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UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-K

(Mark
      One)[ ü ]
    
    ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
      1934For the fiscal year ended December 31, 2007OR[     ]
    
    TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the transition period from __________ to __________


Commission file number 1-13400

STRATASYS, INC.(Exact name of registrant as specified in Its charter)

|Delaware                                                          |  | 36-3658792                                     
|----------------------------------------------------------------- |  | -----------------------------------------------
|(State or other
      jurisdiction of                             |  | (I.R.S.
      Employer                         
|incorporation or
      organization)                              |  | Identification
      No.)                      
|                                                                 
|7665 Commerce Way,
      Eden Prairie, Minnesota 55344            |  | 55344                                          
|(Address of Principal
      Executive Offices)                    |  | (Zip Code)                                     
|                                                                 
|Registrants
      telephone number, including area code          |  | (952)
      937-3000                           
|                                                                 
|Securities registered
      pursuant to Section 12(b) of the Act: |  |                                                
|Title of each
      class                                         |  | Name of each exchange
      on which registered
|Common stock, $.01
      par value                                |  | NASDAQ Global
      Select Market              

Securities registered pursuant section
12(g) of the Act:None

Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.


Yes [ ü ] No [     ]


Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act.


Yes [     ]
No [ ü ]


Indicate by
check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 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 [ ü ] No
[     ]

Indicate by
check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K. [ ü ]

Indicate by
check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the
definitions of large accelerated filer, accelerated filer and smaller
reporting company in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated
      filer [     ]
    Accelerated filer [
      ü ]Non-accelerated filer
      [     ]
    Smaller reporting
      company [     ](Do not check if a smaller
      reporting company)




Indicate by
check mark whether the registrant is a shell company (as defined in Rule 12b-2
of the Exchange Act).


Yes [     ]
No [ ü ]


The
aggregate market value of the registrants Common Stock held by non-affiliates
of the registrant as of June 29, 2007, the last business day of the registrants
most recently completed second quarter, was approximately $453,000,000. On such
date, the closing price of the Registrants Common Stock, as quoted on the
Nasdaq Global Select Market was $23.49.

The registrant had 21,071,037
shares of common stock outstanding as of March 8, 2008.

---

DOCUMENTS INCORPORATED BY REFERENCE

Portions of
the registrants Definitive Proxy Statement to be filed with the Securities and
Exchange Commission with respect to the registrants Annual Meeting of
Stockholders scheduled to be held on May 8, 2008 are incorporated by reference
into Part III of this Annual Report.

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TABLE OF CONTENTS

|           |  |                                                                                                                   |  | Page
|---------- |  | ----------------------------------------------------------------------------------------------------------------- |  | ----
|Part I     |  |                                                                                                                   |  |     
|           |  |                                                                                                                   |  |     
|Item 1.    |  | Business                                                                                                          |  | 1   
|           |  |                                                                                                                   |  |     
|Item 1A.   |  | Risk Factors                                                                                                      |  | 13  
|           |  |                                                                                                                   |  |     
|Item 1B.   |  | Unresolved Staff Comments                                                                                         |  | 17  
|           |  |                                                                                                                   |  |     
|Item 2.    |  | Properties                                                                                                        |  | 17  
|           |  |                                                                                                                   |  |     
|Item 3.    |  | Legal Proceedings                                                                                                 |  | 17  
|           |  |                                                                                                                   |  |     
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                               |  | 17  
|           |  |                                                                                                                   |  |     
|Part II    |  |                                                                                                                   |  |     
|           |  |                                                                                                                   |  |     
|Item 5.    |  | Market for Registrants Common Equity, Related Stockholder Matters
      and IssuerPurchases of Equity Securities |  | 18  
|           |  |                                                                                                                   |  |     
|Item 6.    |  | Selected Financial Data                                                                                           |  | 20  
|           |  |                                                                                                                   |  |     
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition
      andResults of Operation                         |  | 21  
|           |  |                                                                                                                   |  |     
|Item 7A.   |  | Quantitative and Qualitative Disclosures About Market Risk                                                        |  | 40  
|           |  |                                                                                                                   |  |     
|Item 8.    |  | Financial Statements and Supplementary Data                                                                       |  | 40  
|           |  |                                                                                                                   |  |     
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting
      andFinancial Disclosure                         |  | 40  
|           |  |                                                                                                                   |  |     
|Item 9A.   |  | Controls and Procedures                                                                                           |  | 40  
|           |  |                                                                                                                   |  |     
|Item 9B.   |  | Other Information                                                                                                 |  | 41  
|           |  |                                                                                                                   |  |     
|Part III   |  |                                                                                                                   |  |     
|           |  |                                                                                                                   |  |     
|Item 10.   |  | Directors, Executive Officers and Corporate Governance                                                            |  | 42  
|           |  |                                                                                                                   |  |     
|Item 11.   |  | Executive Compensation                                                                                            |  | 42  
|           |  |                                                                                                                   |  |     
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management
      andRelated Stockholder Matters               |  | 42  
|           |  |                                                                                                                   |  |     
|Item 13.   |  | Certain Relationships and Related Transactions, and Director
      Independence                                   |  | 42  
|           |  |                                                                                                                   |  |     
|Item 14.   |  | Principal Accountant Fees and Services                                                                            |  | 42  
|           |  |                                                                                                                   |  |     
|Part IV    |  |                                                                                                                   |  |     
|           |  |                                                                                                                   |  |     
|Item 15.   |  | Exhibits and Financial Statement Schedules                                                                        |  | 43  
|           |  |                                                                                                                   |  |     
|Signatures |  |                                                                                                                   |  |     

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PART I

Item 1. Business.

General Development of Business

We are a leader in the market for
office rapid prototyping (RP) systems, which includes three dimensional (3D)
printing systems. We develop, manufacture and sell a family of systems,
including a line of 3D printers, all of which create physical models from
computerized designs. We were incorporated in Delaware in 1989 and our executive
offices are located in Eden Prairie, Minnesota. Our systems are based on our
core patented fused deposition modeling (FDM®) technology and on
our patented Genisys® technology, which we purchased from IBM in
1994. We sold our first product, the 3D Modeler®, commercially in
April 1992 and introduced our second product, the Benchtop, in June 1993. In
February 2002, we introduced Dimension®, our first 3D printer.
Dimension offers modeling capabilities in ABS plastic on a desktop 3D printer
platform. We believe that Dimension, when introduced at $29,900, was the lowest
priced system in the RP and 3D printing markets. We believe that the Dimension
768BST, when introduced at $18,900, was the lowest priced commercial system in
the RP and 3DP printing markets. In May 2007, we introduced the FDM 200mc, our
first system specifically designed for direct digital manufacturing (DDM)
which is the production of end use parts rather than prototypes. Other recent
significant developments in our business are set forth below:

- In August 2006, we announced that
  effective January 1, 2007 we were discontinuing our North American Distributor
  Agreement with Objet Geometries Ltd. (Objet). The Eden systems that we
  distributed (the Eden Systems) use inkjet technology to jet ultra-fine
  layers of UV-cured resin to build RP models. While the distribution agreement
  contributed approximately $16.2 million in 2006 sales, these sales were at an
  average gross margin of 27%. After allocation of associated costs, our
  internal financial statements indicated that distribution of the Eden Systems
  made a negligible contribution to our earnings. In order to provide a smooth
  transition for our customers, we serviced the Eden Systems we sold through
  August 1, 2007. We recognized approximately $2.4 million of Objet system,
  consumable and maintenance revenue in 2007.
- In January 2007, we introduced the new
  Dimension Elite with soluble supports, offering the customer a new ABSplus
  material that on average is 40% stronger than our other ABS material offering.
  Priced at $32,900, the Elite builds in thinner layers offering better fine
  feature model detail and surface finish.
- In May 2007, we introduced the FDM
  200mc, our first system specifically directed at the DDM market offering the
  stronger ABSplus material and our high-end productivity system software.
- In July 2007, we introduced our high-end
  productivity system, the FDM 400mc, our most accurate and repeatable system
  ever. The FDM 400mc has a build chamber similar to our Vantage line, but
  builds in the new ABS M-30 material as well as other materials previously
  available only on the Vantage product line. This was our second product
  introduction in 2007 directed at the DDM market.
- In December 2007, we introduced the FDM
  900mc, which represents our largest system ever. It is capable of building
  parts up to 4.5 feet measured on the diagonal, nine times larger than parts
  built by the FDM 400mc. The FDM 900mc uses ball-screw technology and improves
  part accuracy and repeatability and can hold tighter tolerances. This new
  product is the direct result of a $3.6 million order from a Fortune 100 global
  manufacturing company received in September 2005 to advance our
  proprietary FDM® technology for DDM applications.
- Effective December 2007, we discontinued
  our distribution agreement with Arcam AB to exclusively distribute its
  metal-based direct digital manufacturing and prototyping systems in North
  America. In Arcams patented electron-beam melting (EBM) process, called CAD
  to Metal®, titanium powder is transformed into solid metal parts
  for either functional prototyping or end-use. We believe that the EDM
  technology is attractive primarily to early adopters and the distribution
  agreement did not result in significant sales or margins to us.
- In January 2008, we introduced two new
  3D printers, the Dimension 1200es SSTand BST. The BST builds with break away supports while the SST
  builds with automated soluble support removal. Both offer the customer the
  ABSplus material previously available only on the Elite. Priced at $34,900 and
  $26,000 depending on the type of supports, the 1200es builds in thinner
  layers, offering better fine feature model detail.

1

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Description of Business

We are a leader in the RP and 3D
printing markets. We develop, manufacture, market, and service a family of 3D
printers and high-performance RP systems 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. Our
high-performance systems are used both to create prototype models as well as to
produce parts for end user applications, which is referred to as direct digital
manufacturing (DDM). Our 3D printers and high-performance systems can be used
in office environments without expensive facility modification. In many
industries, the models and prototypes required in product development are
produced laboriously by hand-sculpting or machining, a traditional process that
can take days or weeks. Our computerized modeling systems use our proprietary
technology to make models and prototypes and end-use-parts directly from a
designers three-dimensional CAD in a matter of hours. In addition to selling RP
systems and 3D printers, through our Paid Parts service, we make and sell parts
for RP and DDM applications based on our customers CAD files. We estimate
approximately 15% to 20% of our Paid Parts revenue is from DDM parts.

We believe that the 3D printers and
high-performance systems using our FDM technology are the only systems
commercially available that can produce prototypes and parts from production
grade plastic without relying on lasers. This affords our products a number of
significant advantages over other commercially available three-dimensional rapid
prototyping technologies that rely primarily 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
- little or no post-processing
- ease of use
- the need for relatively little set up of
  the system for a particular project
- the availability of a variety of
  modeling materials
- modeling in production-grade plastics
  for functional testing
- no need for costly replacement lasers
  and laser parts

Our 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 our FDM systems begins with the
creation of a 3D geometric model on a CAD workstation. The model is then
imported into our proprietary software program, which mathematically slices the
CAD model into horizontal layers that are downloaded into the system. A spool of
thin thermoplastic modeling material feeds into a moving FDM extruding head,
which heats the material to a semi-liquid state. This semi-liquid material is
extruded and deposited, one ultra-thin layer at a time, on a base (the X-Y
Stage) in a thermally-controlled 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.

Based upon data and estimates
furnished in the 2007 Wohlers Report, through 2006 we shipped approximately 32%
of all RP systems since the industrys inception in 1987, an improvement over
the 24% we realized through 2002. The 2006 Wohlers Report also states that we
shipped 41% of all RP systems globally in 2006.

**Applications for High-performance
Systems and 3D Printers****

Both high-performance systems and 3D
printers allow for the physical modeling of a design using a special class of
machine technology. These systems take data created from CAD data, CT and MRI
scan data or 3D digitized data to quickly produce models, using an additive
approach. Traditionally, RP and 3D printing have been used by organizations to
accelerate product development. Many companies use RP and 3D printing models to
test form, fit and function to help improve the time to market.

Frequently, users report rapid
pay-back times by using RP and 3D printing, as they accelerate their product
development cycle and reduce post-design flaws through more extensive design
verification and testing.

2

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There are also opportunities for
DDM. DDM involves the manufacture of parts fabricated directly from systems that
are subsequently incorporated into the users end product or process. DDM is
particularly attractive in applications that require short-run or low volume
parts that require rapid turn-around, and for which tooling would not be
appropriate due to small volumes. Our FDM 200mc, 400mc, and 900mc, Titan,
Vantage and Maxum systems are well suited for these types of applications.

An emerging portion of the DDM
market segment is the production of fabrication and assembly tools that aid in
the customers production and assembly process. In addition, we have seen a
growing number of applications for end-use parts.

During the past five years, the
largest growth segment of the RP market has been 3D printers. 3D printers are
low-cost RP systems (typically under $40,000) that reside in the
design/engineering office environment, allowing product development
organizations quick access to a modeling system.

We have shipped over 9,000 systems
since our inception. A wide variety of design and manufacturing organizations
use our systems. Current markets include:

|AerospaceConsumer ProductsEducational InstitutionsMedical SystemsMold MakingDirect digital manufacturing of custom
        partsHeavy Equipment |  | AutomotiveBusiness MachinesElectronicsMedical AnalysisToolingFixturesArchitecture
|----------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------

Additional future applications
include:

|Architectural designFree-form graphic design |  | Secondary tooling and mold-makingGaming, art and animation
|-------------------------------------------- |  | ----------------------------------------------------------

Among potential medical
applications, rapid prototyping is being used to produce accurate models of
internal organs, bones and skulls for pre-operative evaluations or modeling of
prostheses. In such uses, our RP systems serve as a peripheral device for CT and
MRI devices.

Products

**3D Printers and
High-Performance Systems**

We have been developing and
improving our line of products since our inception in 1989. Since our first
commercial product was introduced in 1992, we have enhanced and expanded our
product line. We have improved both the speed and the accuracy of our FDM
systems, expanded their build envelopes, introduced a number of new modeling
materials and developed and introduced a low-cost 3D printer. We have also
enhanced and upgraded the software that our systems use to read CAD files and
build parts.

Each of our products is based upon
our patented FDM process, and our 3D printers also employ technology acquired
from IBM. Our products are sold as integrated systems, which consist of an RP
machine, the software to convert the CAD designs into a machine compatible
format, and modeling materials. Each of our products is compatible with an
office environment and does not require an operator to be present while it is
running.

Our family of 3D printers and
high-performance systems affords a customers product development team,
including engineers, designers and managers, the ability to create prototypes
through all stages of the development cycle. Our products meet the needs of a
very demanding and diverse industrial base by offering a wide range of
capability and price from which to choose. The domestic list prices of our
systems range from $18,900 for Dimension 768 BST to $400,000 for our high
productivity FDM 900mc. We also offer special pricing for trade-in systems and
upgrades.

3

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The Dimension is a 3D printer that
allows a user to create parts in ABS plastic. ABS usually offers the part
strength required for true form, fit and function testing. Dimension operates in
the office, offering speed, ease of useand
networking capabilities at a competitive price. It features our
Catalyst® software, which offers a single pushbutton operation by
automating all of the required build procedures. We introduced the Dimension BST
in February 2002, although commercial shipments to selected resellers commenced
in December 2001. We believe that Dimension 768 BST, at a list price of $18,900,
is among the lowest-priced whole product systems in the 3D printing market.
Dimension SST, introduced in February 2004, offers users the benefits of our
WaterWorks or automated soluble support removal technology (SST) on the
Dimension platform. It is priced at $24,900. The Dimension 1200es SST,
introduced in January 2008 and priced at $34,900 offers the ability to build
larger parts and creates parts from our new ABSplus material, which on average
are 40% stronger than our standard ABS.

The FDM 200mc is our lowest priced
high performance FDM System that incorporates our WaterWorks soluble support
system and InSight Software. The patented WaterWorks process allows for the easy
removal of supports from a completed prototype by simple immersion into a
water-based solution. Since support material is dissolved, resulting in a
cleaned prototype, most post-processing steps required in our competitors
systems are eliminated. The FDM 200mc is further enhanced by the addition of our
InSight software. InSight offers the customer a more flexible array of features
allowing for a range of fully automatic operation to individual and customized
functions for each step of the build process. With the combination of ABS,
WaterWorks and InSight software, the FDM 200mc offers the customer hands free
operation of the entire prototype building process. The FDM 200mc was introduced
in May 2007, and represents our first system specifically designed to target the
DDM market.

The FDM Titan was introduced in 2001
and provides a unique set of features that addresses demanding customer
requirements. Titan offers users the capability to model with a wide range of
engineering thermoplastic materials, including polycarbonate (PC), ABS, ABSi,
PC/ABS, PC-ISO and polyphenylsulfone (PPSF). These modeling materials provide
superior strength coupled with heat and chemical resistance. This combination of
properties affords engineers and designers a variety of options to meet
demanding industrial prototyping and design requirements. Titan has a large
build envelope and uses new technology based on look ahead motion profiles
that provide faster build speeds. The Titan also incorporates enhanced ease of
use features, such as WaterWorks, the InSight software, automatic material
loading and supply changeover.

The FDM Maxum was released in late
2000. It incorporates MagnaDrive technology, which allows the extrusion head to
float on a bed of air while being controlled through electromagnet devices. Its
build envelope is among the largest in the industry, allowing users to build
large parts. The Maxum also delivers a fine feature detail capability allowing
customers to make prototypes of very small parts. This feature was developed in
conjunction with Fuji Film Corp. of Japan. Features as small as .005 x .010
may be built, allowing for increased prototyping capabilities for the
telecommunications, electrical connector and camera and photography industries.

The FDM 400mc was introduced in July
2007 and represents an increase in repeatability, part accuracy and material
strength over the Vantage and Titan systems, which are being discontinued. In
addition, in January 2008, we introduced the FDM 360mc, which offers similar
part quality to the FDM 400mc, but fewer material choices and slower build
speeds. Both of these systems can be configured to meet specific customer needs.
Prices for these systems range from $75,000 to $225,000 depending on the
configuration and needs of the customer.

In December
2007, we introduced the FDM 900mc, which represents our largest system ever. It
is capable of building parts up to 4.5 feet measured on the diagonal, nine times
larger than parts built by the FDM 400mc. The FDM 900mc uses ball screw
technology and improves part accuracy, repeatability and tolerances. This new
product is the direct result of a $3.6 million order from a Fortune 100 global
manufacturing company entered into in September 2005 to advance our proprietary
FDM® technology for direct digital manufacturing applications.

We periodically discontinue
manufacturing older products. We discontinued sales of the GenisysXs, FDM 8000
and Prodigy systems at various times in 2002. We discontinued sales of the FDM
2000 in 2003 and the FDM 3000 in 2004. We discontinued the Prodigy Plus in 2007
and will discontinue the Vantage and Titan product line during 2008. However, we
continue to support these products in the field.

**Modeling Material**

FDM technology allows the use of a
greater variety of production grade plastic modeling materials than other RP
technologies. We continue to develop filament modeling materials that meet our
customers needs for increased speed, strength, accuracy, surface resolution,
chemical and heat resistance, and color. These materials are processed into our
patented filament form, which is then fed into the FDM systems. Our spool-based
system has proven to be a significant advantage for our products over
ultraviolet (UV) polymer systems or powder based systems, because our system
allows the user to quickly change material by simply mounting the spool and
feeding the desired filament into the FDM devices. Spools weigh from one pound
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
stereo lithography (SLA) UV polymer systems, because the spool-based system
allows the customer to use it in an office environment and to purchase a single
spool, as compared to an entire vat of SLA UV polymer, thereby reducing the
customers up-front costs.

4

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Currently, we have seven modeling
materials commercially available for use with our FDM technology:

- ABS is an engineering thermoplastic
  material (named for its three initial monomers, acrylonitrile, butadiene, and
  styrene), which offers a balance of strength, toughness and thermal resistance
  and is used commercially to make products such as cell phones, computer cases
  and toys.
- ABSplus and M-30 are our newest
  materials and, like ABS, are thermoplastic materials with all the associated
  benefits. ABSplus has the added benefit of creating additional part strength.
  Parts built with these materials are on average 40% stronger than our standard
  ABS parts.
- Polycarbonate (PC) is an engineering
  thermoplastic material, which is used commercially for demanding applications
  in a number of industries. PC offers superior impact strength coupled with
  resistance to heat and corrosive agents.
- PC-ISO, a derivative of PC that is
  translucent, expands the usage of polycarbonate models and prototypes in
  various medical applications.
- Polyphenylsufone (PPSF) is a specialty
  thermoplastic material, which offers excellent mechanical properties while
  being subjected to demanding thermal and chemical environments. PPSF is used
  to make prototype parts for numerous industries, including automotive, fluid
  and chemical handling, aerospace, and medical sterilization.
- ABSi is a higher grade translucent ABS,
  which features greater impact strength than our standard ABS. It can also be
  used in medical applications, including gamma-ray sterilization.
- PC-ABS is a blend of polycarbonate and
  ABS plastic. The blend combines the strength of PC with the flexibility of
  ABS.

In addition to the modeling
materials, we offer a proprietary water-soluble material used for support during
the build process, which is later automatically dissolved from the finished part
in systems that employ WaterWorks. Other proprietary release materials are used
for support and are removed from the final model by hand.

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, a concept
model, or a functional part. ABS and ABSplus are also offered in numerous
colors, including white, black, red, blue, yellow and green. We offer a program
to create custom colors for unique customer needs.

The modeling and support filament
used in the RP and DDM systems and 3D printers that we sell are consumable
products that provide us additional recurring revenue.

**Operating Software**

Our high-performance systems and 3D
printers use one of two software products that convert the three-dimensional CAD
databases into the appropriate two-dimensional data formats. The software
products also provide a wide range of features, including automatic support
generation, part scaling, positioning and nesting, as well as geometric editing
capabilities. The software is not sold as a stand-alone product.

Catalyst EX, our entry-level software
product, enables users to build prototype parts at the push of a button. It was
introduced in 2000 and is used on Dimension 1200es SST and BST, Dimension Elite,
and Dimension 768 BST and SST.

5

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Our InSight preprocessing software
is used on the remainder of our FDM products  FDM 200mc, 360mc, 400mc, and
900mc, Vantage, Titan and Maxum. It increases build speed and improves the
design engineers control and efficiency over the entire build process. It has a
broad set of features that facilitate the demanding applications ranging from a
single push button for automatic pre-processing to individual editing and
manipulation tools for each process step.

We continuously improve both
software products to meet the demands of our sophisticated customers. Throughput
enhancements, advanced build algorithms and features are intended to keep pace
with complex industrial geometric designs while saving valuable operator
time.

Services

**Maintenance, Leasing,
Training and Contract Engineering**

We also provide a number of services
in relation to our rapid prototyping business. We provide maintenance to our
customers under our standard warranties and separate maintenance contracts. In
the United States, we lease or rent RP systems and 3D printers under operating
agreements to customers that do not desire to purchase them or enter into
sales-type leases. We offer training to our customers, particularly on our
high-performance systems. Finally, from time to time we offer contract
engineering services to third parties in connection with the development of
systems and services incorporating our proprietary technology.

**RedEye Paid Parts**

Our RedEye Paid Parts service offers
both existing and potential customers the ability to purchase prototypes and
end-use parts that we make for them from CAD files that they provide to us. We
have a facility near our corporate headquarters dedicated to Paid Parts
operations. Our RedEye RPM website service, www.redeyerpm.com, enables our
customers to obtain quotes and order parts around the clock, seven days a week.
RedEye RPM offers unmatched expertise and production capacity using the latest
in proven rapid prototyping and direct digital manufacturing technologies and
processes.

Marketing, Distribution and Customers

**Marketing and
Customers****

The focus of our marketing begins
with the identification of customer needs. We feature a broad array of products
that allow us to meet the precise needs of engineers, designers, educators,
marketers and manufacturers. Our products range from Dimension BST, priced at
$18,900, to a high productivity FDM 900mc, priced up to $400,000. We currently
offer ten other systems between these price points meeting a variety of
material, size and performance criteria.

We have sold systems to the
following representative customers:

|General Motors
        CorporationIntelThe Boeing CompanyUniversity of Wisconsin -
        MadisonChryslerLegoHondaSt. Jude MedicalHewlett
    Packard | Harley DavidsonDellXeroxUniversity of Texas at El
        PasoLockheed MartinLeverFord Motor CompanyNASAHyundai | ToyotaNikeMitsubishi ElectronicsPioneer SpeakerCornell UniversityToroGracoMedtronic-Sofamar DanekBrigham Young
        University
|------------------------------------------------------------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------

6

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We have also sold systems to a small
number of service bureaus. We sell complete high-performance and 3D printing
systems as well as supplies and services.

