ALIGN TECHNOLOGY INC 10-Q

ITEM 1 FINANCIAL STATEMENTS ALIGN TECHNOLOGY, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (unaudited) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Net revenues $ 734,144 $ 607,341 $ 1,637,421 $ 1,757,009 Cost of net revenues 200,056 169,787 484,649 485,070 Gross profit 534,088 437,554 1,152,772 1,271,939 Operating expenses: Selling, general and administrative 312,492 277,514 852,365 792,572 Research and development 44,527 39,680 126,420 116,034 Impairments and other (gains) charges — ( 6,792 ) — 22,990 Litigation settlement gain — — — ( 51,000 ) Total operating expenses 357,019 310,402 978,785 880,596 Income from operations 177,069 127,152 173,987 391,343 Interest income and other income (expense), net: Interest income 329 3,478 2,788 9,576 Other income (expense), net 7,147 ( 2,211 ) ( 12,368 ) 5,935 Total interest income and other income (expense), net 7,476 1,267 ( 9,580 ) 15,511 Net income before provision for (benefit from) income taxes and equity in losses of investee 184,545 128,419 164,407 406,854 Provision for (benefit from) income taxes 45,174 25,895 ( 1,452,493 ) 77,812 Equity in losses of investee, net of tax — — — 7,528 Net income $ 139,371 $ 102,524 $ 1,616,900 $ 321,514 Net income per share: Basic $ 1.77 $ 1.29 $ 20.54 $ 4.03 Diluted $ 1.76 $ 1.28 $ 20.45 $ 4.00 Shares used in computing net income per share: Basic 78,824 79,332 78,729 79,709 Diluted 79,163 79,825 79,078 80,397 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 3 Table of Contents ALIGN TECHNOLOGY, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands) (unaudited) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Net income $ 139,371 $ 102,524 $ 1,616,900 $ 321,514 Change in foreign currency translation adjustment, net of tax 15,810 ( 92 ) 25,793 530 Change in unrealized gains (losses) on investments, net of tax — 41 ( 194 ) 317 Other comprehensive income (loss) 15,810 ( 51 ) 25,599 847 Comprehensive income $ 155,181 $ 102,473 $ 1,642,499 $ 322,361 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 4 Table of Contents ALIGN TECHNOLOGY, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share data) (unaudited) September 30, 2020 December 31, 2019 ASSETS Current assets: Cash and cash equivalents $ 615,532 $ 550,425 Marketable securities, short-term — 318,202 Accounts receivable, net of allowance for doubtful accounts of $ 13,716 and $ 6,756 , respectively 626,046 550,291 Inventories 123,093 112,051 Prepaid expenses and other current assets 108,576 102,450 Total current assets 1,473,247 1,633,419 Property, plant and equipment, net 703,657 631,730 Operating lease right-of-use assets, net 83,386 56,244 Goodwill and intangible assets, net 555,946 75,692 Deferred tax assets 1,566,227 64,007 Other assets 32,628 39,610 Total assets $ 4,415,091 $ 2,500,702 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $ 119,184 $ 87,250 Accrued liabilities 318,471 319,958 Deferred revenues 684,139 563,762 Total current liabilities 1,121,794 970,970 Income tax payable 108,669 102,794 Operating lease liabilities 65,518 43,463 Other long-term liabilities 85,639 37,306 Total liabilities 1,381,620 1,154,533 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; 78,849 and 78,433 issued and outstanding, respectively) 8 8 Additional paid-in capital 951,740 906,937 Accumulated other comprehensive income (loss), net 24,911 ( 688 ) Retained earnings 2,056,812 439,912 Total stockholders’ equity 3,033,471 1,346,169 Total liabilities and stockholders’ equity $ 4,415,091 $ 2,500,702 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 5 Table of Contents ALIGN TECHNOLOGY, INC. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands) (unaudited) Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss), Net Retained Earnings Total Three Months Ended September 30, 2020 Shares Amount Balance as of June 30, 2020 78,781 $ 8 $ 918,495 $ 9,101 $ 1,917,441 $ 2,845,045 Net income — — — — 139,371 139,371 Net change in foreign currency translation adjustment — — — 15,810 — 15,810 Issuance of common stock relating to employee equity compensation plans 68 — 9,652 — — 9,652 Tax withholdings related to net share settlements of equity awards — — ( 1,636 ) — — ( 1,636 ) Stock-based compensation — — 25,229 — — 25,229 Balance as of September 30, 2020 78,849 $ 8 $ 951,740 $ 24,911 $ 2,056,812 $ 3,033,471 Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss), Net Retained Earnings Total Nine Months Ended September 30, 2020 Shares Amount Balance as of December 31, 2019 78,433 $ 8 $ 906,937 $ ( 688 ) $ 439,912 $ 1,346,169 Net income — — — — 1,616,900 1,616,900 Net change in unrealized gains (losses) from investments — — — ( 194 ) — ( 194 ) Net change in foreign currency translation adjustment — — — 25,793 — 25,793 Issuance of common stock relating to employee equity compensation plans 416 — 20,314 — — 20,314 Tax withholdings related to net share settlements of equity awards — — ( 48,674 ) — — ( 48,674 ) Stock-based compensation — — 73,163 — — 73,163 Balance as of September 30, 2020 78,849 $ 8 $ 951,740 $ 24,911 $ 2,056,812 $ 3,033,471 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 6 Table of Contents ALIGN TECHNOLOGY, INC. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (CONTINUED) (in thousands) (unaudited) Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss), Net Retained Earnings Total Three Months Ended September 30, 2019 Shares Amount Balance as of June 30, 2019 79,865 $ 8 $ 874,275 $ ( 1,876 ) $ 501,275 $ 1,373,682 Net income — — — — 102,524 102,524 Net change in unrealized gains (losses) from investments — — — 41 — 41 Net change in foreign currency translation adjustment — — — ( 92 ) — ( 92 ) Issuance of common stock relating to employee equity compensation plans 76 — 8,293 — — 8,293 Tax withholdings related to net share settlements of equity awards — — ( 3,075 ) — — ( 3,075 ) Common stock repurchased and retired ( 1,132 ) — ( 11,360 ) — ( 188,640 ) ( 200,000 ) Stock-based compensation — — 24,176 — — 24,176 Balance as of September 30, 2019 78,809 $ 8 $ 892,309 $ ( 1,927 ) $ 415,159 $ 1,305,549 Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss), Net Retained Earnings Total Nine Months Ended September 30, 2019 Shares Amount Balance as of December 31, 2018 79,778 $ 8 $ 877,514 $ ( 2,774 ) $ 378,143 $ 1,252,891 Net income — — — — 321,514 321,514 Net change in unrealized gains (losses) from investments — — — 317 — 317 Net change in foreign currency translation adjustment — — — 530 — 530 Issuance of common stock relating to employee equity compensation plans 529 — 17,907 — — 17,907 Tax withholdings related to net share settlements of equity awards — — ( 55,793 ) — — ( 55,793 ) Common stock repurchased and retired ( 1,498 ) — ( 15,006 ) — ( 284,498 ) ( 299,504 ) Stock-based compensation — — 67,687 — — 67,687 Balance as of September 30, 2019 78,809 $ 8 $ 892,309 $ ( 1,927 ) $ 415,159 $ 1,305,549 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 7 Table of Contents ALIGN TECHNOLOGY, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited ) Nine Months Ended September 30, 2020 2019 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,616,900 $ 321,514 Adjustments to reconcile net income to net cash provided by operating activities: Deferred taxes ( 1,502,459 ) 1,470 Depreciation and amortization 68,769 57,194 Stock-based compensation 73,163 67,687 Non-cash operating lease cost 16,819 13,600 