It reads the NTFS Master File Table (MFT) which contains records for all files and folders. It only does this the first time it runs (or when you manually tell it to rebuild the index). It also uses the NTFS USN journal [1] in order to update changes to its index so that it doesn't need to read the MFT and rebuild the index every time it runs.

[1] https://msdn.microsoft.com/en-us/library/windows/desktop/aa3...