No customer accounted for more than
10% of sales in 2007, 2006, or 2005.

We use a variety of tactical
marketing methods to reach potential customers:

|Web-based marketingTrade magazine articlesBrochuresWebsitesCDsPress releasesIndustry associations |  | Print advertisementsDirect mailingsTrade show
demonstrationTelemarketing programsBroadcast e-mailWebinarsInternet search
        engines
|-------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------

In addition, we have developed
domestic and international on-site demonstration capabilities.

**FDM Sales
Organization**

In early 2003, we consolidated our
FDM sales organization by structuring sales, service, and marketing into one
group. The focus of this organization is on our high-performance systems that
feature engineering modeling materials, high quality surface finish, high
accuracy and feature detail, and excellent throughput. This group markets, sells
and services our 200mc, 360mc, 400mc, 900mc, Maxum, Titan and Vantage
systems.

The FDM sales organization operates
worldwide. Our North American territory is organized as a single region managed
by a National Sales Manager. Regional sales and service offices are located in
Novi, Michigan, and Ontario, California. We have identified specialists within
the sales group who are focused on DDM opportunities.

Internationally, our third-party
distributors sell and service our FDM systems. We have relationships throughout
the world including Europe, the Middle East, Japan, Korea, Taiwan, China, and
Latin America. Sales management and technical support were increased to support
the growth of our international business. International sales and service
centers are located in Frankfurt, Germany, Bologna, Italy, Bangalore, India,
Tokyo, Japan and Shanghai, China.

**3D Printing
Sales Organization**

In conjunction with the
consolidation of our FDM sales organization, we also consolidated our 3D
printing sales organization in 2003. A worldwide Director of Sales manages four
channel managers in North America as well as our international regional sales
managers for our 3D printers.

We use a worldwide reseller network
to market, sell, and service our 3D printers. Many of our reseller outlets have
Dimension BST and Dimension SST systems that are available for tradeshows,
product demonstrations, and other promotional activities. As of early 2008, we
had approximately 240 reseller locations worldwide. Most resellers enjoy a
long-term presence in their respective territories. In addition to Dimension,
most resellers sell and service a third-party 3D solid CAD software package.
Most of our North American territories, Germany, Japan and the United Kingdom
contain a reseller devoted to commercial accounts as well as a different
reseller devoted to the education market.

Dimension can be found at many
leading companies. Based on estimates from the 2007 Wohlers Report, we believe
that 3D printers represented approximately 72% of all RP systems sold in 2006,
and that Dimension accounted for about 52% of all 3D printers shipped in 2006.

7

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**RedEye Paid
Parts****

In 2006, we established a dedicated
internal sales channel to offer our RedEye Paid Parts services through our
RedEye RPM instant Internet quoting system. This team is responsible for growing
our Paid Parts business and nurturing customers who have RP and DDM part needs.
Their objective is to insure the customer has a favorable experience when
solving their internal part requirements. Besides a commitment to customer
satisfaction, an essential objective of this operation is to increase the number
of quality FDM parts in the marketplace, which, in turn, we believe will also
support the expansion of our system sales. Various distribution agreements have
been established to accomplish these goals and continue to grow this business.
In 2007, we launched Redeye RPM in both Europe and Australia. In addition, in
February 2008, we launched RedeyeArc.com specifically aimed at serving the
architectural market.

**Customer
Support****

Our Customer Support department
provides on-site system installation and maintenance services and remote
technical support to users of our products. We offer services on a time and
material basis as well as through a number of post-warranty maintenance
contracts with varying levels of support and pricing. Our help desk provides
technical support via phone, fax, and e-mail to international customers,
distributors, and resellers, and our field service personnel. We supply a
toll-free telephone number that our domestic customers can utilize to request
technical assistance, schedule service visits, order parts and supplies, or
directly contact a manager within the Customer Support department.

For our high performance systems, we
employ a field service organization that performs system installation, basic
operation and maintenance training, and a full range of maintenance and repair
services at customer sites. Field representatives have been trained and
certified to service all of our products. Representatives are strategically
located in regional offices across North America and are equipped with cellular
phones and laptop computers. They have secure remote access to a customer
service database containing service history and technical documentation to aid
in troubleshooting and repairing systems.

Customer Support is represented on
all cross-functional product development teams within Stratasys to ensure that
products are designed for serviceability and to provide our internal design and
engineering departments with feedback on field issues. Failure analysis,
corrective action, and continuation engineering efforts are driven by data
collected in the field. Ongoing customer support initiatives include development
of advanced diagnostic and troubleshooting techniques and comprehensive
preventative maintenance programs, an expanded training and certification
program for technical personnel, and improved communication between the field
and the factory.

**Warranty and
Service****

We provide a 90-day warranty on our
commercial systems sold domestically and a one-year warranty on domestic
educational sales and all systems sold internationally. In addition, we offer
annual and multiple-year service and maintenance contracts for our systems.
Annual service contracts for our systems are priced from approximately $2,200 to
$48,000 per year.

Manufacturing

Our manufacturing process consists
of assembling systems using purchased components from our proprietary designs
and producing consumable filament to be used within our systems. We obtain all
parts used in the manufacturing process either from distributors of standard
electrical or mechanical parts or from custom fabricators of our proprietary
designs. Our suppliers are measured by on-time performance and quality. We
currently operate on a build-to-forecast basis.

8

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We purchase major component parts
for our high-performance FDM and 3D printing systems from various outside
suppliers, subcontractors and other sources and assemble them at our Minnesota
facilities. Our production floor has been organized using demand-flow techniques
(DFT) in order to maximize efficiency and quality. Using DFT, our production
lines are balanced and as capacity constraints arise, we can avoid the
requirements of reconfiguring our production floor. Computer-based Material
Requirements Planning (MRP) is used forreordering to insure on-time delivery of forecasted parts. All operators
and assemblers are certified and trained on up-to-date assembly and test
procedures including Assembly Requirement Documents which originate in
engineering. The assembly process includes semi-automated functional tests of
key subassemblies. Key functional characteristics are verified through these
tests and the results are stored in a statistical database. At the completion of
assembly, we perform a complete power up and final quality tests to ensure the
quality of our products before shipment to customers. The complete final quality
tests must be run error free before the system can be cleared for shipment. We
maintain a history log on all products that shows revision level configuration
and a complete history during the manufacturing and test process. All issues on
the system during the manufacturing process are logged and tracked and used to
make continuous process improvements of our production processes. Other
manufacturing strengths that are incorporated into our new designs are the
commonality of designs among our different products as well as the incorporation
of Six Sigma concepts. Our filament production utilizes Factory
Physics® techniques to manage critical buffers of time, capacity and
inventory to ensure product availability. We also utilize the 5S method (Sort,
Set-in-order, Shine, Standardize and Sustain) as part of our lean manufacturing
initiatives to improve organization and efficiency. Additionally, we recycle
many filament cartridge parts.

We maintain an inventory of most of
our necessary supplies, which facilitates the assembly of products required for
production. While most components are available from multiple suppliers, certain
components used in our systems and consumables are only available from single or
limited sources. Should our present single or limited source suppliers become
inadequate, we would be required to spend a significant amount of time and money
researching alternate sources. We consider these suppliers very reliable.
Although we believe we maintain adequate inventories of vendor-specific
materials, the loss of a supplier of such vendor-specific materials or compounds
could result in the delay in the manufacture and delivery of those materials and
compounds. The delay could require us to find an alternate source, which would
require us to re-qualify the product supplied by one or more new vendors. We are
developing risk management plans for these critical suppliers. We consider our
relationships with our suppliers to be good.

Research, Development and Engineering

We believe that ongoing research,
development and engineering efforts are essential to our continued success.
Accordingly, our engineering development efforts will continue to focus on
improvements to the FDM technology and development of new modeling processes,
materials, software, user applications and products. We have devoted significant
time and resources to the development of a universally compatible and
user-friendly software system. We are committed to designing products using the
principles of Six Sigma. We continue to standardize our product platforms,
leveraging each new design so that it will result in multiple product offerings
that are developed faster and at reduced expense. The FDM 200mc, 360mc, 400mc,
900mc and Dimension SST products as well as the Catalyst and InSight software
products are examples of this successful strategic initiative. For the years
ended December 31, 2007, 2006 and 2005, our research, development and
engineering expenses were approximately $7.5 million, $6.7 million and $6.4
million, respectively.

Our filament development and
production operation is located at our facilities in Eden Prairie, MN. We regard
the filament formulation and manufacturing process as a trade secret and hold
patent claims on filament usage in our products.We purchase raw material plastics
for our consumable filament production from various large plastic suppliers.

Intellectual Property

We consider our proprietary
technology to be material to the development, manufacture, and sale of our
products and services and seek to protect our technology through a combination
of patents and confidentiality agreements with our employees and others. All
patents and patent applications for our rapid prototyping processes and
apparatuses associated with the FDM process have been assigned to us by their
inventors. As part of our purchase of rapid prototyping technology assets from
IBM, we were also assigned the rights and title to three patents developed by
IBM, which were incorporated in our Genisys system and are used in several of
our current product lines. We recorded these patents domestically and are in the
process of recording them in certain foreign countries. The terms of two of
these patents extend until April 12, 2011, and May 17, 2011, while the third
patent has expired. The United States patents covering our proprietary FDM
technology expire at various times between 2009 and 2027. In total, we currently
own over 180 U.S. and international patents and patent applications. Other
foreign patent applications have also been filed, including the patent
applications assigned to us by IBM.

9

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Our registered trademarks include:

|Stratasys, Inc.QuickSlice3D PlotterDimension BST | FDMAutoGenFDM QuantumDimension SST | CatalystDimensionGenisysDimension Elite
|------------------------------------------------ | ---------------------------------- | ---------------------------------------

Other trademarks include:

|FDM MaxumBASSInSightFDM 200mcProdigy Plus | FDM TitanBuildFDMTouchworksFDM 360mcProdigy | SupportWorksFDM VantageWaterWorksFDM 400mcFDM
  900mc
|----------------------------------------- | ------------------------------------------- | -----------------------------------------------------

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.

We have also registered a number of
Internet domain names, including the following:

|Stratasys.comBuildFDM.com3Dprinter.comPaidparts.comBuildpolyjet.com | Dimensionprinting.com3D-fax.comwebprototypes.combuildup.comRedeyeARC.com | RedEyeRPM.comDimensionDirect.comprototype.comwebmodeling.com
|------------------------------------------------------------------- | ------------------------------------------------------------------------ | ------------------------------------------------------------

Backlog

Our total backlog of system orders
at December 31, 2007 was approximately $5.7 million, as compared with
approximately $4.1 million at December 31, 2006. We estimate that most of our
backlog will ship in the first half of 2008.

Seasonality

Historically, our results of
operations have been subject to seasonal factors. Stronger demand for our
products has occurred in our fourth quarter primarily due to our customers
capital expenditure budget cycles and our sales compensation incentive programs.
Our first quarter has historically been our weakest quarter. This trend has been
muted recently by the successful introduction of new products coupled with
demonstration programs that have granted extended payment terms to resellers and
distributors of our Dimension product line.

Competition

We compete 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 manual methods generally perform the prototype development
and fabrication. We believe that there is currently no other commercial producer
of 3D modeling devices that uses a single-step, non-toxic technology similar to
our FDM technology. Most of the 3D printing and other RP systems manufactured by
our competitors involve additional postprocessing steps, such as curing the part
after construction of the model or prototype. Our FDM technology does not rely
on the laser or light technology used by other commercial manufacturers in the
RP industry.

10

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Our competitors employ a number of
different technologies in their RP devices. 3D Systems, and CMET, use
stereolithography in their products. 3D Systems and EOS GmbH produce machines
that use selective laser sintering (SLS) to harden powdered material. Z Corp.
uses inkjet technology to bond powdered materials. Solidscape, 3D Systems and
Objet Geometries have developed prototyping systems that use inkjet technology
to deposit resin material layer by layer. A smoothing or milling process is
often required between each deposited layer to maintain accuracy in these
processes. Envisiontec utilizes a photopolymer mask and a light process to build
models. We believe that our FDM technology has important advantages over our
competitors products. These advantages include:

- the ability to be used in an office
  environment
- the availability of multiple
  production-grade modeling materials
- a one-step modeling process
- low acquisition price
- ease of use
- hands-free support removal

Certain of our competitors may have
greater financial and marketing resources than we have. Based on data and
estimates presented in the 2007 Wohlers Report, in 2006 we shipped more units
than any other company in the RP industry globally, and we were the second
largest in terms of revenue. Wohlers reports that we shipped 41% of total units
shipped in the industry in 2006. We believe that this trend continued in 2007 as
well.

Employees

As of March 1, 2008, we had 382
full-time employees and 26 subcontractors or temporary employees. While we have
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 we have not experienced any work
stoppages. We believe our employee relations are good.

Governmental Regulation

We are 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
- export control regulations for U.S. made
  products

Available Information

We file annual, quarterly and
current reports, proxy statements and other information with the Securities and
Exchange Commission. You may read and copy any document we file at the SECs
public reference room at 100 F Street, N.E., Washington, D.C. 20549. Please call
the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC
maintains a website that contains annual, quarterly and current reports, proxy
statements and other information that issuers (including Stratasys) file
electronically with the SEC. The SECs website iswww.sec.gov.

Our website iswww.stratasys.com. We make
available free of charge through our Internet site, via a link to the SECs
website atwww.sec.gov, our annual reports on Form 10-K; quarterly reports on Form
10-Q; current reports on Form 8-K; Forms 3, 4 and 5 filed on behalf of our
directors and executive officers; and any amendments to those reports filed or
furnished pursuant to the Securities Exchange Act of 1934 as soon as reasonably
practicable after such material is electronically filed with, or furnished to,
the SEC.

11

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We make
available onwww.stratasys.comour most recent annual report on Form 10-K, our quarterly
reports on Form 10-Q for the current fiscal year and our most recent proxy
statement, although in some cases these documents are not available on our site
as soon as they are available on the SECs site. You will need to have on your
computer the Adobe Acrobat Reader software to view these documents, which are in
PDF format. If you do not have Adobe Acrobat, a link to Adobes Internet site,
from which you can download the software, is provided. The information on our
website is not incorporated by reference into this report.

Financial Information About Operations
In the United States and Other Countries

The information required by this
item is incorporated by reference to our Financial Statements included elsewhere
in this report. (See Part IV, Item 15, Note 14.)

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Item 1A. Risk Factors.

Many of the factors that affect our
business and operations involve risk and uncertainty. The following describes
the principal risks affecting us and our business. Additional risks and
uncertainties, not presently known to us or currently deemed material, could
negatively impact our results of operations or financial condition in the
future.

We may not be able to introduce new
high-performance systems and 3D printing systems and materials acceptable to the
market or to improve the technology and software used in our current
systems.

Our ability
to compete in the high-performance and 3D printing market depends, in large
part, on our success in enhancing our existing product lines and in developing
new products. Even if we successfully enhance existing systems or create new
systems, it is likely that new systems and technologies that we develop will
eventually supplant our enhanced systems or our competitors will create systems
that will replace ours. The RP industry is subject to rapid and substantial
innovation and technological change. We may be unsuccessful at enhancing
existing systems or developing new systems or materials on a timely basis, and
any of our products may be rendered obsolete or uneconomical by our or others
technological advances.

If the 3D printing market does not
continue to accept our systems, our revenues may stagnate or
decline.

We derive a
substantial portion of our sales from the sale of 3D printers. If the market for
3D printers declines or if competitors introduce products that compete
successfully against ours, we may not be able to sustain the sales of those
products. If that happens, our revenues may not increase and could
decline.

If we are unable to maintain revenues
and gross margins from sales of our existing products, our profitability will be
adversely affected.

Our current strategy is to attempt
to reduce the prices of our high-performance systems and 3D printers to expand
the market and increase sales. In conjunction with that strategy, we are
constantly seeking to reduce our direct manufacturing costs as well. Our
engineering and selling, general and administrative expenses, however, generally
do not vary substantially in relation to our sales. Accordingly, if our strategy
is successful and we increase our revenues while maintaining our gross margins,
our operating profits generally will increase faster as a percentage of revenues
than the percentage increase in revenues. Conversely, if our revenues or gross
margins decline, our operating profits generally will decline faster than the
decline in revenues or gross margins. Therefore, declines in our revenues may
lead to disproportionate reductions in our operating profits.

If other manufacturers were to
successfully develop and market consumables for use in our systems, our revenues
and profits could be adversely affected.

We presently sell substantially all
of the consumables that our customers use in our systems. However, even though
we attempt to protect against replication of our consumables through patents and
trade secrets and we provide that our warranties are valid only if customers use
consumables that we certify, it is possible that other manufacturers could
develop consumables that could be used successfully in our systems. If our
customers were to purchase consumables from our competitors, we would lose some
of our sales and could be forced to reduce prices, which would impair our
overall revenue and profitability.

If we fail to grow our Paid Parts
service as anticipated, our net sales and profitability will be adversely
affected.

We are attempting to grow our Paid
Parts service substantially. To this end, we have made significant
infrastructure, technological and sales and marketing investments. These
investments include a dedicated facility, increased staffing, use of a
substantial number of our FDM systems exclusively for Paid Parts, and the
development and launch of our RedEye RPM service, which enables customers to
obtain quotes for and order parts over the Internet. If our Paid Parts service
does not generate the level of sales required to support our investment, our net
sales and profitability will be adversely affected.

13

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A loss of a significant number of our
international distributors or North American resellers would impair our ability
to sell our products and services and could result in a reduction of sales and
net income.

We sell all of our products
internationally through distributors, and we sell our 3D printers in North
America through resellers. We rely heavily on these distributors and resellers
to sell our products to end users in their respective geographic regions. If a
significant number of those distributors or resellers were to terminate their
relationship with us or otherwise fail or refuse to sell our products, we may
not be able to find replacements that are as qualified or as successful in
selling our products. If we are unable to find qualified and successful
replacements, our sales will suffer, which would have a material adverse effect
on our net income.

We may not be able to adequately
protect or enforce our intellectual property rights, which could harm our
competitive position.

Our success and future revenue
growth will depend, in part, on our ability to protect our intellectual
property. We rely primarily on patents, trademarks and trade secrets, as well as
non-disclosure agreements and other methods, to protect our proprietary
technologies and processes. Despite our efforts to protect our proprietary
technologies and processes, it is possible that competitors or other
unauthorized third parties may obtain, copy, use or disclose our technologies
and processes. We cannot assure you that any of our existing or future patents
will not be challenged, invalidated or circumvented. As such, any rights granted
under these patents may not provide us with meaningful protection. We may not be
able to obtain foreign patents or pending applications corresponding to our U.S.
patent applications. Even if foreign patents are granted, effective enforcement
in foreign countries may not be available. If our patents do not adequately
protect our technology, our competitors may be able to offer products similar to
ours. Our competitors may also be able to develop similar technology
independently or design around our patents. Any of the foregoing events would
lead to increased competition and lower revenue or gross margins, which would
adversely affect our net income.

If our intangible assets become
impaired, we may be required to record a significant charge to
earnings.

As of
December 31, 2007, the net book value of our intangible assets was approximately
$8 million. Accounting rules require us to take a charge against our earnings to
the extent that any of these intangible assets are impaired. Accordingly,
invalidation of our patents, trademarks or other intellectual property or the
impairment of other intangible assets due to litigation, obsolescence,
competitive factors or other reasons could result in a material charge against
our earnings and have a material adverse effect on our results of
operations.

If our investments become impaired, we
may be required to record a significant charge to earnings.

Our investments include tax-free
Auction Rate Certificates (ARCs) and municipal government bonds, all of which
are insured. Given the current volatility in interest rates and the potential
impact of higher interest rates on the issuers of these securities, a
significant increase in interest rates could impair the ability of one or more
issuers to pay interest on, or principal of, these obligations. Defaults by
these issuers or their insurers could cause an impairment of the value of our
investments, resulting in a charge against our earnings. Any such charge could
have a material adverse effect on our results of operations.

We operate a global business that
exposes us to additional risks.

Our sales outside of the United
States accounted for approximately 50% of our consolidated net sales in 2007. We
continue to expand into international markets. The future growth and
profitability of our foreign market is subject to a variety of risks and
uncertainties. Any of the following factors could adversely affect our sales to
customers located outside of the United States:

- Relative strength of the US dollar against foreign
  currencies could make our products more expensive and would reduce our profit
  margins on sales to foreign customers.
- If we are unable to protect our intellectual
  property in foreign countries, competitors could use it to compete against us,
  adversely affecting our sales and profits.
- Political or economic instability in regions where
  we sell our products could reduce or eliminate sales to customers located in
  those regions.
- Seasonal fluctuations in business activity in
  certain countries could result in significant fluctuations in sales from
  quarter to quarter.
- Changes in export controls and tariffs could make
  it more difficult for us to sell our products outside of the United
  States.

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Our operating results and financial
condition may fluctuate.

Our operating results and financial
condition may fluctuate from quarter-to-quarter and year-to-year and are likely
to continue to vary due to a number of factors, many of which are not within our
control. If our operating results do not meet the expectations of securities
analysts or investors, who may derive their expectations by extrapolating data
from recent historical operating results, the market price of our common stock
will likely decline. Fluctuations in our operating results and financial
condition may be due to a number of factors, including, but not limited to,
those listed below and those identified throughout this Risk Factors
section:

- changes in the amount that we spend to develop,
  acquire or license new products, consumables, technologies or
  businesses;
- changes in the amount we spend to promote our
  products and services;
- changes in the cost of satisfying our warranty
  obligations and servicing our installed base of systems;
- delays between our expenditures to develop and
  market new or enhanced systems and consumables and the generation of sales
  from those products;
- development of new competitive systems by
  others;
- changes in accounting rules
- the mix of high-performance systems and 3D
  printers that we sell during any period;
- the geographic distribution of our
  sales;
- our responses to price
  competition;
- market acceptance of our
  products;
- general economic and industry conditions that
  affect customer demand;
- changes in interest rates that affect returns on
  our cash balances and short-term investments;
- failure of a development partner to continue
  supporting certain product development efforts it is funding;
  and
- our level of research and development
  activities.

Due to all
of the foregoing factors, and the other risks discussed in this report, you
should not rely on quarter-to-quarter comparisons of our operating results as an
indicator of future performance.

Default in payment by one or more
international distributors or North American resellers that have large account
receivable balances could adversely impact our results of operations and
financial condition.

Large balances were concentrated
with certain international distributors and North American resellers, and some
of these balances exceed the original payment terms. Default by one or more of
these distributors or customers could result in a significant charge against our
current reported earnings. We have reviewed our policies that govern credit and
collections, and will continue to monitor them in light of current payment
status and economic conditions.Default by one or more of these distributors or resellers would result
in a significant charge against our earnings and adversely affect our results of
operations and financial condition.

If we are unable to retain our key
operating personnel and attract additional skilled operating personnel, our
development of new products will be delayed and our personnel costs will
increase.

Our growth plans require us to
retain key employees in, and to hire additional skilled employees for, our
operating departments, such as engineering and computer programming, to enhance
existing products and develop new products. Our inability to retain and hire key
engineers and other employees could have the effect of delaying our development
and introduction of new products, which would adversely affect our revenues. In
addition, a possible shortage of such personnel in the Minneapolis region could
require us to pay more to retain and hire such employees, thereby increasing our
costs.

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Our common stock price has been and may
continue to be highly volatile.

In the
preceding 12 months, our common stock has traded at prices ranging between
$15.40 and $31.45. Investors may have difficulty selling our common stock
following periods of volatility, because of the markets adverse reaction to
such volatility. Factors that we believe have caused or may cause this
volatility include, among other things:

- actual or anticipated variations in quarterly or
  annual operating results;
- our announcements of the issuance of patents or
  other technological innovations;
- our announcements of new
  products;
- our competitors' announcements of new
  products;
- changes in financial estimates or recommendations
  by securities analysts;
- the employment and termination of key personnel;
  and
- sales or repurchases of our common stock by our
  Company

Many of these factors are beyond our
control. These factors may have a material adverse affect on the market price of
our common stock, regardless of our operating performance.

If our internal controls over financial
reporting do not comply with the requirements of the Sarbanes-Oxley Act, our
business and stock price could be adversely affected.

Section 404 of the Sarbanes-Oxley
Act of 2002 requires us to evaluate the effectiveness of our internal controls
over financial reporting as of the end of each year, and to include a management
report assessing the effectiveness of our internal controls over financial
reporting in all annual reports. Section 404 also requires our independent
registered public accounting firm to report on the effectiveness of our internal
controls over financial reporting.

