<PAGE>   1
                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-KSB

            Annual Report under Section 13 or 15(d) of the Securities
        Exchange Act of 1934 for the fiscal year ended December 31, 1998

                         Commission file number 1-13400

                                 STRATASYS, INC.
                 (Name of Small Business Issuer in its Charter)

              Delaware                                   36-3658792   
   (State or Other Jurisdiction                       (I.R.S. Employer
   of Incorporation or Organization)                  Identification No.)

14950 Martin Drive, Eden Prairie, Minnesota                 55344   
 (Address of Principal Executive Offices)                (Zip Code)

                                 (612) 937-3000
                (Issuer's Telephone Number, Including Area Code)

         Securities registered under Section 12(b) of the Exchange Act:

<TABLE>
<CAPTION>
                                                            Name of Each Exchange on Which
         Title of Each Class                                   Each Class is Registered           
         -------------------                                   ------------------------           
<S>                                                         <C>
        Common Stock, $.01 par value                           The Pacific Exchange Inc.
</TABLE>

              Securities registered under Section 12(g) of the Act:
                          Common Stock, $.01 par value
                                (Title of Class)

         Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for past 90 days. Yes /X/  No/ /

         Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. /X/

         Revenues for the issuer's most recent fiscal year were $32,437,198.

         The aggregate market value of the voting stock held by non-affiliates
computed by reference to the closing price at which the stock was sold on March
18, 1999 as $20,567,679.

         As of March 18, 1999, the Issuer had 6,101,961 shares of Common Stock,
$.01 par value, outstanding.

            Transitional Small Business Disclosure Format:  Yes/ /   No   /X/

Documents Incorporated by Reference

         Part III of the Annual Report on Form 10-KSB is herein incorporated by
reference from the definitive Proxy Statement to be filed with the Security and
Exchange Commission with respect to the Registrant's Meeting of Stock holders
scheduled to be held on May 11, 1999.
<PAGE>   2
ITEM  1.    DESCRIPTION OF BUSINESS.

BUSINESS DEVELOPMENT

         Stratasys, Inc. (the "Company") manufactures and sells a line of rapid
prototyping ("RP") devices that create physical models from computerized
designs. It was incorporated in Delaware in 1989 and its executive offices are
located in Eden Prairie, Minnesota. The Company sold its first product, the 3-D
Modeler, commercially in April 1992 and introduced its second product, the
Benchtop, in June 1993. Other significant developments in the Company's business
are set forth below:

-        On October 20, 1994, the Company successfully completed an initial
         public offering of 1,380,000 shares of its common stock, including
         180,000 shares issued upon exercise of the underwriter's over-allotment
         option. The shares of common stock were sold at $5.00 per share with
         the Company receiving net proceeds of approximately $5,700,000. The
         underwriter was also granted warrants to purchase up to 120,000 shares
         of common stock, exercisable at $7.50 per share, until October 1999,
         all of which have been exercised.

-        On January 1, 1995, the Company purchased certain rapid prototyping
         assets from International Business Machines Corporation, pursuant to an
         Assignment and Sale of Rapid Prototyping Technology and Related Assets
         Agreement dated as of January 1, 1995.

-        In March 1996, the Company announced three new products, Genisys(R),
         the FDM(R) 1650, and the FDM(R) 8000, each of which is oriented to
         separate stages of a customer's product development cycle. Shipments of
         the FDM(R) 1650 began in March 1996 and shipments of Genisys(R) began
         in June 1996. Shipments of the FDM(R) 8000 began in the first quarter
         of 1997.

-        In March 1997, the Company announced the FDM(R) 2000, an enhanced
         version of the Company's FDM(R) 1650. The Company began shipping the
         FDM(R) 2000 in the first quarter of 1997.

-        In November 1997, the Company announced that the United States Food and
         Drug Administration granted 510(k) clearance for the Company's
         MedModeler system, a rapid prototyping system designed for the medical
         market for anatomical part output from MRI and CT scans.

-        In January 1998, the Company introduced the FDM(R) Quantum, which
         offers large modeling capabilities (second largest build envelope in
         the industry) combined with significant speed and performance
         enhancements as compared with the FDM(R) 2000. This product
         incorporates the new MagnaDrive technology that allows the extrusion
         heads to move on a bed of air while controlled by electro-magnetic
         homing devices. Commercial shipments commenced in the first quarter of
         1998.

-        In January 1999, the Company announced the December 1998 acquisition 
         of rapid prototyping technology consisting of technological assets, 
         including software, documentation and know-how, and tangible personal 
         property,including machinery, equipment, and components of the rapid 
         prototyping technology. The Company paid the seller approximately 
         $5,946,000 in cash for this technology and issued the seller's members
         warrants to purchase 128,000 shares of the Company's common stock 
         exercisable at $13.875 per share. The Company also paid the seller 
         $519,000 in early 1999 for invoiced development work with respect to 
         the technology.


BUSINESS OF THE COMPANY

         The Company is a leader in the three dimensional ("3D") imaging
business, which is referred to as "rapid prototyping". The Company develops,
manufactures and markets a family of rapid prototyping devices that enable
engineers and designers to create physical models, tooling and prototypes out of
plastic and other materials directly from a computer aided design ("CAD")
workstation. In many industries, the models and prototypes
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required in product development are produced laboriously by hand-sculpting or
machining, a traditional process that can take days or weeks. The Company's
computerized modeling systems use its proprietary technology to make models and
prototypes more directly from a designer's three-dimensional CAD in a matter of
hours.

         The Company believes that the RP systems using its patented fused
deposition modeling ("FDM(R)") technology and new Genisys(R) technology are the
only rapid prototyping systems commercially available that can produce parts
from plastic without relying on lasers. This affords the Company a number of
significant advantages over other commercially available three-dimensional rapid
prototyping technologies, which primarily rely on lasers to create models. Such
benefits include:

-        the ability to use the device in an office environment due to the
         absence of hazardous emissions

-        the need for relatively little set up of the system for a particular
         project

-        the availability of a variety of modeling materials

-        the lack of any need for costly replacement lasers and laser parts

The Company's systems can also run virtually unattended, producing models while
designers perform other tasks.

         The process involved in the development of a three-dimensional model
using the Company's FDM(R) systems begins with the creation of a conceptual
geometric model on a CAD workstation. The model is then imported into the
Company's proprietary QuickSlice(R) software program, which mathematically
slices the conceptual model into horizontal layers that are downloaded into the
system. These rapid prototyping machines basically draw cross-sections of the
model one layer at a time to create a three-dimensional "blueprint." A spool of
thin thermoplastic modeling material feeds into a moving FDM(R) extruding head,
which heats the material to a semi-liquid state. This semi-liquid material is
then extruded and deposited in ultra-thin flat layers on a base (the "X-Y
Stage") in the modeling chamber. As the material is directed into place by the
computer-controlled head, layer upon layer, the material solidifies, creating a
precise and strong laminated model.

         The Genisys(R) modeling process is similar. Genisys(R) uses Company's
proprietary AutoGen(R) software to slice the conceptual model created on a CAD
workstation into horizontal layers that are downloaded into Genisys(R).
Genisys(R) then uses wafers of polyester modeling material, rather than spools
of filament, to feed the extrusion head. The extrusion head heats these wafers
and, using a precision hydraulic conical pump, deposits a continuous layer of
plastic polymer beads (much like squeezing toothpaste from a tube) onto the X-Y
Stage to create a three-dimensional model by building up layers. In comparison
to the FDM(R) systems, due to its size, Genisys(R) allows the prototype to be
created on a desktop, directly from a workstation, like a 3D printer.

Products

         Modeling Equipment. The Company has been developing and improving its
line of rapid prototyping products since its inception in 1989. Since that time,
the Company has developed and sold systems including the 3D-Modeler, a smaller
benchtop version of the 3D-Modeler called the FDM(R) 1500 Benchtop, introduced
in June 1993; an improved benchtop modeler called the FDM(R) 1600 Benchtop,
introduced in November 1994; the Company's Protoslice operating software
package; its successors, QuickSlice(R) and AutoGen(R); and in some cases, a CAD
workstation manufactured by SGI. The FDM(R) 1600 Benchtop offered customers more
features than its predecessor, the FDM(R) 1500, including dual heads. As such,
it had increased hardware and software performance. Although the Company has
discontinued sales of the 3D Modeler, the FDM(R) 1500, SGI workstations and the
FDM(R) 1600, it continues to support and manufacture modeling materials for
these systems. In addition, the Company no longer sells ProtoSlice, the
predecessor to QuickSlice(R).

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         In March 1996, the Company introduced three new rapid prototyping
machines for commercial sale. Genisys(R) is a 3D desktop printer, which uses the
rapid prototyping technology developed by IBM that the Company purchased in
1995. It is useful for the production of conceptual models employed in the early
stages of the design cycle, as it enables a designer to produce concept
iterations at his desk directly from a workstation in a simple push-button
fashion. The FDM(R) 1650 Benchtop can produce functional prototypes at higher
speeds than those of its predecessor, the FDM(R) 1600 Benchtop, and can
accommodate a variety of engineering modeling materials. The third product, the
FDM(R) 8000, is a rapid prototyping device that incorporates QuickSlice(R)
software and the filament extrusion method of the Company's FDM(R) products. It
is capable of building prototypes up to 24 inches in size with throughput
comparable to the Stratasys FDM(R) 2000 described below. The FDM(R) 8000 builds
prototype parts using ABS plastics. Distribution of the FDM(R) 1650 Benchtop
system began in March and the Genisys(R) system in June 1996, while shipment of
the FDM(R) 8000 began in the first quarter of 1997.

         The Company announced the FDM(R) 2000 in March 1997. It is an enhanced
version of the FDM(R) 1650, but features a 30% to 40% throughput improvement
over the FDM(R) 1650. Upgraded hardware and software accounts for the improved
performance features. The Company began shipping the FDM(R) 2000 in the first
quarter of 1997. In November 1997, the Company announced that its MedModeler
rapid prototyping system had been granted 510(k) pre-market clearance from the
FDA. The MedModeler is a Benchtop rapid prototyping system designed for the
medical market that creates anatomical part output from computed tomography
("CT") and magnetic resonance imaging ("MRI") devices.

         In January 1998, the Company announced the FDM(R) Quantum. This system
features the second largest build envelope in the industry and incorporates the
newly-developed MagnaDrive technology. The MagnaDrive technology, which allows
the extrusion head to float on a bed of air while being controlled through
electromagnetic devices, offers significant speed and performance enhancements
as compared with the FDM(R) 2000. Commercial shipments of the Quantum commenced
in the first quarter of 1998.

         The Company's family of rapid prototyping systems offers product
designers and developers the ability to create prototypes throughout all stages
of the development cycle as well as a wide range of prices from which to choose.
The domestic list prices of the Company's systems range from $45,000 for
Genisys(R) and reach $325,000 for the Quantum FDM(R). By comparison, the
Company's original 3D Modeler sold for between $150,000 and $180,000. The
Company also offers special pricing for trade-in systems and upgrades. Customers
have the option to purchase an entire rapid prototyping system from the Company
or to buy individual components.

