,235			$	231,418
Net income per share:
Basic	$	5.57			$	5.00			$	2.89
Diluted	$	5.53			$	4.92			$	2.83
Shares used in computing net income per share:
Basic	79,424				80,064				80,085
Diluted	80,100				81,357				81,832

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,
	2019				2018				2017
Net income	$	442,776			$	400,235			$	231,418
Net change in foreign currency translation adjustment	1,787				(3,631		)		1,741
Change in unrealized gains (losses) on investments, net of tax	299				286				(232		)
Other comprehensive income (loss)	2,086				(3,345		)		1,509
Comprehensive income	$	444,862			$	396,890			$	232,927

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,
	2019				2018
ASSETS
Current assets:
Cash and cash equivalents	$	550,425			$	636,899
Marketable securities, short-term	318,202				98,460
Accounts receivable, net of allowance for doubtful accounts of $6,756 and $2,378, respectively	550,291				439,009
Inventories	112,051				55,641
Prepaid expenses and other current assets	102,450				72,470
Total current assets	1,633,419				1,302,479
Marketable securities, long-term	—				9,112
Property, plant and equipment, net	631,730				521,329
Operating lease right-of-use assets, net	56,244				—
Equity method investments	—				45,913
Goodwill and intangible assets, net	75,692				81,949
Deferred tax assets	64,007				64,689
Other assets	39,610				26,987
Total assets	$	2,500,702			$	2,052,458
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	87,250			$	64,256
Accrued liabilities	319,958				234,679
Deferred revenues	563,762				393,138
Total current liabilities	970,970				692,073
Income tax payable	102,794				78,008
Operating lease liabilities	43,463				—
Other long-term liabilities	37,306				29,486
Total liabilities	1,154,533				799,567
Commitments and contingencies (Notes 9 and 10)
Stockholders’ equity:
Preferred stock, $0.0001 par value (5,000 shares authorized; none issued)	—				—
Common stock, $0.0001 par value (200,000 shares authorized; 78,433 and 79,778 issued and outstanding, respectively)	8				8
Additional paid-in capital	906,937				877,514
Accumulated other comprehensive income (loss), net	(688		)		(2,774		)
Retained earnings	439,912				378,143
Total stockholders’ equity	1,346,169				1,252,891
Total liabilities and stockholders’ equity	$	2,500,702			$	2,052,458

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, 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 equity awards	—			—				(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 equity awards	—			—				(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
Net income	—			—				—				—				442,776				442,776
Net change in unrealized gains (losses) from investments	—			—				—				299				—				299
Net change in foreign currency translation adjustment	—			—				—				1,787				—				1,787
Issuance of common stock relating to employee equity compensation plans	542			—				17,907				—				—				17,907
Tax withholdings related to net share settlements of equity awards	—			—				(57,676		)		—				—				(57,676		)
Common stock repurchased and retired	(1,887	)		—				(18,992		)		—				(381,007		)		(399,999		)
Stock-based compensation	—			—				88,184				—				—				88,184
Balances at December 31, 2019	78,433			$	8			$	906,937			$	(688	)		$	439,912			$	1,346,169

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,
	2019				2018				2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	442,776			$	400,235			$	231,418
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred taxes	307				(15,680		)		17,572
Depreciation and amortization	78,990				54,727				37,739
Stock-based compensation	88,184				70,763				58,854
Non-cash operating lease cost	18,475				—				—
Impairments on long-lived assets	28,498				—				—
Gain on lease terminations	(6,792		)		—				—
Gain from sale of equity method investment	(15,769		)		—				—
Equity in losses of investee	7,528				8,693				3,219
Other non-cash operating activities	29,860				17,252				13,847
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable	(121,014		)		(109,224		)		(90,990		)
Inventories	(58,269		)		(24,109		)		(5,481		)
Prepaid expenses and other assets	(31,529		)		(9,122		)		(8,669		)
Accounts payable	22,099				25,045				8,175
Accrued and other long-term liabilities	60,240				36,250				24,235
Long-term income tax payable	14,611				(36,548		)		68,958
Deferred revenues	189,075				136,399				79,662
Net cash provided by operating activities	747,270				554,681				438,539
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment	(149,707		)		(223,312		)		(195,695		)
Purchase of marketable securities	(693,284		)		(180,191		)		(390,244		)
Proceeds from maturities of marketable securities	290,754				375,105				349,240
Proceeds from sales of marketable securities	194,677				9,560				39,536
Repayment on unsecured promissory note	21,820				—				—
Purchases of investments in privately held companies	—				(5,000		)		(12,764		)
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	(14,704		)		765				(2,597		)
Net cash provided by (used in) investing activities	(350,444		)		6,927				(251,477		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock	17,907				16,635				14,461
Common stock repurchases	(399,999		)		(300,002		)		(103,793		)
Payroll taxes paid upon the vesting of equity awards	(57,675		)		(86,067		)		(46,168		)
Purchase of finance lease	(45,773		)		—				—
Net cash used in financing activities	(485,540		)		(369,434		)		(135,500		)
Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash	2,282				(4,733		)		5,544
Net increase (decrease) in cash, cash equivalents, and restricted cash	(86,432		)		187,441				57,106
Cash, cash equivalents, and restricted cash at beginning of year	637,566				450,125				393,019
Cash, cash equivalents, and restricted cash at end of year	$	551,134			$	637,566			$	450,125

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, Middle East and Africa ("EMEA") regional headquarters is located in Rotkreuz, Switzerland, which moved from Amsterdam, the Netherlands in January 2020; and our Asia Pacific ("APAC") 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 ASU 2016-18, “Statement of Cash Flows - Restricted Cash,” on a retrospective basis. The Consolidated Statement of Cash Flow for the year ended December 31, 2017 and Consolidated Statement of Stockholders' Equity for the year ended December 31, 2017 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 United States ("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 revenue recognition, useful lives of intangible assets and property and equipment, long-lived assets and goodwill, income taxes and contingent liabilities, the fair values of financial instruments, stock-based compensation, unsecured promissory note receivable, and valuation of investments in privately held companies 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. 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.

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 primarily included in other assets within our Consolidated Balance Sheet.

Marketable Securities

Our marketable securities consist of marketable debt securities which are classified as available-for-sale and are carried at fair value. Marketable securities classified as current assets have maturities within 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, 2019, 2018 and 2017, we had foreign currency net gains (losses) of $(2.0) million, $(5.6) million and $9.0 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, 2019 or 2018, or net revenues for the year ended December 31, 2019, 2018 or 2017.