Our management, including our CEO
and CFO, does not expect that our internal controls over financial reporting
will prevent all error and fraud. A control system, no matter how well designed
and operated, can provide only reasonable, not absolute, assurance that the
control systems objectives will be met. Further, the design of a control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
involving Stratasys have been, or will be detected. These inherent limitations
include the realities that judgments in decision-making can be faulty and that
breakdowns can occur because of simple error or mistake. The design of any
system of controls is based in part on certain assumptions about the likelihood
of future events, and we cannot assure you that any design will succeed in
achieving its stated goals under all potential future conditions. Over time, our
controls may become inadequate because of changes in conditions or deterioration
in the degree of compliance with policies or procedures. Because of the inherent
limitations in a cost-effective control system, misstatements due to error or
fraud may occur and not be detected.

Although our management has
determined, and our independent registered public accounting firm has concluded
in its audit, that our internal controls over financial reporting were effective
as of December 31, 2007, we cannot assure you that our independent registered
accounting firm will not identify a material weakness in our internal controls
in the future. A material weakness in our internal controls over financial
reporting would require management and our independent registered public
accounting firm to evaluate our internal controls as ineffective. If our
internal controls over financial reporting are not considered adequate, we may
experience a loss of public confidence, which could have an adverse effect on
our business and our stock price.

The foregoing list is not
exhaustive. There can be no assurance that we have correctly identified and
appropriately assessed all factors affecting our business or that the publicly
available and other information with respect to these matters is complete and
correct. Additional risks and uncertainties not presently known to us or that we
currently believe to be immaterial also may adversely impact our business.
Should any risks or uncertainties develop into actual events, these developments
could have material adverse effects on our business, financial condition, and
results of operations.

16

---

We assume no obligation (and
specifically disclaim any such obligation) to update these Risk Factors or any
other forward-looking statements contained in this Annual Report to reflect
actual results, changes in assumptions or other factors affecting such
forward-looking statements.

Item 1B. Unresolved Staff
Comments.

None.

Item 2. Properties.

Our executive offices and production
facilities presently comprise approximately 191,000 available square feet in
three buildings in Eden Prairie, Minnesota, near Minneapolis.

On August 1, 2001, we purchased our
Eden Prairie manufacturing facility and land for approximately $3.0 million. The
facility consists of 62,100 square feet, and is used for machine assembly,
inventory storage, operations, sales support, and administration.

In March 2004, we purchased an
additional 42,500 square foot manufacturing facility for approximately $1.2
million. The facility is located near our manufacturing facility in Eden
Prairie, Minnesota, and is used for our Paid Parts service.

In November 2005, we purchased an
additional 86,000 square foot manufacturing facility for approximately $5.1
million. As of December 31, 2007, we had spent approximately $3.2 million in
improvements since its acquisition to make this facility suitable for our
specific usage. This facility is used for R&D, administrative, marketing and
sales activities. The facility is across from our manufacturing facility in Eden
Prairie, Minnesota. We expect it to accommodate our intermediate expansion
requirements. We occupied approximately 69,000 square feet of the building in
January 2008, with the balance of space under a lease agreement that expires at
the end of July, 2008.

We occupy 14,600 square foot
warehouse in Eden Prairie, Minnesota, for shipping and storage under a lease
that expires in August 2011.

We have two North American sales
offices and one service office. We occupy 2,659 square feet of space in Novi,
Michigan, a Detroit suburb, under a lease that expires in July 2010. We also
occupy a 2,504 square foot sales office in Ontario, California under a lease
that expires in August 2008. In addition, we have a 1,440 square foot service
office in Ontario, California, under a lease that expires in August 2009. We are
also responsible for real estate taxes, insurance, utilities, trash removal, and
maintenance expenses at these facilities.

We have three international sales
and service offices under lease. Our German subsidiary leases 8,041 square feet
of space in Frankfurt, Germany under a lease that expires in June 2011. Our
Italian subsidiary leases 1,300 square feet in Bologna, Italy under a lease that
expires in December 2010. We have a 2,500 square foot sales office in Bangalore,
India, under a lease that expires in May 2008. We believe we will be able to
renew the India lease.

Item 3. Legal
Proceedings.

The Company is a party to various
legal matters, the outcome of which, in the opinion of management, will not have
a material adverse effect on the Companys financial position.

Item 4. Submission of Matters to a Vote
of Security Holders.

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, 2007.

17

---

PART II

Item 5. Market for Registrants Common
Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities.

Market Information

Our common stock is traded on the
Nasdaq Global Select Market under the symbol SSYS.

The following table sets forth the
high and low closing sale prices of our common stock for each quarter from
January 1, 2006 through the fiscal year ended December 31, 2007 reported on the
Nasdaq Global Select Market. All prices have been adjusted for our two-for-one
stock split effective August 15, 2007.

**High**
    
    **Low**Closing Sale Prices
      ($)Fiscal Year Ended December 31, 2006January 1, 2006  March 31,
      2006
    
    14.77
    
    11.63April 1, 2006  June 30, 2006
    
    17.20
    
    12.27July 1, 2006  September 30, 2006
    
    14.97
    
    11.02October 1, 2006  December 31, 2006
    
    16.29
    
    12.89Fiscal Year Ended December 31, 2007January 1, 2007  March 31, 2007
    
    21.72
    
    15.49April 1, 2007  June 30, 2007
    
    25.02
    
    20.57July 1, 2007  September 30, 2007
    
    28.34
    
    20.00October 1, 2007  December 31, 2007
    
    30.27
    
    20.75


There were approximately 89 record
and 9,768 beneficial owners of our common stock as of March 8, 2008.

Dividends

We have not paid or declared any
cash dividends to date and do not anticipate paying any in the foreseeable
future. We intend to retain earnings, if any, to support the growth of our
business.

18

---

**Shares Issuable Under Equity Compensation
Plans**

The
following table sets forth the number of securities to be issued upon the
exercise of, and the weighted-average exercise price of, outstanding options,
warrants and rights, and the number of securities remaining available for future
issuance, under our equity compensation plans as of December 31,
2007:

|                              |  |                                      |  |                       |  | **Number of
  securities**      
|----------------------------- |  | ------------------------------------ |  | --------------------- |  | --------------------------------
|                              |  |                                      |  | **Weighted average**  |  | **remaining available
    for** 
|                              |  | **Number of securities**             |  | **exercise price of** |  | **future issuance
  under**     
|                              |  | **to be issued upon**                |  | **outstanding**       |  | **compensation plans**          
|                              |  | **exercise of
    outstanding**      |  | **options, warrants** |  | **(excluding
  securities**     
|                              |  | **options, warrants and
    rights** |  | **and
      rights**  |  | **reflected in column
    (a))**
|                              |  | **(a)**                              |  | **(b)**               |  | **(c)**                         
|Equity compensation plans     |  |                                      |  |                       |  |                                 
|approved by security holders^ |  | 1,802,028                            |  | $15.02                |  | 304,066                         

^ We do not have any equity compensation
plans that have not been approved by security holders.

Issuer Purchases of Equity
Securities

On October 27, 2005, our Board of
Directors authorized us to purchase up to $20 million of our outstanding shares
of common stock. We repurchased no shares in 2007 pursuant to that
authorization. As of December 31, 2007, we had remaining authorization of
approximately $8.0 million for future share repurchases. On February 26, 2008,
our Board of Directors authorized us to purchase up to $30 million of our
outstanding shares of common stock, which superseded the previous
authorization.

Stock Performance Graph

The following graph compares on a
cumulative basis the yearly percentage change, assuming dividend reinvestment,
over the last five fiscal years in (a) the total stockholder return on our
Common Stock with (b) the total return on the Nasdaq (US) Composite Index, and
(c) the total return on the information technology sector of the Standard &
Poors SmallCap 600 Index (S&P 600 Info Tech Index). The S&P 600 Info
Tech Index consists of 125 of the 600 stocks comprising the Standard &
Poors SmallCap 600 Index, a capitalization-weighted index of domestic stocks
chosen for market size, liquidity and industry representation.

The following graph assumes that
$100 had been invested in each of Stratasys, the Nasdaq (US) Composite Index,
and the S&P 600 Info Tech Index on December 31, 2002.

Comparison of Cumulative 5 Year Total Return



19

---

Item 6. Selected Financial
Data.

The selected
consolidated financial data as of and for the five-year period ended December
31, 2007, should be read in conjunction with the Consolidated Financial
Statements and related Notes for the year ended December 31, 2007, and the
Managements Discussion and Analysis of Financial Condition and Results of
Operations.

|                                          |  | Years Ended December
      31,          
|----------------------------------------- |  | ----------------------------------------
|                                          |  | (In Thousands, Except Per Share Amounts)
|                                          |  | 2007                                    
|Statement of Operations Data:            
|Net sales                                 |  | $                                       
|Gross profit (a)                          |  |                                         
|Selling, general
      and administrative |  |                                         
|expenses (a)                              |  |                                         
|Research and development                  |  |                                         
|Operating
      income                    |  |                                         
|Net income                                |  |                                         
|Net income per
      basic common share   |  | $                                       
|Weighted average basic shares             |  |                                         
|outstanding                               |  |                                         
|Net income per
      diluted common       |  |                                         
|share                                     |  | $                                       
|Weighted average diluted shares           |  |                                         
|outstanding                               |  |                                         
|Balance Sheet Data:                      
|Working capital                           |  | $                                       
|Total
      assets                        |  |                                         
|Long term debt (less current portion)     |  |                                         
|Stockholders
      equity                |  |                                         

(a) 2003-2005 have been restated to
reflect customer service costs as part of the cost of sales instead of as
operating expenses. This reclassification had no effect on operating or net
income or net income per basic and diluted common share. Amounts previously
reported and their adjusted balances are as follows:

|                                                                           |  | 2005 |        | 2004 |  | 2003
|-------------------------------------------------------------------------- |  | ---- | ------ | ---- |  | ----
|Gross profit before reclassification                                       |  | $    | 47,525 |      |  | $   
|Reclassification
      of customer service                                 |  |      | (3,770 | )    |  |     
|Gross profit after reclassification                                        |  | $    | 43,755 |      |  | $   
|                                                                          
|Selling, general and administrative expenses before
      reclassification |  | $    | 27,013 |      |  | $   
|Reclassification
      of customer service                                 |  |      | (3,770 | )    |  |     
|Selling, general and administrative expenses after
      reclassification  |  | $    | 23,243 |      |  | $   

20

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Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operation.

Introduction

Managements Discussion and Analysis
of Financial Condition and Results of Operations is intended to facilitate an
understanding of our business and results of operations. It should be read in
conjunction with our Consolidated Financial Statements and the accompanying
Notes to Consolidated Financial Statements included elsewhere in this report.
All amounts in the following discussions are stated in thousands, except
employees, share and per share data, prices for systems, or unless otherwise
indicated.

General

We develop, manufacture, and market
a family of 3D printing, rapid prototyping (RP) and direct digital
manufacturing (DDM) systems, which enable engineers and designers to create
physical models, tooling, jigs, fixtures, prototypes, and end use parts out of
plastic and other materials directly from a computer aided design (CAD)
workstation.

Our strategy
in 2007 was three-fold:

- *Continue expanding our market position in the
  3D printing market through increased sales of the Dimension BST, our low-cost
  3D printer, and the four other Dimension products including the Dimension
  Elite introduced in January 2007.*The Dimension Elite has automated
  soluble support removal and offers the customer a new ABSplus material that on
  average is 40% stronger than our other ABS material offering. The Elite builds
  in thinner layers offering better fine feature model detail. At the end of
  2007, the Dimension product line consisted of five systems ranging in price
  from $18,900 to $32,900. In 2007, the unit growth rate of Dimension was 25%,
  which contributed to a 35% increase in revenues from this product line as
  compared with 2006. According to the 2007 Wohlers Report (Wohlers), we
  shipped more 3D printers than other company in the world in 2006, and based on
  our results in 2007, we believe that we have continued that trend in
  2007.
- *Expand our position in the RP and DDM markets
  through new proprietary product introductions including the FDM 200mc, FDM
  400mc and FDM 900mc, all of which are directed at the DDM market.*In
  2007, revenue from our high-performance proprietary systems grew by 31% over
  2006. The system revenue growth is attributable to our renewed focus on
  proprietary products, customer acceptance of new product introductions, and
  further penetration of DDM applications. We remain fully committed to our
  historic core RP business. We expect growth rates for our high-performance
  systems will continue to be strong. We believe that new opportunities in
  direct digital manufacturing and rapid tooling and expansion of traditional
  rapid prototyping applications will continue to be the impetus for this
  growth. In December 2007, we introduced the FDM 900mc, which is
  capable of building parts nine times larger than the FDM 400mc and represents
  our largest system ever. It can build a part as large as 4.5 feet measured
  along the diagonal. The FDM 900mc uses ball-screw technology and improves part
  accuracy, repeatability and tolerances. This new product is the direct result
  of a $3.6 million order from a Fortune 100 global manufacturing company
  entered into in September 2005 to advance our proprietary FDM®
  technology for direct digital manufacturing applications.
- *Continue to invest in establishing our Paid
  Parts service of producing parts for customers.*We believe this is a
  fragmented global market dominated by numerous small companies generating less
  than $1 million each in annual sales. Sales from our Paid Parts service have
  been volatile quarter-to-quarter as we work to identify the most effective
  ways of reaching customers. In the fall of 2005, we launched RedEye RPM as an
  Internet site allowing customers to obtain instant quotes and then order their
  parts over the Internet via the submission of a standard 3D CAD STL file.
  Year-over-year sales of our Paid Parts service increased by 30%. As customers
  continue to increase their volume of parts ordered, we are often successful in
  selling them systems to produce their own parts.

21

---

In August
2006, we announced that effective January 1, 2007 we were discontinuing our
North American Distributor Agreement with Objet Geometries Ltd. (Objet). The
Eden systems that we distributed for Objet (the Eden Systems) use inkjet
technology to jet ultra-fine layers of UV-cured resin to build RP models. In
order to provide a smooth transition for our customers, we continued to service
the Eden Systems we sold through August 1, 2007.

We also announced that effective
December 2007 we discontinued our distribution agreement with Arcam AB to
exclusively distribute their metal-based direct digital manufacturing and
prototyping systems in North America. In Arcams patented electron-beam melting
(EBM) process, called CAD to Metal®, titanium powder is transformed
into solid metal parts for either functional prototyping or end-use. We believe
that the EBM technology is attractive primarily to early adopters and our
distribution agreement with Arcam did not result in significant sales or
margins.

The discontinuation of the Objet and
Arcam agreements impacts the year-over-year revenue and gross margin analysis.
We sold approximately $4.0 million and $17.5 million of distributed products in
2007 and 2006, respectively. These sales were at gross margins of approximately
minus 4% in 2007 and positive 26% in 2006. In discussing the year-over-year
revenue and gross margin comparisons we refer to these two relationships as
distributed products and services. Proprietary refers primarily to products
that we design and manufacture including third party peripheral items such as
stands and tanks, and services we provide.

As our installed base of systems has
increased, we have derived an increasing amount of revenue from sales of
consumables, maintenance contracts, and other services. Revenue relating to our
installed base of systems generates recurring revenue for us. In 2007, excluding
revenue from distributed Objet and Arcam systems, total non-system revenue
increased by 17% due principally to a 23% growth in proprietary consumable
revenue and 30% growth in Paid Parts revenue, partially offset by a slower
growth in rental and maintenance revenues.

Total net unit shipments increased
21% in 2007 amounting to 2,169 systems compared with the 1,796 net units shipped
in 2006. Wohlers shows we shipped 41% of all systems within the RP industry in
2006. Based on data derived from Wohlers, we believe we shipped more total
systems than any other company in our industry in the world in 2006 and that
this will also be the case for 2007. Our growth was derived from a number of
industries, including automotive, consumer products, electronics, general
manufacturing, educational, government, and aerospace.

In 2008, we plan to continue to make
significant investments in fixed assets, process improvements, information
technology (IT), head count additions, and human resource development
activities that will be required for growth. We anticipate that our operating
expenses will increase in 2008 over the amounts reported in 2007, but that our
gross profit growth will exceed that of our expenses. This should allow for
increased operating profits as a percentage of sales in 2008 as compared with
2007. Our expense levels are based in part on our expectations of future
sales.While we
have adjusted, and will continue to adjust, our expense levels based on both
actual and anticipated sales, fluctuations in sales in a particular period could
adversely impact our operating results.Whereas our backlog as of December 31, 2007, was
$5.7 million, it would not be sufficient to meet our budgeted sales targets
should new system orders in 2008 decline.

We expect growth to be largely
dependent upon our ability to penetrate new markets and develop and market new
RP, DDM and 3D printing systems, materials, applications, and services that meet
the needs of our current and prospective customers. Our ability to implement our
strategy for 2008 is subject to numerous uncertainties, many of which are
described under Risk Factors, above, in this Managements Discussion and
Analysis of Financial Condition and Results of Operations and in the section
below captioned Forward Looking Statements and Factors That May Affect Future
Results of Operations. We cannot ensure that our efforts will be successful.

22

---

Results of Operations

Twelve months ended December 31, 2007
compared with twelve months ended December 31, 2006

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 our consolidated statement of operations.

|For the twelve
      months ended December 31, |  | **2007** |   | **2006**
|---------------------------------------------- |  | -------- | - | --------
|Net sales                                      |  | 100.0    | % |         
|Cost of
      sales                            |  | 46.8     | % |         
|Gross profit                                   |  | 53.2     | % |         
|Selling, general
      and administrative      |  | 30.1     | % |         
|Research & development                         |  | 6.7      | % |         
|Operating
      income                         |  | 16.5     | % |         
|Other income (expense)                         |  | 1.7      | % |         
|Income before
      taxes                      |  | 18.2     | % |         
|Income taxes                                   |  | 5.4      | % |         
|Net
      income                               |  | 12.8     | % |         

Net Sales

Net sales of our products and
services for 2007 and 2006 and changes in net sales were as follows:

**Year-over-**2007
    
    2006
    
    **Year
      Change**Products
    
    $
    89,280
    
    $
    83,449
    
    7.0
    %Services
    
    
    22,963
    
    
    20,359
    
    12.8
    %Net
      sales
    
    $
    112,243
    
    $
    103,808
    
    8.1
    %


The primary drivers of the
year-over-year growth in product sales were:

- 35% increase from Dimension system
  sales
- 31% increase in high productivity system
  sales
- 23% increase in consumable sales

The increase in sales of our
proprietary products was partially offset by a 73% decrease in distributed
system sales.

Adjusting for the impact of the
terminated distributed agreements with Objet and Arcam, net sales of our
products and services for 2007 and 2006 and changes in net sales were as
follows:

**Year-over-**2007
    
    2006
    
    **Year
      Change**Products
    
    $
    86,255
    
    $
    66,790
    
    29.1
    %Services
    
    
    22,002
    
    
    19,496
    
    12.9
    %Net
      sales
    
    $
    108,257
    
    $
    86,286
    
    25.5
    %


Our Dimension systems sales continue
to grow as we introduced a new, higher-priced system in January 2007 and as
awareness of the technology increases. Sales of high-performance systems grew
with new product introductions, the refocus of the domestic sales team on
proprietary products and new applications within the DDM market. As we increase
our installed base of systems in the field, we continue to see solid growth in
consumables. Overall, proprietary systems and consumables grew by 31% in 2007
compared to 2006.

23

---

Service
revenues predominately consisted of the following components: maintenance, Paid
Parts, and rentals. We saw a 30% increase in our Paid Parts service as we
continued to invest in reaching customers through trade shows, direct mailings
and our RedEye RPM website, which allows customers to order their parts over
the Internet. Revenues from maintenance services on our proprietary systems saw
year-over-year revenue growth of 6%. We attribute this slower growth to the
one-year warranty for all international systems and domestic education systems
as well as the high quality and reliability experienced by our 3D printer
customers who now acquire multiple systems.

Net sales and the percentage of net
sales by region for 2007 and 2006, as well as the percentage change were as
follows:

**Year-over-**2007
    
    2006
    
    **Year
      Change**North America
    
    $
    62,525
    
    56
    %
    
    $
    64,705
    
    62
    %
    
    -3.4
    %Europe
    
    
    27,144
    
    24
    %
    
    
    21,459
    
    21
    %
    
    26.5
    %Asia Pacific
    
    
    19,806
    
    18
    %
    
    
    16,629
    
    16
    %
    
    19.1
    %Other
    
    
    2,768
    
    2
    %
    
    
    1,016
    
    1
    %
    
    172.4
    %Total
    
    $
    112,243
    
    100
    %
    
    $
    103,809
    
    100
    %
    
    8.1
    %


North American sales declined
because of the discontinuation of the Objet distribution agreement. Results for
2007 include $2.4 and $1.6 million of Objet and Arcam related revenue,
respectively, compared with $16.2 and $1.3 million of Objet and Arcam related
revenue, respectively, in 2006.

Adjusting for the impact of the
terminated distribution agreements with Objet and Arcam, net sales and the
percentage of net sales by region for 2007 and 2006, as well as the percentage
change were as follows:

**Year-over-**2007
    
    2006
    
    **Year
      Change**North America
    
    $
    58,539
    
    54
    %
    
    $
    47,183
    
    55
    %
    
    24.1
    %Europe
    
    
    27,144
    
    25
    %
    
    
    21,459
    
    25
    %
    
    26.5
    %Asia Pacific
    
    
    19,806
    
    18
    %
    
    
    16,629
    
    19
    %
    
    19.1
    %Other
    
    
    2,768
    
    3
    %
    
    
    1,016
    
    1
    %
    
    172.4
    %Total
    
    $
    108,257
    
    100
    %
    
    $
    86,287
    
    100
    %
    
    25.5
    %


North American sales benefited
from:

- New high-productivity system introductions and a
  renewed focus of the domestic sales team in selling proprietary
  products.
- Our strong Dimension reseller network and the new
  Dimension Elite.
- Growth in our Paid Parts service which focused in
  2007 almost exclusively on North America.

We saw a strong European market
during 2007 for our high-end productivity systems. We believe a portion of this
recovery was due to the weakness of the dollar relative to the euro, but a
portion also related to new product introductions. In addition, we saw strong
growth in sales of our Dimension products as we continued to grow our reseller
network and their effectiveness. We also saw strong growth in Asia Pacific due
to new product introductions, expansion in our Dimension reseller network as
well as the effectiveness of existing resellers.

We believe Europe will remain a
strong market throughout 2008 with new product introductions and assuming
continued weakness in the US dollar. We expect the Asia Pacific region will be
strong due to new product introductions and continued expansions we have made in
our reseller network. North America will be negatively impacted by the
discontinuation of the Arcam agreement. Declining economic conditions in any of
these regions could adversely impact our future sales and
profitability.

24

---

Gross Profit

Gross profit and gross profit as a
percentage of sales for our products and services for 2007 and 2006, as well as
the percentage changes in gross profit were as follows:

**Year-over-**2007
    
    2006
    
    **Year
      Change**% of Relative
    
    
    
    
    % of RelativeSales
    
    
    
    
    SalesProducts
    
    $
    48,739
    
    54.6
    %
    
    $
    41,496
    
    49.7
    %
    
    17.5
    %Services
    
    
    10,969
    
    47.8
    %
    
    
    9,945
    
    48.8
    %
    
    10.3
    %Gross profit
    
    $
    59,708
    
    53.2
    %
    
    $
    51,441
    
    49.6
    %
    
    16.1
    %


Product gross profit increased, as a
percentage of product sales, due to an increase in sales of proprietary products
and a significant decline in sales of Eden Systems and related consumables in
the overall mix. The products that we distributed carried a significantly lower
margin than our proprietary systems and consumables, which we manufacture.Service gross
profit was relatively consistent between the years. Our Paid Parts service
business carries a higher gross margin, but this was offset by lower margins on
our overall maintenance business.