         Modeling Material. FDM(R) technology allows the use of a greater
variety of modeling materials and colors than other technologies. The Company
continues to develop filament modeling materials that meet the customers' needs
for increased speed, strength, accuracy, surface resolution and color. These
materials are processed into its patented filament form, which is then fed into
the FDM(R) systems. The Company's spool-based system has proven to be a
significant advantage for its products over Ultra Violet ("UV") polymer systems,
because the Company's system allows the user to quickly change material by
simply mounting the spool and threading the desired material into the FDM(R)
devices. Spools weigh from 2.3 pounds to ten pounds, and the creation of a model
may require from 0.1 pound to more than one pound of filament. The spool-based
system also compares favorably with UV polymer system because the spool-based
system allows the customer to use the system in an office environment and to
purchase a single spool, as compared to an entire vat of UV polymer, thereby
reducing the customer's up-front costs.

         Currently, the Company has five modeling materials commercially
available for use with its FDM(R) technology:

-        an elastomer material for applications requiring strength, durability
         and flexibility, as used in seals or tubing

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-        an investment casting wax

-        the hard polymer material ABS (named for its three initial monomers,
         acrylonitrile, butadiene and styrene), which is used commercially to
         make products such as telephones

-        a medical grade ABS (MABS), used for medical applications

-        a release material, which is used for support and removed from the
         final model

Each material has specific characteristics that make it appropriate for various
applications. The ability to use different materials allows the user to match
the material to the end use application of the prototype, whether it is a
pattern for tooling or a concept model.

         Genisys uses only one type of modeling material, a plastic polymer,
which is manufactured in the form of wafers. A total of 50 wafers are held in a
cassette, which allows the wafers to be fed into the machine and rapidly
extruded in layers. Additional cassettes are easily loaded into the system. Each
cassette contains a memory chip that instructs the system as to the parameters
and melt temperature of the material lot, which optimizes the automatic build
process of the Genisys(R) system.

         The modeling filament and wafers are consumable products that provide
additional revenue for the Company.

Operating Software

         The Company offers two proprietary software products: QuickSlice(R) and
AutoGen(R). QuickSlice(R) processes three-dimensional computer models to
generate operating data for the Company's FDM(R) 1650, 2000, 8000 and Quantum(R)
products. AutoGen(R) performs the same function for the Company's Genisys(R) 3-D
Printer. The Company has retained copyrights and all other ownership rights for
AutoGen(R) and QuickSlice(R).

         QuickSlice(R) is an interactive software product giving users choices
ranging from semi-automatic operations to a feature-rich array of options and
controls. QuickSlice was originally priced at $7,000.

         In 1994, the Company developed SupportWorks(R), which is used in
conjunction with QuickSlice(R) to automatically generate support structures,
thereby eliminating a time-consuming manual step in the modeling process.
SupportWorks was originally priced at $6,000. In 1995, the Company integrated
SupportWorks(R) into QuickSlice(R), which is currently priced at $15,000.

         AutoGen is an easy-to-use software product, giving users semi-automatic
operation for the Company's Genisys(R) 3-D Printer. AutoGen is able to choose
most options and settings for the user, saving significant operator labor time.
AutoGen(R) is included in the Genisys(R) sales price.

Applications of Rapid Prototyping

         Rapid prototyping systems enable engineers and designers to produce
models of their engineering designs faster and cheaper than with conventional
manual methods. Most companies use rapid prototyping to accelerate new product
development and improve time to market. The prototypes themselves are used to
test a product's or assembly's form, function and fit to specific tolerances.
Companies also use 3D models for tooling as final patterns for a variety of
tooling procedures. In addition, several domestic and international
manufacturers produce one-of-a- kind orthopedic implants for patients using CT
scanning and wax investment casting masters produced with the Company's
MedModeler FDM(R) systems.

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Potential Future Applications

         The Company has positioned its products to be used as devices that
support CAD systems in a variety of design and manufacturing industries. Current
applications include:


         -     automotive                    -     electronics

         -     aerospace                     -     medical

         -     consumer products


The Company's systems are also used in service bureaus and educational
institutions. Additional future applications include:

         -     conceptual design             -     architectural design

         -     casting                       -     rapid manufacturing of small-
                                                   volume custom parts

         -     precision prototypes          -     fit, form and function 
                                                   testing, secondary tooling,
                                                   and mold-making

         -     consumer packaging

         Among potential medical applications, rapid prototyping is being used
to produce accurate models of internal organs, bones or skulls for pre-operative
evaluations or modeling of prostheses. In such uses, the Company's products
could serve as peripheral devices for CT and MRI devices.


Marketing, Distribution and Customers

         The strategic focus of the Company's marketing efforts begins with
identifying the needs of product managers, conceptual designers, design and
manufacturing engineers and production specialists in manufacturing and design
companies. The Company then seeks to understand a customer's needs and
requirements. To satisfy those needs, the Company offers a broad array of
products, ranging from the low cost, easy-to-use Genisys 3D Printer, to the
large-scale, fast and precise FDM(R) Quantum. The Company has sold systems to,
the following representative customers.

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                            REPRESENTATIVE CUSTOMERS


-        General Motors
         Corporation

-        Ford Motor Company

-        Chrysler Corporation

-        Lockheed Martin

-        Square D Company

-        Whirlpool Corporation

-        Callaway Golf

-        Snap-On Tools
         Corporation

-        Xerox

-        Biomet, Inc.

-        St. Jude Medical

-        Motorola

-        Eastman Kodak
         Company

-        Marubeni

-        Hewlett-Packard

-        Brooks Air Force Base

-        Westinghouse Electric
         Corporation

-        Lego

-        Federal Bureau of
         Investigation

-        NASA


         It has also sold systems to service bureaus, universities and
distributors in the United States and abroad. The Company sells both complete
rapid prototyping systems and separate components.

         The Company uses a variety of tactical marketing methods to reach
potential customers, including Web- based marketing, press releases, trade
magazine articles, customer studies, brochures, direct mailings, telemarketing
programs, trade show demonstrations, videos and a Web site (www.Stratasys.com).
In addition, the Company has developed domestic and international on-site
demonstration capabilities.

         Domestically, the Company sells directly to its customers. In 1997, the
Company organized its domestic FDM(R) sales force into three regions.
Salespersons and management reside in the regions they service. In addition,
Genisys(R) resellers have been assigned to managers within this regional
framework. The Company markets internationally through a network of distributors
and sales representatives. During the years ended December 31, 1998 and 1997,
export sales amounted to approximately $14,018,400 and $12,639,000,
respectively.

          No customer accounted for more than 10% of sales in 1998 or 1997.

Warranty and Service

         The Company provides a 90-day warranty on its systems sold domestically
and a one-year warranty on those sold internationally. In addition, the Company
offers annual service and maintenance contracts for its systems. The service
contracts include updates of the Company's software systems. Annual service
contracts for the Company's FDM(R) systems are priced from $10,000 to $32,000,
while annual service contracts for the Genisys(R) system are priced from $6,000
to $10,000.

Manufacturing

         The Company's manufacturing process consists of the manual assembly of
purchased components. The Company obtains all parts used in the manufacturing
process either from distributors of standard electrical or 

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mechanical parts or from custom fabricators of the Company's proprietary
designs. The Company currently operates on a build-to-inventory basis.

         The Company purchases the major component parts for its FDM(R) and
Genisys(R) systems from various outside vendors, subcontractors and other
sources and assembles them at its Minnesota facility. The Company performs
numerous diagnostic tests and quality control procedures throughout the assembly
process in order to assure reliability of its products. Prior to shipment, each
unit is subjected to a test and burn-in procedure to check for defects.
Precision modeling parameters are also checked.

         The Company maintains an inventory of most of its necessary supplies,
which facilitates the assembly of products required for production. The
Company's sole current supplier of the X-Y Stage for the FDM(R) 1650, FDM(R)
2000 and FDM(R) 8000 Benchtop systems is Asymtek; and its sole current supplier
of the FDM(R) head motors is MircoMo Electronics, Inc. The Company also has sole
suppliers for two key components of its new FDM(R) Quantum system. The Company
considers all of these suppliers to be reliable. Nevertheless, the Company
maintains an inventory of such components to support continued supply.
Furthermore, the Company believes that the supplier of the X-Y Stage could be
replaced by in-house design and production of the part within a three-month
period, if necessary; and the Company could employ FDM(R) head motors from other
suppliers by modifications to the design of the FDM(R) 1650 and 2000 Benchtops
and FDM(R) 8000. In-house development to replace the vendors of the Quantum(R)
components would take four to eighteen months to accomplish. In regard to other
parts and materials, the Company uses multiple sources of supply and does not
believe that it is dependent on any single supplier. Although the Company
believes that it maintains adequate inventories of vendor-specific materials,
the loss of a supplier of such vendor-specific materials or compounds could
result in a delay in the manufacture and delivery of those materials and
compounds resulting from the need to retest and recertify products supplied by
one or more new vendors. The Company considers its relationships with its
suppliers to be good.

Research and Development

         The Company has devoted significant time and resources to the
development of a universally compatible and user-friendly software system. The
Company believes that ongoing research and development efforts are essential to
its continued success. Accordingly, the Company's engineering development
efforts will continue to focus on improvements to the FDM(R) and Genisys(R)
technology and development of new modeling processes, materials, software and
products. To date, much of the Company's activity has been focused on research
and development. For the years ended December 31, 1998 and 1997, the Company's
research and development expenses, excluding the non-recurring charge for
purchase of in-process engineering, were approximately $5,944,000 and
$5,055,000.

         The Company's filament development and production operation is located
at its facility in Eden Prairie, Minnesota. The Company regards the filament
formulation and manufacturing process as a trade secret, and the Company holds
patent claims on filament usage in its products.

Intellectual Property

         The Company considers its proprietary technology to be material to the
development, manufacture, and sale of its products and seeks to protect its
technology through a combination of patents and confidentiality agreements with
its employees and others. Scott Crump, the Company's President, was granted two
U.S. patents that cover many claims relating to various aspects of its products,
FDM(R) technology and the associated modeling process. The term of one patent
lasts until June 9, 2009, and the term of the other lasts until August 23, 2011.
The patents have been assigned to the Company. In addition, other employees of
the Company have assigned to the Company patents and patent applications for
other rapid prototyping processes and apparatuses associated with the FDM(R)
process. As part of its purchase of rapid prototyping technology assets from
IBM, the Company was also assigned the rights and title to three patents
developed by IBM, which cover the Genisys(R) system and which

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the Company believes will further augment its own product lines. The Company
recorded these patents domestically and is in the process of recording them in
certain foreign countries. The terms of these patents extend until June 7, 2005,
April 12, 2011, and May 17, 2011. In total, the Company currently owns eleven
primary U.S. patents.

         Corresponding patent applications covering the same claims that are
contained in the Company's issued patents have been initiated in various foreign
countries. Other foreign patent applications have also been filed, including the
patent applications assigned to the Company by IBM. The Company's registered
trademarks include:

                              REGISTERED TRADEMARKS


-        Stratasys, Inc.

-        3D Modeler

-        QuickSlice

-        3D Plotter

-        3D Visualizer

-        FDM

-        Genisys

-        AutoGen

-        3D Visualizer

-        FD

-        FDMM

-        FDC

-        BMD


Each of the registered trademarks has a duration of 10 years and may be renewed
every 10 years while it is in use. Trademark applications have also been filed
in Japan and the European Community.

Competition

         The Company competes in a marketplace that is still dominated by
conventional methods of model-making and prototype development. Machinists and
engineers working from blueprints or CAD files and using machining or by-hand
methods generally perform the prototype development and fabrication. The Company
believes that there is currently no other commercial producer of 3D modeling
devices that uses a single-step, non-toxic technology similar to the Company's
FDM(R) and Genisys(R) technologies. Most other rapid prototyping or 3D printing
systems involve an additional post-processing step, such as curing the part
after construction of the model or prototype. The Company's FDM(R) and
Genisys(R) technologies do not rely on the laser or light technology used by
many other commercial manufacturers in the rapid prototyping industry.