The U.S. Food and Drug Administration (“FDA”) and similar international agencies regulate 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 in Juarez, Mexico, where we conduct our aligner fabrication, distribution, repair of our iTero scanners and perform our CAD/CAM services. In the fourth quarter of 2018, we also began fabricating our aligners in our manufacturing facility in Ziyang, China, our first aligner fabrication facility outside of Juarez, Mexico. In addition, we produce our handheld intraoral scanner wand, perform final scanner assembly and repair our scanners at our facilities in Or Yehuda, Israel and Ziyang, China. 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 standard cost which approximates actual cost on a first-in-first-out basis. Excess and obsolete inventories are determined primarily based on future demand forecasts, and write-downs of excess and obsolete inventories are recorded as a component of cost of 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*.*

Leases

We lease office and retail spaces, vehicles and office equipment with original lease periods of up to 10 years. We determine if an arrangement is a lease at inception under ASC 842. Operating lease right-of-use (“ROU”) assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. If a lease arrangement does not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We use the implicit rate when readily determinable. Our lease terms may include options to extend or terminate the lease which we include in our lease term when it is reasonably certain that we will exercise that option. We have lease agreements with lease and non-lease components which are accounted for as a single lease component. Leases with an initial term of 12 months or less are not recorded on the balance sheet.

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, 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. 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 Statement 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. There were no significant internally developed software costs capitalized in 2019 or 2018.

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

We offer assurance warranties on our products which provide the customer assurance that the product will function as the parties intended because it complies with agreed-upon specifications; therefore, warranties are not treated as a separate revenue performance obligation and are accounted for as guarantees under GAAP.

Clear Aligner

We warrant our Invisalign products against material defects until the treatment plan is complete except in the case of retainers, which are warranted up to three months from expected first use. We accrue for warranty costs in cost of net revenues upon shipment of products which is primarily based on historical experience as to product failures as well as current information on replacement costs.

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.

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.

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 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.

Accrued Sales Return Reserve

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

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 revenues, 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, 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.

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 costs are 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, 2019, 2018 and 2017, we incurred advertising costs of $119.1 million, $88.4 million and $70.1 million, respectively.

Common Stock Repurchase

We repurchase our own common stock from time to time under stock repurchase programs approved by our Board of Directors. 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.

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 revenues and expenses 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 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.

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 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 period presentation for fiscal year 2017 has been retrospectively adjusted. The adoption of ASU 2014-09 did not have a material impact on our Consolidated Statement of Operations, Consolidated Statement of Comprehensive Income or Consolidated Statement of Cash Flows.

In February 2016, the Financial Accounting Standards Board (“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 adopted the guidance 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. The standard had a material impact on our Consolidated Balance Sheet as we recognized assets and liabilities related to our leases. The adoption did not have an impact to prior periods.

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 adopted the standard in the first quarter of fiscal year 2019 which did not have a material impact on our consolidated financial statements and related disclosures. The TCJA did not affect our accumulated other comprehensive income (loss), net, and therefore we did not reclassify any income tax effects from accumulated other comprehensive income (loss), net to our retained earnings.

(ii) Recent Accounting Updates Not Yet Effective

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses” (Topic 326) 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. We will adopt this standard in the first quarter of fiscal 2020 and do not expect the adoption of this standard to have a material impact 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 in this update, an entity will recognize an impairment charge for the amount by which the carrying value exceeds the fair value. The updated guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2019 on a prospective basis. We will adopt this standard in the first quarter of fiscal 2020 and do not expect the adoption of this standard to have any 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 updated guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2019 on a prospective basis. We will adopt this standard in the first quarter of fiscal 2020 and do not expect the adoption of this standard to have any impact on our consolidated financial statements and 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 in this update, 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 prospective basis early adoption is permitted. We will adopt this standard in the first quarter of fiscal 2020 on a prospective basis beginning and do not expect the adoption of this standard to have any impact on our consolidated financial statements and related disclosures.

In December 2019, the FASB issued ASU 2019-12, "Income Taxes (Topic 740) Simplifying the Accounting for Income Taxes,” to enhance and simplify various aspects of the income tax accounting guidance. The amendment removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. The amendments are effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2020. We are currently evaluating the impact of this guidance on our consolidated financial statements and related disclosures; however, we anticipate the adoption of the guidance will not have a material impact to our consolidated financial statements and related disclosures.

Note 2. Investments and Fair Value Measurements

As of December 31, 2019 and 2018, 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, 2019		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Corporate bonds		$	210,891			$	142			$	(27	)		$	211,006
U.S. government treasury bonds		70,587				65				$	(2	)		70,650
U.S. government agency bonds		22,085				17				(1		)		22,101
Commercial paper		14,426				—				—				14,426
Certificates of deposit		19				—				—				19
Total marketable securities, short-term		$	318,008			$	224			$	(30	)		$	318,202

December 31, 2018		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Corporate bonds		$	45,100			$	—			$	(48	)		$	45,052
U.S. government agency bonds		19,981				—				(77		)		19,904
Commercial paper		17,793				—				—				17,793
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

We have no long-term marketable securities as of December 31, 2019.

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 marketable securities that have been in a continuous material unrealized loss position for greater than twelve months as of December 31, 2019 and 2018. Amounts reclassified to earnings from accumulated other comprehensive income (loss), net related to unrealized gains or losses were not material in 2019 and 2018. For the year ended December 31, 2019, 2018 and 2017, realized gains or losses were not material.

Our fixed-income securities investment portfolio consists of investments that can have a maximum effective maturity of up to 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 primarily due to changes in interest rates and credit spreads. 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 seven months and four months as of December 31, 2019 and 2018, 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, 2019 and 2018 (in thousands):

		December 31,
		2019				2018
Maturities within one year		$	318,202			$	98,460
Due in greater than one year		—				9,112
Total available for sale short-term and long-term marketable securities		$	318,202			$	107,572

Investments in Privately Held Companies

Our investments in privately held companies as of December 31, 2019 and 2018 are as follows (in thousands):

	December 31,
	2019				2018
Equity securities under the equity method investment 1	$	—			$	45,913
Equity securities without readily determinable fair values 2	$	5,887			$	9,862

1	Refer to Note 5 “Equity Method Investments” of the Notes to Consolidated Financial Statements for more information

2	The equity securities are reported within other assets in our Consolidated Balance Sheet and valued on a nonrecurring basis. During the year ended December 31, 2019, we recorded a $4.0 million of impairment loss resulting from an observable price change.