Allowance for doubtful accounts provisions 13,090 4,084 Impairments on equity investments 3,787 3,975 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 Other non-cash operating activities 10,402 13,342 Changes in assets and liabilities, net of effects of acquisition: Accounts receivable ( 101,888 ) ( 95,566 ) Inventories ( 11,774 ) ( 40,775 ) Prepaid expenses and other assets ( 28,251 ) ( 14,826 ) Accounts payable 21,837 1,343 Accrued and other long-term liabilities ( 28,343 ) 31,089 Long-term income tax payable 119 13,425 Deferred revenues 128,585 138,072 Net cash provided by operating activities 280,756 529,093 CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition, net of cash acquired ( 420,788 ) — Purchase of property, plant and equipment ( 101,757 ) ( 107,157 ) Purchase of marketable securities ( 5,341 ) ( 588,805 ) Proceeds from maturities of marketable securities 42,641 211,829 Proceeds from sales of marketable securities 278,817 194,677 Repayment on unsecured promissory note 17,828 13,185 Other investing activities 1,760 ( 14,062 ) Net cash used in investing activities ( 186,840 ) ( 290,333 ) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 20,314 17,907 Common stock repurchases — ( 299,504 ) Payroll taxes paid upon the vesting of equity awards ( 48,674 ) ( 55,793 ) Purchase of finance lease — ( 45,773 ) Net cash used in financing activities ( 28,360 ) ( 383,163 ) Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash ( 568 ) ( 2,098 ) Net increase (decrease) in cash, cash equivalents, and restricted cash 64,988 ( 146,501 ) Cash, cash equivalents, and restricted cash at beginning of the period 551,134 637,566 Cash, cash equivalents, and restricted cash at end of the period $ 616,122 $ 491,065 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 8 Table of Contents ALIGN TECHNOLOGY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Note 1. Summary of Significant Accounting Policies Basis of Presentation The accompanying unaudited Condensed Consolidated Financial Statements have been prepared by Align Technology, Inc. (“we”, “our”, or “Align”) in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) and contains all adjustments, including normal recurring adjustments, necessary to state fairly our results of operations for the three and nine months ended September 30, 2020 and 2019, our comprehensive income for the three and nine months ended September 30, 2020 and 2019, our financial position as of September 30, 2020, our stockholders’ equity for the three and nine months ended September 30, 2020 and 2019, and our cash flows for the nine months ended September 30, 2020 and 2019. The Condensed Consolidated Balance Sheet as of December 31, 2019 was derived from the December 31, 2019 audited financial statements. It does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S.”). The results of operations for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020 or any other future period, and we make no representations related thereto. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Consolidated Financial Statements and notes thereto included in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2019. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) in the U.S. requires our management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, we evaluate our estimates, including those related to 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. Significant Accounting Policies Our significant accounting policies are described in Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K. As a result of our exocad Global Holdings GmbH (“exocad”) acquisition, we have added or amended relevant significant accounting policies as described below . Refer to Note 4 “ Business Combination ” of the Notes to Condensed Consolidated Financial Statements for additional details on the exocad acquisition which is included in our Imaging Systems and CAD/CAM Services ( “ Systems and Services ” ) reportable segment. Business Combinations We allocate the fair value of the purchase consideration to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. When determining the fair value of assets acquired and liabilities assumed, management is required to make certain estimates and assumptions, especially with respect to intangible assets. The estimates and assumptions used in valuing intangible assets include, but are not limited to, the amount and timing of projected future cash flows, the discount rate used to determine the present value of these cash flows, and the determination of the assets’ life cycle. Amounts recorded in a business combination may change during the measurement period, which is a period not to exceed one year from the date of acquisition, as additional information about conditions existing at the acquisition date becomes available. Revenue Recognition - Systems and Services We sell intraoral scanners and computer-aided design/computer-aided manufacturing (“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/ 9 Table of Contents or extended warranty, we allocate revenues based on the respective standalone selling price (“SSP”) 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. CAD/CAM services, where sold separately, include the initial software license and maintenance and support. We allocate revenues based upon the respective SSPs of the software license and the maintenance and support. We estimate the SSP of each element using historical prices. Revenues related to the software license are recognized upfront and revenues related to the maintenance and support are recognized over time. For both scanner and service sales, most consideration is collected upfront and in cases where there are payment plans, consideration is collected within one year and, therefore, there are no significant financing components. Certain Risks and Uncertainties Due to the COVID-19 pandemic, we are subject to a greater degree of uncertainty than normal in making the judgments and estimates needed to apply our significant accounting policies. As the COVID-19 pandemic continues to be a global issue, we may make changes to these estimates and judgments, which could result in meaningful impacts to our financial statements in future periods. The extent and duration of the impact of the COVID-19 pandemic on our business is highly uncertain and difficult to predict and the response to the pandemic is rapidly evolving. The severity of the impact of the COVID-19 pandemic on our business will depend on a number of factors, including, but not limited to, the duration and severity of the pandemic and the extent and severity of the impact on our customers, all of which are uncertain and cannot be predicted. Our future results of operations and liquidity could be adversely impacted by delays in payments of outstanding receivable amounts beyond normal payment terms, supply chain disruptions or limitations, changes in manufacturing efficiency and capacity constraints caused by uneven or rapid changes in demand, and the impact of any initiatives or programs that we may undertake to address financial and operations challenges faced by us or our customers. Additionally, the uncertainty of future results and cash flows may impact our significant assumptions and estimates including the collectability of accounts and other receivables and realization of our deferred tax assets. The extent to which the