Operating Expenses

Operating expenses and operating
expense as a percentage of sales for 2007 and 2006, as well as the percentage
change in operating expenses were as follows:

**Year-over-**2007
    
    2006
    
    **Year
      Change**% of
      Sales
    
    
    
    % of
      SalesSelling, general & administrative
    
    $
    33,770
    
    30.1
    %
    
    $
    29,105
    
    28.0
    %
    
    16.0
    %Research and
      development
    
    
    7,465
    
    6.7
    %
    
    
    6,699
    
    6.5
    %
    
    11.4
    %Total operating
      expenses
    
    $
    41,235
    
    36.7
    %
    
    $
    35,804
    
    34.5
    %
    
    15.2
    %


Selling, general and administrative
expenses for 2007 increased significantly over the prior year as a percentage of
sales for the following primary reasons:

- We significantly expanded our sales and marketing
  efforts in our Paid Parts business in an effort to capture market share in a
  segment of the RP market that is very fragmented today.
- With the discontinuation of the Objet distribution
  agreement and no new high productivity systems at the beginning of 2007, we
  were concerned with retaining our highly trained domestic sales team and set
  individual quotas at levels to insure their retention. With the renewed focus
  on proprietary high productivity systems and the new product introductions
  throughout 2007, many sales persons exceeded quotas and were paid commissions
  at an accelerated commission rate as a percentage of sales.
- We opened an office in Japan to support our
  growing sales both within Japan and elsewhere in the Asia Pacific
  region.
- We incurred a bad debt expense of $564,000 that
  resulted from the bankruptcy of an Italian distributor we originally engaged
  in early 2005 to sell 3D printers. At that time, it was a subsidiary of a
  large Italian company, but was subsequently sold to management without our
  knowledge.

25

---

Research and
development increased by 11.4% over the previous year as we remain committed to
designing new products and materials, reducing costs on existing products, and
improving the quality and reliability of all of our platforms. Increases were
primarily the result of increases in engineering headcounts partially offset by
an increase in internally capitalized software. During the quarter ended
September 30, 2005, we announced that we received a $3.6 million order from a
Fortune 100 global manufacturing company to advance our proprietary FDM
technology for direct digital manufacturing applications. This effort resulted
in the FDM 900mc. The agreement includes payments to us over four years as
R&D milestones are achieved, as well as payments that are dependent upon
future deliverables. R&D payments received offset accelerated R&D
efforts aimed at direct digital manufacturing advances and are not recognized as
revenue. During 2007 and 2006, we offset approximately $980,000 and $1.1
million, respectively, of R&D expenses with monies received from this
customer, respectively. As we continue our commitment to R&D and certain
quality initiatives into 2008, we expect to report accelerated R&D and
quality improvement spending in 2008 as a percentage of sales. This spending is
focused on accelerating our development efforts to address both the 3D printer
and DDM market opportunities we believe exists.

Operating Income

Operating income and operating
income as a percentage of sales for 2007 and 2006, as well as the percentage
change in operating income were as follows:

**Year-over-**2007
    
    2006
    
    **Year
      Change**% of
      Sales
    
    
    
    
    % of
      SalesOperating income
    
    $
    18,473
    
    16.5
    %
    
    $
    15,637
    
    15.1
    %
    
    18.1
    %


Operating income increased due to
the higher sales volume and the increase in sales of our high-end proprietary
systems and 3D printers compared with distributed products which carry a lower
margin.

Other Income (Expenses)

Other income (expenses) for 2007 and
2006 and changes in other income (expenses) were as follows:

**Year-over-****Year****2007**
    
    **2006**
    
    **Change**Interest income
    
    2,316
    
    
    1,648
    
    
    41
    %Foreign currency
      transaction losses
    
    (503
    )
    
    (307
    )
    
    64
    %Other
    
    76
    
    
    (13
    )
    
    -685
    %Total
    
    1,889
    
    
    1,328
    
    
    42
    %


Interest income increased in 2007
compared with 2006 as we had higher average cash and investment balances
throughout the year.

We incurred foreign currency
transaction losses because we sell primarily in euros throughout most of Europe.
Consequently, we have euro denominated receivables that we mark to the current
exchange rate at the end of each month. As the euro has fluctuated compared to
the US dollar throughout most of 2007, we adjusted the carrying value of these
receivables to reflect the changes in the exchange rate. Each month we enter
into 30-day forward contracts to offset a portion of the impact of variations in
exchange rates. In 2007, our hedging strategy resulted in a larger transaction
loss due to the continuing weakening of the US dollar relative to the euro. At
December 31, 2007 we had approximately €4.5 million net in euro-denominated
receivables and a €3.3 million 30-day forward contract.

26

---

Income Taxes

Income taxes and income taxes as a percentage of net income before taxes
for 2007 and 2006, as well as the percentage change were as follows:

Year-over-2007
    
    2006
    
    Year ChangeIncome taxes
    
    $
    6,038
    
    
    $
    5,800
    
    
    4
    %As a percent
      of income before income taxes
    
    
    29.6
    %
    
    
    34.2
    %


The following is a reconciliation of the 2007 effective income tax rate
compared with the 2006 rate:

2006 effective income tax rate
    34.2
    %Discrete items
      recognized in 2007 not recurring in 2006
    (3.7
    )Impact of increase in manufacturer's deduction rate
    (1.1
    )Uitilization of
      research and development credit
    (1.0
    )Impact of increased tax-free interest income
    (0.9
    )Reduction in
      effective state income taxes, net
    (0.9
    )Increase in tax contigencies
    2.2Impact of
      phase-out of extraterritorial income exclusion
    1.0Other
    (0.2
    )2007
      effective income tax rate
    29.6
    %


Net Income

Net income and net income as a percentage of sales for 2007 and 2006, as
well as the percentage change in net income were as follows:

Year-over-2007
    
    2006
    
    Year Change% of Sales
    
    
    
    
    % of SalesNet income
    
    $
    14,324
    
    12.8
    %
    
    $
    11,164
    
    10.8
    %
    
    28.3
    %


For the reasons cited above, our net income for the twelve months ended
December 31, 2007 was at a higher percentage of sales than in the year ended
December 31, 2006.

27

---

Twelve months ended December 31, 2006
compared with twelve months ended December 31, 2005

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 our consolidated statement of operations.

For
      the twelve months ended December 31,2006
    
    2005Net sales
    
    100.0
    %
    
    100.0
    %Cost of
      sales
    
    50.4
    %
    
    47.2
    %Gross profit
    
    49.6
    %
    
    52.8
    %Selling,
      general, and administrative
    
    28.0
    %
    
    28.0
    %Research & development
    
    6.5
    %
    
    7.7
    %Operating
      income
    
    15.1
    %
    
    17.1
    %Other income (expenses)
    
    1.3
    %
    
    1.3
    %Income before
      taxes
    
    16.4
    %
    
    18.4
    %Income taxes
    
    5.6
    %
    
    5.6
    %Net
      income
    
    10.8
    %
    
    12.8
    %


Net Sales

Net sales of our products and services for 2006 and 2005 and changes in
net sales were as follows:

Year-over-2006
    
    2005
    
    Year ChangeProducts
    
    $
    83,449
    
    $
    66,179
    
    26.1
    %Services
    
    
    20,359
    
    
    16,665
    
    22.2
    %Net sales
    
    $
    103,808
    
    $
    82,844
    
    25.3
    %


The primary drivers of the year-over-year growth in product sales
were:

- 35% increase in consumable sales
- 34% increase from Dimension system
  sales
- 65% increase in Eden Systems sales

As we increased our installed base of systems in the field, we continued
to see significant growth in consumables. Sales of our low-cost 3D printers
represented by the Dimension systems increased due to increased market awareness
and promotion. Sales of the Dimension BST benefited from a price decrease from
$24,900 to $18,900 in January 2006. 3D printer sales growth was also due to the
introduction of the Dimension 1200 BST and SST offered at $22,900 and $29,900,
respectively. The Eden Systems we distributed experienced sales growth with the
introduction of a new, larger Eden500 system in late 2005.

Service revenues predominately consisted of the following components:
maintenance, Paid Parts, contract engineering services, and rentals. We saw a
45% increase in our relatively new Paid Parts service as we continued to invest
in reaching customers through trade shows, direct mailings and our RedEye
RPMwebsite. Our
maintenance business saw year-over-year revenue growth of 16%. We attribute this
to a high maintenance renewal rate on our high-performance systems and 3D
printers, as well as the increase in our installed base of active systems in the
field.

28

---

Net sales and the percentage of net
sales by region for 2006 and 2005, as well as the percentage change were as
follows:

Year-over-2006
    
    2005
    
    Year ChangeNorth America
    
    $
    64,705
    
    62
    %
    
    $
    50,595
    
    61
    %
    
    27.9
    %Europe
    
    
    21,459
    
    21
    %
    
    
    17,296
    
    21
    %
    
    24.1
    %Asia Pacific
    
    
    16,629
    
    16
    %
    
    
    14,176
    
    17
    %
    
    17.3
    %Other
    
    
    1,016
    
    1
    %
    
    
    777
    
    1
    %
    
    30.8
    %Total
    
    $
    103,809
    
    100
    %
    
    $
    82,844
    
    100
    %
    
    25.3
    %


North American sales benefited from:

- Our strong Dimension reseller
  network
- Sales of Eden Systems, which we distributed only
  in North America
- Growth in our Paid Parts service, which was
  focused almost exclusively on North America.

We saw a recovery in the European
market during 2006 for our high-end productivity systems; we believe a portion
of this recovery was due to the weakness of the dollar relative to the euro. In
addition, we saw strong growth in our Dimension products as we continued to grow
our reseller network and their effectiveness. We saw growth in Asia Pacific due
to our increasing installed base of systems and increased effectiveness in our
Dimension reseller network.

Gross Profit

Gross profit and gross profit as a
percentage of sales for our products and services for 2006 and 2005, as well as
the percentage changes in gross profit were as follows:

Year-over-2006
    
    2005
    
    Year Change% of
      Relative
    
    
    
    
    % of
      RelativeSales
    
    
    
    
    SalesProducts
    
    $
    41,496
    
    49.7
    %
    
    $
    36,053
    
    54.5
    %
    
    15.1
    %Services
    
    
    9,945
    
    48.8
    %
    
    
    7,702
    
    46.2
    %
    
    29.1
    %Gross profit
    
    $
    51,441
    
    49.6
    %
    
    $
    43,755
    
    52.8
    %
    
    17.6
    %


Product gross profit declined, as a
percentage of product sales, due to an increased component of Eden Systems and
related consumables in the overall mix. The products that we distributed carried
a significantly lower margin than our proprietary systems and consumables, which
we manufacture.Service gross profit increased as a percentage of sales due to a larger
component of sales from our Paid Parts service, which carries a somewhat higher
margin.

Operating Expenses

Operating expenses and operating
expense as a percentage of sales for 2006 and 2005, as well as the percentage
change in operating expenses were as follows:

**Year-over-****2006**
    
    2005
    
    **Year
      Change**% of Sales
    
    
    
    
    % of SalesSelling, general & administrative
    
    $
    29,105
    
    28.0
    %
    
    $
    23,244
    
    28.1
    %
    
    25.2
    %Research and
      development
    
    
    6,699
    
    6.5
    %
    
    
    6,354
    
    7.7
    %
    
    5.4
    %Total operating expenses
    
    $
    35,804
    
    34.5
    %
    
    $
    29,598
    
    35.7
    %
    
    21.0
    %


29

---

Selling, general and administrative expenses for 2006 included
approximately $1.3 million of stock option compensation expense due to the
adoption of Statement of Financial Accounting Standards No. 123 Revised
Accounting for Stock-Based Compensation (SFAS No. 123(R)), which is a
revision to SFAS No. 123. SFAS 123(R) requires all share-based payments to
employees, including grants of stock options to employees, to be recognized in
the financial statements based on their grant date fair values. In 2005 and
prior years, we elected the disclosure-only method as an alternative to
financial statement recognition. Consequently, there was no similar expense
recorded in the 2005 consolidated financial statements. Even with the adoption
of SFAS No. 123(R), selling, general and administrative expenses declined as a
percentage of sales as we successfully obtained some operating leverage on the
higher sales volume. In 2006, we invested significantly in our information
technology (IT) systems as we established a formal IT department and made both
hardware and software investments.

Research and development expense in 2006 increased by 5.4% over the
previous year as we remained committed to designing new products and materials,
reducing costs on existing products, and improving the quality and reliability
of all of our platforms. Increases were primarily the result of increases in
engineering headcounts partially offset by an increase in internally capitalized
software. During the quarter ended September 30, 2005, we announced that we
received a $3.6 million order from a Fortune 100 global manufacturing company to
advance our proprietary FDM technology for direct digital manufacturing
applications. This effort is based around our high-performance systems. The
agreement includes payments to us over four years as R&D milestones are
achieved, as well as payments that are dependent upon future deliverables.
R&D payments received offset accelerated R&D efforts aimed at direct
digital manufacturing advances and are not recognized as revenue. During 2006 we
offset approximately $1.1 million of R&D expenses with monies received from
this customer.

Operating Income

Operating income and operating income as a percentage of sales for 2006
and 2005, as well as the percentage change in operating income were as follows:

**Year-over-**2006
    
    2005
    
    **Year
      Change**% of Sales
    
    
    
    
    % of SalesOperating income
    
    $
    15,637
    
    15.1
    %
    
    $
    14,157
    
    17.1
    %
    
    10.5
    %


Operating income increased due to the higher overall sales volume.
However, operating income declined as a percentage of sales primarily due to the
adoption of SFAS No. 123(R) and the decline in revenue from our high gross
profit, high-end proprietary systems as compared with solid growth in sales of
our 3D printers and distributed products.

Other Income (Expenses)

Other income (expenses) for 2006 and 2005 and changes in other income
(expenses) were as follows:

**Year-over-**2006
    
    2005
    
    **Year
      Change**Interest income
    
    $
    1,648
    
    
    $
    1,616
    
    
    2
    %Foreign currency
      transaction losses
    
    
    (307
    )
    
    
    (484
    )
    
    -37
    %Other
    
    
    (13
    )
    
    
    (7
    )
    
    86
    %Total
    
    $
    1,328
    
    
    $
    1,125
    
    
    18
    %


Interest income was relatively flat. We had higher average cash and
investment balances throughout the year compared with 2005, but we shifted our
investment strategy more toward tax free instruments, which have a lower pre-tax
yield but a higher net after-tax return.

30

---

We incurred foreign currency transaction losses because we sell primarily
in euros throughout most of Europe. Consequently, we have euro denominated
receivables that we mark to the current exchange rate at the end of each month.
As the euro fluctuated compared to the US dollar throughout most of 2006, we had
written down the carrying value of these receivables to reflect the changes in
the exchange rate. Each month we entered into 30-day forward contracts to offset
a portion of the impact in exchange rates. In 2006, our hedging strategy was
more effective than in 2005 due to better forecasting of euro denominated cash
flow. At December 31, 2006 we had approximately €3.5 million net in
euro-denominated receivables and a €3.5 million 30-day forward contract.

Income Taxes

Income taxes and income taxes as a percentage of net income before taxes
for 2006 and 2005, as well as the percentage change were as follows:

**Year-over-**2006
    
    2005
    
    **Year
      Change**Income taxes
    
    $
    5,800
    
    
    $
    4,680
    
    
    24
    %As a percent
      of income before income taxes
    
    
    34.2
    %
    
    
    30.6
    %


The following is a reconciliation of the 2006 effective income tax rate
compared with the 2005 rate:

2005 effective income tax rate
    30.6
    %Discrete items
      recognized in 2005 not recurring in 2006
    2.1Impact of increased tax-free interest income
    (1.2
    )Accounting for
      stock based compensation expenses
    1.0Increase in effective foreign income taxes
    0.7Impact of
      partial phase-out of extraterritorial income exclusion
    0.6Increase in effective state income taxes, net
    0.42006
      effective incoem tax rate
    34.2
    %


Net Income

Net income and net income as a percent of sales for 2006 and 2005, as
well as the percentage change in net income were as follows:

**Year-over-**2006
    
    2005
    
    **Year
      Change**% of Sales
    
    
    
    
    % of SalesNet income
    
    $
    11,164
    
    10.8
    %
    
    $
    10,603
    
    12.8
    %
    
    5.3
    %


For the reasons cited above, our net income for the twelve months ended
December 31, 2006 was at a lower percent of sales than in the year ended
December 31, 2005.

31

---

Liquidity and Capital Resources

A summary of our statement
of cash flows for the three years ended December 31, 2007 is as follows:

2007
    
    2006
    
    2005Net income
    
    $
    14,324
    
    
    $
    11,164
    
    
    $
    10,602Depreciation and
      amortization
    
    
    4,974
    
    
    
    3,832
    
    
    
    3,060Stock-based compensation
    
    
    955
    
    
    
    1,266
    
    
    
    -Change in
      working capital and other
    
    
    916
    
    
    
    (3,866
    )
    
    
    (5,537
    )Net cash provided by operating and other activities
    
    
    21,169
    
    
    
    12,396
    
    
    
    8,125Net cash used in
      investing activities
    
    
    (23,841
    )
    
    
    (7,603
    )
    
    
    (10,297
    )Net cash provided by (used in) in financing activities
    
    
    9,321
    
    
    
    (1,704
    )
    
    
    (9,329
    )Effect of
      exchange rate changes on cash
    
    
    260
    
    
    
    132
    
    
    
    (147
    )Net increase (decrease) in cash and equivalents
    
    
    6,909
    
    
    
    3,221
    
    
    
    (11,648
    )Cash and
      equivalents, beginning of year
    
    
    9,303
    
    
    
    6,082
    
    
    
    17,730Cash and equivalents, end of year
    
    $
    16,212
    
    
    $
    9,303
    
    
    $
    6,082


The net cash provided by our operating activities over the past three
years has amounted to approximately $41.7 million, principally derived from
$36.1 million in net income, plus $11.9 million in depreciation and
amortization, $2.2 million in stock-based compensation, less $8.5 million
attributable to changes in net working capital and other items.

In 2007, the principal source of cash from our operating activities was
our net income, as adjusted to exclude the effects of non-cash charges, and
changes in working capital, primarily inventories and accounts receivable. Our
net accounts receivable balances increased to $26.3 million in 2007 from $25.0
million in 2006 and were $20.0 million in 2005, principally due to higher sales
in the second half of 2007. In addition, we allow 3D Printing resellers extended
180 day terms on demo units. These factors adversely impacted our days sales
outstanding (DSO). DSOs were 86 days in 2007 and 88 days in both 2006 and
2005.

For the years ended December 31, 2007, 2006, and 2005, our inventory
balances have amounted to $12.8 million, $9.9 million, and $10.9 million,
respectively. The increase in 2007 from 2006 was principally due to a build-up
in Dimension systems due to differences in our forecasted mix versus actual
demand; inventory to support new product introductions; and increased consumable
inventory to support our increasing installed base. We have instituted better
inventory management, but recognize that we have opportunities to make
considerably more improvement to reduce overall inventory and improve turns. A
significant portion of our inventory is dedicated to fulfill our service
contract and warranty obligations. As we have introduced new products over the
past few years, there are more platforms and models to service than in the past,
which increases the requirements to maintain spare parts inventory. With the
introduction of these new products, older products have been discontinued but
certain inventory is still required to fulfill our service contracts. Our
procedures for dealing with this inventory are more fully explained in the
section below captioned Critical Accounting Policies.

Investments in sales-type leases used cash of $1.2 million in 2007, $0.9
million in 2006 and $1.2 million in 2005. In mid-2003 we introduced a leasing
program that was principally designed for the Dimension. The program
successfully enabled us to offer an attractive leasing solution to approximately
264 accounts. The program includes customers interested in our high-performance
systems. We intend to continue to use this leasing program in 2008.

For the years ended December 31, 2007, 2006, and 2005, increases in
accounts payable and other current accrued liabilities provided cash of $5.6
million, $0.7 million and $3.0 million, respectively. These liabilities have
grown as our overall business has grown over the years. In 2007, the increase
was related to the increases in the timing of payments for inventory purchases
and employee compensation.

32

---

Unearned revenue, principally due to maintenance contracts or implied
maintenance contracts, provided cash of $1.1 million in 2007, $1.2 million in
2006 and $1.4 million in 2005. This was principally due to the larger number of
maintenance contracts and increased implied maintenance contracts due to higher
sales and a larger installed base of systems.

Our investing activities used cash of $23.8 million, $7.6 million, and
$10.3 million in the twelve months ended December 31, 2007, 2006 and 2005,
respectively. In 2007, purchases of investments, net of proceeds, utilized cash
of approximately $10.0 million, whereas our purchases and proceeds netted to
zero in 2006. Net investments provided cash of approximately $3.5 million in
2005 as we changed our investment strategy to invest in longer-term municipal
bonds and auction rate certificates during 2006 and 2007.

At December 31, 2007, our investments included:

- approximately $24.9 million in municipal
  government bonds maturing between January 2008 and November 2010, all of which
  have ratings of AAA or AA; and
- $18.8 million in tax-free Auction Rate Certificates (ARCs),
  which re-price approximately every 30 days. All the ARCs had ratings of AAA or
  AA at December 31, 2007.

Subsequent to December 31, 2007 we have
reduced our investment in ARCs to $7.4 million including a $2.6 million ARC with
Jefferson County Alabama Sewer that has had a rating reduction to
A.

Property and equipment acquisitions totaled $10.2 million, $6.1 million,
and $9.8 million in 2007, 2006, and 2005, respectively. In the fall of 2005, we
purchased a building for approximately $5.1 million in order to accommodate our
growth needs over the next several years. Many of the capital expenditures in
2007 included renovating the building to fit our needs. Most of the remaining
capital expenditures in 2007 were for equipment required by the fastest growing
components of our business, including 3D printers, consumable manufacturing, and
Paid Parts service as well as our IT infrastructure. In March 2004, due to the
anticipated growth requirements for consumable manufacturing and Paid Parts
service, we purchased a 40,000 sq. ft. building near our current manufacturing
facility for approximately $1.2 million, and subsequently spent approximately
$0.5 million for building improvements. Over the three-year period ended
December 31, 2007, our other principal capital expenditures were for
manufacturing or engineering development equipment, tooling, and leasehold
improvements, and for the acquisition of computer systems and software
applications. Payments for intangible assets, including patents and capitalized
software, amounted to $3.7 million, $1.5 million and $4.1 million for the years
ended December 31, 2007, 2006, and 2005, respectively.

Proceeds from the exercise of 720,894 stock options provided $8.5 million
in 2007 and an excess tax benefit of approximately $0.8 million. Our 2006
financing activity included the repurchase of 257,000 shares of common stock for
approximately $3.1 million representing an average price of $12.11 per share.
The 2006 financing activity also includes $1.4 million in proceeds from the
exercise of 315,350 stock options. Proceeds from the exercise of 150,740 stock
options provided cash of $0.3 million in 2005.

For 2008, we expect to use our cash as follows;

- for improvements to our
  facilities;
- for the continuation of our leasing
  program;
- for working capital purposes;
- for information systems (I/S) and infrastructure
  enhancements;
- for new product and materials
  development;
- for sustaining engineering;
- for the acquisition of equipment, including
  production equipment, tooling, and computers;
- for the purchase or development of intangible
  assets, including patents;
- for increased selling and marketing activities,
  especially as they relate to the continued market and channel
  development;
- for acquisitions and/or strategic alliances;
  and
- for our common stock buyback
program.

33

---

While we believe that the primary source of liquidity during 2008 will be
derived from current cash balances and cash flows from operations, we have
maintained a line of credit for the lesser of $4.0 million or a defined
borrowing base. To date, we have not borrowed against this credit facility.

At December 31, 2007, large receivable balances were concentrated with
certain international distributors and North American resellers, and some of
these balances exceed our payment terms. Default by one or more of these
distributors or customers could result in a significant charge against our
current reported earnings. We have reviewed our policies that govern credit and
collections, and will continue to monitor them in light of current payment
status and economic conditions. While we can give no assurances, we believe that
most, if not all, of the accounts receivable balances will ultimately be
collected. For further information, see the section below captioned Critical
Accounting Policies.

Our total current assets amounted to $89.0 million at December 31, 2007,
the majority of which consisted of cash and cash equivalents, investments,
inventories and accounts receivable. Total current liabilities amounted to $24.9
million. We have no debt. We estimate that we will spend between approximately
$9 and $12 million in 2008 for property and equipment. We also estimate that as
of December 31, 2007, we estimate that material commitments for inventory
purchases from selected vendors for the ensuing twelve-month period ending
December 31, 2008, amounted to approximately $10.3 million. In addition, we have
future commitments for leased facilities. We intend to finance these purchases
from existing cash or from cash flows from operations. The future contractual
cash obligations related to the commitments are as follows:

Year ending December
      31,
    
    Facilities
    
    Inventory
    
    Total2008
    
    $
    244,000
    
    $
    10,300,000
    
    $
    10,544,0002009
    
    
    204,000
    
    
    
    
    
    204,0002010
    
    
    152,000
    
    
    
    
    
    152,0002011
    
    
    46,000
    
    
    
    
    
    46,0002012
    
    
    -
    
    
    
    
    
    -$
    646,000
    
    $
    10,300,000
    
    $
    10,946,000


Inflation

We believe that inflation has not had a material effect on our operations
or on our financial condition during the three most recent fiscal years.