Fair Value Measurements

The following tables summarize our financial assets measured at fair value on a recurring basis as of December 31, 2019 and 2018 (in thousands):

Description		Balance as of December 31, 2019				Level 1				Level 2				Level 3
Cash equivalents:
Money market funds		$	236,923			$	236,923			$	—			$	—
Short-term investments:
Corporate bonds		211,006				—				211,006				—
Commercial paper		14,426				—				14,426				—
U.S. government agency bonds		22,101				—				22,101				—
U.S. government treasury bonds		70,650				70,650				—				—
Certificates of deposit		19				—				19				—
Prepaid expenses and other current assets:
Israeli funds		3,226				—				3,226				—
Current unsecured promissory note		25,005				—				—				25,005
Other Assets:
Long term unsecured promissory note		7,328				—				—				7,328
		$	590,684			$	307,573			$	250,778			$	32,333

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
Corporate bonds		3,880				—				3,880
U.S. government treasury bonds		2,195				2,195				—
Short-term investments:
Corporate bonds		45,052				—				17,793
Commercial paper		17,793				—				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:
Corporate bonds		4,960				—				4,960
U.S. government agency bonds		1,407				—				1,407
U.S. government treasury bonds		2,244				2,244
Certificates of deposit		501				—				501
Prepaid expenses and other current assets:
Israeli funds		3,047				—				3,047
		$	552,456			$	450,811			$	101,645

Our investments in equity securities is considered Level 3 in the fair value hierarchy since the investments are in private companies without quoted market prices and we adjust the carrying value based on observable price changes.

The unsecured promissory note that was entered into in 2019 is classified as Level 3 in our fair value hierarchy as financial information of third parties may not be timely available and consequently we estimate the fair value based on the best available information at the measurement date. The original amount of the note was $54.2 million which decreased over 2019 due to payments received. Refer to Note 5 “Equity Method Investments” of the Notes to Consolidated Financial Statements for more information.

Derivative Financial Instruments

We enter 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 net gain from the settlement of foreign currency forward contracts during the year ended December 31, 2019 and 2018 was $3.2 million and $9.9 million, respectively. As of December 31, 2019 and 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, 2019 and 2018 (in thousands):

	December 31, 2019
	Local Currency Amount		Notional Contract Amount (USD)
Euro	€97,000		$	108,870
Chinese Yuan	¥431,000		60,702
Canadian Dollar	C$52,000		39,802
Israeli Shekel	ILS63,700		18,439
British Pound	£28,000		36,770
Japanese Yen	¥3,000,000		27,604
Brazilian Real	R$130,000		32,185
Mexican Peso	M$140,000		7,398
Australian Dollar	A$3,000		2,101
			$	333,871

	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,
	2019				2018
Raw materials	$	54,947			$	26,119
Work in process	30,974				13,784
Finished goods	26,130				15,738
Total inventories	$	112,051			$	55,641

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following (in thousands):

	December 31,
	2019				2018
Tax related receivables	$	41,252			$	36,794
Current promissory note 1	25,005				—
Other prepaid expenses and current assets	24,637				23,227
Prepaid software and maintenance	7,128				5,938
Other current receivables	4,428				6,511
Total prepaid expenses and other current assets	$	102,450			$	72,470

1	Refer to Note 5“Equity Method Investments” 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		2019				2018
Clinical and manufacturing equipment	Up to 10 years		$	309,809			$	236,179
Building	20 years		209,643				139,315
Computer software	3 years		61,722				59,617
Leasehold improvements	Lease term 1		53,327				77,168
Furniture and fixtures	5 years		44,373				33,436
Computer hardware	3 years		39,199				34,297
Land	—		26,422				17,630
CIP	—		116,751				95,414
Total			861,246				693,056
Less: Accumulated depreciation and amortization and impairment charges			(229,516		)		(171,727		)
Total property, plant and equipment, net			$	631,730			$	521,329

1	Shorter of the remaining lease term or the estimated useful lives of the assets.

Depreciation and amortization was $79.0 million, $54.7 million and $37.7 million for the year ended December 31, 2019, 2018 and 2017, respectively. In the first quarter of 2019, we recorded impairment losses of $14.3 million related to leasehold improvements and other fixed assets. Refer to Note 8“Impairments and Other (Gains) Charges” of the Notes to Consolidated Financial Statements for more information.

On September 26, 2019, we entered into a Purchase and Sale Agreement to purchase a building located in San Jose, California for $21.3 million. The remaining and substantial portion of the purchase price will be paid on or before the closing date, which is expected to occur in the first quarter of 2020.

Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

	December 31,
	2019				2018
Accrued payroll and benefits	$	162,486			$	127,109
Accrued expenses	55,529				39,323
Current operating lease liabilities	15,737				—
Accrued income taxes	14,130				5,752
Accrued sales rebate	11,393				5,668
Others	60,683				56,827
Total accrued liabilities	$	319,958			$	234,679

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 accrual as of December 31, 2019 and 2018 consists of the following activity (in thousands):

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
Charged to cost of net revenues	12,421
Actual warranty expenditures	(9,767		)
Accrued warranty as of December 31, 2019	$	11,205

Deferred Revenues

Deferred revenues consist of the following (in thousands):

	December 31,
	2019				2018
Deferred revenues - current	$	563,762			$	393,138
Deferred revenues - long-term 1	35,503				17,051

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

During the year ended December 31, 2019 and 2018, we recognized $2.4 billion and $2.0 billion of net revenues, respectively, of which $262.7 million and $180.6 million was included in the deferred revenues balance at December 31, 2018 and December 31, 2017, respectively.

Note 4. Leases

Lessee

We have operating leases for office and retail spaces, vehicles and office equipment.

The supplemental balance sheet information for our operating leases consist of following (in thousands):

Balance Sheet Caption		December 31, 2019
Operating lease right-of-use assets, net		$	56,244
Accrued liabilities		$	15,737
Operating lease liabilities		43,463
Total operating lease liabilities		$	59,200

The components of lease expenses consist of following (in thousands):

Lease Cost		Year Ended December 31, 2019
Operating lease cost 1		$	22,778
Variable lease cost		1,899
Total lease cost		$	24,677

1	Includes short-term lease expense which is not material.

The following table provides a summary of our operating lease terms and discount rates:

Remaining Lease Term and Discount Rate		December 31, 2019
Weighted average remaining lease term (in years)		5.7
Weighted average discount rate		4.1	%

Maturities of operating lease liabilities as of December 31, 2019 are as follows (in thousands):

Fiscal Year Ending December 31,		Operating Leases
2020		$	18,354
2021		18,057
2022		11,847
2023		8,177
2024		2,595
Thereafter		5,453
Total lease payments		$	64,483
Less: Interest		(5,283		)
Total lease liabilities		$	59,200

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.