         The Company's competitors employ a number of different technologies in
their rapid prototyping devices. 3D Systems, D-MEC, Mitsui and Teijin Seiki Co.
use stereolithography in their products. 3D Systems, in which Ciba-Geigy has a
substantial interest, introduced the first rapid prototyping product. The
Company believes that 3D Systems accounts for approximately 28% of sales of
rapid prototyping units to date. DTM Corporation produces machines that use
lasers to sinter or harden powdered material. Helisys, Inc. utilizes lasers to
cut and laminate sheets of materials, such as paper. The Company believes that
its FDM(R) and Genisys(R) technologies have important advantages over the
products of these companies. These advantages include:

-        the ability to be used in an office environment

-        the availability of multiple modeling materials

-        a one-step process

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<PAGE>   10
Sanders Prototype, Inc. and 3D Systems have developed prototyping systems that
use ink-jet technology to deposit wax material layer by layer, which can be used
in an office environment. A smoothing or milling process is required between
each deposited layer to maintain accuracy in these processes. Certain of the
Company's competitors have greater financial and marketing resources than the
Company.

         The Company believes that in 1998 it sold more units than any other
rapid prototyping company and was the second largest RP company in revenue.
According to a March 1998 report by Wohlers Associates, Inc., the Company was
the second largest rapid prototyping vendor in the world in terms of both
revenue and units shipped in 1997.

Employees

         As of March 12, 1999, the Company had 178 full-time employees and 16
subcontractors or temporary employees. While the Company has separate internal
departments, such as manufacturing, marketing, engineering and sales, many
employees perform overlapping functions within the organization. No employee is
represented by a union, and the Company has not experienced a work stoppage. The
Company believes its employee relations are good.

Governmental Regulation

             General

         The Company is subject to various local, state and federal laws,
regulations and agencies that affect businesses generally. These include:

-        regulations promulgated by federal and state environmental and health
         agencies

-        the federal Occupational Safety and Health Administration

-        laws pertaining to the hiring, treatment, safety and discharge of
         employees

         FDA Regulation

            The FDA has the authority to regulate the preclinical and clinical
testing, manufacture, labeling, distribution, and promotion of the Company's
MedModeler FDM(R) system as a Class II medical device under the Federal Food,
Drug, and Cosmetic Act of 1976. Before a new device can be introduced into the
market, the manufacturer must generally obtain prior FDA permission to market it
through either clearance of a 510(k) notification to the FDA or approval of a
pre-market application ("PMA"). The FDA will grant a 510(k) clearance if the
submitted information establishes that the proposed device is "substantially
equivalent" to a legally marketed Class I or II medical device or to a Class III
medical device for which the FDA has not called for PMA's. After a device
receives 510(k) clearance from the FDA, any modification that could
significantly affect its safety or effectiveness, or would constitute a major
change in the intended use of the device, will require a new 510(k) submission.

             In November 1997, the Company announced that the FDA granted the
MedModeler FDM(R) system 510(k) clearance. The Company has subsequently made
modifications to the MedModeler, which it believes do not require the submission
of a new 510(k) notification. There can be no assurance, however, that the FDA
would agree with the determination by the Company not to submit, or would not
require the Company to submit, a new 510(k) notification for any of these
changes. If the FDA requires the Company to submit a new 510(k) notification for
any device modification, the Company may be prohibited from marketing the
modified device until the 510(k) notification is cleared by the FDA.

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         The MedModeler and any other medical devices manufactured or
distributed by the Company will be subject to pervasive and continuing
regulation by the FDA. The Company's manufacturing facility will be subject to
inspection by the FDA to assure compliance with its Quality System Regulation
("QSR"), which imposes testing, control, documentation and other quality
assurance procedures. In addition, the Company will be subject to other
regulatory requirements that usually apply to medical devices marketed in the
United States, including :

-            labeling regulations

-            Medical Device Reporting ("MDR") regulations which require that a
             manufacturer report to the FDA certain types of adverse events
             involving its products

-            the FDA's prohibitions against promoting products for unapproved or
             "off-label" uses

In addition, Class II devices can be subject to additional special controls that
do not apply to Class I devices, such as performance standards, postmarket
surveillance, patient registries, and FDA guidelines. Failure to comply with
applicable requirements could result in FDA enforcement action, including, among
other things:

-            fines

-            injunctions

-            civil penalties

-            refusal to grant pre-market clearances or approvals

-            recall or seizure of the products

-            withdrawal of marketing approvals

-            criminal prosecution recall or seizure of the products


Although the Company believes that any such enforcement action would not have a
material adverse effect on the Company's ability to market its products other
than as medical devices, any such enforcement action could have a material
adverse effect on its ability to market the MedModeler FDM(R) system

             The MedModeler FDM(R) system may be subject in certain instances to
regulation by foreign regulatory authorities to the extent that the Company
seeks to market it outside the United States.


ITEM 2.     PROPERTIES.

            The Company's executive offices and production facilities presently
occupy approximately 87,156 square feet in two adjacent buildings in Eden
Prairie, Minnesota, near Minneapolis. The Company occupies a 27,756 square foot
facility under a lease that was to expire on July 31, 1999. In July 1998, the
Company extended this lease until July 31, 2002. In October 1996, the Company
leased an additional 59,400 square feet of office and production space in a
building adjacent to its original Eden Prairie premises under a lease expiring
in October 1999. Approximately 40% of the new premises will be sublet until
needed by the Company. The Minnesota facilities are used for machine assembly
and filament production, as well as sales, administration and operations. The
current monthly rent for the premises occupied by the Company total
approximately $36,600. The Company does not require a large space for
production, because it assembles its devices from sub-assemblies manufactured by
outside vendors.

                                       10
<PAGE>   12
            The Company opened two regional sales offices in 1997. In June 1997,
the Company entered into a three year lease to occupy 1,912 square feet of space
in Southfield, Michigan, a suburb of Detroit. This lease expires in May 2000,
with monthly rent of approximately $3,019. In September 1997, the Company
entered into a three-year lease to occupy 2,504 square feet of space in Ontario,
California. The lease expires in May 2000, with base monthly rent of
approximately $3,005. The Company is also responsible for real estate taxes,
insurance, utilities, trash removal and maintenance expenses at all of these
premises. In November 1997, the Company's German subsidiary entered into a lease
to occupy 4,360 square feet of space in Frankfurt, Germany. The lease expires in
November 2001, with base monthly rent of approximately $6,100.


ITEM 3.     LEGAL PROCEEDINGS.

            The Company is not a party to any pending legal or administrative
proceeding, and its property is not subject to any such proceeding, other than
actions arising in the ordinary course of the Company's business, which the
Company believes are not material.


ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS.

            No matter was submitted to a vote of Stockholders, through the
solicitation of proxies or otherwise, during the fourth quarter of the fiscal
year ended December 31, 1998.

                                       11
<PAGE>   13
                                     PART II

ITEM 5.     MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

MARKET INFORMATION

            The Company's common stock is quoted on the National Association of
Securities Dealers, Inc. Automated Quotation System National Market ("Nasdaq")
under the symbol SSYS and is traded on The Pacific Stock Exchange Incorporated
under the symbol SAS.

            The following table sets forth the high and low closing bid prices
of the Company's common stock for each quarter from January 1, 1997 through the
fiscal year ended December 31, 1998.

<TABLE>
<CAPTION>
                                                                      High             Low 
Fiscal Year Ended December 31, 1998                                      Bid Prices ($)
-----------------------------------                                      --------------
<S>                                                                  <C>             <C>
January 1, 1998 - March 31, 1998                                      13.50           7.385
April 1, 1998 - June 30, 19986                                        12.125          7.875
July 1, 1998 - September 30, 1998                                      8.688          5.125
October 1, 1998 - December 31, 1998                                    7.438          4.50


Fiscal Year Ended December 31, 1997
-----------------------------------
January 1, 1997 - March 31, 1997                                      23.00          16.625
April 1, 1997 - June 30, 1997                                         25.75          15.00
July 1, 1997 - September 30, 1997                                     18.00          13.00
October 1, 1997 - December 31, 1997                                   17.75          10.25
</TABLE>


             There were approximately 156 stockholders of record of the
Company's common stock as of March 18, 1999.

DIVIDENDS

             The Company has not paid or declared any cash dividends to date and
does not anticipate paying any in the foreseeable future. The Company intends to
retain earnings, if any, to support the growth of the Company's business.


RECENT SALES OF UNREGISTERED SECURITIES

             In November 1998, the Company issued warrants to purchase 20,000
shares of its common stock, exercisable at $5.00 per share and expiring in
November 2002, to the Company's investors relations firm in connection with
services rendered by that firm. The Company relied upon Section 4(2) promulgated
under the Securities Act of 1933, as amended (the "Securities Act"), for the
exemption from registration under the Securities Act in connection with the
issuance of the warrants.

             In November 1998, the Company issued warrants to purchase 6,000
sharers of its common stock, exercisable at $5.00 per share and expiring in
November 2004, to an employee of a company developing technology on behalf of
the Company as an incentive. The Company relied upon Section 4(2) promulgated
under 

                                       12
<PAGE>   14
the Securities Act for the exemption from registration under the Securities Act
in connection with the issuance of the warrants.

             Under a Technology Sale and Assignment Agreement, dated as of
December 21, 1998, the Company agreed to issue warrants to purchase 128,000
shares of its common stock to members of the seller, as partial consideration
for the in-process rapid prototyping engineering sold under this Agreement. Each
of the seller's members represented that it was an accredited investor under
Regulation D. The Company issued the warrants on January 4, 1999. The Company
relied upon Section 4(2) promulgated under the Securities Act for the exemption
from registration under the Securities Act in connection with the issuance of
the warrants.


ITEM 6.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND
           RESULTS OF OPERATIONS

GENERAL

          The Company develops, manufactures, and markets a family of rapid
prototyping devices that enable engineers and designers to create physical
models, tooling and prototypes out of plastic and other materials directly from
a computer aided design ("CAD") workstation. Historically, the Company's growth
has come from sales to a number of industries, including automotive, consumer
products, electronics, medical, and aerospace. Universities, other educational
institutions, and service bureaus have also been significant markets for the
Company. The Company's current and future growth is largely dependent upon its
ability to penetrate new markets, and develop and market new rapid prototyping
devices and applications that meet the needs of its current and prospective
customers. New product developments will focus on various rapid prototyping
devices, modeling materials, and software enhancements. The Company anticipates
that in 1999 its primary business strategy will focus on expanding international
and domestic sales of its existing family of rapid prototyping devices, while
maintaining on-going development of new rapid prototyping equipment, modeling
materials, and software. In addition, the Company expects to incur expenditures
throughout 1999 for the development of the technology it purchased in December
1998. The Company does not expect to commercialize this technology until the
latter part of 1999. The Company can give no assurances that it will
successfully develop this technology or that it will avoid developmental delays
that could negatively impact the commercialization of this technology.

          In February 1998 the Company introduced the FDM(R) Quantum. The
Quantum incorporates a new technology called the MagnaDrive(TM) system. This
system offers frictionless movement of its extrusion head that floats on a bed
of air while controlled through a precise electromagnetic homing device. The
Quantum offers a large-build envelope combined with throughput improvements that
offer faster model build times. The Company has continued to market the FDM(R)
8000, its first large envelope system. Continuing software and hardware
enhancements to improve the performance, throughput, and capabilities of the
Company's products have also been introduced.