Foreign Currency Transactions

We invoice sales to certain European distributors in euros. Our reported
results are therefore subject to fluctuations based upon changes in the exchange
rates of that currency in relation to the United States dollar. In the year
ended December 31, 2007, the loss from foreign currency transactions amounted to
approximately $.5 million, whereas in the comparable 2006 period we reported
losses from foreign currency transactions of approximately $.3 million. In the
year ended December 31, 2007, we hedged between €2.7 and €4.0 million of our
accounts receivable that were denominated in euros. The hedge resulted in a
currency exchange loss of approximately $.5 million for this period. We intend
to continue to hedge some of our accounts receivable balances that are
denominated in euros throughout 2008, and will continue to monitor our exposure
to currency fluctuations. Instruments to hedge our risks may include foreign
currency forward, swap, and option contracts. These instruments will be used to
selectively manage risk, but there can be no assurance that we will be fully
protected against material foreign currency fluctuations. We expect to continue
to derive most of our revenue from regions where the transactions are
negotiated, invoiced, and paid in US dollars. Fluctuations in the currency
exchange rates in these other countries may therefore reduce the demand for our
products by increasing the price of our products in the currency of countries in
which the local currency has declined in value.

34

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Critical Accounting Policies

We have prepared our consolidated financial statements and related
disclosures in conformity with accounting principles generally accepted in the
United States of America. This has required us to make estimates, judgments, and
assumptions that affected the amounts we reported. Note 1 of Notes to
Consolidated Financial Statements contains the significant accounting principles
that we used to prepare our consolidated financial statements.

We have identified several critical accounting policies that required us
to make assumptions about matters that were uncertain at the time of our
estimates. Had we used different estimates and assumptions, the amounts we
recorded could have been significantly different. Additionally, if we had used
different assumptions or different conditions existed, our financial condition
or results of operations could have been materially different. The critical
accounting policies that were affected by the estimates, assumptions, and
judgments used in the preparation of our consolidated financial statements are
listed below.

Revenue Recognition

We recognize revenue, consistent with SAB 104 and EITF 00-21, when 1)
persuasive evidence of a final agreement exists, 2) delivery has occurred or
services have been rendered, 3) the selling price is fixed or determinable, and
4) collectibility is reasonably assured. Our standard terms are FOB shipping
point, and as such most of our revenue from system sales is primarily recognized
at time of shipment if the shipment conforms to the terms and conditions of the
purchase agreement. Exceptions to this policy occur only if a customers
purchase order indicates an alternative term or provides that the equipment sold
would be subject to certain contingencies, such as formal acceptance. In these
instances, revenues would be recognized only upon satisfying the conditions
established by the customer in its purchase order to us. Revenue from sales-type
leases of our FDM systems is recognized at the time of lessee acceptance, which
follows installation. Revenue from sales-type leases of our Dimension systems is
recognized at time of shipment, since either the customer or the reseller
performs the installation. We recognize revenue from sales-type leases at the
net present value of future lease payments. Revenue from operating leases is
recognized ratably over the lease period. Revenue from maintenance contracts is
recognized ratably over the term of the contract, usually one year. On certain
sales that require a one-year warranty rather than our standard 90-day warranty,
a percentage of the selling price that represents the fair value of the extended
warranty is deferred and recognized ratably over the period of the extended
warranty as an implied maintenance contract. This has had the effect of
deferring, as of December 31, 2007, approximately $2.3 million of revenue that
will be recognized in future periods.

We assess collectibility as part of the revenue recognition process. We
evaluate a number of factors to assess collectibility, including an evaluation
of the credit worthiness of the customer, past payment history, and current
economic conditions. If it is determined that collectibility cannot be
reasonably assured, we would decline shipment, request a down payment, or defer
recognition of revenue until ultimate collectibility is more determinable. We
also record a provision for estimated product returns and allowances in the
period in which the related revenue is recorded. This provision against current
gross revenue is based principally on historical rates of sales returns, but
also factors in changes in the customer base, geographic economic conditions,
and changes in the financial conditions of our customers. If past trends were to
change, we would potentially have to increase or decrease the amount of the
provision for these returns. We have little history as to potential returns
under our lease programs. We will monitor our lease sales in the future, and if
necessary will record a provision for returns on leased systems. As of December
31, 2007 and 2006 our allowance for returns was $0.2 million.

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (FASB)
issued SFAS No. 123(R),Accounting for
Stock-Based Compensation (Revised). SFAS No. 123(R) supersedes APB No. 25 and
its related implementation guidance. SFAS No. 123(R) establishes standards for
the accounting for transactions in which an entity exchanges its equity
instruments for goods or services. It also addresses transactions in which an
entity incurs liabilities in exchange for goods or services that are based on
the fair value of the entitys equity instruments or that may be settled by the
issuance of those equity instruments.

35

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SFAS No. 123(R) focuses primarily on accounting for transactions in which
an entity obtains employee services in share-based payment transactions. SFAS
No. 123(R) requires a public entity to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant-date
fair value of the award (with limited exceptions). That cost will be recognized
over the period during which an employee is required to provide service in
exchange for the award the requisite service period (usually the vesting
period). No compensation costs are recognized for equity instruments for which
employees do not render the requisite service.

The grant-date fair value of employee share options and similar
instruments will be estimated using option-pricing models adjusted for the
unique characteristics of those instruments (unless observable market prices for
the same or similar instruments are available). If an equity award is modified
after the grant date, incremental compensation cost will be recognized in an
amount equal to the excess of the fair value of the modified award over the fair
value of the original award immediately before the modification.

We adopted SFAS No. 123(R), effective January 1, 2006. On that date, we
elected to use the modified prospective transition method as permitted by SFAS
No. 123R and therefore did not restate our financial results for prior periods.
Under this transition method, we apply the provisions of SFAS No. 123R to new
awards and to awards modified, repurchased, or cancelled after January 1, 2006.
Additionally, we recognize compensation costs over the remaining applicable
service period for the portion of awards that were outstanding as of January 1,
2006 but for which the requisite service had not yet been rendered.

Based on stock options that vested since adoption of SFAS No. 123(R), we
recorded approximately $955,000 and $1.3 million of additional compensation
expense for the years ended December 31, 2007 and December 31, 2006,
respectively.

Prior to January 1, 2006 we followed SFAS No. 123, "Accounting for
Stock-Based Compensation." The provisions of SFAS No. 123 allowed companies to
either expense the estimated fair value of stock options or to continue to
follow the intrinsic value method set forth in APB Opinion 25, "Accounting for
Stock Issued to Employees" ("APB 25"), but disclose the pro forma effect on net
income (loss) had the fair value of the options been expensed.

Allowance for Doubtful Accounts

While we evaluate the collectibility of a sale as part of our revenue
recognition process, we must also make judgments regarding the ultimate
realization of our accounts receivable. A considerable amount of judgment is
required in assessing the realization of these receivables, including the aging
of the receivables and the creditworthiness of each customer. We may not be able
to accurately and timely predict changes to a customers financial condition. If
a customers financial condition should suddenly deteriorate, calling into
question our ability to collect the receivable, our estimates of the realization
of our receivables could be adversely affected. We might then have to record
additional allowances for doubtful accounts, which could have an adverse effect
on our results of operations in the period affected.

Our allowance for doubtful accounts is adjusted quarterly using two
methods. First, our overall reserves are based on a percentage applied to
certain aged receivable categories that are predominately based on historical
bad debt write-off experience. Then, we make an additional evaluation of overdue
customer accounts, for which we specifically reserve. In our evaluation we use a
variety of factors, such as past payment history, the current financial
condition of the customer, and current economic conditions. We also evaluate our
overall concentration risk, which assesses the total amount owed by each
customer, regardless of its current status.

Certain of our international distributors have carried large balances
that have become overdue. Most of these distributors have continued to pay down
their balances and are still considered performing. A default by one or more of
these distributors could have a material effect, ranging from $.2 million to
$1.0 million, on our reported operating results in the period affected. As of
December 31, 2007 and 2006, our allowance for doubtful accounts amounted to $
1.2 and $1.3 million, respectively. The decrease in the reserve was primarily
due to the write-off of a $.6 million receivable in 2007 from a Italian
distributor that filed for bankruptcy.

36

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Inventories

Our inventories are recorded at the lower
of cost or market, with cost based on a first-in, first-out basis. We
periodically assess this inventory for obsolescence and potential excess by
reducing the difference between our cost and the estimated market value of the
inventory based on assumptions about future demand and historical sales
patterns. Our inventories consist of materials and products that are subject to
technological obsolescence and competitive market conditions. If market
conditions or future demand are less favorable than our current expectations,
additional inventory write downs or reserves may be required, which could have
an adverse effect on our reported results in the period the adjustments are
made. Additionally, engineering or field change orders (ECO and FCO,
respectively) introduced by our engineering group could suddenly create
extensive obsolete and/or excess inventory. Although our engineering group
considers the estimated effect that an ECO or FCO would have on our inventories,
a mandated ECO or FCO could have an immediate adverse affect on our reported
financial condition if it they required the use of different materials in either
new production or our service inventory.

Some of our inventory is returned to us by our customers and refurbished.
This refurbished inventory, once fully repaired and tested, is functionally
equivalent to new production and is utilized to satisfy many of our requirements
under our warranty and service contracts. Upon receipt of the returned material,
this inventory is recorded at a discount from original cost, and further reduced
by estimated future refurbishment expense. While we evaluate this service
material in the same way as our stock inventory (i.e., we periodically test for
obsolescence and excess), this inventory is subject to changing demand that may
not be immediately apparent. Adjustments to this service inventory, following an
obsolescence or excess review, could have an adverse effect on our reported
financial condition in the period when the adjustments are made. We review the
requirements for service inventory for discontinued products using the number of
active maintenance contracts per product line as the key determinant for
inventory levels and composition. A sudden decline in the number of customers
renewing service agreements in a particular period could lead to an
unanticipated write down of this service inventory for a particular product
line.

Income Taxes

We comply with SFAS No. 109, Accounting for Income Taxes, which
requires that deferred tax assets and liabilities be recognized using enacted
tax rates for the effect of temporary differences between the book and tax bases
of recorded assets and liabilities. SFAS 109 also requires a valuation allowance
if it is more likely than not that a portion of the deferred tax asset will not
be realized. We have determined that it is more likely than not that our future
taxable income will be sufficient to realize our deferred tax assets.

Our provision for income taxes is based on our effective income tax rate.
The effective rate is highly dependent upon a number of factors, including our
total earnings, the geographic location of sales, the availability of tax
credits, and the effectiveness of our tax planning strategies. We monitor the
effects of these variables throughout the year and adjust our income tax rate
accordingly. However, if our actual results differ from our estimates, we could
be required to adjust our effective tax rate or record a valuation adjustment on
our deferred tax assets. This could have an adverse effect on our financial
condition and results of operations.

Effective January 1, 2007, we adopted the provisions of FASB
Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxesan
Interpretation of FASB Statement No. 109. FIN 48 contains a two-step approach
to recognizing and measuring uncertain tax positions (tax contingencies)
accounted for in accordance with SFAS No. 109. The first step is to evaluate the
tax position for recognition by determining if the weight of available evidence
indicates it is more likely than not that the position will be sustained on
audit, including resolution of related appeals or litigation processes, if any.
The second step is to measure the tax benefit as the largest amount which is
more than 50% likely of being realized upon ultimate settlement. We reevaluate
these tax positions quarterly and make adjustments as required.

37

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Impairment of Long-Lived Assets

The Company adheres to SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets and 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. A change in the estimated
future values of these assets could have an adverse effect on our financial
condition and results of operations.

Recently Issued Accounting
Pronouncements

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Correction Replacement of APB Opinion No. 20 and FASB Statement No. 3 (SFAS
No. 154). SFAS No. 154 replaces APB Opinion No. 20, Accounting Changes
(Opinion 20), and FASB Statement No. 3, Reporting Accounting Changes in Interim
Financial Statements, and changes the requirements for the accounting for and
reporting of a change in accounting principle. Opinion 20 previously required
that most voluntary changes in accounting principle be recognized by including
in net income of the period of the change the cumulative effect of changing to
the new accounting principle. SFAS No. 154 requires retrospective application to
prior periods financial statements of changes in accounting principle. SFAS No.
154 defines retrospective application as the application of a different
accounting principle to prior accounting periods as if that principle had always
been used. SFAS No. 154 also requires that a change in depreciation,
amortization, or depletion method for long-lived, non-financial assets be
accounted for as a change in accounting estimate affected by a change in
accounting principle. The adoption of SFAS No. 154 had no impact on the
consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements (SFAS No. 157). SFAS No. 157 1) establishes a single definition
of fair value and a framework for measuring fair value; 2) sets out a fair value
hierarchy to be used to classify the source of information used in fair value
measurements; and 3) requires new disclosures of assets and liabilities measured
at fair value based on their level in the hierarchy. SFAS No. 157 is effective
for fiscal years beginning after November 15, 2007 and is to be applied
prospectively.

In February 2008, the FASB issued Staff Positions No. 157-1 and No. 157-2
which partially defer the effective date of SFAS No. 157 for one year for
certain nonfinancial assets and liabilities and remove certain leasing
transactions from its scope. We are currently evaluating the impact of this
standard, but do not expect SFAS No. 157 to have a material impact on our
consolidated statements.

In February 2007, the FASB issued SFAS No. 159 The Fair Value Option for
Financial Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159
permits entities to choose to measure many financial assets and financial
liabilities at fair value. Unrealized gains and losses on items for which the
fair value option has been elected are to be reported in earnings. SFAS No. 159
is effective for fiscal years beginning after November 15, 2007. We are
currently evaluating the impact of this standard, but do not expect SFAS No. 159
to have a material impact on the consolidated statements.

In December 2007, the FASB issued SFAS No. 141(revised 2007), Business
Combinations (SFAS No. 141R). SFAS No. 141R provides revised guidance on how
acquirers recognize and measure the consideration transferred, identifiable
assets acquired, liabilities assumed, noncontrolling interests, and goodwill
acquired in a business combination. SFAS No. 141R also expands required
disclosures surrounding the nature and financial effects of business
combinations. SFAS No. 141R is effective for fiscal years beginning after
December 15, 2008. We are evaluating the impact of this standard and will
evaluate its impact on any acquisitions that would occur after the effective
date.

38

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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, estimate or believe or other
similar words are forward-looking statements that we deem to be covered by and
to qualify for the safe harbor protection covered by the Private Securities
Litigation Reform Act of 1995 (the 1995 Act). Investors and prospective
investors in our 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 RP, DDM, and 3D printing systems, services and consumables, and our
ability to maintain our gross margins on these sales. The forward-looking
statements include our assumptions about the size of the RP, DDM and 3D printing
markets, and our ability to penetrate, compete in, and successfully sell our
products in these markets. They include our plans and objectives to introduce
new products, to control expenses, to improve the quality and reliability of our
systems, to respond to new or existing competitive products, and to improve
profitability. The forward-looking statements included herein are based on
current expectations that involve a number of risks and uncertainties, some of
which are described in Item 1A, Risk Factors above. These forward-looking
statements are based on assumptions, among others, that we will be able to:

- continue to introduce new high-performance and 3D
  printing systems and materials acceptable to the market, and to continue to
  improve our existing technology and software in our current product
  offerings;
- successfully develop the 3D printing market with
  our Dimension BST, Dimension SST and Dimension Elite systems, and that the
  market will accept these systems;
- successfully develop the DDM market with our FDM
  200mc 360mc, 400mc and 900mc, and that the market will accept these
  systems;
- maintain our revenues and gross margins on our
  present products;
- control our operating expenses;
- expand our manufacturing capabilities to meet the
  expected demand generated by our Dimension BST, Dimension SST and Dimension
  Elite systems, our consumable products and our Paid Parts
  service;
- successfully commercialize new materials and gain
  market acceptance for these new materials; and
- recruit, retain, and develop employees with the
  necessary skills to produce, create, commercialize, market, and sell our
  products.

Assumptions relating to the foregoing involve judgments with respect to,
among other things, future economic, geo-political, competitive, market and
technological conditions, and future business decisions, all of which are
difficult or impossible to predict accurately and many of which are beyond our
control. Although we believe 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 us to alter our
marketing plans, our capital expenditure budgets, or our engineering, selling,
manufacturing or other budgets, which may in turn affect our results of
operations or the success of our new product development and introduction. We
may not be able to alter our plans or budgets in a timely manner, resulting in
reduced profitability or losses.

Due to the factors noted above and elsewhere in this Managements
Discussion and Analysis of Financial Condition and Results of Operations, our
future earnings and stock price may be subject to significant volatility,
particularly on a quarterly basis. Additionally, we may not learn of revenue or
earnings shortfalls until late in a fiscal quarter, since we frequently receive
a significant number of orders very late in a quarter. This could result in an
immediate and adverse effect on the trading price of our 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.

39

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Item 7A. Quantitative and Qualitative
Disclosures About Market Risk.

Interest Rate Risk

Our cash and cash equivalent investments are exclusively in short-term
money market and sweep instruments with maturities of less than 90 days. These
are subject to limited interest rate risk; however, given the volatility in the
auction rate certificates interest rates, interest rate fluctuations may impact
the carrying value of the underlying investments. A 10% change in interest rates
would not have a material effect on our financial condition or results of
operations. Our short- and long-term investments are invested in Auction Rate
Certificates municipal government bonds, and certificates of deposit that bear
interest at rates of 2.5% to 6.0%. An immediate 10% change in interest rates
would have no material effect on our financial condition or results of
operations.

Foreign Currency Exchange Rate Risk

We have not historically hedged sales from or expenses incurred by our
European operations that are conducted in euros. Therefore, a hypothetical 10%
change in the exchange rates between the U.S. dollar and the euro could increase
or decrease our income before taxes by less than $0.3 million for the continued
maintenance of our European facility. Throughout 2007 we hedged between €2.7
million and €4.0 million of our accounts receivable balances that were
denominated in euros. A hypothetical 10% change in the exchange rates between
the US dollar and the euro could increase or decrease income before taxes by
between $.9 million and $1.4 million.

Item 8. Financial Statements and
Supplementary Data.

This information appears following Item 15 of this report and is
incorporated herein by reference.

Item 9. Changes In and Disagreements
With Accountants on Accounting and Financial Disclosure.

On June 8, 2007, the Audit Committee of our Board of Directors dismissed
Rothstein, Kass & Company, P.C. (Rothstein Kass) as our independent
registered public accounting firm. On June 12, 2007, the Audit Committee
appointed Grant Thornton, LLP as our new independent registered public
accounting firm.

In connection with the audits of our consolidated financial statements
for each of the two fiscal years ended December 31, 2006 and 2005, and in the
subsequent interim period ended June 8, 2007, there were no disagreements
between us and Rothstein Kass on any matters of accounting principles or
practices, financial statement disclosure or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of Rothstein Kass, would have
caused it to make reference to the subject matter of the disagreements in
connection with its report on the financial statements for such year.

During the two fiscal years ended December 31, 2006 and 2005, and in the
subsequent interim period ended June 8, 2007, there were no reportable events
as defined in Section 304(a)(1)(v) of Regulation S-K.

Item 9A. Controls and Procedures.

Disclosure Controls and Procedures

Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we conducted
an evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report (the Evaluation Date). Based on this evaluation, our Chief Executive
Officer and Chief Financial Officer concluded as of the Evaluation Date that our
disclosure controls and procedures were effective such that the information
relating to us required to be disclosed in our Securities and Exchange
Commission (SEC) reports (i) is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms, and (ii) is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure.

40

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Internal Control over Financial
Reporting

Under the supervision and
with the participation of our management, including our Chief Executive Officer
and Chief Financial Officer, we are responsible for establishing and maintaining
an effective system of internal control over financial reporting (as defined in
Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934). Our
management has conducted an assessment of our internal control over financial
reporting based on the framework established by the committee of Sponsoring
Organizations of the Treadway Commission in Internal Control  Integrated
Framework. There have not been any changes in our internal control over
financial reporting identified in connection with the assessment that occurred
during the fourth quarter of 2007 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting. Our management has prepared an annual report on internal control over
financial reporting. Managements report is included in this Annual Report on
Form 10-K on page F-1. In addition, Grant Thornton, LLP, our independent
registered public accounting firm, has prepared its report on the effectiveness
of our internal control over financial reporting and such report is included on
pages F-4 to F-5 of the consolidated financial statements.

Item 9B. Other Information.

None.

41

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PART III

Item 10. Directors, Executive Officers
and Corporate Governance.

Incorporated
herein by reference to our Definitive Proxy Statement with respect to our Annual
Meeting of Stockholders scheduled to be held May 8, 2008.

Item 11. Executive
Compensation.

Incorporated herein by reference to our Definitive Proxy Statement with
respect to our Annual Meeting of Stockholders scheduled to be held May 8, 2008.

Item 12. Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder
Matters.

Incorporated herein by reference to our Definitive Proxy Statement with
respect to our Annual Meeting of Stockholders scheduled to be held May 8, 2008.

Item 13. Certain Relationships and
Related Transactions, and Director Independence.

Incorporated herein by reference to our Definitive Proxy Statement with
respect to our Annual Meeting of Stockholders scheduled to be held May 8, 2008.

Item 14. Principal Accountant Fees and
Services.

Incorporated herein by reference to our Definitive Proxy Statement with
respect to our Annual Meeting of Stockholders scheduled to be held May 8, 2008.

42

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PART IV

Item 15. Exhibits and Financial
Statement Schedules.

|**(a)** |  | Documents                                                                                                    |             
|------- |  | ------------------------------------------------------------------------------------------------------------ | ------------
|        |  |                                                                                                              |             
|        |  | 1. Financial Statements
      --                                                                             |             
|        |  |                                                                                                             
|        |  | Managements Report on
      Internal Control Over Financial Reporting                                       | F-3         
|        |  |                                                                                                             
|        |  | Reports of Independent
      Registered Public Accounting Firms                                              | F-4 to F-6  
|        |  |                                                                                                             
|        |  | Consolidated Balance Sheets
      December 31, 2007 and 2006                                                 | F-7         
|        |  | Consolidated
      Statements of Operations Years Ended December 31, 2007, 2006 and2005                      | F-8         
|        |  | Consolidated
      Statements of Changes in Stockholders Equity Years Ended December31, 2007, 2006 and 2005 | F-9         
|        |  | Consolidated Statements of
      Cash Flows Years Ended December 31, 2007, 2006 and2005                      | F-10        
|        |  | Notes to Consolidated
      Financial Statements                                                             | F-11 to F-29
|        |  |                                                                                                             
|        |  | 2. Financial Statement
      Schedule --                                                                     |             
|        |  |                                                                                                             
|        |  | Schedule II-- Valuation and
      Qualifying Accounts and Reserves                                           | F-30        

43

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STRATASYS, INC. AND
SUBSIDIARIES

****

****

****

STRATASYS, INC. AND
SUBSIDIARIES

CONSOLIDATED FINANCIAL
STATEMENTSANDREPORTS OF INDEPENDENT
REGISTEREDPUBLIC ACCOUNTING FIRMS

DECEMBER 31, 2007 AND 2006





F-1

---

STRATASYS, INC. AND
SUBSIDIARIES

|CONTENTS                                                                |          
|----------------------------------------------------------------------- | ---------
|                                                                        |          
|Managements Report on Internal Controls over Financial
      Reporting | F-3      
|                                                                       
|Reports of Independent Registered Public Accounting
    Firms           | F-4-F-6  
|                                                                       
|Consolidated Financial Statements                                       |          
|                                                                       
|Balance Sheets                                                          | F-7      
|                                                                       
|Statements of
      Operations                                          | F-8      
|                                                                       
|Statements of Changes in
      Stockholders' Equity                     | F-9      
|                                                                        |          
|Statements of Cash
      Flows                                          | F-10     
|                                                                        |          
|Notes to Financial
      Statements                                     | F-11-F-29
|                                                                        |          
|Schedule II - Valuation and Qualifying Accounts and
      Reserves      | F-30     

F-2

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STRATASYS, INC. AND
SUBSIDIARIES

MANAGEMENTS RESPONSIBILITY FOR
FINANCIAL REPORTING

Management
of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting (as such term is defined in Rule 13a-15(f)
under the Securities Exchange Act of 1934). The Companys internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the Company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with accounting
principles generally accepted in the United States, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the Companys assets that could have a
material effect on the financial statements.