COVID-19 pandemic may continue to materially impact our financial condition, liquidity, or results of operations is uncertain for all of the foregoing reasons stated above and many others directly and indirectly related to the virus and efforts to contain its spread. Recent Accounting Pronouncements (i) New Accounting Updates Recently Adopted In June 2016, the Financial Accounting Standards Board ( “ 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 adopted this standard in the first quarter of fiscal year 2020 which did not have a material impact on our condensed 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 adopted this standard in the first quarter of fiscal year 2020 which did not have any impact on our condensed 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 adopted this standard in the first quarter of fiscal year 2020 which did not have any impact on our condensed 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 10 Table of Contents Software , to determine which implementation costs under the service contract to be capitalized as an asset and which costs to expense. The updated guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2019 either on a retrospective or prospective basis. We adopted this standard in the first quarter of fiscal year 2020 on a prospective basis which did not have any impact on our condensed consolidated financial statements and related disclosures. (ii) Recent Accounting Updates Not Yet Effective 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 Marketable Securities We have no short-term or long-term marketable securities as of September 30, 2020. As of December 31, 2019, the estimated fair value of our short-term marketable securities, classified as available for sale, are as follows (in thousands): 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 We had no long-term marketable securities as of December 31, 2019. Cash equivalents are not included in the table above as the gross unrealized gains and losses are not material. We had no short-term marketable securities that have been in a continuous material unrealized loss position for greater than twelve months as of December 31, 2019. Amounts reclassified to earnings from accumulated other comprehensive income (loss), net related to unrealized gains or losses were not material for the three and nine months ended September 30, 2020 and 2019. For the three and nine months ended September 30, 2020 and 2019, realized gains or losses were not material. Our fixed-income securities investment portfolio allows for investments with 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 which 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 as of December 31, 2019. As the carrying value approximates the fair value for our short-term marketable securities shown in the table above, the fair value of our short-term marketable securities as of December 31, 2019 had a contractual maturity one year or less. 11 Table of Contents Fair Value Measurements The following tables summarize our financial assets measured at fair value on a recurring basis as of September 30, 2020 and December 31, 2019 (in thousands): Description Balance as of September 30, 2020 Level 1 Level 2 Level 3 Cash equivalents: Money market funds $ 285,228 $ 285,228 $ — $ — Prepaid expenses and other current assets: Israeli funds 3,399 — 3,399 — Current unsecured promissory note 14,505 — — 14,505 $ 303,132 $ 285,228 $ 3,399 $ 14,505 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 treasury bonds 70,650 70,650 — — U.S. government agency bonds 22,101 — 22,101 — 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 The unsecured promissory note that was entered into in 2019 with SmileDirectClub, LLC (“SDC”) 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 has decreased due to payments received. Refer to Note 6 “Equity Method Investments” of the Notes to Condensed Consolidated Financial Statements for more information. Investments in Privately Held Companies Our investments in equity securities of privately held companies without readily determinable fair values were $ 2.1 million and $ 5.9 million as of September 30, 2020 and December 31, 2019, respectively, and are reported as nonrecurring investments within other assets in our Condensed Consolidated Balance Sheet. Our investments in equity securities are 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 change s. During the nine months ended September 30, 2020 and September 30, 2019, we recorded impairment losses of $ 3.8 million and $ 4.0 million, respectively, resulting from observable price changes. Derivatives Not Designated as Hedging Instruments Recurring foreign currency forward contracts 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. As a result of the settlement of foreign currency forward contracts, during the three months ended September 30, 2020 and 2019, we recognized net losses of $ 12.1 million and net gains of $ 10.1 million, respectively, and during the nine months ended September 30, 2020 and 2019, we recognized net gains of $ 0.6 million and $ 10.5 million, 12 Table of Contents respectively. As of September 30, 2020 and December 31, 2019, 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 September 30, 2020 and December 31, 2019 (in thousands): September 30, 2020 Local Currency Amount Notional Contract Amount (USD) Chinese Yuan ¥ 1,075,000 $ 158,198 Euro € 127,000 148,852 Canadian Dollar C$ 77,000 57,570 British Pound £ 29,200 37,524 Japanese Yen ¥ 3,385,000 32,042 Brazilian Real R$ 112,500 19,899 Israeli Shekel ILS 53,000 15,441 Mexican Peso M$ 140,000 6,266 Australian Dollar A$ 6,900 4,925 Swiss Franc CHF 4,000 4,343 $ 485,060 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 British Pound £ 28,000 36,770 Brazilian Real R$ 130,000 32,185 Japanese Yen ¥ 3,000,000 27,604 Israeli Shekel ILS 63,700 18,439 Mexican Peso M$ 140,000 7,398 Australian Dollar A$ 3,000 2,101 $ 333,871 Other foreign currency forward contract Prior to the closing of the exocad acquisition on April 1, 2020, we entered into a Euro foreign currency forward contract with a notional contract amount of € 376.0 million. During the nine months ended September 30, 2020, we recognized a $ 10.2 million loss within other income (expense), net in our Condensed Consolidated Statement of Operations. Note 3. Balance Sheet Components Inventories consist of the following (in thousands): September 30, 2020 December 31, 2019 Raw materials $ 70,659 $ 54,947 Work in process 26,167 30,974 Finished goods 26,267 26,130 Total inventories $ 123,093 $ 112,051 13 Table of Contents Prepaid expenses and other current assets consist of the following (in thousands): September 30, 2020 December 31, 2019 Tax related receivables $ 55,162 $ 41,252 Current promissory note and related interest receivable 1 14,552 25,005 Prepaid software and maintenance 13,598 7,128 Others 25,264 29,065 Total prepaid expenses and other current assets $ 108,576 $ 102,450 1 Refer to Note 6“Equity Method Investments” of the Notes to Condensed Consolidated Financial Statements for more information. Accrued liabilities consist of the following (in thousands): September 30, 2020 December 31, 2019 Accrued payroll and benefits $ 126,112 $ 162,486 Accrued expenses 63,117 55,529 Accrued property, plant and equipment 25,597 9,167 Current operating lease liabilities 20,674 15,737 Accrued professional fees 19,112 10,410 Accrued