          Net revenue derived from sales of the Company's rapid prototyping
devices, modeling materials, and maintenance has increased each year since 1990.
Management expects, but cannot assure, that this trend will continue. The
Company believes that it shipped more rapid prototyping systems than any of its
competitors in 1998, and that it recorded the second highest revenues within the
industry in 1998. It can give no assurances, however, that this trend will
continue. The Company's operating income, excluding the non-recurring charge in
the fourth quarter of 1998 for the purchase of in-process research and
development, declined in 1998 as compared with 1997, in spite of the 9.5%
revenue growth. The Company significantly expanded its expenditures on research
and development ("R&D") for both new products and sustaining engineering. R&D as
a percentage of sales increased to 18.3% in 1998 as compared to 17.1% in 1997.
While Selling, General and Administrative ("SG&A") expenses increased by 4.4% in
1998 as compared with 1997, this growth was considerably less than the revenue
growth of the Company. Much of the SG&A increase was due to the full year
operation of the Company's sales offices in Michigan, California and Germany.
The Company's headcount expanded from 177 employees and contractors at the end
of 1997 to 194 employees and contractors at the end of 1998. The majority

                                       13
<PAGE>   15
of these additions were in the sales and engineering departments. Future
profitability of the Company will be dependent upon the Company's ability to
control its operating expenses while increasing revenues. The Company does not
believe that meaningful improvements to its gross margins are achievable, and
gross margins could possibly decline in the event that significant price
competition emerges within the industry or if the Company's product mix were to
change dramatically. While the Company believes that profitability will improve
in 1999 as compared with 1998 as a result of operating expense control, it can
give no assurance that these results will be realized.

          The Company believes that the rapid prototyping industry is growing at
approximately 10-15% per year. It believes that there is a trend toward lower
priced rapid prototyping systems capable of producing functional prototypes, and
that a sizable market exists for concept or visualization 3D printers. This
pricing trend should lead to growth in the more traditional functional
prototyping marketplace as companies continue to address in-house rapid
prototyping and concept-modeling needs. Certain market segments in the industry
have not demonstrated pricing sensitivity. These segments are more interested in
modeling envelope size, modeling material variety, throughput, and part quality,
which should allow growth to continue for higher priced rapid prototyping
systems addressing these needs.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997

          The following table sets forth certain statement of operations data as
a percentage of net sales for the periods indicated. All items are included in
or derived from the Company's statement of income.

<TABLE>
<CAPTION>
                                                              For the years ended December 31,
                                                                  1998                 1997
<S>                                                           <C>                  <C>
         Net sales                                               100.0%               100.0%
         Cost of sales                                            34.2 %               32.7%
         Gross margin                                             65.8 %               67.3%
         Selling, general, and administrative expenses            47.2%                49.5%
         Purchased in-process research and development            20.1%                 0.0%
         Research & development expense                           18.3%                17.1%
         Operating income (loss)                                 (19.8%)                 .7%
         Other income                                              2.3%                 1.5%
         Income (loss) before taxes                              (17.6%)                2.2%
         Income taxes (benefit)                                   (7.3%)                 .4%
         Net income (loss)                                       (10.2%)                1.7%
</TABLE>

NET SALES

          Net sales for the year ended December 31, 1998 were $32,437,198,
compared with sales of $29,636,370 for the year ended December 31, 1997. This
represents an increase of $2,800,828, or 9.5%. Sales of the FDM Quantum were
strong throughout the year, following its introduction in the first quarter of
1998. The Company's FDM Benchtop systems, including refurbished and upgraded
systems, continued to account for a majority of the Company's revenue in the
year ended December 31, 1998. Gensiys systems, consumable, and maintenance
revenue increased significantly in the twelve months ended December 31, 1998 as
compared with the comparable 1997 period. Maintenance and materials revenues
were enhanced by the larger installed base of systems, customer satisfaction
with ABS and other material selections, and increased emphasis on the sale of
maintenance contracts.

                                       14
<PAGE>   16
          The Company booked 270 orders for new systems and sold 262 systems in
1998. System sales in 1998 included gross sales of all systems, including
trade-in and upgrade systems. Consumable and maintenance revenue increased by
approximately 64% in 1998 as compared with 1997, and continued to constitute one
of the fastest growing components of the Company's revenue mix. The Company
ended 1998 with an order backlog of approximately $3,500,000 compared with an
order backlog of approximately $1,000,000 at December 31,1997. The 1998 backlog
is the highest in the Company's history.

          Domestic sales accounted for approximately 57% of total revenue, which
equals the 57% recorded in 1997. In the United States, the eastern and central
regions recorded the most revenue, while the western region was weak. Europe
accounted for approximately 19% of total revenue in 1998, down from 20% of 1997
revenue. The Company's combined Asia-Pacific region, which comprises Japan,
China, the Far East and India, accounted for approximately 22% of total revenue,
up from the 20% attained in 1997. Historically, the Company has derived a larger
percentage of its revenues from Europe as well as countries other than Japan in
the Asia-Pacific region. The Company believes that 1999 sales into the Asia
Pacific countries that have been most impacted by the recent currency and
economic turbulence will be weak. These countries include Singapore, Thailand,
Indonesia, and Malaysia. Sales in the remainder of the Asia Pacific countries
are expected to remain strong in 1999, while sales into Europe are expected to
improve as well. No assurances, however, can be given that future sales and
profitability will not be adversely impacted by the economic conditions of these
regions.

GROSS PROFIT

          Gross profit increased to $21,347,127, or 65.8% of sales, in the year
ended December 31, 1998, compared with $19,939,905, or 67.3% of sales, in the
year ended December 31, 1997, an improvement of $1,407,222, or 7.1%. Gross
profit increased due to higher sales volume, with a significant contribution
from sales of the Company's Quantum systems. Gross profit was negatively
impacted by higher material cost of goods sold that primarily resulted from
changes in the Company's product mix.

OPERATING EXPENSES

          SG&A expenses increased to $15,319,918 for the year ended December 31,
1998, from $14,676,175 for the year ended December 31, 1997. This represents an
increase of $643,743, or 4.4%. Personnel expenses, primarily in the Company's
sales organization, and regional office expenses accounted for much of the
increase in 1998 as compared with 1997.

          R&D expenses, excluding the non-recurring charge for the purchase of
in-process research and development, increased to $5,943,926 for the year ended
December 31, 1998 from $5,054,767 for the year ended December 31, 1997. The
increase in 1998 over 1997 amounted to $889,159, or 17.6%. Payroll related
expenses, materials, and professional services accounted for much of the
increase in R&D expenses in 1998 as compared with 1997. The non-recurring
pre-tax charge for the purchase of in-process research and development amounted
to $6,512,665, and was expensed because of the risk associated with the
purchased research and development as well as the significant amount of
engineering resources that will be committed by the Company to commercialize
this technology.

          The Company's operating loss for the year ended December 31, 1998
amounted to $6,429,382, or 19.8% of sales, compared with operating income of
$208,963, or .7% of sales, for the year ended December 31, 1997. Without the
non-recurring charge, operating income would have been $83,283, or .3% of sales.

                                       15
<PAGE>   17
OTHER INCOME

          Other income and expense netted to $736,037 in 1998 compared with
$435,293 in 1997. Interest income amounted to $789,638, an increase of $292,825
compared with 1997. This was due to a higher average balance of cash and
marketable securities. Interest expense declined by $7,919 to $53,601 in 1997 as
the Company paid off various capitalized leases.

NET INCOME (LOSS)

          The net loss for 1998 amounted to $3,318,015 compared with net income
of $514,833 in 1997. This resulted in a loss per common and common equivalent
share of $.55, compared with income per common and common equivalent share
(diluted) of $.09 in the period ended December 31, 1997. Excluding the
non-recurring charge for the purchase of in-process research and development,
the Company's net income for the period ending December 31, 1998 would have been
approximately $533,000, which represents income per common and common equivalent
share (diluted) of $.09.

LIQUIDITY AND CAPITAL RESOURCES

          Operating activities during 1998 provided cash of $5,736,609,
primarily reflecting decreases in accounts receivable of $1,827,218 and
inventory of $456,542, combined with increases in the Company's accounts payable
and other current liabilities of $519,624. These changes resulted from a general
tightening of credit terms and increased focus on working capital management. In
addition, the Company's core business, excluding the non-recurring charge for
the purchase of in-process research and development, was profitable in 1998,
resulting in a profit of approximately $533,000. In 1997 the Company used cash
of $597,363 in its operating activities, principally as a result of increased
accounts receivable and inventories of $1,058,899 and $2,843,140, respectively,
combined with a reduction in accounts payable and other current liabilities of
$556,213. The use of cash in 1997 was partially offset by the Company's net
income of $514,833, coupled with increases in unearned maintenance revenues of
$1,344,226. The Company used $1,691,536 of cash in its 1998 investing
activities, including $1,190,567 used for the acquisition of property and
equipment, and $341,980 for payments for intangible assets. The Company used
$151,089 for net purchases of marketable securities in the same 1998 period. In
the 1997 period the Company used $185,049 of cash in its investing activities,
including $2,048,884 for the acquisition of property and equipment and $173,635
for payments for intangible assets, which was offset by net proceeds from the
sale of marketable securities of $2,131,527. In 1998, the Company's financing
activities used net cash of $1,891,103, which included $1,000,000 for the
repurchase of warrants and $781,927 for the purchase of treasury stock under its
stock buyback program. In 1997, financing activities provided net cash proceeds
of $5,933,676, $6,166,806 of which was generated from the sale of the Company's
common stock. The net increase in cash for the year ended December 31, 1998
amounted to $2,127,607 as compared with a net increase of $5,151,264 for the
comparable 1997 period. The Company's ending cash and cash equivalents balances
as of December 31, 1998 and 1997 were $11,243,839 and $9,116,232, respectively.

          At December 31, 1998, the Company's cash, cash equivalents, and
marketable securities balances totaled $15,837,749. In early 1999, the Company
paid approximately $6,500,000 in cash for the purchased in-process research and
development that was transferred in December 1998. The remainder of these assets
will be used by the Company for working capital purposes, for improvement to
facilities, for new product development and tooling, for acquisition of
production equipment and computers, for increased selling and marketing
activities, and for engineering costs required to develop and commercialize the
in-process research and development acquisition. Additionally, the Company may
continue its common stock buyback program. Management believes that the
Company's revenue from operations, its current cash and cash equivalents
balance, and the proceeds from the sale of short-term marketable securities
should provide sufficient cash resources to finance its operations for at least
24 months.

                                       16
<PAGE>   18
          The Company has historically been unable to finance its growth from
cash generated from operations. Furthermore, the Company's working capital
requirements may significantly increase if revenue growth slows, if R&D expenses
related to new product development accelerate, including development of the
in-process research and development that the Company recently acquired, or if
significant operating losses occur. No assurances can be given as to the
adequacy of the Company's working capital to support the Company's operations
following a period of losses. If the existing cash balances are insufficient or
if working capital requirements are greater than estimated, the Company could be
required to raise additional capital. There can be no assurance that the Company
will be able to raise additional capital or that the terms upon which such
capital will be available to the Company will be acceptable.