Internal
control over financial reporting is designed to provide reasonable assurance to
the Companys management and board of directors regarding the preparation of
reliable financial statements for external purposes in accordance with
accounting principles generally accepted in the United States. Internal control
over financial reporting includes self-monitoring mechanisms and actions taken
to correct deficiencies as they are identified. Because of the inherent
limitations in any internal control, no matter how well designed, misstatements
may occur and not be prevented or detected. Accordingly, even effective internal
control over financial reporting can provide only reasonable assurance with
respect to financial statement preparation. Further, the evaluation of the
effectiveness of internal control over financial reporting was made as of a
specific date, and continued effectiveness in future periods is subject to the
risks that controls may become inadequate because of changes in conditions or
that the degree of compliance with the policies and procedures may decline.

MANAGEMENTS REPORT ON INTERNAL
CONTROLS OVER FINANCIAL REPORTING

Management
conducted an evaluation of the effectiveness of the Companys system of internal
control over financial reporting as of December 31, 2007 based on the framework
set forth in Internal Control  Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission. Based on its evaluation,
management concluded that, as of December 31, 2007, the Companys internal
control over financial reporting is effective based on the specified
criteria.

|/s/ S. SCOTTCRUMP             | 
|----------------------------- | 
|S. Scott
      Crump         
|Chief
      Executive Officer
|                             
|                             
|                             
|/s/ ROBERTF. GALLAGHER        | 
|Robert F.
      Gallagher    
|Chief
      Financial Officer
|                             
|                             
|Date: March
      14, 2008   

F-3

---

STRATASYS, INC. AND
SUBSIDIARIES

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

Board of Directors and
ShareholdersStratasys, Inc.

We have audited
the accompanying consolidated balance sheet of Stratasys, Inc. (a Delaware
corporation) and subsidiaries (collectively, the Company) as of December 31,
2007 and the related consolidated statements of operations, stockholders equity
and comprehensive income, and cash flows for the year then ended. Our audit of
the basic financial statements included the financial statement schedule listed
in the index appearing under Item 15. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial schedule based on our audit.

We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). 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
audit provides 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, 2007, and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America. Also
in our opinion, the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.

As discussed in Note 1 to the consolidated financial statements,
effective January 1, 2006, the Company changed its method of accounting for
share-based payments to adopt Statement of Financial Accounting Standards No.
123(R),Share-Based Payment.

We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), Stratasys, Inc.s internal
control over financial reporting as of December 31, 2007, based on criteria
established inInternal ControlIntegrated
Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) and our report dated
March 13, 2008 expressed an unqualified opinion on the effectiveness of the
Companys internal control over financial reporting.

/s/ GRANTTHORNTONLLPMinneapolis, MinnesotaMarch 13, 2008

F-4

---

STRATASYS, INC. AND
SUBSIDIARIES

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

Board of Directors and
ShareholdersStratasys, Inc.

We have audited Stratasys, Inc.s (the Company) internal control over
financial reporting as of December 31, 2007, based on criteria established inInternal ControlIntegrated
Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). The Companys
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Managements
Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the effectiveness of the Companys internal control over
financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.

A companys internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A companys internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys
assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.

In our opinion, Stratasys, Inc. maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2007,
based on criteria established inInternal
Control  Integrated Frameworkissued by
COSO.

We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated financial
statements and financial statement schedule as of and for the year ended
December 31, 2007 of the Company and our report dated March 13, 2008 expressed
an unqualified opinion on those financial statements and financial statement
schedule.

/s/ GRANTTHORNTONLLPMinneapolis, MinnesotaMarch 13, 2008

F-5

---

STRATASYS, INC. AND
SUBSIDIARIES

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
ofStratasys, Inc.

We have audited the accompanying
consolidated balance sheets of Stratasys, Inc. and Subsidiaries (collectively,
the Company) as of December 31, 2006 and 2005, and the related consolidated
statements of operations, changes in stockholders equity, and cash flows for
each of the years in the three-year period ended December 31, 2006. 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
the standards of the Public Company Accounting Oversight Board (United States).
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, 2006
and 2005, and the results of their operations and their cash flows for each of
the years in the three-year period ended December 31, 2006, in conformity with
accounting principles generally accepted in the United States of America.

We also have audited, in accordance with
the standards of the Public Company Accounting Oversight Board (United States),
the effectiveness of the Companys internal control over financial reporting as
of December 31, 2006, based on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report dated January
31, 2007 expressed an unqualified opinion on managements assessment of internal
control over financial reporting and an unqualified opinion on the effectiveness
of internal control over financial reporting.

In connection with our audits of the
financial statements referred to above, we audited the financial schedule listed
under Schedule II  Valuation and Qualifying Accounts and Reserves. In our
opinion, this financial schedule, when considered in relation to the financial
statements taken as a whole, presents fairly, in all material respects, the
information stated therein.

/s/ ROTHSTEIN,KASS&COMPANY,P.C.Roseland, New JerseyJanuary
31, 2007

F-6

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|Consolidated Balance
      Sheets                                    |  |      |             |      |  |   |             |  
|-------------------------------------------------------------------- |  | ---- | ----------- | ---- |  | - | ----------- | -
|                                                                    
|December 31,                                                         |  | 2007 |             | 2006
|ASSETS                                                               |  |      |             |      |  |   |             |  
|Current
      assets                                                 |  |      |             |      |  |   |             |  
|Cash and cash
      equivalents                                      |  | $    | 16,211,771  |      |  | $ | 9,302,845   |  
|Short-term
    investments                                           |  |      | 27,257,592  |      |  |   | 24,574,332  |  
|Accounts receivable, less
      allowance for returns and            |  |      |             |      |  |   |             |  
|doubtful
      accounts of $1,205,621 and $1,265,837                 |  |      |             |      |  |   |             |  
|in 2007 and
      2006, respectively                                 |  |      | 26,307,053  |      |  |   | 25,035,665  |  
|Inventories                                                          |  |      | 12,771,235  |      |  |   | 9,925,217   |  
|Net investment in sales-type
      leases                            |  |      | 3,256,953   |      |  |   | 2,858,054   |  
|Prepaid expenses                                                     |  |      | 2,507,316   |      |  |   | 3,368,586   |  
|Deferred income
taxes                                                |  |      | 711,000     |      |  |   | 459,000     |  
|Total current assets                                                 |  |      | 89,022,920  |      |  |   | 75,523,699  |  
|Property and equipment,net                                           |  |      | 26,577,362  |      |  |   | 20,412,719  |  
|Other
      assets                                                   |  |      |             |      |  |   |             |  
|Intangible assets,
    net                                           |  |      | 8,063,319   |      |  |   | 5,663,141   |  
|Net investment in sales-type
      leases                            |  |      | 4,101,682   |      |  |   | 3,271,015   |  
|Deferred income
taxes                                                |  |      | 719,000     |      |  |   | 915,000     |  
|Long-term
investments                                                |  |      | 17,965,489  |      |  |   | 10,747,689  |  
|Other                                                                |  |      | 2,307,250   |      |  |   | 1,470,982   |  
|Total other assets                                                   |  |      | 33,156,740  |      |  |   | 22,067,827  |  
|Total assets                                                         |  | $    | 148,757,022 |      |  | $ | 118,004,245 |  
|                                                                    
|LIABILITIES AND STOCKHOLDERS' EQUITY                                 |  |      |             |      |  |   |             |  
|Current
      liabilities                                            |  |      |             |      |  |   |             |  
|Accounts payable and other
      current liabilities                 |  | $    | 13,959,022  |      |  | $ | 10,335,607  |  
|Unearned revenues                                                    |  |      | 10,964,471  |      |  |   | 9,876,719   |  
|Total current liabilities                                            |  |      | 24,923,493  |      |  |   | 20,212,326  |  
|Commitments and
      contingencies                                  |  |      |             |      |  |   |             |  
|Stockholders' equity                                                 |  |      |             |      |  |   |             |  
|Common stock, $.01 par value,
      authorized 30,000,000 shares;    |  |      |             |      |  |   |             |  
|issued
      25,610,654 shares and 24,889,760                        |  |      |             |      |  |   |             |  
|shares in
      2007 and 2006, respectively                          |  |      | 256,108     |      |  |   | 248,898     |  
|Capital in excess of par
      value                                 |  |      | 87,023,541  |      |  |   | 75,602,267  |  
|Retained earnings                                                    |  |      | 56,284,182  |      |  |   | 41,960,124  |  
|Accumulated other
      comprehensive loss                           |  |      | 172,073     |      |  |   | (116,995    | )
|Less cost of treasury stock,
      4,600,056 shares in 2007 and 2006 |  |      | (19,902,375 | )    |  |   | (19,902,375 | )
|Total stockholders' equity                                           |  |      | 123,833,529 |      |  |   | 97,791,919  |  
|Total liabilities
      and stockholders' equity                     |  | $    | 148,757,022 |      |  | $ | 118,004,245 |  
|                                                                    
|See accompanying
      notes to consolidated financial statements.   |  |      |             |      |  |   |             |  

F-7

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|Consolidated
      Statements of Operations                          |  |      |             |      |  |      |             |   |  |   |            |  
|-------------------------------------------------------------------- |  | ---- | ----------- | ---- |  | ---- | ----------- | - |  | - | ---------- | -
|                                                                    
|Years Ended December
    31,                                         |  | 2007 |             | 2006 |  | 2005
|Net
      sales                                                      |  |      |             |      |  |      |             |   |  |   |            |  
|Products                                                             |  | $    | 89,280,009  |      |  | $    | 83,449,388  |   |  | $ | 66,178,670 |  
|Services                                                             |  |      | 22,962,572  |      |  |      | 20,359,463  |   |  |   | 16,665,634 |  
|                                                                     |  |      | 112,242,581 |      |  |      | 103,808,851 |   |  |   | 82,844,304 |  
|                                                                    
|Cost
      of sales                                                  |  |      |             |      |  |      |             |   |  |   |            |  
|Products                                                             |  |      | 40,540,564  |      |  |      | 41,953,162  |   |  |   | 30,125,996 |  
|Services                                                             |  |      | 11,993,906  |      |  |      | 10,414,305  |   |  |   | 8,963,516  |  
|                                                                     |  |      | 52,534,470  |      |  |      | 52,367,467  |   |  |   | 39,089,512 |  
|                                                                    
|Gross profit                                                         |  |      | 59,708,111  |      |  |      | 51,441,384  |   |  |   | 43,754,792 |  
|                                                                    
|Operating expenses                                                   |  |      |             |      |  |      |             |   |  |   |            |  
|Research and
    development                                         |  |      | 7,465,334   |      |  |      | 6,699,373   |   |  |   | 6,353,877  |  
|Selling, general and
      administrative                            |  |      | 33,769,880  |      |  |      | 29,105,342  |   |  |   | 23,243,455 |  
|                                                                     |  |      | 41,235,214  |      |  |      | 35,804,715  |   |  |   | 29,597,332 |  
|                                                                    
|Operating income                                                     |  |      | 18,472,897  |      |  |      | 15,636,669  |   |  |   | 14,157,460 |  
|                                                                    
|Other income (expense)                                               |  |      |             |      |  |      |             |   |  |   |            |  
|Interest income, net                                                 |  |      | 2,316,001   |      |  |      | 1,648,035   |   |  |   | 1,616,851  |  
|Foreign currency transaction
      losses, net                       |  |      | (503,309    | )    |  |      | (307,314    | ) |  |   | (484,352   | )
|Other                                                                |  |      | 76,468      |      |  |      | (13,211     | ) |  |   | (7,062     | )
|                                                                     |  |      | 1,889,160   |      |  |      | 1,327,510   |   |  |   | 1,125,437  |  
|                                                                    
|Income before income taxes                                           |  |      | 20,362,057  |      |  |      | 16,964,179  |   |  |   | 15,282,897 |  
|Income taxes                                                         |  |      | 6,037,999   |      |  |      | 5,800,000   |   |  |   | 4,680,000  |  
|                                                                    
|Net
      income                                                     |  | $    | 14,324,058  |      |  | $    | 11,164,179  |   |  | $ | 10,602,897 |  
|                                                                    
|Net
      income per common share                                    |  |      |             |      |  |      |             |   |  |   |            |  
|Basic                                                                |  | $    | 0.69        |      |  | $    | 0.55        |   |  | $ | 0.50       |  
|Diluted                                                              |  |      | 0.66        |      |  |      | 0.54        |   |  |   | 0.49       |  
|                                                                    
|Weighted average commons shares outstanding                          |  |      |             |      |  |      |             |   |  |   |            |  
|Basic                                                                |  |      | 20,771,656  |      |  |      | 20,240,012  |   |  |   | 21,055,614 |  
|Diluted                                                              |  |      | 21,565,618  |      |  |      | 20,723,166  |   |  |   | 21,489,166 |  
|                                                                    
|*See accompanying notes to consolidated financial
      statements.* |  |      |             |      |  |      |             |   |  |   |            |  

F-8

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Stratasys, Inc. and
SubsidiariesConsolidated Statements of
Changes in Stockholders' Equity and Comprehensive Income

|Years Ended December 31, 2007, 2006,
      and 2005                         
|----------------------------------------------------------------------------
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Balances,January 1, 2005                                                    
|Exercise of stock options and
      warrants                                
|Income tax reductions relating
      to exercise of stock options           
|Purchase of 803,006 shares of
      treasury stock                          
|Net income                                                                  
|**Other comprehensive loss,**foreign currency translation adjustment        
|Total comprehensive
      income                                            
|Balances,December 31, 2005                                                  
|                                                                            
|Exercise of stock options and
      warrants                                
|Income tax reductions relating to
      exercise of stock options           
|Purchase of 257,000 shares of
      treasury stock                          
|Stock based
    compensation                                                
|Net income                                                                  
|**Other comprehensive income,**foreign currency translation adjustment      
|Total comprehensive
      income                                            
|Balances,December 31, 2006                                                  
|                                                                            
|Exercise of stock options and
      warrants                                
|Income tax reductions relating to
      exercise of stock options           
|Stock based
      compensation                                              
|Net income                                                                  
|**Other comprehensive
      income,**foreign currency translation adjustment
|Total comprehensive
      income                                            
|Balances,December 31, 2007                                                  
|                                                                            
|See
      accompanying notes to consolidated financial
  statements.        

F-9

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Consolidated Statements of Cash
Flows

|Years Ended December
    31,                                   |  | 2007 |             | 2006 |  | 2005
|-------------------------------------------------------------- |  | ---- | ----------- | ---- |  | ----
|Cash
      flows from operating activities                     |  |      |             |      |  |     
|Net income                                                     |  | $    | 14,324,058  |      |  | $   
|Adjustments to reconcile net
      income to net cash provided |  |      |             |      |  |     
|by operating
      activities:                                 |  |      |             |      |  |     
|Deferred income taxes                                          |  |      | (56,000     | )    |  |     
|Depreciation                                                   |  |      | 3,608,601   |      |  |     
|Amortization                                                   |  |      | 1,365,735   |      |  |     
|Stock based compensation                                       |  |      | 954,783     |      |  |     
|Loss on disposal of property and equipment                     |  |      | 7,379       |      |  |     
|Loss on write-off of intangible assets                         |  |      | -           |      |  |     
|Increase (decrease) in cash attributable to changes in         |  |      |             |      |  |     
|operating assets and liabilities:                              |  |      |             |      |  |     
|Accounts receivable, net                                       |  |      | (1,271,388  | )    |  |     
|Inventories                                                    |  |      | (2,423,068  | )    |  |     
|Net investment in sales-type leases                            |  |      | (1,229,566  | )    |  |     
|Prepaid expenses                                               |  |      | 861,270     |      |  |     
|Other assets                                                   |  |      | (836,268    | )    |  |     
|Accounts payable and other current liabilities                 |  |      | 5,588,851   |      |  |     
|Unearned revenues                                              |  |      | 1,087,752   |      |  |     
|Excess tax benefit from stock options                          |  |      | (812,766    | )    |  |     
|Net
      cash provided by operating activities                |  |      | 21,169,373  |      |  |     
|Cash flows from
      investing activities                     |  |      |             |      |  |     
|Proceeds from sale of investments                              |  |      | 14,475,022  |      |  |     
|Proceeds from sale of property and equipment                   |  |      | 63,630      |      |  |     
|Purchases of investments                                       |  |      | (24,459,978 | )    |  |     
|Acquisition of property and equipment                          |  |      | (10,237,990 | )    |  |     
|Acquisition of intangible and other assets                     |  |      | (3,682,017  | )    |  |     
|Net cash used in
      investing activities                    |  |      | (23,841,333 | )    |  |     
|Cash
      flows from financing activities                     |  |      |             |      |  |     
|Proceeds from exercise of stock options and warrants           |  |      | 8,508,265   |      |  |     
|Excess tax benefit from stock options                          |  |      | 812,766     |      |  |     
|Purchase of treasury stock                                     |  |      | -           |      |  |     
|Net
      cash provided by (used in) financing activities      |  |      | 9,321,031   |      |  |     
|                                                              
|Effect of exchange rate changes on cash                        |  |      | 259,855     |      |  |     
|Net increase
      (decrease) in cash and cash equivalents     |  |      | 6,908,926   |      |  |     
|Cash
      and cash equivalents,beginning of
      year        |  |      | 9,302,845   |      |  |     
|Cash and cash
      equivalents,end of year                    |  | $    | 16,211,771  |      |  | $   
|                                                              
|Supplemental Disclosures of
      cash flow information:       |  |      |             |      |  |     
|Cash paid for taxes                                            |  | $    | 3,011,834   |      |  | $   
|Transfer of fixed assets to inventory                          |  |      | 422,950     |      |  |     

F-10

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES 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, distributes and markets a
family of rapid prototyping (RP), three-dimensional (3D) printing and direct
digital manufacturing (DDM) systems 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 systems and the related consumable materials and
maintenance worldwide. In addition, the Company offers both existing and
potential customers the ability to purchase prototypes and parts that it makes
for them from CAD files that they provide to the Company.

Principles of Consolidation

The accompanying consolidated financial
statements include the accounts of Stratasys, Inc. and its wholly owned
subsidiaries. All 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," approximate the carrying amounts presented in the
consolidated balance sheets.

Cash and Cash Equivalents

The Company considers all highly-liquid
debt instruments purchased with maturities of three months or less when acquired
to be cash equivalents. At December 31, 2007 and 2006, cash equivalents
consisted of money market accounts aggregating approximately $13,855,820 and
$7,948,806, respectively. As of December 31, 2007 and 2006, and at various times
during those years, 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.

Short-term and Long-term Investments

Short-term and long-term investments
consist of Auction Rate Certificates (ARC), tax-free government bonds,
certificates of deposit and municipal notes, with maturities ranging from
January 2008 through February 2042 at December 31, 2007 and from January 2007
through October 2025 at December 31, 2006. At December 31, 2007, our investments
included:

- approximately $24.9 million in municipal
  government bonds maturing between January 2008 and November 2010, all of which
  have ratings of AAA or AA; and
- $18.8 million in tax-free Auction Rate
  Certificates (ARCs), which re-price approximately every 30 days. All the ARCs
  had ratings of AAA or AA at December 31, 2007.

Subsequent to December 31, 2007 we have
reduced our investment in ARCs to $7.4 million including a $2.6 million ARC with
Jefferson County Alabama Sewer that has had a rating reduction to A.

Accounts Receivable

The Company carries its accounts
receivable at cost less an allowance for returns and doubtful accounts. On a
periodic basis, the Company evaluates its accounts receivable and establishes an
allowance for doubtful accounts based on a history of past write-offs and
collections and current credit conditions. Accounts are written-off against the
reserve when management deems the accounts are no longer collectible.

F-11

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

Inventories

Inventories are stated on the first-in,
first-out method, at the lower of cost or market. Inventory costs consist of
material, direct labor and overhead. The Company periodically assesses inventory
for obsolescence and excess by reducing the carrying amount by an amount equal
to the difference between its cost and the estimated market value based on
assumptions about future demand and historical sales patterns.

Impairment of Long-Lived Assets

The Company adheres to SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, and annually
assesses the recoverability of the carrying amounts of long-lived assets,
including intangible assets, at year-end. An impairment loss would be recognized
if expected undiscounted future cash flows are less than the carrying amount of
the asset. This loss would be determined by calculating the difference by which
the carrying amount of the asset exceeds its fair value. Based on the Companys
assessment as of December 31, 2007, no long-lived assets were determined to be
impaired.

Property and Equipment

Property and equipment is stated at cost
less accumulated depreciation and amortization. Depreciation and amortization
are computed using the straight-line method over the estimated useful lives of
the assets ranging from 2 to 30 years. Maintenance and repairs are charged to
operations, while betterments and improvements are capitalized.

Intangible Assets

Intangible assets are capitalized and
amortized over their estimated useful or economic lives using the straight-line
method in conformity with SFAS No. 142, Goodwill and Other Intangible Assets,
as follows:

| | RP
      technology                          | 11
      years
| | -------------------------------------------- | --------------
| | Capitalized
      software development costs | 3
      years 
| | Patents                                      | 10
      years
| | Trademarks                                   | 5
      years 

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. In the 2006 financial
statement, Goodwill had been included in the 2006 balance sheet as other assets.
Goodwill and is now classified as intangible assets in the 2007 presentation.
See Footnote 16 for a reconciliation of the amounts as previously reported to
the amounts reported in the current financial statements.

Warranty Policy and Methodology

The Company services and supports
customers by providing warranties for its products. The standard warranty is
three months, however, educational and international customers are granted a
12-month warranty. In all cases, three months of expected warranty costs will be
accrued in the same period as the product revenues. These expected warranty
costs are based on historical costs of supporting the Companys products. When
the warranty period exceeds the standard three-month warranty period, an accrual
of expected costs for the three-month standard warranty period is made and the
portion of revenue applicable to the remaining nine months of extended warranty
coverage will be deferred. The amount deferred is based on the fair market value
of a purchased maintenance agreement for the same product and term of coverage.
The expenses of maintaining the products under the extended warranty periods are
treated as period costs, as they are expected to be incurred evenly throughout
the same period and reflect a proper matching of revenue and expenses.

F-12

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

Unearned Revenues

The Company services and supports
customers by providing warranties and selling maintenance agreements for its
products. Unearned revenues comprise purchased maintenance agreements, covering
future periods, and deferred implied maintenance, as discussed in the Warranty
Policy and Methodology section. Implied maintenance is recognized as earned
maintenance revenue in equal installments over the extended nine-month warranty
period (months 4 through 12). The purchased maintenance is deferred in whole and
amortized over the period of coverage ranging from one to two years.

Revenue Recognition

The Company derives revenue from sales of
3D printing, rapid prototyping (RP) and direct digital manufacturing (DDM)
systems, consumables, and services. The Company recognizes revenue when (1)
persuasive evidence of a final agreement exists, (2) delivery has occurred or
services have been rendered, (3) the selling price is fixed or determinable, and
(4) collectibility is reasonably assured. The Companys standard terms are FOB
shipping point, and as such most of the revenue from the sale of RP machines and
consumables is recognized when shipped. Exceptions to this policy occur only if
a customers purchase order indicates an alternative term or provides that the
equipment sold would be subject to certain contingencies, such as formal
acceptance. In these instances, revenues would be recognized only upon
satisfying the conditions established by the customer as contained in its
purchase order to the Company. Revenue from sales-type leases for the Companys
FDM systems is recognized at the time of lessee acceptance, which follows
installation. Revenue from sales-type leases for the Companys Dimension systems
is recognized at the time of shipment, since either the customer or the reseller
performs the installation. The Company recognizes revenue from sales-type leases
at the net present value of future lease payments. Revenue from operating leases
is recognized ratably over the lease period.

Service revenue is derived from sales of
maintenance contracts, installation services, and training. Service revenue from
maintenance contracts is recognized ratably over the term of the contract,
typically one to two years. On certain sales that require a one-year warranty,
rather than the standard 90-day warranty, the extended warranty is treated for
revenue recognition purposes as a maintenance agreement. The fair value of this
maintenance agreement is deferred and recognized ratably over the period of the
extended warranty as an implied maintenance contract. Installation service
revenues are recognized upon completion of the installation. Training revenues
are recognized upon completion of the training.