Minimum future lease payments previously disclosed under ASC 840 in our Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2018 are as follows (in thousands):

Fiscal Year Ending December 31,		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

Lessor

In April 2019, as part of the $56.0 million purchase of a building located in Raleigh, North Carolina, we assumed an existing lease with a third-party for one floor of the building which is classified as an operating lease. The lease has annual escalating payments and expires in August 2029 in accordance with the terms and conditions of the existing agreement.

Lease payments due to Align as of December 31, 2019 are as follows (in thousands):

Fiscal Year Ending December 31,		Operating Lease
2020		$	858
2021		1,145
2022		1,199
2023		1,229
2024		1,259
Thereafter		6,182
Total minimum lease payments		$	11,872

For the year ended December 31, 2019, operating lease income was not material.

Note 5. Equity Method Investments

On July 25, 2016, we acquired a 17% equity interest, on a fully diluted basis, in SDC for $46.7 million. Concurrently with the investment, we also entered into a supply agreement to manufacture clear aligners for SDC, which expired on December 31, 2019. The sale of aligners to SDC and the income from the supply agreement are reported in our Clear Aligner business segment. On July 24, 2017, we purchased an additional 2% equity interest in SDC for $12.8 million. The investment was accounted for as an equity method investment and recorded in our Consolidated Balance Sheet. We recorded our proportional share of SDC's losses within equity in losses of investee, net of tax, in our Consolidated Statement of Operations.

As a result of the arbitrator’s decision regarding SDC announced on March 5, 2019, we were ordered to tender our SDC equity interest by April 3, 2019 for a purchase price equal to the “capital account” balance as of October 31, 2017 under the terms of the investment. In April 2019, based on the “capital account” value provided by SDC, we entered into an unsecured promissory note with SDC to receive $54.2 million through February 1, 2021 in exchange for the tender of our membership interests. As a result, we derecognized the equity method investment balance of $38.4 million in exchange for an unsecured promissory note of $54.2 million and we recorded the difference of $15.8 million as a gain in the second quarter of 2019 in other income in our Consolidated Statement of Operations. Although we tendered our membership interests pursuant to the arbitrator’s decision, the parties did not agree on the amount of the “capital account” balance as of October 31, 2017 or the appropriate repurchase price for the membership units. On July 3, 2019, we filed a demand for arbitration regarding SDC’s calculation of the “capital account” balance. The arbitration proceeding remains pending and currently is scheduled to be heard (Refer to Note 10 “Legal Proceedings” of the Notes to Consolidated Financial Statements for SDC legal proceedings discussion).

Note 6. Goodwill and Intangible Assets

Goodwill

The change in the carrying value of goodwill for the year ended December 31, 2019 and 2018, all attributable to our Clear Aligner reporting unit, is as follows (in thousands):

	Total
Balance as of December 31, 2017	$	64,614
Adjustments 1	(585		)
Balance as of December 31, 2018	64,029
Adjustments 1	(105		)
Balance as of December 31, 2019	$	63,924

1	Adjustments were related to foreign currency translation within the measurement period.

Based on the qualitative assessments performed, there were no impairments to goodwill in 2019 or 2018.

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 2019 or 2018 that would cause impairments of our intangible 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, 2019				Accumulated Amortization				Accumulated Impairment Loss				Net Carrying Value as of December 31, 2019
Trademarks	15		$	7,100			$	(2,045	)		$	(4,179	)		$	876
Existing technology	13		12,600				(5,831		)		(4,328		)		2,441
Customer relationships	11		33,500				(18,405		)		(10,751		)		4,344
Reacquired rights	3		7,500				(7,059		)		—				441
Patents	8		6,796				(3,165		)		—				3,631
Other	2		618				(583		)		—				35
Total intangible assets			$	68,114			$	(37,088	)		$	(19,258	)		$	11,768

	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

The total estimated annual future amortization expense for these acquired intangible assets as of December 31, 2019 is as follows (in thousands):

Fiscal Year		Amortization
2020		$	3,845
2021		3,372
2022		2,116
2023		1,495
2024		555
Thereafter		385
Total		$	11,768

Amortization expense was $5.9 million, $6.0 million and $6.2 million for the year ended December 31, 2019, 2018 and 2017, respectively.

Note 7. Credit Facility

On February 27, 2018, we entered into a 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. 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, 2019, we had no outstanding borrowings under this credit facility and were in compliance with the conditions and performance requirements.

Note 8. Impairments and Other (Gains) Charges

On March 5, 2019, we announced the outcome of the arbitration regarding SDC (Refer to Note 9 “Legal Proceedings” of the Notes to Consolidated Financial Statements for SDC legal proceedings discussion) which required Align to close its Invisalign stores and tender Align’s equity interest in SDC by April 3, 2019. Accordingly, Align evaluated the ongoing value of the Invisalign stores’ operating lease right-of-use assets and related leasehold improvements and other fixed assets in accordance with ASC 360, Property, Plant and Equipment. Based on the evaluation, Align determined that the carrying value of these assets were not recoverable. Align evaluated the fair value of these assets in accordance with ASC 820, Fair Value Measurement, and we considered the market participant’s ability to generate economic benefits by using these assets in its highest and best use or by selling it to another market participant that would use the asset in its highest and best use. As a result, in the first quarter of 2019, we recorded impairment losses of $14.2 million for operating lease right-of-use assets and $14.3 million of leasehold improvements and other fixed assets. In addition, we also recorded $1.3 million of employee severance costs and other charges. During the third quarter of 2019, we negotiated early termination of our Invisalign store leases and recorded lease termination gains of $6.8 million.

Note 9. 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”). On May 10, 2019, the lead plaintiff filed a consolidated complaint against Align and four of our executive officers alleging similar claims as the initial complaints on behalf of a purported class of purchasers of our common stock between April 25, 2018 and October 24, 2018. On June 24, 2019, defendants filed a motion to dismiss the consolidated complaint. On October 29, 2019, that motion to dismiss was granted with leave to amend. On November 29, 2019, the lead plaintiff filed an amended consolidated complaint against Align and two of our executive officers alleging similar claims as the initial complaints on behalf of a purported class of purchasers of our common stock from May 23, 2018 and October 24, 2018. Defendants’ motion to dismiss the amended consolidated complaint was filed on January 17, 2020. Align believes these 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 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 Actions, 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. On February 26, 2019, the three lawsuits were consolidated. On April 10, 2019, the court stayed the consolidated action pending final disposition of the Securities Actions.

On April 12, 2019, a derivative lawsuit was also filed in California Superior Court for Santa Clara County, 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 this complaint are similar to those in the derivative suits described above. On May 16, 2019, the court stayed this action pending final disposition of the Securities Actions.