income taxes 15,539 14,130 Others 48,320 52,499 Total accrued liabilities $ 318,471 $ 319,958 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. We also warrant our CAD/CAM software for a one year period to perform in accordance with agreed product specifications. As we have not historically incurred any material warranty costs, we do not accrue for these software warranties. Warranty accrual consists of the following activity (in thousands): Nine Months Ended September 30, 2020 2019 Balance at beginning of period $ 11,205 $ 8,551 Charged to cost of net revenues 8,047 9,429 Actual warranty expenditures ( 8,229 ) ( 7,178 ) Balance at end of period $ 11,023 $ 10,802 Deferred revenues consist of the following (in thousands): September 30, 2020 December 31, 2019 Deferred revenues - current $ 684,139 $ 563,762 Deferred revenues - long-term 1 $ 46,986 $ 35,503 1 Included in Other long-term liabilities within our Condensed Consolidated Balance Sheet During the three months ended September 30, 2020 and 2019, we recognized $ 734.1 million and $ 607.3 million of revenue, respectively, of which $ 99.6 million and $ 70.1 million was included in the deferred revenues balance at December 31, 2019 and 2018, respectively. During the nine months ended September 30, 2020 and 2019, we recognized $ 1.6 billion and $ 1.8 billion of revenue, respectively, of which $ 263.3 million and $ 207.0 million was included in the deferred revenues balance at December 31, 2019 and 2018, respectively. Our unfulfilled performance obligations, including deferred revenues and backlog, as of September 30, 2020 were $ 744.7 million. These performance obligations are expected to be recognized over the next one to five years . 14 Table of Contents Note 4. Business Combination On April 1, 2020 (the “acquisition date”), we completed the acquisition of privately-held exocad for a total purchase consideration of $ 430.0 million and exocad became a wholly-owned subsidiary. exocad is a German dental CAD/CAM software company that offers fully integrated workflows to dental labs and dental practices. We believe the synergies from the acquisition will strengthen our digital platform by adding exocad’s expertise in restorative dentistry, implantology, guided surgery, and smile design to extend our digital solutions and pave the way for new, seamless cross-discipline dentistry in the lab and at chairside. The total purchase consideration consisted of the following (in thousands): Cash paid to exocad stockholders $ 412,287 Cash paid to settle exocad’s bank debt 17,691 Total purchase consideration paid $ 429,978 The preliminary allocation of purchase price to assets acquired and liabilities assumed which is subject to change within the measurement period is as follows (in thousands): Goodwill $ 340,181 Identified intangible assets 118,700 Cash and cash equivalents 9,190 Deferred tax liabilities ( 35,419 ) Other assets (liabilities), net ( 2,674 ) Total $ 429,978 Goodwill represents the excess of the purchase price over the fair value of the underlying net tangible and identifiable intangible assets, and represents the expected synergies of the transaction and the knowledge and experience of the workforce in place. None of this goodwill is deductible for tax purposes. Under the applicable accounting guidance, goodwill will not be amortized but will be tested for impairment on an annual basis or more frequently if certain indicators are present. We allocated approximately $ 296.7 million of goodwill to our Systems and Services reporting unit (formerly the "Scanner and Services" reporting unit prior to its renaming during the second quarter of 2020) and approximately $ 43.5 million of the goodwill to our Clear Aligner reporting unit (Refer to Note 5 "Goodwill and Intangible Assets" of the Notes to Condensed Consolidated Financial Statements for additional details) . Our reporting units are the same as our operating segments. Acquisition related costs are recognized separately from the business combination and expensed as incurred. The following table presents details of the identified intangible assets acquired (in thousands, except years): Weighted Average Amortization Period (in years) Fair Value Intangible assets subject to amortization: Existing technology 10 $ 87,000 Customer relationships 10 21,500 Tradenames 7 9,800 Intangible assets not subject to amortization: In-process Research and Development (“IPR&D”) N/A 400 Total intangible assets $ 118,700 We believe the amount of purchased intangible assets recorded above represent the fair values and approximate the amount a market participant would pay for these intangible assets as of the acquisition date. Existing technology represents the estimated fair value of exocad’s core technology that has reached technological feasibility. We valued the existing technology using the multi-period excess earnings method under the income approach. The economic useful life of existing technology was determined by considering the life cycle of the technology and related cash flows. 15 Table of Contents Customer relationships represent the fair value of future projected revenue that will be derived from sales of products to existing customers. Customer relationships were valued using the with-and-without method under the income approach. The economic useful life for customer relationships was based on historical customer attrition rates. Tradenames relates to the exocad tradenames that are recognized within the industry. The fair value was determined using the relief-from-royalty method under the income approach. The economic useful life of tradenames was determined by benchmarking against similar transactions entered into by peer companies. IPR&D refers to the fair value of projects that are not yet completed but have potential value to the company. Deferred tax liabilities were recorded for significant basis differences primarily to reflect the tax effect of fair value adjustments made to the beginning balance of the intangible assets and deferred revenue as of the acquisition date (Refer to Note 13 "Accounting for Income Taxes" of the Notes to Condensed Consolidated Financial Statements for additional details). Our condensed consolidated financial statements include the operating results of exocad from the acquisition date. Separate post-acquisition operating results and pro forma results of operations for this acquisition have not been presented as the effect is not material to our financial results. Note 5. Goodwill and Intangible Assets Goodwill The change in the carrying value of goodwill for the nine months ended September 30, 2020, categorized by reportable segments, is as follows (in thousands): Clear Aligner Systems and Services Total Balance as of December 31, 2019 $ 63,924 $ — $ 63,924 Additions from exocad acquisition 1 43,500 296,681 340,181 Adjustments 2 2,695 20,542 23,237 Balance as of September 30, 2020 $ 110,119 $ 317,223 $ 427,342 1 Includes goodwill adjustments within the measurement period (up to one year from acquisition date). Refer to Note 4 "Business Combination" of the Notes to Condensed Consolidated Financial Statements for additional details. 2 Adjustments related to foreign currency translation within the measurement period During the fourth quarter of fiscal 2019, we performed our annual goodwill impairment testing and found no impairment as the fair value of our Clear Aligner reporting unit was significantly in excess of the carrying value. 