In accordance with Emerging Issues Task
Force (EITF) No. 00-21, Revenue Arrangements with Multiple Deliverables,
when two or more product offerings are contained in a single arrangement,
revenue is allocated between the elements based on their relative fair value,
provided that each element meets the criteria for treatment as a separate unit
of accounting. An item is considered a separate unit of accounting if it has
value to the customer on a stand-alone basis and there is objective and reliable
evidence of the fair value of the undelivered items. Fair value is generally
determined based upon the price charged when the element is sold separately. In
the absence of fair value for a delivered element, revenue is allocated first to
the fair value of the undelivered elements and then the residual revenue is
allocated to the delivered elements. In the absence of fair value for an
undelivered element, the arrangement is accounted for as a single unit of
accounting, resulting in a delay of revenue recognition for the delivered
elements until all undelivered elements have been fulfilled.

Revenues from training and installation
are unbundled and are recognized after the services have been performed. Both of
these services are optional to the customer. The majority of the Companys
products are sold through distribution channels, with training and installation
services offered by the resellers or distributors. For the Dimension product
neither installation nor training is offered. Consistent with the SECs Staff
Accounting Bulletin (SAB) No. 104, Revision of Topic 13: Revenue Recognition
in Financial Statements, the equipment the Company manufactures and sells is
subject to factory testing that should replicate the conditions under which the
customers intend to use the equipment. All of the systems are sold subject to
published specifications, and all systems sales involve standard models.

The Company assesses collectibility as
part of the revenue recognition process. The Company also evaluates a number of
factors to assess collectibility, including an evaluation of the
creditworthiness of the customer, past payment history, and current economic
conditions. If it is determined that collectibility cannot be reasonably
assured, the Company will decline shipment, request a down payment, or defer
recognition of revenue until ultimate collectibility is more determinable.

F-13

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

The Company also records a provision for
estimated product returns and allowances in the period in which the related
revenue is recorded. This provision against current gross revenue is based
principally on historical rates of sales returns, but also factors in changes in
the customer base, geographic economic conditions, and changes in the financial
conditions of the Companys customers. If past trends were to change, the
Company would potentially have to increase or decrease the amount of the
provision for these returns. As of December 31, 2007, the allowance for returns
was approximately $191,000 as compared with approximately $169,000 as of
December 31, 2006.

Derivative Financial Instruments

The Company uses derivatives primarily to
hedge its exposure to changes in foreign currency exchange rates between the US
dollar and the Euro. The Company is exposed to fluctuations in foreign currency
cash flows related primarily to third party purchases. Forward contracts of
generally one-month duration are used to hedge some of these risks and any
ineffectiveness is recognized in earnings in the period deemed ineffective. At
December 31, 2007 and 2006, the Company had forward contracts (in Euros) of €3.3
million and €3.5 million, respectively.

Advertising

Advertising costs are charged to
operations as incurred and were approximately $3,543,000, $2,740,000, and
$3,396,000, for 2007, 2006 and 2005, respectively.

Research and Development Costs

The Company complies with SFAS No. 2,
Accounting for 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 basis 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.

Effective January 1, 2007, we adopted the
provisions of FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in
Income Taxesan Interpretation of FASB Statement No. 109. FIN 48 contains a
two-step approach to recognizing and measuring uncertain tax positions (tax
contingencies) accounted for in accordance with SFAS No. 109. The first step is
to evaluate the tax position for recognition by determining if the weight of
available evidence indicates it is more likely than not that the position will
be sustained on audit, including resolution of related appeals or litigation
processes, if any. The second step is to measure the tax benefit as the largest
amount which is more than 50% likely of being realized upon ultimate settlement.
We reevaluate these tax positions quarterly and make adjustments as required.

Earnings Per Share

The Company complies with SFAS No. 128,
"Earnings Per Share." SFAS No. 128 requires dual presentation of basic and
diluted income per common share for all periods presented. Basic income per
common 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 common 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 share in the income of the Company. The difference between thenumber of common shares used to compute basic
income per common share and diluted income per common share relates to
additional common shares to be issued upon the assumed exercise of stock options
and warrants, net of common shares hypothetically repurchased at the average
market price with the proceeds of exercise. The additional common shares
amounted to 793,962 in 2007, 483,154 in 2006 and 433,552 in 2005.

F-14

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

Stock-Based Compensation

In December 2004, the Financial Accounting
Standards Board (FASB) issued SFAS No. 123(R), Accounting for Stock-Based
Compensation (Revised). SFAS No. 123(R) supersedes APB No. 25 and its related
implementation guidance. SFAS No. 123(R) establishes standards for the
accounting for transactions in which an entity exchanges its equity instruments
for goods or services. It also addresses transactions in which an entity incurs
liabilities in exchange for goods or services that are based on the fair value
of the entitys equity instruments or that may be settled by the issuance of
those equity instruments.

SFAS No. 123(R) focuses primarily on
accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123(R) requires a public entity to
measure the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award (with limited
exceptions). That cost will be recognized over the period during which an
employee is required to provide service in exchange for the award the requisite
service period (usually the vesting period). No compensation costs are
recognized for equity instruments for which employees do not render the
requisite service. The grant-date fair value of employee share options and
similar instruments will be estimated using option-pricing models adjusted for
the unique characteristics of those instruments (unless observable market prices
for the same or similar instruments are available). If an equity award is
modified after the grant date, incremental compensation cost will be recognized
in an amount equal to the excess of the fair value of the modified award over
the fair value of the original award immediately before the modification.

The Company adopted SFAS No. 123(R),
effective January 1, 2006. On that date, the Companys managment elected to use
the modified prospective transition method as permitted by SFAS No. 123R and
therefore did not restate the financial results for prior periods. Under this
transition method, the provisions of SFAS No. 123R were applied to new awards
and to awards modified, repurchased, or cancelled after January 1, 2006.
Additionally, compensation costs were recognized over the remaining applicable
service period for the portion of awards that were outstanding as of January 1,
2006 but for which the requisite service had not yet been rendered.

Based on stock options that vested since
adoption of SFAS No. 123(R), the Company recorded approximately $955,000 and
$1.3 million of additional compensation expense for the years ended December 31,
2007 and December 31, 2006, respectively.

Prior to January 1, 2006 the Company
followed SFAS No. 123, "Accounting for Stock-Based Compensation." The provisions
of SFAS No. 123 allowed companies to either expense the estimated fair value of
stock options or to continue to follow the intrinsic value method set forth in
APB Opinion 25, "Accounting for Stock Issued to Employees" ("APB 25"), but
disclose the pro forma effect on net income (loss) had the fair value of the
options been expensed.

F-15

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

Had compensation cost for the Company's
five stock option plans been determined based on the fair value at the grant or
issue date prior to January 1, 2006 and consistent with the provisions of SFAS
No. 123(R), the Company's net income and income per share would have been
reduced to the pro forma amounts indicated below:

|                                             | 2005
|-------------------------------------------- | ----
|Net income, as reported                      | $   
|Deduct: Total
      stock-based              |     
|compensation expense determined              |     
|under the fair value method for all          |     
|awards, net of related tax effect            |     
|Net income, pro forma                        | $   
|                                            
|Income per share:                            |     
|Basic income per share - as reported         | $   
|Diluted income per share
      - as reported | $   
|Basic income per share - pro forma           | $   
|Diluted income per share
      - pro forma   | $   

Use of Estimates

The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America 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

The Company complies with SFAS No. 130,
"Reporting Comprehensive Income" which establishes rules for the reporting and
display of comprehensive income (loss) and its components. The Company reports
the financial impact of translating its foreign subsidiaries financial
statements from local currency to reporting currency as a component of
comprehensive income (loss).

Recently Issued Accounting
Pronouncements

In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Correction Replacement of APB Opinion No. 20 and
FASB Statement No. 3 (SFAS No. 154). SFAS No. 154 replaces APB Opinion No.
20, Accounting Changes (Opinion 20), and FASB Statement No. 3, Reporting
Accounting Changes in Interim Financial Statements, and changes the
requirements for the accounting for and reporting of a change in accounting
principle. Opinion 20 previously required that most voluntary changes in
accounting principle be recognized by including in net income of the period of
the change the cumulative effect of changing to the new accounting principle.
SFAS No. 154 requires retrospective application to prior periods financial
statements of changes in accounting principle. SFAS No. 154 defines
retrospective application as the application of a different accounting principle
to prior accounting periods as if that principle had always been used. SFAS No.
154 also requires that a change in depreciation, amortization, or depletion
method for long-lived, non-financial assets be accounted for as a change in
accounting estimate affected by a change in accounting principle. The adoption
of SFAS No. 154 had no impact on the consolidated financial statements.

In September 2006, the FASB issued SFAS
No. 157, Fair Value Measurements (SFAS No. 157). SFAS No. 157 1) establishes
a single definition of fair value and a framework for measuring fair value, 2)
sets out a fair value hierarchy to be used to classify the source of information
used in fair value measurements; and 3) requires new disclosures of assets and
liabilities measured at fair value based on their level in the hierarchy. SFAS
No. 157 is effective for fiscal years beginning after November 15, 2007 and is
to be applied prospectively.

In February 2008, the FASB issued Staff
Positions No. 157-1 and No. 157-2 which partially defer the effective date of
SFAS No. 157 for one year for certain nonfinancial assets and liabilities and
remove certain leasing transactions from its scope. The Company is currently
evaluating the impact of this standard, but does not expect SFAS No. 157 to have
a material impact on the consolidated statements.

In February 2007, the FASB issued SFAS No.
159 The Fair Value Option for Financial Assets and Financial Liabilities
(SFAS No. 159). SFAS No. 159 permits entities to choose to measure many
financial assets and financial liabilities at fair value. Unrealized gains and
losses on items for which the fair value option has been elected are to be
reported in earnings. SFAS No. 159 is effective for fiscal years beginning after
November 15, 2007. The Company is currently evaluating the impact of this
standard, but does not expect SFAS No. 159 to have a material impact on the
consolidated statements.

F-16

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

In December 2007, the FASB issued SFAS No.
141(revised 2007), Business Combinations (SFAS No. 141R). SFAS No. 141R
provides revised guidance on how acquirers recognize and measure the
consideration transferred, identifiable assets acquired, liabilities assumed,
noncontrolling interests, and goodwill acquired in a business combination. SFAS
No. 141R also expands required disclosures surrounding the nature and financial
effects of business combinations. SFAS No. 141R is effective for fiscal years
beginning after December 15, 2008. The Company is evaluating the impact of this
standard and will evaluate its impact on any acquisitions that would occur after
the effective date.

Reclassifications

Certain reclassifications have been made
to the 2006 and 2005 balance sheets, income statements and statements of cash
flows to conform to the current presentation. A reconciliation between the
current presentation and the presentation provided in the prior years annual
reports is provided in Note 16. These reclassifications had no effect on total
assets, operating income, net income, net income per common share - basic, and
net income per common share - diluted.

2.Inventories

Inventories consist of the following at
December 31:

|                    | 2007 |            | 2006
|------------------- | ---- | ---------- | ----
|Finished goods      | $    | 6,060,801  |     
|Raw
      materials |      | 6,710,434  |     
|                    | $    | 12,771,235 |     

F-17

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

3.Net investment in sales-type leases

The Company leases certain of its systems
under agreements accounted for as sales-type leases. Included in revenues for
the years ended December 31, 2007, 2006 and 2005 are approximately $2,293,000,
$1,543,000 and $1,546,000, respectively, of revenues related to sales-type
leases. These non-cancelable leases expire over the next two to four years.

The following lists the components of the
net investment in sales-type leases as of December 31, 2007 and 2006:

|                                                      |  | 2007 |           | 2006
|----------------------------------------------------- |  | ---- | --------- | ----
|Net minimum lease payments receivable                 |  | $    | 8,042,435 |     
|Less unearned
      interest income                   |  |      | (683,800  | )   
|Net investment in sales-type leases                   |  | $    | 7,358,635 |     
|                                                     
|Sales-type leases consist of:                         |  |      |           |     
|Net investment in sales-type leases - short-term      |  | $    | 3,256,953 |     
|Net investment in sales-type leases -
      long-term |  |      | 4,101,682 |     
|Net investment
      in sales-type leases, as above   |  | $    | 7,358,635 |     

Future minimum lease payments due from
customers under sales-type leases as of December 31, 2007 are as follows:

| | Year ending
      December 31, |  |   |          
| | ------------------------------ |  | - | ---------
| | 2008                           |  | $ | 3,549,835
| | 2009                           |  |   | 2,549,168
| | 2010                           |  |   | 1,420,917
| | 2011                           |  |   | 522,515  
| |                                |  | $ | 8,042,435

The interest income for sales-type leases
amounted to approximately $329,000, $251,000, and $152,000 for the years ended
December 31, 2007, 2006 and 2005, respectively.

F-18

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

4.Property and equipment

Property and equipment consists of the
following at December 31:

| |                                           | 2007 |            | 2006
| | ----------------------------------------- | ---- | ---------- | ----
| | Machinery and equipment                   | $    | 19,573,763 |     
| | Building and
      improvements           |      | 10,301,107 |     
| | Land and improvements                     |      | 2,989,069  |     
| | Computer
      equipment and software     |      | 8,915,635  |     
| | Office equipment                          |      | 2,385,988  |     
| | Leasehold
      improvements              |      | 2,065,197  |     
| |                                           |      | 46,230,759 |     
| |                                          
| | Accumulated depreciation and amortization |      | 19,653,397 |     
| |                                           | $    | 26,577,362 |     

5.Intangible assets

Intangible assets consist of the following
at December 31:

|                                                | 2007     |            | 2006        
|----------------------------------------------- | -------- | ---------- | ------------
|                                                | Gross    |            |             
|                                                | Carrying |            | Accumulated 
|                                                | Amount   |            | Amortization
|RP technology                                   | $        | 5,518,732  |             
|Capitalized
      software development costs    |          | 8,896,977  |             
|Patents                                         |          | 2,654,848  |             
|Trademarks                                      |          | 268,793    |             
|                                                |          | 17,339,350 |             
|Accumulated
      amortization                  |          | 10,154,864 |             
|Net book value of amortizable intangible assets |          | 7,184,486  |             
|Goodwill                                        |          | 878,833    |             
|Net book value intangible assets                | $        | 8,063,319  |             

For the years ended December 31, 2007,
2006 and 2005, amortization of intangible assets charged to operations was
approximately $1,282,000, $1,049,000 and $785,000, respectively. The change in
Goodwill between 2007 and 2006 is due to a translation adjustment.

F-19

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

Estimated amortization expense, for all
intangible assets, for the five years subsequent to December 31, 2007 is
approximately as follows:

| | Year ending December 31, |  |   |          
| | ------------------------ |  | - | ---------
| | 2008                     |  | $ | 1,882,000
| | 2009                     |  |   | 1,612,000
| | 2010                     |  |   | 1,253,000
| | 2011                     |  |   | 641,000  
| | 2012                     |  |   | 396,000  

6.Line of credit

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 defined rates based upon two
different indexes and expires in July 2009. No amounts were outstanding at
December 31, 2007 and 2006.

7.Accounts payable and other current liabilities

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

|                                | 2007 |            | 2006
|------------------------------- | ---- | ---------- | ----
|Trade                           | $    | 6,385,861  |     
|Compensation,
      commissions |      |            |     
|and related benefits            |      | 4,108,295  |     
|Reserve for warranty expenses   |      | 270,858    |     
|Income taxes                    |      | 982,166    |     
|Other                           |      | 2,211,842  |     
|                                | $    | 13,959,022 |     

8.Unearned revenues

Unearned revenues consist of the following
at December 31:

|                                    | 2007 |            | 2006
|----------------------------------- | ---- | ---------- | ----
|Maintenance contracts               | $    | 7,838,840  |     
|Implied
      maintenance contracts |      | 2,329,930  |     
|Other                               |      | 795,701    |     
|                                    | $    | 10,964,471 |     

F-20

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

9.Income taxes

The components of the Company's deferred
tax assets (liabilities) at December 31, 2007 and 2006 are as follows:

|                                        | 2007 |           | 2006
|--------------------------------------- | ---- | --------- | ----
|Current deferred tax assets:            |      |           |     
|Allowance for doubtful accounts         | $    | 371,000   |     
|State research and
      development    |      |           |     
|credit
      carryforward               |      | 224,000   |     
|Reserve for warranty expenses           |      | 102,000   |     
|Reserve for sales
      returns, net    |      | 72,000    |     
|Current
      deferred tax asset        |      | 769,000   |     
|Current deferred
      tax liabilities: |      |           |     
|Unrealized gain on foreign currency     |      | (58,000   | )   
|Net current deferred tax asset          | $    | 711,000   |     
|                                       
|Long-term deferred tax assets:          |      |           |     
|Inventory reserves                      | $    | 463,000   |     
|Stock compensation
      expense        |      | 374,000   |     
|Deferred maintenance revenue            |      | 310,000   |     
|Amortization                            |      | 235,000   |     
|Long-term deferred tax asset            |      | 1,382,000 |     
|Long-term deferred tax liabilities:     |      |           |     
|Depreciation                            |      | (663,000  | )   
|Net long-term
      deferred tax asset  | $    | 719,000   |     

Income before income taxes for the years
ended December 31, 2007, 2006 and 2005 is as follows:

|              | 2007 |            | 2006 |   | 2005      
|------------- | ---- | ---------- | ---- | - | ----------
|United States | $    | 19,915,765 |      | $ | 16,647,884
|Foreign       |      | 446,291    |      |   | 316,295   
|              | $    | 20,362,056 |      | $ | 16,964,179

The components of income tax expense for
the years ended December 31, 2007, 2006 and 2005 are as follows:

|                         | 2007 |           | 2006 |  | 2005
|------------------------ | ---- | --------- | ---- |  | ----
|Current                  |      |           |      |  |     
|Federal                  | $    | 6,547,184 |      |  | $   
|State                    |      | (718,749  | )    |  |     
|Foreign                  |      | 153,564   |      |  |     
|                         |      | 5,981,999 |      |  |     
|                        
|Deferred                 |      |           |      |  |     
|Federal                  |      | (157,000  | )    |  |     
|State                    |      | 213,000   |      |  |     
|                         |      | 56,000    |      |  |     
|Total Income
      taxes | $    | 6,037,999 |      |  | $   

F-21

---

**STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL
STATEMENTS**

During the years ended December 31, 2007,
2006, and 2005, approximately $1,965,000, $590,000, and $439,000, respectively,
was added to additional paid-in capital in accordance with FASB No. 109
reflecting the permanent book to tax difference in accounting for tax benefits
related to employee stock option transactions.

A reconciliation of the statutory federal
income tax rate and the effective tax rate for the years ended December 31,
2007, 2006 and 2005 are as follows:

|                                      | 2007 |   | 2006 |      | 2005
|------------------------------------- | ---- | - | ---- | ---- | ----
|Federal statutory rate                | 35.0 | % |      | 35.0 | %   
|State income
      taxes, net of      |      |   |      |      |     
|federal benefit                       | 1.9  |   |      | 2.8  |     
|Tax contingencies                     | 2.2  |   |      | -    |     
|Prior year
      amendments for state |      |   |      |      |     
|research and development credits      | (3.7 | ) |      | -    |     
|Tax exempt interest income            | (3.2 | ) |      | (2.3 | )   
|Stock
      compensation expense      | 0.7  |   |      | 1.0  |     
|Export tax benefits                   | -    |   |      | (1.0 | )   
|Manufacturing
      deduction         | (1.8 | ) |      | (0.7 | )   
|Federal of research and               |      |   |      |      |     
|development tax credit                | (1.8 | ) |      | (0.8 | )   
|Earnings of
      subsidiaries taxed  |      |   |      |      |     
|at other than U.S. statutory rate     | -    |   |      | 0.3  |     
|Other                                 | 0.3  |   |      | (0.1 | )   
|Effective income
      tax rate       | 29.6 | % |      | 34.2 | %   

We are subject to income taxes in the
U.S., various states and certain foreign jurisdictions. We may be subject to
examination by the Internal Revenue Service (IRS) for calendar years 2005
through 2007. The expiration of the statute of limitations related to the
various state and foreign income tax returns that the Company files, varies by
state and foreign jurisdiction.

At December 31, 2007 the Company had
Minnesota tax credit carryforwards of approximately $344,000. The Company
expects to utilize its state research and development tax credit carryforwards
that would otherwise expire from 2018 through 2022.

Significant judgment is required in
evaluating our tax positions and determining our provision for income taxes.
During the ordinary course of business, there are many transactions and
calculations for which the ultimate tax determination is uncertain. We establish
reserves for tax-related uncertainties based on estimates of whether, and the
extent to which, additional taxes will be due. These reserves are established
when we believe that certain positions might be challenged despite our belief
that our tax return positions are fully supportable. We adjust these reserves in
light of changing facts and circumstances, such as the outcome of a tax audit or
changes in the tax law. The provision for income taxes includes the impact of
reserve provisions and changes to reserves that are considered appropriate.
Accruals for tax contingencies are provided for in accordance with the
requirements of FIN 48.

Our Federal income tax returns are closed
for all tax years up to and including 2003. The expiration of the statute of
limitations related to the various state income tax returns that the Company and
subsidiaries file, varies by state.

F-22

---

**STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL
STATEMENTS**

At December 31, 2007 we had unrecognized
tax benefits of $1,021,000. If recognized, these benefits would favorably impact
the effective tax rate. A reconciliation of the beginning and ending amount of
unrecognized tax benefits is as follows:

|Balance as of January 1, 2007                                 |  | $       | 563,187  
|------------------------------------------------------------- |  | ------- | ---------
|Additions for tax positions related to the current
      year |  | 458,406
|Balance as of December 31, 2007                               |  | $       | 1,021,593

The increase in tax liabilities is
primarily due to potential U.S. Federal and state adjustments taken in the
Companys 2007 income tax provision. Included in the ending liability for
unrecognized tax benefits is an estimate for interest and penalties totaling
$52,000. Our policy is to include interest and penalties related to our tax
contingencies in income tax expense.

10.Commitments

The Company rents certain of its
facilities under non-cancellable operating leases, which expire through 2011.

Aggregate future minimum annual rental
payments in the years subsequent to December 31, 2007 are approximately as
follows:

| | Year ending
      December 31, |  |   |        
| | ------------------------------ |  | - | -------
| | 2008                           |  | $ | 244,000
| | 2009                           |  |   | 204,000
| | 2010                           |  |   | 152,000
| | 2011                           |  |   | 46,000 

Rent expense for the years ended December
31, 2007, 2006 and 2005 was approximately $894,000, $739,000 and $664,000,
respectively.

11.Common stock

In August 2007, the Company effected a
two-for-one stock split of the Companys common stock in the form of a common
stock dividend. Prior year share and per-share information has been
retroactively adjusted to reflect the stock split.

The Company has a common stock repurchase
program and repurchased 128,500 and 401,503 shares of common stock during the
years ended December 31, 2006 and 2005, respectively. There were no common stock
repurchases during the year ended December 31, 2007. As of December 31, 2007,
the Company was authorized to repurchase approximately $8.0 million of
additional common stock. In February 2008, the Company announced an increase in
its stock repurchase authorization to $30 million, which superseded all prior
repurchase authorizations.