On February 22, 2019, a purported stockholder sent a letter to Align pursuant to 8 Del. C. § 220 demanding certain books and records for the stated purpose of investigating potential breaches of duty, corporate mismanagement, and alleged wrongdoing by fiduciaries of the Company. On April 16, 2019, Align responded and refused the demand on several legal grounds. On June 10, 2019, the purported stockholder petitioned the Superior Court of the State of California, County of Santa Clara, to issue a writ of mandate commanding Align to provide the books and records requested. On August 23, 2019, Align filed a demurrer seeking to dismiss the petition, and on October 28, 2019, the Court issued an order sustaining Align’s demurrer and dismissing the petition without an opportunity to amend. On December 19, 2019, the same purported stockholder filed a complaint in the Superior Court of California, County of Santa Clara, seeking an order from the Court compelling Align to permit the inspection of the same books and records that were previously requested, as well as requesting attorneys’ fees. Align expects to respond to this new complaint by March 12, 2020.

Align is currently unable to predict the outcome of this demand or of these lawsuits and therefore cannot determine the likelihood of loss nor estimate a range of possible loss.

3Shape Litigation

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 sought 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. Two of those cases were stayed pending the ITC determinations, and the other two cases have been active in discovery and pretrial proceedings. Trials in the latter two cases have been rescheduled to begin on August 5, 2020 in one case

and November 30, 2020 in the other. Certain of Align’s asserted patents in the Delaware actions were found invalid by the District Court Judge. The ITC conducted hearings in the Section 337 investigations in September and November 2018. On March 1, 2019, the Administrative Law Judge issued an Initial Determination in one of the Section 337 investigations, finding no violation of Section 337 by 3Shape. On April 26, 2019, the Administrative Law Judge issued an Initial Determination in the second Section 337 investigation, finding no violation of Section 337 by 3Shape. On August 20, 2019, the Commission vacated one Initial Determination and terminated the investigation. In the corresponding Delaware case, the District Court lifted the stay and scheduled trial to begin on November 8, 2021. On November 22, 2019, the Commission affirmed a finding of no violation on modified grounds in the other investigation.

.

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 another 3Shape patent. On August 19, 2019, the Court consolidated the two actions, and 3Shape filed an amended complaint alleging infringement of an additional patent on August 30, 2019. Align has asserted counterclaims for patent infringement of three additional Align patents. The case is active and in the early discovery phase, with trial scheduled to begin on April 12, 2021.

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. The ITC instituted the investigation, and one of the District Court cases was stayed pending the ITC determination. The remaining District Court case is in the very early stages of discovery and pretrial proceedings, and trial has been scheduled for February 7, 2022. The ITC evidentiary hearing was held at the end of October 2019. The deadline for the Administrative Law Judge’s initial determination is March 6, 2020.

On November 5, 2019, Align filed a complaint for patent infringement asserting an additional patent against 3Shape. On January 7, 2020, Align voluntarily dismissed the suit without prejudice, and Align has instead asserted the patent as a counterclaim in the patent infringement suit brought by 3Shape.

3Shape has sought to invalidate certain of Align’s patents through petitions for inter partes review proceedings. Align disputes 3Shape’s positions and intends to vigorously defend the validity of its patent rights.

Each of the District Court patent infringement complaints seek monetary damages and injunctive relief against further infringement.

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 alleged market activities, including Align’s assertion of its patent portfolio, in alleged clear aligner and intraoral scanning markets, and the Court scheduled trial to begin on May 10, 2021. Align filed a motion to dismiss 3Shape’s complaint on October 17, 2018. Align also moved to stay the litigation pending the outcome of its motion to dismiss. The court granted Align’s motion to stay. On August 15, 2019, the Magistrate Judge recommended that Align’s motion to dismiss be granted, and, on September 26, 2019, the District Court Judge adopted the Magistrate Judge’s Report and Recommendation, granted Align’s motion to dismiss, and dismissed 3Shape’s complaint with leave to amend within thirty days of the order. On October 28, 2019, 3Shape filed an amended complaint, and Align again moved to dismiss the complaint. A hearing on Align’s motion to dismiss was held on February 13, 2020 before the magistrate judge. A written report and recommendation from the magistrate judge will be forthcoming.

Align is currently unable to predict the outcome of these lawsuits and therefore cannot determine the likelihood of loss, if any, nor estimate a range of possible loss.

Simon & Simon

On March 14, 2019, a dental practice named Simon and Simon, PC d/b/a City Smiles brought an antitrust action in the United States District Court for the District of Delaware on behalf of itself and a putative class of similarly situated practices seeking monetary damages and injunctive relief relating to Align’s alleged market activities in alleged clear aligner and intraoral scanning markets. Align filed a motion to dismiss the complaint on April 5, 2019, and the court held a hearing on Align’s motion. On October 15, 2019, the Magistrate Judge issued a Report and Recommendation on Align’s motion to dismiss which recommends that Align’s motion be granted and that the plaintiffs’ complaint be dismissed without prejudice. On October 29, 2019, Simon and Simon filed objections to the Magistrate Judge’s Report and Recommendation, and Align responded on November 12, 2019. Align believes

the plaintiffs’ claims are without merit and intends to vigorously defend itself. Align is currently unable to predict the outcome of this lawsuits and therefore cannot determine the likelihood of loss, if any, nor estimate a range of possible loss.

SDC Dispute

In February 2018, Align 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 store pilot program constituted 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) sought to exercise a right to repurchase all of Align's SDC Financial LLC membership interests for a purchase price equal to the current “capital account” balance of Align. The SDC Entities’ communication also alleged that Align breached confidentiality provisions applicable to the SDC Financial LLC members and demanded that Align cease all activities related to the Invisalign store pilot project, close existing Invisalign stores and cease using SDC’s confidential information. In April 2018, the SDC Entities instigated confidential arbitration proceedings and filed a complaint in the Chancery Court of Davidson County, State of Tennessee that sought, among other forms of relief, to preliminarily and permanently enjoin all activities related to the Invisalign store pilot project, require Align to close existing Invisalign stores, prohibit Align from opening any additional stores, and allow the SDC Entities to exercise a right to repurchase all of Align's SDC Financial LLC membership interests for a purchase price equal to Align's current “capital account” balance.