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 September 30, 2020 Accumulated Amortization Accumulated Impairment Loss Net Carrying Value as of September 30, 2020 Trademarks and tradenames 10 $ 16,900 $ ( 2,849 ) $ ( 4,179 ) $ 9,872 Existing technology 10 99,600 ( 10,603 ) ( 4,328 ) 84,669 Customer relationships 11 55,000 ( 20,876 ) ( 10,751 ) 23,373 Other 1 5 14,913 ( 11,885 ) — 3,028 $ 186,413 $ ( 46,213 ) $ ( 19,258 ) 120,942 Foreign currency translation 7,662 Total intangible assets 2 $ 128,604 1 Includes reacquired rights, patents and other intangible assets 2 Refer to Note 4 "Business Combination" of the Notes to Condensed Consolidated Financial Statements for additional details on intangible assets from our exocad acquisition. 16 Table of Contents 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 The total estimated annual future amortization expense for these acquired intangible assets as of September 30, 2020 is as follows (in thousands): Fiscal Year Ending December 31, Amortization Remainder of 2020 $ 3,907 2021 15,622 2022 14,366 2023 13,745 2024 12,805 Thereafter 60,497 Total $ 120,942 Amortization expense for the three months ended September 30, 2020 and 2019 was $ 4.1 million and $ 1.5 million, respectively, and amortization expense for the nine months ended September 30, 2020 and 2019 was $ 9.5 million and $ 4.5 million, respectively. Note 6. 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 Condensed Consolidated Balance Sheet. We recorded our proportional share of SDC’s losses within equity in losses of investee, net of tax, in our Condensed 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 Condensed 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 (Refer to Note 9 “Legal Proceedings” of the Notes to Condensed Consolida ted Financial Statements for SDC legal proceedings discussion). As of September 30, 2020, the unsecured promissory note had a remaining current balance of $ 14.5 million. Note 7. Credit Facility On July 21, 2020 we entered into a new credit facility for a $ 300.0 million unsecured revolving line of credit, with a $ 50.0 million letter of credit sublimit, and a maturity date of July 21, 2023 (“2020 Credit Facility”), replacing our previous credit facility which provided for a $ 200.0 million revolving line of credit with a $ 50.0 million letter of credit. The 2020 Credit Facility requires us to comply with specific financial conditions and performance requirements. Loans under the 2020 Credit Facility bear interest, at our option, at either a rate based on the reserve adjusted LIBOR for the applicable interest period or a 17 Table of Contents 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 1.50 % to 2.25 % for LIBOR loans and 0.50 % to 1.25 % 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. The outstanding principal, together with accrued and unpaid interest, is due on the maturity date. As of September 30, 2020, we had no outstanding borrowings under the 2020 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 Condensed 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 2018 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 alleged claims under the federal securities laws and sought 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. 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. On September 9, 2020, Defendants’ motion to dismiss the amended consolidated complaint was granted in part and denied in part. On September 24, 2020, the Court stayed the case until otherwise ordered to allow the parties time to pursue private mediation. Align believes these remaining 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. 2019 Shareholder Derivative Lawsuit In January 2019, three derivative lawsuits were filed in the U.S. District Court for the Northern District of California which were later consolidated, 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 asserted in the 2018 Securities Class Action Lawsuit, but the complaints assert various state law causes of action, including for breaches of fiduciary duty, insider trading, and unjust enrichment. 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. The consolidated action has been stayed pending final disposition of the 2018 Securities Class Action Lawsuit. 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 the complaint are similar to those in the derivative suits described above. The matter has been similarly stayed pending final disposition of the 2018 Securities Class Action Lawsuit. 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 . 2020 Securities Class Action Lawsuit 18 Table of Contents On March 2, 2020, a class action lawsuit against Align and two of our executive officers was filed in the U.S. District Court for the Southern District of New York (later transferred to the U.S. District Court for the Northern District of California) on behalf of a purported class of purchasers of our common stock between April 24, 2019 and July 24, 2019. The complaint alleged claims under the federal securities laws and sought monetary damages in an unspecified amount and costs and expenses incurred in the litigation. The lead plaintiff filed an amended complaint on August 4, 2020 against Align and three of our executive officers alleging similar claims as in the initial complaint on behalf of a purported class of purchasers of our common stock from April 25, 2019 to July 24, 2019. A motion to dismiss the amended complaint was filed on September 18, 2020. Align believes these claims are without merit and intends to vigorously defend itself. Align is currently unable to predict the outcome of this lawsuit and therefore cannot determine the likelihood of loss nor estimate a range of possible loss. 2020 Shareholder Derivative Lawsuit On May 4, 2020, a derivative lawsuit was 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 complaint are similar to those presented in the 2020 Securities Class Action Lawsuit, but this complaint asserts state law claims for breach of fiduciary duty and insider trading. The complaint seeks unspecified monetary damages on behalf of Align, which is named solely as a no minal defendant against whom no recovery is sought, as well as disgorgement and the costs and expenses associated with the litigation, including attorneys’ fees. This action has been stayed pending final disposition of the 2020 Securities Class Action Lawsuit. Align is currently unable to predict the outcome of this lawsuit and therefore cannot determine the likelihood of loss nor estimate a range of possible loss. 3Shape Litigation On November 14, 2017, Align filed several patent infringement lawsuits asserting 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. These lawsuits included 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. Three of the cases are active, and one was voluntarily dismissed by Align. Certain of Align’s asserted patents in the Delaware actions were found invalid by the District Court judge. On May 9, 2018, and June 14, 2018, 3Shape filed separate complaints in the U.S. District Court for the District of Delaware alleging patent infringement by Align’s iTero Element scanner of two 3Shape patents. On August 19, 2019, the Court consolidated the two actions, and on August 30, 2019, 3Shape filed an amended complaint alleging infringement of a third patent. In December 