          As of December 31, 1998, the Company had gross accounts receivable of
$10,248,177, less an allowance of $409,341 for returns and doubtful accounts.
Historically, the Company's bad debt expense has been minimal. However, at
December 31, 1998, large balances were concentrated with certain international
distributors. While the Company can give no assurances, it believes that most,
if not all, the accounts receivable balances will ultimately be collected.

          The Company's total current assets amounted to $31,548,536 at December
31, 1998, the majority of which consisted of cash, cash equivalents, marketable
securities, inventories and accounts receivable. Total current liabilities
amounted to $12,893,772, $6,464,709 of which was for the purchased in-process
research and development payable. The Company's debt is minimal, consisting
primarily of principal payments due under capital leases of $370,996. The
Company estimates that it will spend approximately $1,600,000 in 1999 for
facility improvements, production and R&D equipment, computers and integrated
software, and tooling. As of December 31, 1998, material commitments for
inventory purchases from selected vendors for the ensuing twelve-month period
ending December 31, 1999 amount to approximately $2,000,000.

INFLATION

          Management believes that inflation has not had a material effect on
the Company's operations or on its financial condition.

FOREIGN CURRENCY TRANSACTIONS

          Substantially all of the Company's transactions are negotiated,
invoiced, and paid in US dollars. Fluctuations in the currency exchange rates in
other countries may therefore reduce the demand for the Company's products by
increasing the price of the Company's products in the currency of countries in
which the local currency has declined in value.

YEAR 2000 ISSUES

          The Company believes that its products are not "date-dependant" or
"date-aware", meaning they do not rely upon calendar dates for internal
operations or overall product functionality. Furthermore, the Company's products
do not pass dates onto other computers, as dates are only used for display
purposes. The Company defines Year 2000 compliance as the ability to function
properly without interruption before, during, and after January 1, 2000. The
Company believes that all its products, including its propriety software, meet
this definition of Year 2000 compliance. The Company's internal accounting and
manufacturing software was upgraded in 1998 to a version that the vendor has
represented to be Year 2000 compliant. The Company intends to test that software
during 1999. The Company is currently working with its vendors to determine
whether they are Year 2000 compliant. The Company may be required to change
vendors that are determined not to be in compliance. The Company's customers use
a variety of CAD packages and hardware platforms. Many of these customers will
be required to upgrade these CAD packages and operating systems to new versions
that are Year 2000 compliant in order to operate their systems. Those customers
and future customers that do not elect to upgrade their systems may be unable to
generate certain required files and thus use or purchase our products. This
could have the 

                                       17
<PAGE>   19
potential to reduce future revenue, although the Company believes that the
overall impact on revenue will not be material. The cost to the Company to
determine its Year 2000 compliance has not been material and has been included
in its operating results. The Company does not believe that future costs
associated with this issue will be material to its financial condition or its
results of operations.

FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS OF
OPERATIONS

          All statements herein that are not historical facts or that include
such words as expect, anticipate, project, estimates or believes or other
similar words are forward-looking statements deemed by the Company to be covered
by and to qualify for the safe harbor protection covered by the safe harbor
protection provided by the Private Securities Litigation Reform Act of 1995 (the
"1995 Act"). Investors and prospective investors in the Company should
understand that several factors govern whether any forward-looking statement
herein will be or can be achieved. Any one of these factors could cause actual
results to differ materially from those projected herein. These forward-looking
statements include the expected increases in net sales of rapid prototyping
systems and services, the ability of the Company to maintain its gross margins
on these sales, and the plans and objectives of management to introduce new
products, control expenses, improve profitability, and develop and commercialize
the purchased in-process technology. The forward-looking statements included
herein are based on current expectations that involve a number of risks and
uncertainties. These forward-looking statements are based on assumptions, among
others, that the Company (1) will be able to continue to introduce new rapid
prototyping systems acceptable to the market and improve existing technology and
software in its current product offering, including the Genisys rapid
prototyping system that has been especially affected by technological problems,
(2) will be able to maintain its gross margins on its present products, (3) will
be able to control its operating expenses, (4) will be able to retain and
recruit employees with the necessary skills to produce, develop, market, and
sell its products, and (5) will be able to further develop and commercialize the
purchased in-process research and development that the Company acquired in
December 1998. Assumptions relating to the foregoing involve judgments with
respect to, among other things, future economic, competitive, market and
technology conditions and future business decisions, all of which are difficult
or impossible to predict accurately and many of which are beyond the control of
the Company. Although the Company believes that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of those
assumptions could prove inaccurate, and therefore there is and can be no
assurance that the results contemplated in any such forward-looking statement
will be realized. The impact of actual experience and business developments may
cause the Company to alter its marketing plans, its capital expenditure budgets,
or its engineering, selling or other budgets, which may in turn affect the
Company's results of operations or the success of its engineering efforts. Due
to the factors noted above and elsewhere in the Management's Discussion and
Analysis of Financial Condition and Results of Operations, the Company's future
earnings and stock price may be subject to significant volatility, particularly
on a quarterly basis. Additionally, the Company may not learn of revenue or
earnings shortfalls until late in a fiscal quarter, since the Company frequently
receives the majority of its orders very late in a quarter. This could result in
an immediate and adverse effect on the trading price of the Company's common
stock. Past financial performance should not be considered a reliable indicator
of future performance, and investors should not use historical trends to
anticipate results or trends in future periods.

ITEM 7.   FINANCIAL STATEMENTS.

          This information that appears following Item 13 of this report and is
incorporated herein by reference.


ITEM 8.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
          FINANCIAL DISCLOSURE.

          The Company did not have any changes in or disagreements with its
accountants on accounting and financial disclosure.

                                       18
<PAGE>   20
                                    PART III

ITEM 9.   DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; 
          COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.

          Incorporated herein by reference to the Company's Definitive Proxy
Statement with respect to the Company's Annual Meeting of Stockholders scheduled
to be held May 11, 1999.


ITEM 10.   EXECUTIVE COMPENSATION.

          Incorporated herein by reference to the Company's Definitive Proxy
Statement with respect to the Company's Annual Meeting of Stockholders scheduled
to be held May 11, 1999.


ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

          Incorporated herein by reference to the Company's Definitive Proxy
Statement with respect to the Company's Annual Meeting of Stockholders scheduled
to be held May 11, 1999.


ITEM 12.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

          Incorporated herein by reference to the Company's Definitive Proxy
Statement with respect to the Company's Annual Meeting of Stockholders scheduled
to be held May 11, 1999.


ITEM 13.  EXHIBITS, LIST AND REPORTS ON FORM 8-K.

(a)       Exhibits

<TABLE>
<CAPTION>
Exhibit No.                Description
-----------                -----------
<S>               <C>
 3.1              Restated Certificate of Incorporation of the Company. (3)

 3.2              Amendment to Certificate of Incorporation of the Company. (6)

 3.3              By-Laws of the Company. (1)

 4.1              Agent's Warrant issued to R.J. Steichen & Company dated November 12, 1993. (1)

 4.2              Agent's Warrant issued to R.J. Steichen & Company dated December 13, 1993. (1)

 4.3              Form of Common Stock purchase warrants issued by the Company dated as of November 12,
                  1993 and December 13, 1993. (1)

 4.4              Form of Common Stock purchase warrant issued by the Company in its August 1995 private
                  placement (2).

 4.5              Form of 3-year Common Stock purchase warrants issued by the Company in its November 1995
                  offering under Regulation D and Regulation S. (5)
</TABLE>

                                       19
<PAGE>   21
<TABLE>
<CAPTION>
<S>               <C>
 4.6              Form of 3-month Common Stock purchase warrants issued by the Company in its November 1995
                  offering under Regulation D and Regulation S. (5)

 4.7              Form of Placement Agent's warrant issued by the Company in its November 1995 offering under
                  Regulation D and Regulation S. (5)

 4.8              Form of warrant issued to Sunrise Securities Corp. by the Company in connection with its
                  November 1995 offering under Regulation D and Regulation S. (5)

10.1              Non-Competition Agreement between the Company and S. Scott Crump, dated October 15, 1990.
                  (1)

10.2              Non-Competition Agreement between the Company and S. Lisa Crump, dated October 15, 1990.
                  (1)

10.3              Employee Confidentiality Agreement between the Company and S. Scott Crump, dated October
                  15, 1990. (1)

10.4              Employee Confidentiality Agreement between the Company and Lisa Crump, dated October 15,
                  1990. (1)

10.5              Stratasys, Inc. Employee Stock Option Plan #1. (1)

10.6              Amended and Restated Stratasys, Inc. 1994 Stock Plan. (3)

10.7              Second Amended and Restated Stratasys, Inc. 1994-2 Stock Plan. (8)

10.8              Stratasys, Inc. 1998 Stock Option Plan. (10)

10.9              Asset Purchase Agreement between the Company and IBM dated January 1, 1995. (4)

10.10             Equipment Lease Agreement between the Company and IBM dated January 1, 1995. (4)

10.11             Assignment, dated October 23, 1989, from S. Scott Crump to the
                  Company with respect to a patent application for an apparatus
                  and method for creating three-dimensional objects. (7)

10.12             Assignment, dated June 5, 1992, from S. Scott Crump to the Company with respect to a patent
                  application for a modeling apparatus for three dimensional objects. (7)

10.13             Assignment, dated June 1, 1994, from S. Scott Crump, James W. Comb, William R. Priedeman,
                  Jr., and Robert Zinniel to the Company with respect to a patent application for a process and
                  apparatus of support removal for three-dimensional modeling. (7)

10.14             Lease between the Company and Welsh Edenvale Partners '86, dated October 9, 1992 (1)
</TABLE>

                                       20
<PAGE>   22
<TABLE>
<CAPTION>
<S>               <C>                                              
10.15             Amendment #4 to Lease between the Company and Welsh Edenvale Partners '86, dated October 9,
                  1992, between the Company and Carpenter Land Company LLP, dated July 27, 1998.

10.16             Lease between the Company and Richard A. Burke, dated October 14, 1996. (9)


10.17             Warrant Purchase Agreement by and among the Company and certain holder's of the Company's
                  Warrants dated September 30, 1998. (11)

10.18             Technology Sale and Assignment Agreement, between the Company and SEK Technologies LLC,
                  dated as of December 21, 1998. (12)

10.19             User Agreement, between the Company and SEK Technologies LLC, dated as of August 21,
                  1997. (12)

10.20             Option Agreement, between the Company and SEK Technologies LLC, dated August 21, 1997.
                  (12)

10.21             Form of Registration Rights Agreement, between the Company and holders of Investment Units in
                  SEK Technologies LLC, dated as of January 4, 1999. (12)

21.1              Subsidiaries of the Company. (5)

23.1              Consent of Rothstein, Kass & Company, P.C.

27.1              Financial Data Schedule.

(1)               Incorporated by reference from the Company's Registration Statement on Form SB-2 (File No.
                  33-83638-C) filed September 2, 1994

(2)               Incorporated by reference from the Company's Form 8-K, dated August 24, 1995.

(3)               Incorporated by reference from the Company's Form 10-KSB for the year ended December 31,
                  1994.

(4)               Incorporated by reference from the Company's Form 8-K, Amendment No.2, dated January 1,
                  1995.

(5)               Incorporated by reference from the Company's Registration Statement on Form SB-2 (File No.
                  33-99108) filed November 8, 1995.

(6)               Incorporated by reference from the Company's Form 10-QSB for the nine months ended
                  September 30, 1995.

(7)               Incorporated by reference from Amendment No. 1 to the Company's Registration Statement on
                  Form SB-2 (File No. 33-99108) filed December 20, 1995.