On June 29, 2018, the Chancery Court of Davidson County, State of Tennessee denied the SDC Entities’ request for a temporary injunction to prevent Align from opening additional Invisalign stores. During December 2018, the parties participated in binding arbitration proceedings and presented closing arguments on January 23, 2019. The arbitrator issued his decision on March 4, 2019. The arbitrator found that Align breached the non-compete provision applicable to the members of SDC Financial LLC and that Align misused the SDC Entities’ confidential information and violated fiduciary duties to SDC Financial LLC. The arbitrator ordered Align to close its Invisalign stores by April 3, 2019, and enjoined Align from opening new Invisalign stores or providing certain services in physical retail establishments in connection with the marketing and sale of clear aligners, and enjoined Align from using the SDC Entities’ confidential information. The arbitrator extended the expiration date of specified aspects of the non-compete provision to August 18, 2022. The arbitrator also ordered Align to tender its SDC Financial LLC membership interests to the SDC Entities for a purchase price equal to the “capital account” balance as of October 31, 2017, to be determined in accordance with the applicable provisions of the SDC Operating Agreements. No financial damages were awarded to the SDC Entities. The SDC Entities filed a motion to confirm the Award, which Align did not oppose, in the Circuit Court for Cook County, Illinois. The motion to confirm the Award was granted on April 29, 2019.

As required by the Award, on April 3, 2019, Align had closed its Invisalign stores, returned SDC’s alleged confidential information, and tendered its membership interests for a purchase price that SDC claims to be Align’s “capital account” balance as of October 31, 2017. Align disputes that the SDC Entities properly determined the value of Align’s “capital account” balance as of October 31, 2017 as required by the SDC Operating Agreements and the Award. Consequently, on July 3, 2019, Align filed a confidential demand for arbitration challenging the propriety of the SDC Entities’ determination of Align’s “capital account” balance as of October 31, 2017. That arbitration proceeding remains pending and currently is scheduled to be heard June 23-26, 2020. Although Align expects the proper amount of its Capital Account balance as of October 31, 2017 to be determined in the course of the pending arbitration, that amount is not capped at $97.0 million as SDC has claimed in its public filings. Relatedly, the SDC Entities filed a contempt petition with the Illinois court which confirmed the Award, asserting that Align had no right to contest the “capital account” determination as made by the SDC Entities. On September 4, 2019, the Illinois court denied in its entirety the contempt petition filed by the SDC Entities. The SDC Entities have appealed the denial of the contempt petition, and that appeal remains pending.

On August 19, 2019, the SDC Entities filed a separate confidential arbitration proceeding alleging that Align has violated the non-compete provisions applicable to the members of the SDC Entities by virtue of Align’s alleged dealings with a third-party claimed to be a competitor of the SDC Entities. Align has denied the claim and intends to vigorously defend itself against the newly asserted allegations. The SDC Entities have yet to identify the range of damages they may seek to recover in the course of this arbitration and no hearing date has yet been set.

Align is currently unable to predict the outcome of these disputes and therefore cannot determine the likelihood of loss nor estimate a range of possible loss.

Straumann Group Litigation Settlement

In March 2019, Align entered into an agreement with Straumann Group to settle all outstanding patent disputes in the U.S., the U.K., and Brazil, including those involving ClearCorrect, a subsidiary of Straumann Group. Under the terms of the settlement, Straumann Group paid Align $35.0 million on March 29, 2019. In addition, Align also signed a non-binding letter of

intent with Straumann Group for a 5-year global development and distribution agreement whereby Straumann would distribute 5,000 iTero Element scanners that would be fully integrated into the Straumann/Dental Wings CARES®/DWOS® workflow. The agreement provided that if for any reason the companies chose not to enter into the development and distribution agreement by July 2, 2019 or by a mutually agreed extended date, Straumann Group would pay Align an additional $16.0 million in lieu of the development and distribution agreement. In June 2019, the parties terminated the discussions regarding a possible development and distribution agreement and as a result, Straumann paid us the additional $16.0 million in July 2019. In 2019, we recognized a litigation settlement gain of $51.0 million.

In addition to the above, 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 10. Commitments and Contingencies

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 $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 for a purchase price of approximately $27.0 million with an option to purchase additional three floors with progress payments due through 2020. During the fourth quarter of 2019, we exercised the option to purchase three additional floors and purchased one additional floor in the building for a purchase price of approximately $24.4 million. As of December 31, 2019, we have a remaining commitment of $31.2 million which is expected to be paid in 2020.

On September 26, 2019, we entered into a Purchase and Sale Agreement to purchase a building located in San Jose, California for $21.3 million. The remaining and substantial portion of the purchase price will be paid on or before the closing date, which is expected to occur in the first quarter of 2020.

On October 3, 2019, we entered into a Promotional Rights Agreement (the “Agreement”) for $36.0 million with a third-party which includes certain advertising and media coverage. The expense related to the Agreement will be incurred over the period of April 1, 2020 through March 31, 2023.

Off-Balance Sheet Arrangements

As of December 31, 2019, 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 the Commitments and Contingencies 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, 2019, we did not have any material indemnification claims that were probable or reasonably possible.

Note 11. 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 ("RSUs"), market-performance based restricted stock units ("MSUs"), 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-performance based restricted 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, 2019, the 2005 Incentive Plan (as amended) has a total reserve of 27,783,379 shares for issuance of which 5,450,162 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 purchase plan for the year ended December 31, 2019, 2018 and 2017 is as follows (in thousands):

	For the Year Ended December 31,
	2019				2018				2017
Cost of net revenues	$	5,154			$	3,695			$	3,330
Selling, general and administrative	69,817				56,422				46,550
Research and development	13,213				10,646				8,974
Total stock-based compensation	$	88,184			$	70,763			$	58,854

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. During the year ended December 31, 2019, 8,187 stock options were exercised at a weighted average exercise price of $8.07 per share. As of December 31, 2019, there were no options outstanding and exercisable.

The aggregate intrinsic value represents the total pre-tax intrinsic value (the difference between our closing stock price on the last trading day in 2019 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 2019. 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, 2019, 2018 and 2017 was $2.0 million, $17.6 million and $18.1 million respectively.

Restricted Stock Units

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, 2019, 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)
Unvested as of December 31, 2018	931			$	129.42
Granted	292			255.42
Vested and released	(443	)		105.83
Forfeited	(84	)		184.04
Unvested as of December 31, 2019	696			$	190.60			1.1		$	194,114

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 2019 by the number of unvested RSUs) that would have been received by the unit holders had all RSUs been vested and released as of the last trading day of 2019. This amount will fluctuate based on the fair market value of our stock. During 2019, of the 442,524 shares vested and released, 141,543 shares vested were withheld for employee statutory tax obligations, resulting in a net issuance of 300,981 shares.

The total intrinsic value of RSUs vested and released during 2019, 2018 and 2017 was $112.4 million, $146.7 million and $99.5 million, respectively. The total fair value of RSUs vested during the year ended December 31, 2019, 2018 and 2017 was $46.8 million, $42.2 million and $46.2 million, respectively. The weighted average grant date fair value of RSUs granted during 2019, 2018 and 2017 was $255.42, $262.58 and $118.77 respectively. As of December 31, 2019, there was $88.7 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 2.0 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, 2019, the maximum number of MSUs which will be eligible to vest are 250% of the MSUs initially granted.