2018, Align filed three additional patent infringement lawsuits asserting 10 additional patents against 3Shape. On December 10, 2018, Align filed one Section 337 complaint with the ITC alleging that 3Shape violates U.S. trade laws 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 April 30, 2020, an Administrative Law Judge (“ALJ”) issued an initial determination that 3Shape infringed on 7 of the 9 patent claims asserted by Align, found valid 6 of the 9 claims asserted by Align, and found a violation of Section 337 stemming from 3Shape’s infringement of 4 claims in 2 of Align’s asserted patents. The ALJ recommended an exclusion order and cease and desist order be entered against 3Shape’s unlawful importation. The Initial Determination is now subject to review by the Commissioners at the ITC. The current deadline for completing the investigation is November 2, 2020. In addition to the December 10, 2018 ITC Complaint, 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. One of the District Court cases was stayed pending the parallel ITC investigation. The remaining District Court case is in the early stages of discovery and pretrial proceedings. On October 19, 2020, Align filed a complaint in the U.S. District Court for the Western District of Texas alleging patent infringement by 3Shape ’s intraoral scanners and associated software products. 3Shape has not yet responded to the complaint. 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. 19 Table of Contents Each of the District Court patent infringement complaints seek monetary damages and/or injunctive relief against further infringement. Trial dates in the District Court cases are uncertain given the ongoing pandemic. 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. After the Court dismissed 3Shape’s complaint with leave, 3Shape filed an amended complaint on October 28, 2019. On May 20, 2020, the Magistrate Judge recommended that Align’s motion to dismiss the amended complaint be denied. Align’s objection to the Magistrate Judge’s Report and Recommendation has been fully briefed to the District Court, and the parties are waiting for a ruling. 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 June 5, 2020, 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 Northern District of California 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. Prior to filing in the Northern District of California, on May 4, 2020, Plaintiff voluntarily dismissed a similar action in the U.S. District Court for the District of Delaware after the Magistrate Judge recommended that its complaint be dismissed. Plaintiff filed an amended complaint and added VIP Dental Spas as a plaintiff on August 14, 2020. On September 9, 2020, Align moved to dismiss Plaintiffs’ amended complaint. A lign believes the plaintiffs’ claims are without merit and intends to vigorously defend itself. Align is currently unable to predi ct the outcome of this lawsuit and therefore cannot determine the likelihood of loss, if any, nor estimate a range of possible loss. SDC Dispute In April 2018, the SDC Financial LLC, SmileDirectClub LLC, and the Members of SDC Financial LLC other than the Company (collectively, the “SDC Entities”) initiated confidential arbitration proceedings against Align. During December 2018, the parties participated in binding arbitration proceedings and presented closing arguments on January 23, 2019. In an award dated March 4, 2019, (“Award”) an arbitrator found that Align breached a restrictive covenant and that Align misused the SDC Entities’ confidential information and violated fiduciary duties to SDC Financial LLC. As part of the Award, Align was enjoined 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 from using the SDC Entities’ confidential information. The arbitrator extended the expiration date of specified aspects of the restrictive covenant 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 Circuit Court for Cook County, Illinois confirmed the Award on April 29, 2019. As required by the Award, Align tendered its membership interests for a purchase price that SDC claims to be Align’s “capital account” balance. 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. That arbitration proceeding remains pending and a hearing is currently expected to occur in December 2020. 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 a restrictive covenant 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. On April 27, 2020, the SDC Entities filed an amended arbitration demand, which additionally asserts that Align’s alleged dealings with a third-party constitute contempt of the Award. Align denies and intends to vigorously defend itself against all asserted allegations. On September 30, 2020, SDC announced that it was withdrawing its claim for damages in this arbitration proceeding, and that it would instead seek injunctive and equitable relief. That arbitration proceeding remains pending and a hearing is currently expected to occur in March 2021. 20 Table of Contents On August 27, 2020, Align initiated a confidential arbitration proceeding against the SDC entities before the American Arbitration Association in San Jose, California. This arbitration relates to the Strategic Supply Agreement (“Supply Agreement”) entered into between the parties in 2016. The complaint states that the SDC Entities breached the Supply Agreement ’ s terms, causing damages to Align in an amount to be determined. Align is currently unable to predict the outcome of these disputes and therefore cannot determine the likelihood of loss or success nor estimate a range of possible loss or success, if any. 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 Other Commitments On October 3, 2019, we entered into a Promotional Rights Agreement (the “Agreement”) with NFL Properties LLC for $ 36.0 million which includes certain advertising and m edia coverage. As of September 30, 2020, we had a remaining commitment of $ 32.5 million which is expected to be paid through 2023. Off-Balance Sheet Arrangements As of September 30, 2020, 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 Note 10 “ Commitments and Contingencies” of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K. 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 September 30, 2020, we did not have any material indemnification claims that were probable or reasonably possible. Note 11. Stockholders’ Equity Summary of Stock-Based Compensation Expense As of September 30, 2020, the 2005 Incentive Plan (as amended) has a total reserve of 27,783,379 shares of which 4,617,148 shares are available for issuance. 