(8)               Incorporated by reference from the Company's definitive Proxy Statement on Schedule 14A with
                  respect to the Company's 1997 Annual Meeting of Stockholders.

(9)               Incorporated by reference from the Company's Form 10-KSB for the year ended December 31,
                  1996.
</TABLE>

                                       21
<PAGE>   23
<TABLE>
<CAPTION>
<S>               <C>
(10)              Incorporated by reference from the Company's definitive Proxy Statement on Schedule 14A with
                  respect to the Company's 1998 Annual Meeting of Stockholders.

(11)              Incorporated by reference from the Company's Form 8-K filed on October 16, 1998.

(12)              Incorporated by reference from the Company's Form 8-K filed January 15, 1999.

(b)               Reports on Form 8-K
</TABLE>

            The Company filed Current Reports on Form 8-K on October 16, 1998
and January 15, 1999.

                                       22
<PAGE>   24
                                   SIGNATURES

            In accordance with Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

Dated:  March 31, 1999
                                               STRATASYS, INC.
                                               By: /s/ S. Scott Crump
                                                   ----------------------------
                                                   S. Scott Crump, President

            In accordance with the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
<S>                                   <C>                                               <C>
/s/ S. Scott Crump                    Chairman of the Board of Directors,               March 31, 1999
-----------------------------         President, Chief Executive Officer,
S. Scott Crump                        Treasurer, (Principal Executive Officer)

/s/ Thomas W. Stenoien                Chief Financial Officer                           March 31, 1999
-----------------------------         (Principal Financial and Accounting Officer)
Thomas W. Stenoien                    

/s/ Ralph E. Crump                    Director                                          March 31, 1999
-----------------------------
Ralph E. Crump

/s/ Clifford H. Schwieter             Director                                          March 31, 1999
-----------------------------
Clifford H. Schwieter

/s/ Arnold J. Wasserman               Director                                          March 31, 1999
-----------------------------
Arnold J. Wasserman

/s/ Gregory L. Wilson                 Director                                          March 31, 1999
-----------------------------
Gregory L. Wilson

/s/ Cameron Truesdell                 Director                                          March 31, 1999
-----------------------------
Cameron Truesdell
</TABLE>
<PAGE>   25
                        STRATASYS, INC. AND SUBSIDIARIES

                        CONSOLIDATED FINANCIAL STATEMENTS
                                       AND
                          INDEPENDENT AUDITORS' REPORT

                           DECEMBER 31, 1998 AND 1997
<PAGE>   26
                                 STRATASYS, INC.
                                AND SUBSIDIARIES


CONTENTS








<TABLE>
<CAPTION>
<S>                                                                               <C>
INDEPENDENT AUDITORS' REPORT                                                            F-1

CONSOLIDATED FINANCIAL STATEMENTS
     Balance Sheets                                                                     F-2
     Statements of Operations and Comprehensive Income (Loss)                           F-3
     Statements of Stockholders' Equity                                                 F-4
     Statements of Cash Flows                                                       F5 - F6
     Notes to Financial Statements                                                 F7 - F18
</TABLE>
<PAGE>   27
INDEPENDENT AUDITORS' REPORT




Board of Directors
Stratasys, Inc.


We have audited the accompanying consolidated balance sheets of Stratasys, Inc.
and Subsidiaries as of December 31, 1998 and 1997 and the related consolidated
statements of operations and comprehensive income (loss), stockholders' equity,
and cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Stratasys, Inc. and
Subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.


                                             /s/ Rothstein, Kass & Company, P.C.
                                                 Rothstein, Kass & Company, P.C.




Roseland, New Jersey
January 29, 1999

                                      F-1
<PAGE>   28
STRATASYS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
=====================================================================================================================
DECEMBER 31,                                                                            1998                 1997
---------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>                  <C>
ASSETS

CURRENT ASSETS
Cash and cash equivalents                                                           $ 11,243,839         $  9,116,232
Marketable securities                                                                  4,593,910            4,441,380
Accounts receivable, less allowance for returns and
 doubtful accounts of $409,341 in 1998 and $514,461
  in 1997                                                                              9,838,836           11,666,054
Inventories                                                                            5,035,588            5,492,130
Prepaid expenses                                                                         593,363              226,698
Deferred income taxes                                                                    243,000            1,051,000
                                                                                    ------------         ------------
Total current assets                                                                  31,548,536           31,993,494
                                                                                    ------------         ------------
PROPERTY AND EQUIPMENT, net                                                            3,601,829            3,445,265
                                                                                    ------------         ------------

OTHER ASSETS
Intangible assets, net                                                                 2,788,769            3,376,038
Deferred income taxes                                                                  3,072,000                   --
Other                                                                                    179,042              169,633
                                                                                    ------------         ------------
                                                                                       6,039,811            3,545,671
                                                                                    ------------         ------------
                                                                                    $ 41,190,176         $ 38,984,430
                                                                                    ============         ============


LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
Obligations under capital leases, current portion                                   $    177,669         $    144,137
Purchased in-process research and development payable                                  6,464,709
Accounts payable and other current liabilities                                         3,601,570            3,066,342
Unearned maintenance revenues                                                          2,649,824            2,426,270
                                                                                    ------------         ------------
Total current liabilities                                                             12,893,772            5,636,749
                                                                                    ------------         ------------
DEFERRED INCOME TAXES                                                                         --              124,000
                                                                                    ------------         ------------
OBLIGATIONS UNDER CAPITAL LEASES, less current portion                                   193,327              136,314
                                                                                    ------------         ------------


COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY
Common stock, $.01 par value, authorized 15,000,000 shares; issued 6,100,524
 shares in 1998 and 6,079,659
  shares in 1997                                                                          61,005               60,797
Capital in excess of par value                                                        32,710,484           33,556,084
Accumulated deficit                                                                   (3,847,529)            (529,514)
Accumulated other comprehensive loss                                                     (38,956)
Less cost of treasury stock, 137,300 shares                                             (781,927)
                                                                                    ------------         ------------
Total stockholders' equity                                                            28,103,077           33,087,367
                                                                                    ------------         ------------
                                                                                    $ 41,190,176         $ 38,984,430
                                                                                    ============         ============
</TABLE>


See accompanying notes to consolidated financial statements.



                                     F-2
<PAGE>   29
STRATASYS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)


<TABLE>
<CAPTION>
=============================================================================================
YEARS ENDED DECEMBER 31,                                        1998                 1997
---------------------------------------------------------------------------------------------
<S>                                                         <C>                  <C>
OPERATIONS

SALES                                                       $ 32,437,198         $ 29,636,370

COST OF SALES                                                 11,090,071            9,696,465
                                                            ------------         ------------

GROSS PROFIT                                                  21,347,127           19,939,905

COSTS AND EXPENSES
Research and development                                       5,943,926            5,054,767
Purchased in-process research and development                  6,512,665
Selling, general and administrative                           15,319,918           14,676,175
                                                            ------------         ------------
                                                              27,776,509           19,730,942
                                                            ------------         ------------
OPERATING INCOME (LOSS)                                       (6,429,382)             208,963
                                                            ------------         ------------

OTHER INCOME (EXPENSE)
Interest and other income                                        789,638              496,813
Interest expense                                                 (53,601)             (61,520)
                                                            ------------         ------------
                                                                 736,037              435,293
                                                            ------------         ------------

INCOME (LOSS) BEFORE INCOME TAXES (BENEFIT)                   (5,693,345)             644,256

INCOME TAXES (BENEFIT)                                        (2,375,330)             129,423
                                                            ------------         ------------

NET INCOME (LOSS)                                           $ (3,318,015)        $    514,833
                                                            ============         ============


INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE
Basic and diluted                                           $      (0.55)        $       0.09
                                                            ============         ============

WEIGHTED AVERAGE NUMBER OF COMMON AND
 COMMON EQUIVALENT SHARES OUTSTANDING
  Basic                                                        6,071,787            5,726,339
                                                            ============         ============

  Diluted                                                      6,071,787            6,016,381
                                                            ============         ============

COMPREHENSIVE INCOME (LOSS)

NET INCOME (LOSS)                                           $ (3,318,015)        $    514,833

OTHER COMPREHENSIVE LOSS
Foreign currency translation adjustment                          (38,956)
                                                            ------------         ------------

COMPREHENSIVE INCOME (LOSS)                                 $ (3,356,971)        $    514,833
                                                            ============         ============
</TABLE>


See accompanying notes to consolidated financial statements.


                                     F-3
<PAGE>   30
STRATASYS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


<TABLE>
<CAPTION>
===================================================================================================================================
YEARS ENDED DECEMBER 31, 1998 AND 1997
-----------------------------------------------------------------------------------------------------------------------------------

                                                                                                         ACCUMULATED
                                                                      CAPITAL IN                            OTHER
                                                    COMMON STOCK      EXCESS OF   ACCUMULATED  TREASURY  COMPREHENSIVE
                                               SHARES       AMOUNT    PAR VALUE     DEFICIT     STOCK        LOSS          TOTAL
<S>                                            <C>         <C>       <C>         <C>           <C>       <C>            <C>
BALANCES, January 1, 1997                      5,517,309   $55,173   $27,394,902 $(1,044,347)                           $26,405,728

SALE OF COMMON STOCK, less related expenses      562,350     5,624     6,161,182                                          6,166,806

NET INCOME                                                                           514,833                                514,833
                                               ---------   -------   ----------- -----------   ---------   --------     -----------

BALANCES, December 31, 1997                    6,079,659    60,797    33,556,084    (529,514)          -          -      33,087,367

ISSUANCE OF COMMON STOCK                          20,865       208        68,640                                             68,848

PURCHASE OF WARRANTS                                                  (1,000,000                                         (1,000,000)

WARRANTS ISSUED IN CONNECTION WITH
 PURCHASED RESEARCH AND DEVELOPMENT                                       85,760                                             85,760

NET LOSS                                                                          (3,318,015)                            (3,318,015)

FOREIGN CURRENCY TRANSLATION ADJUSTMENT                                                                     (38,956)        (38,956)

PURCHASE OF 137,300 SHARES OF TREASURY STOCK                                                    (781,927)                  (781,927)
------------------------------------------------------------------------------------------------------------------------------------


BALANCES, December 31, 1998                    6,100,524   $61,005   $32,710,484 $(3,847,529)  $(781,927)  $(38,956)    $28,103,077
                                               =========   =======   =========== ===========   =========   ========     ===========
</TABLE>


See accompanying notes to consolidated financial statements.