The following table summarizes the MSU performance for the year ended December 31, 2019:

	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)
Unvested as of December 31, 2018	324			$	215.07
Granted	138			240.73
Vested and released	(191	)		77.17
Forfeited	(27	)		271.96
Unvested as of December 31, 2019	244			$	331.35			1.1		$	68,055

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 2019 by the number of unvested MSUs) that would have been received by the unit holders had all MSUs been vested and released as of the last trading day of 2019. This amount will fluctuate based on the fair market value of our stock. During 2019, of the 191,176 shares vested and released, 88,292 shares were withheld for tax payments, resulting in a net issuance of 102,884 shares.

The total intrinsic value of MSUs vested and released during 2019, 2018 and 2017 was $47.7 million, $92.7 million and $28.8 million, respectively. The total fair value of MSUs vested during the year ended December 31, 2019, 2018 and 2017 was $14.8 million, $19.5 million and $15.0 million, respectively. As of December 31, 2019, we expect to recognize $36.2 million of total unamortized compensation cost, net of estimated forfeitures, related to MSUs over a weighted average period of 1.1 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,
	2019				2018				2017
Expected term (in years)	3.0				3.0				3.0
Expected volatility	37.3		%		31.9		%		28.9		%
Risk-free interest rate	2.5		%		2.5		%		1.5		%
Expected dividends	—				—				—
Weighted average fair value per share at grant date	$	392.03			$	470.75			$	120.39

Total payments to tax authorities for payroll taxes related to RSUs, including MSUs, that vested during the period were $57.7 million, $86.1 million and $46.2 million during the year ended December 31, 2019, 2018 and 2017, respectively, and are reflected as a financing activity in the Consolidated Statement of Cash Flows.

Employee Stock Purchase Plan ("ESPP")

In May 2010, our stockholders 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 purchase under the 2010 Purchase Plan is 2.4 million shares. In June 2019, the 2010 Purchase Plan was amended to include a non-Code Section 423 component to grant purchase rights to employees outside the U.S. and Canada with six-month offering periods and purchase periods.

The following table summarizes the ESPP shares issued:

	Year Ended December 31,
	2019				2018				2017
Number of shares issued (in thousands)	130				164				202
Weighted average price	$	136.73			$	96.95			$	59.93

As of December 31, 2019, 416,293 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,
	2019				2018				2017
Expected term (in years)	1.4				1.3				1.2
Expected volatility	50.0		%		35.2		%		26.8		%
Risk-free interest rate	2.2		%		2.2		%		1.0		%
Expected dividends	—				—				—
Weighted average fair value at grant date	$	86.02			$	94.71			$	31.36

We recognized stock-based compensation related to our employee stock purchase plan of $12.1 million, $5.6 million and $5.4 million for the year ended December 31, 2019, 2018 and 2017, respectively. As of December 31, 2019, there was $9.9 million of total unamortized compensation costs related to future employee stock purchases which we expect to be recognized over a weighted average period of 0.9 year.

Note 12. 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 $190.0 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 commissions, 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 which 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 commissions, 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 2018, we entered into an accelerated stock repurchase agreement ("ASR") 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.

In 2019, we repurchased on the open market approximately 0.8 million shares of our common stock at an average price of $264.93 per share, including commissions, for an aggregate purchase price of $200.0 million. We also entered into an ASR to repurchase $200.0 million of our common stock which was completed in September 2019. We 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 May 2018 Repurchase Program.

Note 13. Employee Benefit Plans

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. We contributed approximately $6.2 million, $5.2 million and $4.3 million to the 401(k) plan during the year ended December 31, 2019, 2018 and 2017, respectively.

Note 14. Income Taxes

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

		Year ended December 31,
		2019				2018				2017
Domestic		$	184,956			$	171,658			$	123,696
Foreign		377,695				294,993				241,103
Net income before provision for income taxes and equity in losses of investee		$	562,651			$	466,651			$	364,799

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

	Year Ended December 31,
	2019				2018				2017
Federal
Current	$	76,528			$	35,788			$	91,214
Deferred	1,235				(5,989		)		15,724
	77,763				29,799				106,938
State
Current	9,169				9,568				2,580
Deferred	209				(3,274		)		2,677
	9,378				6,294				5,257
Foreign
Current	28,364				22,753				15,285
Deferred	(3,158		)		(1,123		)		2,682
	25,206				21,630				17,967
Provision for income taxes	$	112,347			$	57,723			$	130,162

The differences between income taxes using the federal statutory income tax rate for 2019, 2018 and 2017 and our effective tax rates are as follows:

	Year Ended December 31,
	2019			2018			2017
U.S. federal statutory income tax rate	21.0	%		21.0	%		35.0	%
State income taxes, net of federal tax benefit	1.7			1.3			1.4
U.S. tax on foreign earnings	1.9			4.1			1.5
Impact of U.S. Tax Cuts and Jobs Act (“TCJA”)	—			2.1			23.1
Impact of differences in foreign tax rates	(5.1	)		(6.7	)		(18.0	)
Impact of expiration of statute of limitations	—			(6.2	)		—
Stock-based compensation	(1.2	)		(3.4	)		(6.3	)
Other items not individually material	1.7			0.2			(1.0	)
Effective tax rate	20.0	%		12.4	%		35.7	%

The TCJA was enacted into law on December 22, 2017 and 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. We 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.

As of December 31, 2019, undistributed earnings of our foreign subsidiaries totaled $452.6 million and substantially all of the earnings previously determined to be not indefinitely reinvested have been repatriated. Under the GILTI provisions of the TCJA, U.S. income taxes have already been provided on the $452.6 million undistributed earnings that is indefinitely reinvested in our international operations, therefore, the tax impact upon distribution is limited to mainly state income and withholding taxes and is not significant.

As of December 31, 2019 and 2018, the significant components of our deferred tax assets and liabilities are (in thousands):

		Year Ended December 31,
		2019				2018
Deferred tax assets:
Net operating loss and capital loss carryforwards		$	18,182			$	25,410
Reserves and accruals		39,264				24,769
Stock-based compensation		8,416				8,571
Deferred revenue		20,909				14,285
Net translation losses		1,589				1,158
Credit carryforwards		1,801				115
		90,161				74,308
Deferred tax liabilities:
Depreciation and amortization		23,817				8,320
Prepaid expenses		1,341				902
Unremitted foreign earnings		—				612
		25,158				9,834
Net deferred tax assets before valuation allowance		65,003				64,474
Valuation allowance		(1,086		)		(251		)
Net deferred tax assets		$	63,917			$	64,223

The available positive evidence at December 31, 2019 included historical operating profits and a projection of future income sufficient to realize most of our remaining deferred tax assets. As of December 31, 2019, it was considered more likely than not that our deferred tax assets would be realized with the exception of certain capital loss carryovers as we are unable to forecast sufficient future profits to realize the deferred tax assets.