F-23

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

12.Stock options and warrants

The Company has various stock option plans
that have been approved by stockholders. Prior to the Companys two-for-one
stock split, the plans provided for the granting of options to purchase up to
3,825,000 shares of the Companys common stock to qualified employees of the
Company, independent contractors, consultants, and other persons. Of those
3,825,000 options available for grant, 3,564,417 options had been granted prior
to the two-for-one stock split, leaving 260,583 options prior to the split
available to be granted by the Company and 521,166 options available after the
split. In 2007, after the stock split, the Company granted options to purchase
260,000 shares while options to purchase 42,900 shares either expired or were
forfeited, leaving 304,066 shares available for grant as of December 31, 2007.
Options principally vest immediately or ratably over five years and are
exercisable over a period ranging from five to six years. The information
presented below has been adjusted to reflect the two-for-one stock split.

|                          |                  |   |                    |   |          |             |       |         | Weighted
|------------------------- | ---------------- | - | ------------------ | - | -------- | ----------- | ----- | ------- | --------
|                          | Number           |   |                    |   |          |             |       | Average
|                          | of
      Options |   | Per Share          |   | Exercise
|                          | Outstanding      |   | Exercise
    Price |   | Price   
|Shares under option       |                  |   |                    |   |          |             |       |         |         
|at January 1, 2005        | 1,623,680        |   |                    | $ | 0.92     | -   $       | 18.20 |         | $       
|Granted in
      2005     | 1,246,000        |   |                    |   | 12.49    | -           | 14.48 |         |         
|Exercised in 2005         | (150,740         | ) |                    |   | 1.00     | -           | 12.99 |         |         
|Expired in
      2005     | (81,750          | ) |                    |   | 1.00     | -           | 6.14  |         |         
|Forfeited in 2005         | (16,018          | ) |                    |   | 1.02     | -           | 18.20 |         |         
|Shares under
      option |                  |   |                    |   |          |             |       |         |         
|at December 31, 2005      | 2,621,172        |   |                    |   | 0.92     | -           | 18.20 |         |         
|Exercised in 2006         | (315,350         | ) |                    |   | 1.02     | -           | 14.48 |         |         
|Shares under
      option |                  |   |                    |   |          |             |       |         |         
|at December 31, 2006      | 2,305,822        |   |                    |   | 0.92     | -           | 17.92 |         |         
|Granted in 2007           | 260,000          |   |                    |   | 20.75    | -           | 26.15 |         |         
|Exercised in
      2007   | (720,894         | ) |                    |   | 1.02     | -           | 14.66 |         |         
|Expired in 2007           | (15,900          | ) |                    |   | 1.00     | -           | 2.83  |         |         
|Forfeited in
      2007   | (27,000          | ) |                    |   | 1.02     | -           | 14.43 |         |         
|Shares under option       |                  |   |                    |   |          |             |       |         |         
|at December 31, 2007      | 1,802,028        |   |                    | $ | 0.92     | -  
      $ | 17.92 |         | $       

F-24

---

**STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL
STATEMENTS**

The following table summarizes information
about stock options exercisable at December 31, 2007:

|                       |           |  |                    |      |        |   |       |  | Weighted
|---------------------- | --------- |  | ------------------ | ---- | ------ | - | ----- |  | --------
|                       | Number    |  |                    |      |        |   |       |  | Average 
|                       | of        |  | Per Share          |      | Option
|                       | Shares    |  | Option
      Price |      | Price 
|Options exercisable at |           |  |                    |      |        |   |       |  |         
|December 31, 2007      | 1,411,978 |  | $                  | 1.67 | -      | $ | 17.92 |  | $       
|                      
|Options exercisable at |           |  |                    |      |        |   |       |  |         
|December 31, 2006      | 2,060,340 |  | $                  | 0.92 | -      | $ | 17.92 |  | $       
|                      
|Options exercisable at |           |  |                    |      |        |   |       |  |         
|December 31, 2005      | 2,158,200 |  | $                  | 0.92 | -      | $ | 17.92 |  | $       

The following table summarizes information
about stock options outstanding at December 31, 2007:

|                |  | Options Outstanding |            | Options Exercisable
|--------------- |  | ------------------- | ---------- | -------------------
|                |  | Number              |            | Weighted-          
|                |  | Outstanding         |            | Average            
|                |  | at                  |            | Remaining          
|Exercise        |  | December 31,        |            | Contractual        
|Prices          |  | 2007                |            | Life               
|$1.67-8.62      |  |                     | 10,800     |                    
|10.92-13.40     |  |                     | 451,500    |                    
|14.17-17.92     |  |                     | 1,079,728  |                    
|20.75-26.15     |  |                     | 260,000    |                    
|                |  |                     | 1,802,028  |                    
|               
|Aggregate       |  |                     |            |                    
|intrinsic value |  | $                   | 15,203,228 |                    

The weighted average life remaining on
vested options is 2.8 years. The weighted average grant date fair value based on
the Black-Scholes models for options granted in 2007 was $9.60. The Company
issues new shares of common upon exercise of stock options. The total intrinsic
value of options exercised was approximately $5.8 million in 2007, $1.6 million
in 2006 and $1.2 million in 2005.

F-25

---

**STRATASYS, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

The Company used the Black-Scholes
option-pricing model to determine the fair value of grants made in 2007 and
2005. There were no options granted in 2006. The following assumptions were
applied in determining the pro forma compensation cost:

|                           | **2007**        |  | **2006** |  | **2005**       
|-------------------------- | --------------- |  | -------- |  | ---------------
|Risk-free interest rate    | 3.3%            |  | n/a      |  | 2.6% - 4.0%    
|Expected option
      term | 4.5
      years |  | n/a      |  | 5-6
      years
|Expected price volitility  | 47%             |  | n/a      |  | 45% & 68%      
|Dividend
      yield       | -               |  | n/a      |  | -              

The Company, as part of sales of common
stock and other agreements, has issued warrants to purchase theCompanys common stock. As of December 31, 2007, the Company
had 450,000 shares under warrants with a price that ranges from $11.56 to $13.82
and an average price of $12.24. There were no warrants issued or exercised in
2007, 2006 and 2005. The amount of shares under warrants have been adjusted for
the two-for-one stock split in August 2007.

As of December 31. 2007, there were
approximately $3.2 million of total unrecognized compensation expense related to
unvested share-based compensation granted under the Companys plans. That cost
is expected to be recognized over a weighted-average period of 3.7 years. The
fair value of options shares vested during the year 2007 was approximately
$806,000

13.Litigation

The Company is a party to various legal
matters, the outcome of which, in the opinion of management, will not have a
material adverse effect on the financial position, results of operations or cash
flows of the Company.

14.Export sales

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

|                   |  | 2007 |            | 2006 |   | **2005**  
|------------------ |  | ---- | ---------- | ---- | - | ----------
|Europe             |  | $    | 27,144,055 |      | $ | 21,459,208
|Asia
      Pacific |  |      | 19,806,049 |      |   | 16,628,696
|Other              |  |      | 2,767,662  |      |   | 4,352,914 
|                   |  | $    | 49,717,766 |      | $ | 42,440,818

At December 31, 2007 and 2006, accounts
receivable included balances due from foreign customers of approximately
$14,977,000 and $13,397,000, respectively.

15.Retirement plan

The Company has a defined contribution
retirement plan (the Plan) under the provisions of Section 401(k) of the
Internal Revenue Code (IRC) that covers all eligible employees as defined in
the Plan. Participants may elect to contribute up to 50% of pre-tax annual
compensation, as defined by the Plan, up to a maximum prescribed by the IRC. The
Company makes matching contributions equal to the lesser of $3,000 or 3% of the
participants annual compensation. The Company, at its discretion, may make
additional contributions subject to limitations. For the years ended December
31, 2007, 2006 and 2005, the Company made 401(k) Plan contributions of
approximately $506,000, $440,000 and $383,000, respectively.

F-26

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

16.Reclassification of Prior Year Amounts

Bond Investments

Certain 2006 and 2005 amounts in the
financial statements were reclassified in accordance with SFAS No. 95,
"Statement of Cash Flows. Specifically, we had previously presented bond
investments that were maturing within 90 days of year-end as cash equivalents
although we had acquired them when their maturity dates were greater than 90
days from the date of purchase. SFAS No. 95 requires these amounts to remain in
short-term investments based on the original maturity date being greater than 90
days when acquired. All of these bonds became due within 90 days of the
respective year-end and were converted into cash upon their maturity date with
no gain or loss. The table below summarizes the changes to the affected lines of
the Balance Sheet and Statement of Cash Flows for the years indicated:

|Consolidated Balance Sheet (Affected lines
      only)                              |  | 2006 |            |      |  |  
|----------------------------------------------------------------------------------- |  | ---- | ---------- | ---- |  | -
|Cash and cash equivalents (as previously
      reported)                            |  | $    | 12,509,861 |      |  |  
|Adjustment to reclassify bonds with short-term
      maturities                     |  |      | (3,207,016 | )    |  |  
|Cash
      and cash equivalents (as currently reported)                             |  | $    | 9,302,845  |      |  |  
|                                                                                   
|Short-term investments (as previously reported)                                     |  | $    | 21,367,316 |      |  |  
|Adjustment to reclassify bonds with short-term
      maturities                     |  |      | 3,207,016  |      |  |  
|Short-term investments (as currently
      reported)                                |  | $    | 24,574,332 |      |  |  
|                                                                                   
|Intangible assets, net (as previously
      reported)                               |  | $    | 4,868,923  |      |  |  
|Adjustment to reclassify Goodwill from "Other" to
      "Intangible assets, net"    |  |      | 794,218    |      |  |  
|Intangible assets, net (as currently reported)                                      |  | $    | 5,663,141  |      |  |  
|                                                                                   
|Other assets - other (as previously
      reported)                                 |  | $    | 2,265,200  |      |  |  
|Adjustment to reclassify Goodwill from "Other" to
      "Intangible assets, net"    |  |      | (794,218   | )    |  |  
|Other assets - other (as currently
      reported)                                  |  | $    | 1,470,982  |      |  |  
|                                                                                   
|Consolidated Statements of Cash Flows (Affected lines
      only)                   |  | 2006 |            | 2005
|Proceeds from sale of investments (as previously reported)                          |  | $    | 6,820,000  |      |  | $
|Adjustment to reclassify bonds with short-term maturities                           |  |      | 816,567    |      |  |  
|Proceeds from sale of investments (as
      currently reported)                     |  | $    | 7,636,567  |      |  | $
|                                                                                   
|Net cash used by investing activities (as
      previously reported)                |  | $    | (8,419,071 | )    |  | $
|Adjustment to reclassify bonds with
      short-term maturities                     |  |      | 816,567    |      |  |  
|Net cash used by investing activities (as
      currently reported)                 |  | $    | (7,602,504 | )    |  | $
|                                                                                   
|Net increase (decrease) in cash and cash
      equivalents (as previously reported) |  | $    | 2,404,662  |      |  | $
|Adjustment to reclassify bonds with
      short-term maturities                     |  |      | 816,567    |      |  |  
|Net increase (decrease) in cash and cash
      equivalents (as currently reported)  |  | $    | 3,221,229  |      |  | $
|                                                                                   
|Cash and cash equivalents, beginning of year
      (as previously reported)         |  | $    | 10,105,199 |      |  | $
|Adjustment to reclassify bonds with
      short-term maturities                     |  |      | (4,023,583 | )    |  |  
|Cash and cash equivalents, beginning of year
      (as currently reported)          |  | $    | 6,081,616  |      |  | $
|                                                                                   
|Cash and cash equivalents, end of year (as
      previously reported)               |  | $    | 12,509,861 |      |  | $
|Adjustment to reclassify bonds with
      short-term maturities                     |  |      | (3,207,016 | )    |  |  
|Cash and cash equivalents, end of year (as
      currently reported)                |  | $    | 9,302,845  |      |  | $

F-27

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

Because these bond investments were
converted into cash upon their maturity date with no gain or loss, this
reclassification has no impact on current assets, total assets or any portion of
the income statement. As shown above, quantitatively, the error is significant
to various line items within current assets as well as within the statement of
cash flows. However, while quantitatively significant, the Company does not
consider them material given the high liquidity of the investments for the
Company. The Company does not see any relative cash trends that an investor
would be evaluating that are impacted by this misclassification since it only
relates to the near-term timing of cash flows from bond sale proceeds.

Customer Service Costs

The 2005 income statement was restated to
reflect customer services costs as part of the cost of sales instead of as
operating expenses. These reclassifications had no effect on operating or net
income or net income per basic and diluted common share. The table below
reflects the amounts before and after reclassification.

|Consolidated Statement of Operations (Affected lines
      only)   |  | 2005
|------------------------------------------------------------------ |  | ----
|Cost of sales - Services (as previously
      reported)            |  | $   
|Adjustment to reclassify Customer services costs                   |  |     
|Cost of sales - Services (as currently
      reported)             |  | $   
|                                                                  
|Total cost of sales (as previously
      reported)                 |  | $   
|Adjustment to reclassify Customer services costs                   |  |     
|Total cost of sales (as currently
      reported)                  |  | $   
|                                                                  
|Gross profit (as previously reported)                              |  | $   
|Adjustment to reclassify Customer services costs                   |  |     
|Gross profit (as currently reported)                               |  | $   
|                                                                  
|Selling, general and administrative (as
      previously reported) |  | $   
|Adjustment to reclassify Customer services costs                   |  |     
|Selling, general and administrative (as
      currently reported)  |  | $   
|                                                                  
|Total operating expenses (as previously
      reported)            |  | $   
|Adjustment to reclassify Customer services costs                   |  |     
|Total operating expenses (as currently
      reported)             |  | $   

F-28

---

STRATASYS, INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

17.Quarterly Results (unaudited)

|                      | First       |            | Second  |   | Third      |  | Fourth 
|--------------------- | ----------- | ---------- | ------- | - | ---------- |  | -------
|                      | **Quarter** |            | Quarter |   | Quarter    |  | Quarter
|2007                  |             |            |         |   |            |  |        
|Net sales             | $           | 27,344,860 |         | $ | 28,223,494 |  | $      
|Gross profit          |             | 14,706,020 |         |   | 15,600,589 |  |        
|Net income            |             | 3,157,438  |         |   | 3,633,559  |  |        
|Net income per common |             |            |         |   |            |  |        
|share:                |             |            |         |   |            |  |        
|Basic                 | $           | 0.15       |         | $ | 0.18       |  | $      
|Diluted               |             | 0.15       |         |   | 0.17       |  |        
|                     
|2006                  |             |            |         |   |            |  |        
|Net sales             | $           | 22,223,095 |         | $ | 26,699,285 |  | $      
|Gross profit          |             | 10,821,379 |         |   | 13,614,296 |  |        
|Net income            |             | 2,015,210  |         |   | 2,935,971  |  |        
|Net income per common |             |            |         |   |            |  |        
|share:                |             |            |         |   |            |  |        
|Basic                 | $           | 0.10       |         | $ | 0.14       |  | $      
|Diluted               |             | 0.10       |         |   | 0.14       |  |        

During the fourth quarter of 2006, the
income statement was restated to reflect customer services costs as part of the
cost of sales instead of as operating expenses. These reclassifications had no
effect on operating or net income or net income per basic and diluted common
share. The table below reflects the amounts before and after reclassification on
the 2006 quarterly gross profit for the first three quarters of 2006:

|                                  | First   |            | Second  |  | Third  
|--------------------------------- | ------- | ---------- | ------- |  | -------
|                                  | Quarter |            | Quarter |  | Quarter
|2006                              |         |            |         |  |        
|Gross profit (as
      previously |         |            |         |  |        
|reported)                         | $       | 11,798,774 |         |  | $      
|Adjustment to reclass customer    |         |            |         |  |        
|service costs                     |         | (977,395   | )       |  |        
|Gross profit (as currently        |         |            |         |  |        
|reported)                         | $       | 10,821,379 |         |  | $      

F-29

---

STRATASYS, INC. AND SUBSIDIARIES

|SCHEDULE II                                          |  |                 |  |                            |  |                  |  |                  |  |                
|---------------------------------------------------- |  | --------------- |  | -------------------------- |  | ---------------- |  | ---------------- |  | ---------------
|VALUATION AND QUALIFYING ACCOUNTS
      AND RESERVES
|                                                    
|Years
      Ended December 31, 2007, 2006, and 2005  |  |                 |  |                            |  |                  |  |                  |  |                
|                                                     |  |                 |  |                            |  |                  |  |                 
|Column A                                             |  | Column
      B  |  | Column C -
      Additions |  | Column
      D   |  | Column
      E  
|                                                     |  |                 |  |                            |  |                  |  |                  |  |                
|                                                     |  | Balances at     |  | Charged to                 |  | Charged to       |  |                  |  | Balances       
|                                                     |  | beginning       |  | costs and                  |  | other accounts   |  | Deductions       |  | at end         
|Description                                          |  | of
      period |  | expenses                   |  | -
      describe |  | -
      describe |  | of
      period
|2007                                                 |  |                 |  |                            |  |                  |  |                  |  |                
|Reserve for bad debts and allowances                 |  | 1,097,193       |  | 749,978                    |  | -                |  | 677,706          |  | 1,169,465      
|                                                     |  |                 |  |                            |  |                  |  |                  |  |                
|Reserve for sales returns and other allowances       |  | 168,644         |  | 170,700                    |  | -                |  | 148,338          |  | 191,006        
|                                                     |  |                 |  |                            |  |                  |  |                  |  |                
|2006                                                 |  |                 |  |                            |  |                  |  |                  |  |                
|Reserve for bad debts and allowances                 |  | 1,482,298       |  | 217,978                    |  | -                |  | 603,083          |  | 1,097,193      
|                                                     |  |                 |  |                            |  |                  |  |                  |  |                
|Reserve for sales returns and other allowances       |  | 101,851         |  | 66,793                     |  | -                |  | -                |  | 168,644        
|                                                     |  |                 |  |                            |  |                  |  |                  |  |                
|2005                                                 |  |                 |  |                            |  |                  |  |                  |  |                
|Reserve for bad debts and allowances                 |  | 1,508,517       |  | 502,326                    |  | -                |  | 528,545          |  | 1,482,298      
|                                                     |  |                 |  |                            |  |                  |  |                  |  |                
|Reserve for sales returns and other allowances       |  | 223,313         |  | 47,051                     |  | -                |  | 168,513          |  | 101,851        

F-30

---

STRATASYS, INC. AND SUBSIDIARIES

(b) Exhibits

EXHIBITNO.
    
    DESCRIPTION3.1
    
    
    Restated Certificate of Incorporation of the
      Company.(14)3.2
    
    
    Amended and Restated By-Laws of the
    Company.(13)4.1
    
    
    Form of Warrant, dated August 22, 2003, issued to Mainfield
      Enterprises, Inc. and Smithfield Fiduciary
      LLC.(11)4.2
    
    
    First Amendment to Warrants, dated as of August 22, 2003, among the
      Registrant, Mainfield Enterprises, Inc. and
      Smithfield Fiduciary LLC.(11)4.3
    
    
    Second Amendment to Warrants, dated as of August 22, 2003, among
      the Registrant, Mainfield Enterprises, Inc. and
      Smithfield Fiduciary LLC.(11)4.4
    
    
    Form of Warrant, dated August 22, 2003, issued to Smithfield
      Fiduciary LLC and Cranshire Capital,
      L.P.(11)4.5
    
    
    First Amendment to Warrants, dated as of August 22, 2003, among the
      Registrant, Smithfield Fiduciary LLC and
      Cranshire Capital, L.P.(11)10.1
    
    
    Non-Competition Agreement between the Company and S. Scott Crump,
      dated October 15,
1990.(1)10.2
    
    
    Employee Confidentiality Agreement between the Company and S. Scott
      Crump, dated October 15,
      1990.(1)10.3
    
    
    Amended and Restated Stratasys, Inc. 1994 Stock
      Plan.(2)*10.4
    
    
    Second Amended and Restated Stratasys, Inc. 1994-2 Stock
      Plan.(5)*10.5
    
    
    Stratasys, Inc. 1998 Incentive Stock Option
      Plan.(6)*10.6
    
    
    Stratasys, Inc. 2000 Incentive Stock Option
      Plan.(7)*10.7
    
    
    Stratasys, Inc. 2002 Long-Term Performance and Incentive
      Plan.(8)*10.8
    
    
    Form of Option Agreement.(12)*10.9
    
    
    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.(4)*10.10
    
    
    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.(4)*


---

STRATASYS, INC. AND SUBSIDIARIES

EXHIBITNO.
    
    DESCRIPTION10.11
    
    
    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.(4)10.12
    
    
    Asset Purchase Agreement between the Company and IBM dated January
      1, 1995.(3)10.13
    
    
    Securities Purchase Agreement, dated as of August 17, 2003, among
      the Company, Mainfield Enterprises, Inc. and Smithfield Fiduciary
      LLC.(9)10.14
    
    
    Securities Purchase Agreement, dated August 22, 2003, among the
      company Cranshire Capital L.P. and Smithfield Fiduciary
      LLC.(10)21.1
    
    
    Subsidiaries of the Company.23.1
    
    
    Consent of Grant Thornton LLP.23.2
    
    
    Consent of Rothstein, Kass & Company, P.C.31.1
    
    
    Certification pursuant to Rules 13a-14(a) and 15d-14(a) under the
      Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
    
    
    Certification pursuant to Rules 13a-14(a) and 15d-14(a) under the
      Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
    
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


| | (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 10-KSB for the year ended December 31,
  1994.                                                                
| |    
| | (3) |  | Incorporated by reference from
      the Companys Form 8-K, Amendment No. 2, dated January 1,
  1995.                                                                
| |    
| | (4) |  | Incorporated by reference from
      Amendment No. 1 to the Registration Statement on Form SB-2 (File No.
      33-99108) filed December 20, 1995.                    
| |    
| | (5) |  | Incorporated by reference from
      the Companys definitive Proxy Statement on Schedule 14A with respect to
      the Companys 1997 Annual Meeting of Stockholders.
| |    
| | (6) |  | Incorporated by reference from
      the Companys definitive Proxy Statement on Schedule 14A with respect to
      the Companys 1998 Annual Meeting of Stockholders.
| |    
| | (7) |  | Incorporated by reference from
      the Companys Registration Statement on Form S-8 (File No. 333-32782)
      filed March 17, 2000.                                

---

STRATASYS, INC. AND SUBSIDIARIES

| | (8)  |  | Incorporated
      by reference from the Companys definitive Proxy Statement on Schedule 14A
      with respect to the Companys 2002 Annual Meeting of
    Stockholders.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     
| | (9)  |  | Incorporated
      by reference from the Companys Form 8-K filed on August 19,
    2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |     
| | (10) |  | Incorporated
      by reference from the Companys Form 8-K filed on August 25,
    2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |     
| | (11) |  | Incorporated
      by reference from the Companys Registration Statement on Form S-3 (File
      No. 333-108816) filed September 15, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |     
| | (12) |  | Incorporated
      by reference from the Companys Form 10-K for the year ended December 31,
      2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | (13) |  | Incorporated by
      reference from the Companys Form 8-K filed July 31, 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |     
| | (14) |  | Filed
      herewith. The Restated Certificate of Incorporation is a pro forma
      restatement that includes the Restated Certificate of Incorporation filed
      as an Exhibit to the Companys Form 10-KSB for the year ended December 31,
      1994, as amended by the Amendment to Certificate of Incorporation filed as
      an exhibit to the Companys Form 10-QSB for the nine months ended
      September 30, 1995, and as further amended by the Amendment to Certificate
      of Incorporation filed as an exhibit to the Companys definitive Proxy
      Statement on Schedule 14A with respect to the Companys 2007 Annual
      Meeting of Stockholders.
| |      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | *    |  | Compensatory plan or arrangement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

(c) Other required financial statements

All other
schedules called for under Regulation S-X are not submitted because they are not
applicable or not required, or because the required information is included in
the financial statements or notes thereto.

Separate
financial statements of the Registrant have been omitted because the Registrant
is primarily an operating company. All subsidiaries included in the consolidated
financial statements are majority owned, and none of the subsidiaries have
indebtedness that is not guaranteed by the Registrant.

---

SIGNATURES

Pursuant to
the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

| | STRATASYS, INC.
| | ---------------
| |                
| |                
| |                
| | By:            
| |                
| |                
| | Dated:         

Pursuant to
the requirements of 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.

|                            | Chairman of
      the Board of Directors, |                     
|--------------------------- | ----------------------------------------- | --------------------
|/s/ S. SCOTTCRUMP           | President,
      Chief Executive Officer, | March 14,
      2008
|S. Scott
      Crump        | Treasurer,
      (Principal Executive     |                     
|                            | Officer)                                  |                     
|                           
|/s/ ROBERTF. GALLAGHER      | Chief
      Financial Officer (Principal  | March 14,
      2008
|Robert F.
      Gallagher   | Financial and
      Accounting Officer)   |                     
|                           
|                           
|/s/ RALPHE. CRUMP           | Director                                  | March 14,
      2008
|Ralph E.
      Crump        |                                           |                     
|                           
|                           
|/s/ EDWARDJ. FIERKO         | Director                                  | March 14,
      2008
|Edward J.
      Fierko      |                                           |                     
|                           
|                           
|/s/ JOHN J. McELENEY        | Director                                  | March 14,
      2008
|John J.
      McEleney      |                                           |                     
|                           
|                           
|                           
|/s/ CLIFFORDH. SCHWIETER    | Director                                  | March 14,
      2008
|Clifford H.
      Schwieter |                                           |                     
|                           
|                           
|                           
|/s/ ARNOLDJ. WASSERMAN      | Director                                  | March 14,
      2008
|Arnold J.
      Wasserman   |                                           |                     
|                           
|                           
|                           
|/s/ GREGORYL. WILSON        | Director                                  | March 14,
      2008
|Gregory L.
      Wilson     |                                           |                     

---