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 our stock-based awards and employee stock purchase plans for the three and nine months ended September 30, 2020 and 2019 is as follows (in thousands): 21 Table of Contents Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Cost of net revenues $ 1,247 $ 1,354 $ 3,485 $ 3,744 Selling, general and administrative 19,951 19,394 58,284 54,321 Research and development 4,031 3,428 11,394 9,622 Total stock-based compensation $ 25,229 $ 24,176 $ 73,163 $ 67,687 Restricted Stock Units (“RSUs”) The fair value of RSUs is based on our closing stock price on the date of grant. A summary for the nine months ended September 30, 2020 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, 2019 696 $ 190.60 Granted 298 266.07 Vested and released ( 308 ) 150.22 Forfeited ( 34 ) 233.59 Unvested as of September 30, 2020 652 $ 241.90 1.4 $ 213,410 As of September 30, 2020, we expect to recognize $ 113.4 million of total unamortized compensation cost, net of estimated forfeitures, related to RSUs over a weighted average period of 2.4 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. The maximum number of MSUs which will be eligible to vest range fr om 250 % to 300 % of the MSUs initially granted and the vesting period is three years . A summary for the nine months ended September 30, 2020 is as follows: 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, 2019 244 $ 331.35 Granted 156 242.04 Vested and released ( 173 ) 120.39 Unvested as of September 30, 2020 227 $ 430.50 1.4 $ 74,391 As of September 30, 2020, we expect to recognize $ 39.0 million of total unamortized compensation cost, net of estimated forfeitures, related to MSUs over a weighted average period of 1.4 years. Employee Stock Purchase Plan (“ESPP”) In May 2010, our stockholders approved the 2010 Employee Stock Purchase Plan (the “2010 Purchase Plan”) which 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 2,400,000 shares. As of September 30, 2020, we have 325,665 shares 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: 22 Table of Contents Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Expected term (in years) 1.0 1.5 1.0 1.4 Expected volatility 71.7 % 52.0 % 55.0 % 50.1 % Risk-free interest rate 0.1 % 1.8 % 0.9 % 2.2 % Expected dividends — — — — Weighted average fair value at grant date $ 117.32 $ 80.42 $ 96.94 $ 86.02 As of September 30, 2020, there was $ 4.9 million of total unamortized compensation costs related to employee stock purchases which we expect to be recognized over a weighted average period of 0.5 year. Note 12. Common Stock 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 marke t 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 September 30, 2020, we have $ 100.0 million available for repurchase under the May 2018 Repurchase Program. Note 13. Accounting for Income Taxes During the nine months ended September 30, 2020, we completed an intra-entity transfer of certain intellectual property rights and fixed assets to our Swiss subsidiary, where our Europe, Middle East and Africa ( “EMEA”) regional headquarters is 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 resulted in the recognition of a deferred tax asset and related one-time tax benefit of approximately $ 1,493.5 million during the nine months ended September 30, 2020, which is the net impact of the deferred tax asset recognized as a result of the additional Swiss tax deductible basis in the transferred assets and certain costs related to the transfer of fixed assets and inventory. Our provision for income t axes was $ 45.2 million and $ 25.9 million for the three months ended September 30, 2020 and 2019, representing effective tax rates of 24.5 % and 20.2 %, respectively. O ur benefit from income taxes was $ 1,452.5 million for the nine months ended September 30, 2020 and our provision for income taxes was $ 77.8 million for the nine months ended September 30, 2019, representing effective tax rates of ( 883.5 )% and 19.1 %, respectively. Our effective tax rate differs from the statutory federal income tax rate of 21% for the three months ended September 30, 2020 primarily due to the recognition of additional tax expense resulting from state tax and non-deductible expenses in the U.S., partially offset by the recognition of a tax benefit for the release of certain unrecognized tax benefits following the settlement of an Internal Revenue Service ( “ IRS ” ) income tax audit for years 2015 and 2016. Our effective tax rate differs from the statutory federal income tax rate of 21% for the nine months ended September 30, 2020 mainly as a result of the recognition of tax benefits related to the intra-entity transfer of certain intellectual property rights and fixed assets mentioned above. Our effective tax rate differs from the statutory federal income tax rate of 21% for the three and nine months ended September 30, 2019 mainly as a result of certain foreign earnings, primarily from the Netherlands and Costa Rica, being taxed at lower tax rates and the recognition of excess tax benefits related to stock-based compensation, partially offset by non-deductible officers ’ compensation . The increase in our effective tax rate for the three months ended September 30, 2020 compared to the same period in 2019 is primarily attributable to reduced tax benefit of certain foreign earnings being taxed at lower tax rates and tax benefits recorded last year related to certain statute of limitations expirations and adjustments for prior years that did not recur in 2020, offset in part by a tax benefit recorded this quarter for the release of certain unrecognized tax benefits following the settlement of an IRS income tax audit for years 2015 and 2016. The decrease in our effective tax rate for the nine months ended 23 Table of Contents September 30, 2020 compared to the same period in 2019 is primarily attributable to the recognition of a deferred tax asset related to the intra-entity transfer of certain intellectual property rights during the nine months ended September 30, 2020. We exercise significant judgment in regards to estimates of future market growth, forecasted earnings and projected taxable income in determining the provision for income taxes and for purposes of assessing our ability to utilize any future benefit from deferred tax assets. We continue to assess the realizability of the deferred tax assets as we take into account new information. 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 Switzerland. We are no longer subject to U.S. federal tax examination for years before 2017 and U.S. state tax examination for years before 2015. With few exceptions, we are no longer subject to examination by foreign tax authorities for years before 2013. Our total gross unrecognized tax benefits, excluding interest and penalties, were $ 47.0 million and $ 46.7 million as of September 30, 2020 and December 31, 2019, respectively, a material amount of which would impact our effective tax rate if recognized. Total interest and penalties accrued as of September 30, 2020 was not material. We have elected to recognize interest and penalties related to unrecognized tax benefits as a component of income taxes. 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. During the three months ended September 30, 2020, we recognized $ 8.7 million of previously unrecognized tax benefits through our effective tax rate due to the settlement of the IRS audit for tax years 2015 and 2016. We do not anticipate the total unrecognized tax benefits will change significantly within the next 12 months due to settlement of audits nor expiration of statutes of limitations. Our total deferred tax liabilities were $ 36.8 million as of September 30, 2020, which were primarily related to the intangible assets from our exocad acquisition. Our deferred tax liabilities as of December 31, 2019 were not material. 