The total valuation allowance as of December 31, 2019 as well as the increase for the year 2019 was not material to our financial statements.

As of December 31, 2019, we have foreign net operating loss carryforwards of approximately $82.1 million, the majority of which can be carried forward indefinitely, and a minor portion of which, if not utilized, will expire beginning after 2024.

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, 2019, 2018 and 2017, are as follows (in thousands):

Unrecognized tax benefits 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 benefits 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 benefits as of December 31, 2018	33,262
Tax positions related to current year:
Additions for uncertain tax positions	19,012
Tax positions related to prior year:
Additions for uncertain tax positions	143
Decreases for uncertain tax positions	(3,783		)
Reductions due to lapse of applicable statute of limitations	(1,984		)
Unrecognized tax benefits as of December 31, 2019	$	46,650

The total amount of gross unrecognized tax benefits as of December 31, 2019 was $46.7 million, of which $43.9 million 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 2012.

We have elected to recognize interest and penalties related to unrecognized tax benefits as a component of income taxes. Interest and penalties included in tax expense for the year ended December 31, 2019 and 2018 as well as accrued as of December 31, 2019 and 2018 was not material to our financials. 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.

Subsequent to the year ended December 31, 2019, we completed an intra-entity transfer of certain intellectual property rights and fixed assets to our new Swiss subsidiary, where our EMEA regional headquarters is now located beginning January 1, 2020. The transfer of intellectual property rights did not result in a taxable gain; however, it did result in a step-up of the Swiss tax deductible basis in the transferred assets, and accordingly, created a temporary difference between the book basis and the tax basis of such intellectual property rights. Consequently, this transaction will result in the recognition of a deferred tax asset and related one-time tax benefit of up to $1.6 billion, in our consolidated financial statements during the three months ending March 31, 2020. 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. Effective January 1, 2020, Switzerland will become a major tax jurisdiction owing to the relocation of our EMEA regional headquarters from the Netherlands.

Note 15. 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 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,
	2019				2018				2017
Numerator:
Net income	$	442,776			$	400,235			$	231,418
Denominator:
Weighted average common shares outstanding, basic	79,424				80,064				80,085
Dilutive effect of potential common stock	676				1,293				1,747
Total shares, diluted	80,100				81,357				81,832
Net income per share, basic	$	5.57			$	5.00			$	2.89
Net income per share, diluted	$	5.53			$	4.92			$	2.83

For the year ended December 31, 2019, 2018 and 2017, potentially anti-dilutive shares excluded from diluted net income per share related to RSUs, MSUs and ESPP were not material.

Note 16. Supplemental Cash Flow Information

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

	Year Ended December 31,
	2019				2018				2017
Taxes paid	$	71,746			$	114,601			$	51,231
Non-cash investing and financing activities:
Fixed assets acquired with accounts payable or accrued liabilities	$	16,488			$	15,069			$	15,105
Conversion of convertible notes receivable into equity securities	$	—			$	4,862			$	—
Fair value of option to purchase property	$	—			$	—			$	3,936
Issuance of promissory note in exchange for sale of equity method investment	$	54,154			$	—			$	—
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	26,337			$	—			$	—
Investing cash flows from finance leases (1)	$	10,896			$	—			$	—
Financing cash flows from finance leases	$	45,773			$	—			$	—
Right-of-use assets obtained in exchange for lease obligations:
Operating leases	$	32,723			$	—			$	—
Finance leases	$	51,064			$	—			$	—

1	A portion of finance lease purchase payment relates to leasing a part of the building to a third party as a lessor. This amount is included in Other investing activities in our Consolidated Statements of Cash Flows.

Note 17. 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 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 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.

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,
	2019				2018				2017
Net revenues
Clear Aligner	$	2,025,750			$	1,691,467			$	1,309,262
Scanner	381,046				275,025				164,151
Total net revenues	$	2,406,796			$	1,966,492			$	1,473,413
Gross profit
Clear Aligner	$	1,499,713			$	1,280,495			$	1,019,563
Scanner	244,184				167,372				97,384
Total gross profit	$	1,743,897			$	1,447,867			$	1,116,947
Income from operations
Clear Aligner	$	835,957			$	712,439			$	564,648
Scanner	137,720				98,998				49,613
Unallocated corporate expenses	(431,184		)		(344,873		)		(260,650		)
Total income from operations	$	542,493			$	466,564			$	353,611
Depreciation and amortization
Clear Aligner	$	38,979			$	29,001			$	21,581
Scanner	7,441				4,965				4,385
Unallocated corporate depreciation and amortization	32,570				20,761				11,773
Total depreciation and amortization	$	78,990			$	54,727			$	37,739
Impairments and other (gains) charges
Clear Aligner	$	(22,990	)		$	—			$	—
Total impairments and other (gains) charges	$	(22,990	)		$	—			$	—

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,
	2019				2018				2017
Total segment income from operations	$	973,677			$	811,437			$	614,261
Unallocated corporate expenses	(431,184		)		(344,873		)		(260,650		)
Total income from operations	542,493				466,564				353,611
Interest income	12,482				8,576				6,948
Other income (expense), net	7,676				(8,489		)		4,240
Net income before provision for income taxes and equity in losses of investee	$	562,651			$	466,651			$	364,799

Geographical Information

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

	For the Year Ended December 31,
	2019				2018				2017
Net revenues 1:
United States	$	1,161,959			$	1,023,559			$	836,200
The Netherlands	760,444				610,039				456,108
China	196,733				155,790				81,661
Other International	287,660				177,104				99,444
Total net revenues	$	2,406,796			$	1,966,492			$	1,473,413

1	Net revenues are attributed to countries based on the location of where revenues are recognized by our legal entities.

Tangible long-lived assets, which includes Property, plant and equipment, net, and Operating lease right-of-use assets, net are presented below by geographic area (in thousands):

	As of December 31,
	2019				2018
Long-lived assets 2:
The Netherlands	$	226,286			$	206,679
United States	164,451				139,239
Costa Rica	82,083				80,218
China	73,174				36,249
Other International	141,980				58,944
Total long-lived assets	$	687,974			$	521,329

2	Long-lived assets are attributed to countries based on the location of our entity that owns or leases the assets.