                                     F-4
<PAGE>   31
STRATASYS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
==============================================================================================
YEARS ENDED DECEMBER 31,                                           1998                 1997
----------------------------------------------------------------------------------------------
<S>                                                          <C>                  <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)                                            $ (3,318,015)        $    514,833
Adjustments to reconcile net income (loss) to
 net cash provided by (used in) operating activities:
Deferred income taxes                                          (2,388,000)             (53,000)
Depreciation and amortization                                   1,341,045            1,019,973
Amortization of intangibles                                       929,249              917,454
Purchased in-process research and development                   6,512,665
Increase (decrease) in cash attributable to changes
 in assets and liabilities
Accounts receivable                                             1,827,218           (1,058,899)
Inventories                                                       456,542           (2,843,140)
Prepaid expenses                                                 (367,273)             117,403
Accounts payable and other current liabilities                    519,624             (556,213)
Unearned maintenance revenues                                     223,554            1,344,226
                                                             ------------         ------------

NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES             5,736,609             (597,363)
                                                             ------------         ------------


CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of marketable securities                    40,090,164           35,166,222
Acquisition of marketable securities                          (40,241,253)         (33,034,695)
Acquisition of property and equipment                          (1,190,567)          (2,048,884)
Payments for intangible assets                                   (341,980)            (173,635)
Payments for other assets, net                                     (7,900)             (94,057)
                                                             ------------         ------------

NET CASH USED IN INVESTING ACTIVITIES                          (1,691,536)            (185,049)
                                                             ------------         ------------

CASH FLOWS FROM FINANCING ACTIVITIES
Repayments of obligations under capital leases                   (178,024)            (233,130)
Repurchase of warrants                                         (1,000,000)
Net proceeds from sale of common stock                             68,848            6,166,806
Repurchase of treasury stock                                     (781,927)
                                                             ------------         ------------


NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES            (1,891,103)           5,933,676
                                                             ------------         ------------


EFFECT OF EXCHANGE RATE CHANGES ON CASH                           (26,363)                  --
                                                             ------------         ------------

NET INCREASE IN CASH AND CASH EQUIVALENTS                       2,127,607            5,151,264

CASH AND CASH EQUIVALENTS, beginning of year                    9,116,232            3,964,968
                                                             ------------         ------------

CASH AND CASH EQUIVALENTS, end of year                       $ 11,243,839         $  9,116,232
                                                             ============         ============

STRATASYS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
</TABLE>


See accompanying notes to consolidated financial statements.


                                     F-5
<PAGE>   32

STRATASYS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,                                           1998                 1997
----------------------------------------------------------------------------------------------
<S>                                                          <C>                  <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
 INFORMATION, cash paid during the year
 for:
Interest                                                     $     53,601         $     61,520
                                                             ============         ============

Income taxes                                                 $    437,916         $    202,495
                                                             ============         ============

SUPPLEMENTAL SCHEDULES OF NONCASH INVESTING AND
 FINANCING ACTIVITIES, machinery and equipment
 acquired under capital lease obligations                    $    268,569         $    232,189
                                                             ============         ============
</TABLE>



See accompanying notes to consolidated financial statements.


                                     F-6

<PAGE>   33
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.       NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         Nature of Operations

         Stratasys, Inc. and Subsidiaries (collectively the "Company") develops,
         manufactures and markets a family of rapid prototyping systems (RPS)
         and devices that permit engineers and designers to create physical
         models and prototypes, made of various materials, utilizing three
         dimensional Computer Aided Design ("3D CAD") files at a CAD
         workstation. The Company sells these devices worldwide.

         Principles of Consolidation

         The consolidated financial statements include the accounts of
         Stratasys, Inc. and its wholly owned subsidiaries. All material
         intercompany accounts and transactions have been eliminated in
         consolidation.

         Fair Value of Financial Instruments

         The fair value of the Company's assets and liabilities, which qualify
         as financial instruments under Statement of Financial Accounting
         Standards (SFAS) No. 107, "Disclosures about Fair Value of Financial
         Instruments," approximates the carrying amounts presented in the
         consolidated balance sheet.

         Cash Equivalents

         The Company considers all highly liquid debt instruments purchased with
         a maturity of three months or less to be cash equivalents. Cash
         equivalents include U.S. Treasury notes and funds and a money market
         account. As of December 31, 1998, and at various times during the year,
         balances of cash at financial institutions exceeded the federally
         insured limit. The Company has not experienced any losses in such
         accounts and believes it is not subject to any significant credit risk
         on cash and cash equivalents.

         Marketable Securities

         The Company records its marketable securities in accordance with SFAS
         No. 115, "Accounting for Certain Investments in Debt and Equity
         Securities." Marketable securities have been categorized as available
         for sale and, as a result, are stated at fair value. Realized gains or
         losses are determined on the specific identification method and are
         reflected in the statement of operations.

                                     F-7
<PAGE>   34
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.       NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
         (CONTINUED) 

         Inventories

         Inventories are stated at the lower of cost, on the first in, first out
         method, or market.

         Impairment of Long-Lived Assets

         The Company periodically assesses the recoverability of the carrying
         amounts of long-lived assets, including intangible assets. A loss is
         recognized when expected undiscounted future cash flows are less than
         the carrying amount of the asset. The impairment loss is the difference
         by which the carrying amount of the asset exceeds its fair value.

         Property and Equipment

         Property and equipment is stated at cost. Depreciation and amortization
         is computed using the straight line method over the estimated useful
         lives of the assets ranging from 3-5 years.

         Intangible Assets

         Intangible assets are being amortized over their estimated useful lives
         using the straight line method as follows:

<TABLE>
<CAPTION>
<S>                                                            <C>
           RPS Technology                                       11 years
           Capitalized software development costs                3 years
           Patents                                              17 years
           Copyrights and licensed internal code                 5 years
</TABLE>

         The costs of software development, including significant product
         enhancements, incurred subsequent to establishing technological
         feasibility have been capitalized in accordance with SFAS No. 86,
         "Accounting for the Costs of Computer Software to be Sold, Leased or
         Otherwise Marketed." Costs incurred prior to establishment of
         technological feasibility are charged to research and development
         expense.

                                     F-8
<PAGE>   35
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.       NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
         (CONTINUED) 

         Unearned Maintenance Revenues

         Maintenance revenues are amortized over the term of the related
         maintenance contracts, typically one to five years.

         Revenue Recognition

         The Company recognizes revenues from the sale of RPS machines when
         shipped. The Company establishes allowances for estimated returns at
         the time of shipment.

         Software revenues are recorded based on Statement of Position 97-2 (SOP
         97-2), "Software Revenue Recognition," which provides for recognizing
         revenues from software product sales when a non-cancelable license
         agreement has been signed, the product has been delivered, all
         significant obligations have been satisfied and collectibility of the
         receivable is reasonably certain. The Company sells its software
         principally as an integral part of the RPS machines.

         Service revenues, excluding maintenance contracts, are recognized at
         the time the services are performed.

         Advertising

         Advertising costs are charged to operations as incurred and were
         approximately $603,000 and $824,000 for 1998 and 1997, respectively.

         Research and Development Costs

         Expenditures for research, development and engineering of products and
         manufacturing processes are expensed as incurred.

         Income Taxes

         The Company complies with SFAS No. 109, "Accounting for Income Taxes,"
         which requires an asset and liability approach to financial reporting
         of income taxes. Deferred income tax assets and liabilities are
         computed for differences between the financial statement and tax bases
         of assets and liabilities that will result in taxable or deductible
         amounts in the future, based on enacted tax laws and rates applicable
         to the periods in which the differences are expected to affect taxable
         income. Valuation allowances are established, when necessary, to reduce
         the deferred income tax assets to the amount expected to be realized.

                                     F-9
<PAGE>   36
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.       NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
         (CONTINUED) 

         Income (Loss) Per Common Share

         Effective December 31, 1997, the Company adopted SFAS No. 128,
         "Earnings Per Share". SFAS No. 128 requires dual presentation of basic
         and diluted income (loss) per share for all periods presented. Basic
         income (loss) per share excludes dilution and is computed by dividing
         income available to common stockholders by the weighted average number
         of common shares outstanding for the period. Diluted income per share
         reflects the potential dilution that could occur if securities or other
         contracts to issue common stock were exercised or converted into common
         stock or resulted in the issuance of common stock that then shared in
         the income of the Company. The difference between the number of shares
         used to compute basic income (loss) per share and diluted income per
         share relates to additional shares to be issued (-0- in 1998 due to
         their antidilutive effect and 394,415 in 1997) upon the assumed
         exercise of stock options and warrants, net of shares hypothetically
         repurchased at the average market price with the proceeds of exercise.

         Use of Estimates

         The preparation of financial statements in conformity with generally
         accepted accounting principles requires management to make estimates
         and assumptions that affect the reported amounts of assets and
         liabilities and disclosure of contingent assets and liabilities at the
         date of the financial statements and the reported amounts of revenues
         and expenses during the reporting period. Actual results could differ
         from those estimates.

         Comprehensive Income (Loss)

         Effective December 31, 1998, the Company adopted SFAS No. 130,
         "Reporting Comprehensive Income." SFAS No. 130 establishes new rules
         for the reporting and display of comprehensive income (loss) and its
         components; however, the adoption of this Statement had no impact on
         the Company's net income (loss) or shareholders' equity. SFAS No. 130
         requires the Company's change in the foreign currency translation
         adjustment to be included in other comprehensive income (loss). The
         prior year's financial statements have been reclassified to conform to
         these requirements.

                                     F-10
<PAGE>   37
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


2.       ACCOUNTS RECEIVABLE 

         At December 31, 1998 and 1997, accounts receivable included balances
         due from foreign entities of approximately $5,315,000 and $5,732,000,
         respectively.


3.       INVENTORIES 

         Inventories consist of the following at December 31:

<TABLE>
<CAPTION>
                                                    1998             1997
<S>                                              <C>               <C>
Finished goods                                   $ 3,058,539       $ 2,318,013
Work in process                                      145,108           276,366
Raw materials                                      1,831,941         2,897,751
                                                 -----------------------------
                                                 $ 5,035,588       $ 5,492,130
                                                 =============================
</TABLE>

4.       PROPERTY AND EQUIPMENT

         Property and equipment consists of the following at December 31:

<TABLE>
<CAPTION>
                                                       1998              1997
<S>                                                <C>               <C>
Machinery and equipment                            $ 1,735,854       $ 1,108,874
Computer equipment and
 software                                            2,305,424         1,813,069
Office equipment                                       680,449           460,456
Leasehold improvements                               1,060,281           911,618
Equipment under capital leases                         784,908           851,950
                                                   -----------------------------

                                                     6,566,916         5,145,967
Accumulated depreciation
 and amortization (including
 $313,003 in 1998 and $154,881
 in 1997 under capital leases)                       2,965,087         1,700,702
                                                   -----------------------------
                                                   $ 3,601,829       $ 3,445,265
                                                   =============================
</TABLE>

                                     F-11
<PAGE>   38
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


5.       INTANGIBLE ASSETS 

         Intangible assets consist of the following at December 31:

<TABLE>
<CAPTION>
                                                     1998             1997
<S>                                               <C>               <C>
RPS Technology                                    $2,558,532        $2,558,532
Capitalized software
 development costs                                 2,251,782         2,009,739
Patents                                              595,818           495,881
Copyrights and licensed
 internal code                                        56,856            56,856
Other                                                 17,488            17,488
                                                  ----------------------------
                                                   5,480,476         5,138,496
Accumulated amortization                           2,691,707         1,762,458
                                                  ----------------------------
                                                  $2,788,769        $3,376,038
                                                  ============================
</TABLE>

         For the years ended December 31, 1998 and 1997, amortization of
         computer software development costs charged to operations was $646,296
         and $632,219, respectively.

         Included in research and development expense for the years ended
         December 31, 1998 and 1997 are computer software development
         expenditures of $1,364,100 and $1,625,188, respectively.


6.       PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT

         In December 1998 the Company purchased substantially all of the assets
         of a private research and development company including mechanical
         drawings, data tapes, code, schematics and fixed assets. The purchase
         price was approximately $6,550,000, of which approximately $6,464,000
         paid in cash in January 1999 and the balance through the issuance of
         warrants to purchase 128,000 shares of common stock of the Company at
         $13.88 per share.