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 Global Intangible Low-Taxed Income provisions of the Tax Cuts and Jobs Act, U.S. income taxes have already been provided on the 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. Note 14. Net Income per Share Basic net income per share is computed using the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed using the weighted average number of shares of common stock, adjusted for any dilutive effect of potential common stock. Potential common stock, computed using the treasury stock method, includes RSUs, MSUs 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): Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Numerator: Net income $ 139,371 $ 102,524 $ 1,616,900 $ 321,514 Denominator: Weighted average common shares outstanding, basic 78,824 79,332 78,729 79,709 Dilutive effect of potential common stock 339 493 349 688 Total shares, diluted 79,163 79,825 79,078 80,397 Net income per share, basic $ 1.77 $ 1.29 $ 20.54 $ 4.03 Net income per share, diluted $ 1.76 $ 1.28 $ 20.45 $ 4.00 Anti-dilutive potential common shares 1 65 398 66 25 1 Represents RSUs and MSUs not included in the calculation of diluted net income per share as the effect would have been anti-dilutive. 24 Table of Contents Note 15. Supplemental Cash Flow Information The supplemental cash flow information consists of the following (in thousands): Nine Months Ended September 30, 2020 2019 Non-cash investing and financing activities: Fixed assets acquired with accounts payable or accrued liabilities $ 43,147 $ 14,331 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 $ 19,384 $ 21,186 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 $ 44,915 $ 26,395 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 Condensed Consolidated Statements of Cash Flows. Note 16. Segments and Geographical Information Segment Information Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (“CODM”), or decision-making group, in deciding how to allocate resources and in assessing performance. Our CODM is our Chief Executive Officer. We report segment information based on the management approach. The management approach designates the internal reporting used by CODM for decision making and performance assessment as the basis for determining our reportable segments. The performance measures of our reportable segments include net revenues, gross profit and income from operations. Income from operations for each segment includes all geographic revenues, related cost of net revenues and operating expenses directly attributable to the segment. Certain operating expenses are attributable to operating segments and each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Costs not specifically allocated to segment income from operations include various corporate expenses such as stock-based compensation and costs related to IT, facilities, human resources, accounting and finance, legal and regulatory, and other separately managed general and administrative costs outside the operating segments. We group our operations into two reportable segments: Clear Aligner segment and Imaging Systems and CAD/CAM services ("Systems and Services") segment. The Systems and Services segment was formerly known as the Scanner and Services segment prior to our acquisition of exocad on April 1, 2020 (Refer to Note 4 "Business Combination" of the Notes to Condensed Consolidated Financial Statements for additional details on the exocad acquisition). • Our Clear Aligner segment consists of Comprehensive Products, Non-Comprehensive Products and Non-Case revenues as defined below: ▪ Comprehensive Products include, but are not limited to, Invisalign Comprehensive and Invisalign First. ▪ Non-Comprehensive Products include, but are not limited to, Invisalign Moderate, Lite and Express packages and Invisalign Go. ▪ Non-Case includes, but not limited to, Vivera retainers along with our training and ancillary products for treating malocclusion. • Our Systems and Services segment consists of our iTero intraoral scanning systems, which includes a single hardware platform and restorative or orthodontic software options, OrthoCAD services and ancillary products, as well as exocad ’ s CAD/CAM software solution that integrates workflows to dental labs and dental practices. 25 Table of Contents 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): Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Net revenues Clear Aligner $ 620,764 $ 516,265 $ 1,400,716 $ 1,482,172 Systems and Services 113,380 91,076 236,705 274,837 Total net revenues $ 734,144 $ 607,341 $ 1,637,421 $ 1,757,009 Gross profit Clear Aligner $ 463,747 $ 379,202 $ 1,007,605 $ 1,096,702 Systems and Services 70,341 58,352 145,167 175,237 Total gross profit $ 534,088 $ 437,554 $ 1,152,772 $ 1,271,939 Income from operations Clear Aligner $ 261,774 $ 211,952 $ 467,078 $ 614,622 Systems and Services 34,912 32,760 52,194 100,286 Unallocated corporate expenses ( 119,617 ) ( 117,560 ) ( 345,285 ) ( 323,565 ) Total income from operations $ 177,069 $ 127,152 $ 173,987 $ 391,343 Depreciation and amortization Clear Aligner $ 10,413 $ 9,306 $ 30,231 $ 27,851 Systems and Services 5,092 1,987 11,882 5,349 Unallocated corporate expenses 8,981 8,413 26,656 23,994 Total depreciation and amortization $ 24,486 $ 19,706 $ 68,769 $ 57,194 Impairments and other (gains) charges Clear Aligner $ — $ ( 6,792 ) $ — $ 22,990 Total impairments and other (gains) charges $ — $ ( 6,792 ) $ — $ 22,990 Litigation settlement gain Clear Aligner $ — $ — $ — $ ( 51,000 ) Total litigation settlement gain $ — $ — $ — $ ( 51,000 ) The following table reconciles total segment income from operations in the table above to net income before provision for (benefit from) income taxes and equity losses of investee (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Total segment income from operations $ 296,686 $ 244,712 $ 519,272 $ 714,908 Unallocated corporate expenses ( 119,617 ) ( 117,560 ) ( 345,285 ) ( 323,565 ) Total income from operations 177,069 127,152 173,987 391,343 Interest income 329 3,478 2,788 9,576 Other income (expense), net 7,147 ( 2,211 ) ( 12,368 ) 5,935 Net income before provision for (benefit from) income taxes and equity in losses of investee $ 184,545 $ 128,419 $ 164,407 $ 406,854 26 Table of Contents Geographical Information Net revenues are presented below by geographic area (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Net revenues 1 : United States $ 332,414 $ 286,050 $ 744,978 $ 861,710 Switzerland 2 219,910 — 512,681 — The Netherlands 2 — 173,926 — 540,858 China 76,825 63,636 142,927 151,075 Other International 104,995 83,729 236,835 203,366 Total net revenues $ 734,144 $ 607,341 $ 1,637,421 $ 1,757,009 1 Net revenues are attributed to countries based on the location of where revenues are recognized by our legal entities. 2 During the first quarter of 2020, we implemented a new international corporate structure. This changed the structure of our international procurement and sales operations from the Netherlands to Switzerland. 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): September 30, 2020 December 31, 2019 Long-lived assets 1 : Switzerland 2 $ 241,782 $ 7,755 United States 178,767 164,451 China 107,042 73,174 Costa Rica 99,000 82,083 The Netherlands 2 855 226,286 Other International 159,597 134,225 Total long-lived assets $ 787,043 $ 687,974 1 Long-lived assets are attributed to countries based on the location of our entity that owns or leases the assets. 2 As a result of the new international corporate structure changes, most of the long-lived assets were transferred from our Netherlands entity to our Switzerland entity during the first quarter of 2020 . 27 Table of Contents