         The Company expects the rapid prototyping technology purchased to
         significantly enhance its product mix and capabilities. While products
         derived from this new technology are anticipated to reach the market
         place during late 1999, substantial development remains in order to
         create a functional and reliable machine. There are also many risks
         involving the various areas of the technology, as well as the total
         integration of the various systems. Accordingly, approximately
         $6,512,000 of the purchase price was expensed as research and
         development expense.

                                     F-12
<PAGE>   39
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


7.       CREDIT LINE

         The Company has an available line of credit from a financial
         institution for the lesser of $4,000,000 or a defined borrowing base.
         The credit line bears interest at prime and expires on November 1,
         1999. No amounts were outstanding at December 31, 1998 and 1997.


8.       ACCOUNTS PAYABLE AND OTHER CURRENT LIABILITIES 

         Accounts payable and other current liabilities consist of the following
         at December 31:

<TABLE>
<CAPTION>
                                                  1998                1997
<S>                                           <C>                 <C>
Trade                                         $ 1,626,253         $ 1,474,061
Compensation and related
 benefits                                       1,363,159             928,656
Reserve for warranty expenses                     127,638             225,425
Other                                             484,520             438,200
                                              -------------------------------
                                              $ 3,601,570         $ 3,066,342
                                              ===============================
</TABLE>

9.       OBLIGATIONS UNDER CAPITAL LEASES

         Aggregate minimum lease payments for obligations under capital
         leases in the years subsequent to December 31, 1998 are as follows:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31
<S>                                                                  <C>
1999                                                                 $ 221,399
2000                                                                   143,028
2001                                                                    72,400
                                                                     ---------
Total minimum lease payments                                           436,827
Less amounts representing interest                                      65,831
                                                                     ---------
Present value of minimum lease payments                                370,996
Less current portion                                                   177,669
                                                                     ---------
                                                                     $ 193,327
                                                                     =========
</TABLE>

                                     F-13
<PAGE>   40
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


10.      INCOME TAXES 

         The components of the Company's deferred tax assets (liabilities) are
         as follows:

<TABLE>
<CAPTION>
                                                    1998              1997
<S>                                             <C>                  <C>
Net operating loss
 carryforwards                                  $ 1,905,000          $ 54,000
Depreciation                                        (71,000)         (116,000)
Amortization                                         21,000            (8,000)
Allowance for doubtful accounts                     104,000           188,000
Reserve for warranty expenses                        91,000            92,000
Reserve for sales returns, net                       48,000            21,000
Federal minimum tax credit
 carryforwards                                       74,000            74,000
Research and development tax
 credit carryforwards                             1,143,000           622,000
                                                -----------------------------
                                                $ 3,315,000         $ 927,000
                                                =============================
</TABLE>

         At December 31, 1998, the Company had federal and state net operating
         loss carryforwards of approximately $5,500,000, which can be utilized
         against future taxable income and expire in various years through 2018.

         At December 31, 1998, the Company had research and development tax
         credit carryforwards of approximately $1,143,000, which can be utilized
         against future federal income tax and expire in various years through
         2018.

         The components of income taxes (benefit) for the years ended December
         31, 1998 and 1997 are as follows:

<TABLE>
<CAPTION>
                                                     1998              1997
<S>                                             <C>                 <C>
FEDERAL
Current                                         $    47,011         $ 175,423
Deferred                                         (2,211,000)         (102,000)
                                                ------------------------------
                                                 (2,163,989)           73,423
                                                ------------------------------
STATE AND OTHER
Current                                             (34,341)            7,000
Deferred                                           (177,000)           49,000
                                                ------------------------------
                                                   (211,341)           56,000
                                                ------------------------------
                                                $(2,375,330)        $ 129,423
                                                ==============================
</TABLE>

                                     F-14
<PAGE>   41
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


10.      INCOME TAXES (CONTINUED)                        

         A reconciliation of income tax expense (benefit) to the federal
         statutory rate is as follows for the years ended December 31:

<TABLE>
<CAPTION>
                                                        1998          1997 
<S>                                                  <C>            <C>
Federal statutory rate                                (34.0)%        34.0 %

Foreign sales corporation exclusion                                  (2.7)

Loss of foreign subsidiary                                            9.0

State income tax, net of federal effect                (1.9)          0.7

Permanent differences and other                        (0.3)          3.4

Utilization of research and
 development tax credit                                (5.5)        (24.4)
                                                      --------------------

Effective income tax rate                             (41.7)%        20.0%
                                                      ====================
</TABLE>

11.      COMMITMENTS AND CONTINGENCIES                     

         The Company leases its facilities under leases which expire through
         2000.

         Aggregate future minimum annual rental payments in the years subsequent
         to December 31, 1998 are as follows:

<TABLE>
<CAPTION>
            YEAR ENDING DECEMBER 31,
<S>                                                                   <C>
                      1999                                             $ 482,062
                      2000                                                51,952
                                                                       ---------
                                                                       $ 534,014
                                                                       =========
</TABLE>

         Rent expense for the years ended December 31, 1998 and 1997 was
         approximately $663,000 and $800,000, respectively.


12.      COMMON STOCK

         During 1998 and 1997, options to purchase 20,865 and 200,298 shares,
         respectively, of the Company's common stock were exercised with
         proceeds to the Company of approximately $43,000 and $1,156,000,
         respectively. In addition, during 1997, warrants to purchase 7,007
         shares of the Company's common stock were exercised with net proceeds
         to the Company of approximately $41,000.

                                     F-15
<PAGE>   42
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


13.      STOCK OPTIONS AND WARRANTS

         The Company has established four employee stock option plans, the
         Stratasys, Inc. Employee Incentive Stock Option Plan #1 (Plan 1),
         Stratasys, Inc. 1994 Incentive Stock Option Plan (Plan 2), Stratasys,
         Inc. 1994 -2 Incentive Stock Option Plan (Plan 3) and Stratasys, Inc.
         1998 Incentive Stock Option Plan (Plan 4). The four plans provide for
         the granting of options to qualified employees of the Company,
         independent contractors, consultants and other persons to purchase up
         to 1,800,000 shares of common stock.

         All the options under Plan 1 have been granted and the plan expires
         April 19, 2001. Under Plan 2, options to purchase 173,442 shares of
         common stock have been granted. Under Plan 3, options to purchase an
         aggregate of 1,003,804 shares of common stock have been granted. Under
         Plan 4, options to purchase an aggregate of 167,200 shares of common
         stock have been granted. All options under the above plans are granted
         at a price not less than the fair market value of the Company's common
         stock at the dates of grant and are exercisable over approximately five
         years.

         The following summarizes the information relating to outstanding stock
         options and the activity during 1998 and 1997:

<TABLE>
<CAPTION>
                                                                    WEIGHTED
                                   NUMBER                           AVERAGE
                                     OF             PER SHARE       EXERCISE
                                   SHARES          OPTION PRICE       PRICE
<S>                             <C>           <C>        <C>       <C>
Shares under option
 at January 1, 1997                732,899    $ 1.59 -   $ 21.44   $ 10.15

Granted in 1997                    638,574     10.94 -     23.75     14.97

Exercised in 1997                 (200,298)     1.59 -     16.63      9.18

Forfeited in 1997                 (300,274)     5.38 -     16.62     12.73
                                  ----------------------------------------
Shares under option
 at December 31, 1997              870,901      1.59 -     23.56     14.09

Granted in 1998                    224,500      5.00 -     11.56      6.75

Exercised in 1998                  (20,665)     1.59 -      5.38      2.07

Forfeited in 1998                  (76,520)     5.38 -     23.56     13.92
                                  ----------------------------------------
Shares under option
 at December 31, 1998              998,216    $ 1.59 -   $ 23.56    $ 3.54
                                  ========================================
Options exercisable at
 December 31, 1998                 521,383    $ 1.59 -   $ 23.56    $ 7.51
                                  ========================================
</TABLE>

                                     F-16
<PAGE>   43
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


13.      STOCK OPTIONS AND WARRANTS (CONTINUED)

         The Company, as part of sales of common stock and other agreements, has
         issued warrants to purchase the Company's common stock. The following
         summarizes the information relating to outstanding warrants and the
         activity during 1998 and 1997:

<TABLE>
<CAPTION>
                                                                    Weighted
                                   Number                            Average
                                     of            Per Share        Exercise
                                   Shares        Warrant Price        Price
<S>                               <C>         <C>         <C>       <C>
Shares under warrants
 at January 1, 1997                250,405    $ 5.80  -   $ 21.00   $ 15.95

Granted in 1997                    710,090     13.50 -      14.50     14.08

Exercised in 1997                   (7,007)     5.80                   5.80
                                  -----------------------------------------
Shares under warrants
 at December 31, 1997              953,488      5.80 -      21.00     14.60

Granted in 1998                    154,000      5.00 -      13.88     12.38

Repurchased in 1998               (710,090)    13.50 -      14.50     14.08

Forfeited in 1998                 (161,043)     5.80 -      21.00     15.95
                                  -----------------------------------------
Shares under warrants
 at December 31, 1998              236,355    $ 5.00  -   $ 15.44   $ 12.48
                                  =========================================
Options exercisable at
 December 31, 1998                 236,355    $ 5.00  -   $ 15.44   $ 12.48
                                  =========================================
</TABLE>


         Had compensation cost for the Company's three stock option plans and
         stock purchase warrants been determined based on the fair value at the
         grant date of awards in 1998 and 1997, consistent with the provisions
         of SFAS 123, the Company's net income (loss) and income (loss) per
         share would have been reduced (increased) to the pro forma amounts
         indicated below:

<TABLE>
<CAPTION>
                                                        1998             1997
<S>                                                 <C>                <C>
Net Income (loss) - as reported                     $ (3,318,015)      $ 514,833
Net loss - pro forma                                  (3,576,561)       (271,113)
Diluted earnings per share - as reported                   (0.55)           0.09
Diluted loss per share -
 pro forma                                                 (0.59)          (0.05)
</TABLE>

                                      F-17
<PAGE>   44
STRATASYS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


14.      EXPORT SALES

         Export sales were as follows for the years ended December 31:

<TABLE>
<CAPTION>
                                                               1998           1997
<S>                                                        <C>            <C>
Europe                                                     $ 5,866,235    $ 5,735,000
Asia Pacific                                                 7,131,958      6,057,000
Other                                                        1,020,244        847,000
                                                           --------------------------
                                                           $14,018,437   $ 12,639,000
                                                           ==========================
</TABLE>

15.      QUARTERLY RESULTS (UNAUDITED)

<TABLE>
<CAPTION>
                                            THREE MONTHS ENDED
                          MARCH 31       JUNE 30       SEPTEMBER 30       DECEMBER 31
<S>                     <C>           <C>              <C>               <C>
1998                                                                    
  Net sales             $ 7,007,672   $ 8,256,810       $ 7,836,247      $ 9,336,469
  Gross profit            4,631,825     5,721,092         4,887,940        6,106,270
  Net income (loss)          11,772       434,737            49,618       (3,814,142)
  Income (loss) per                                                     
   common share:                                                        
Basic                             -          0.07              0.01            (0.63)
Dilutive                          -          0.07              0.01            (0.63)
                                                                        
1997                                                                    
  Net sales             $ 5,208,527    $6,965,334       $ 7,345,471     $ 10,117,038
  Gross profit            3,445,164     4,651,832         4,559,308        7,283,601
  Net income               (404,414)      (82,884)           50,763          951,368
  Income per common                                                     
   share:                                                               
Basic                         (0.07)        (0.01)             0.01             0.16
Dilutive                      (0.07)        (0.01)             0.01             0.16
</TABLE>

                                     F-18