General

We are a leader in the rapid prototyping ("RP") and three-dimensional ("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"). We estimate that approximately 30% of the high-end systems that we sell are used for DDM applications. 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 as well as end-use-parts directly from a designer's 3D CAD in a matter of hours. In addition to selling RP systems and 3D printers, through our Paid Parts service we make and sell physical models, tooling and prototypes for RP and DDM applications based on our customers' CAD files. We estimate that approximately 30% of our high-end sales are used for DDM applications.

For the quarter ended September 30, 2008, our revenues increased to approximately $30.6 million, a 16% increase over the approximately $26.5 million that we reported in the third quarter of 2007. Revenues derived from products increased 16% in the quarter ended September 30, 2008, as compared with the quarter ended September 30, 2007. The number of units that we shipped in the quarter decreased by approximately 5% to 497 units as compared with 521 units shipped in the third quarter of 2007. Despite a reduction in units shipped during the quarter, revenue increased as a result of the introduction of the 900mc, growth in our Paid Parts service and increased sales of consumables due to the growing installed base of systems. Gross profit increased by 17% to $15.8 million for the third quarter of 2008, when compared to $13.5 million for the same period in the prior year. The gross profit increase was primarily due to growth in our proprietary consumables and a 68% increase in the revenues from our high-end proprietary systems.

In 2007, we discontinued our distribution of Objet and Arcam, which carried a very low gross margin when compared with sales of our proprietary systems. Based on industry reports, we believe that since 2002 we have shipped more total RP systems than any other company in the world. We believe that our consumable sales should increase in future quarters due to the significant expansion of our active installed base over the past several years.

We believe that we are successfully implementing our marketing strategy by addressing the needs of both the high-performance and 3D printing ends of the market. Our sales growth in the first nine months of 2008 was derived from a number of industries, including consumer products, government agencies, educational institutions, electronics, general manufacturing, medical, automotive, and aerospace.

Our strategy for the remainder of 2008 will be to continue to expand our position in the 3D printing market through increased sales of our Dimension product line (our low-cost 3D printers). In February 2008, we introduced the Dimension 1200es SST and BST priced at $34,900 and $26,900, respectively. These replace the Dimension 1200's and offer the same, more durable ABS plus modeling material as our Dimension Elite. We now have five Dimension models ranging in price from $18,900 to $34,900. With the introduction of the Dimension SST in February 2004, we initiated a highly successful distributor program involving resellers purchasing demonstration systems with extended payment terms on both the Dimension SST and Dimension BST. While the program impacted our accounts receivable days sales outstanding ("DSO") during portions of the past four years, it proved an effective tool in promoting and selling our systems. Given the success of the program in the past, we offered a similar program in 2008. Again, this program adversely impacted our DSO in the first nine months of 2008 as we expected. However, we believe our distributor program is an integral part of our strategy to expand the 3D printing market.

Our strategy also includes the expansion of our position in the RP market through the growth of our high performance systems, represented principally by our FDM 200mc, 360mc, 400mc, and 900mc, Titan, Vantage and Maxum systems. Prices for our FDM systems now range from $50,000 for the base model 200mc to over $400,000 for the fully equipped 900mc.

We also have 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 injection mold tooling would not be appropriate due to small volumes.

As our installed base has increased, we have derived an increasing amount of revenue from the sales of consumables, maintenance contracts, and other services that represents recurring revenue for us. We expect that this trend to continue.

During the quarter ended September 30, 2005, we announced that we received a $3.6 million order from a Fortune 500 global manufacturing company to advance our proprietary FDM technology for rapid manufacturing applications. This effort was based around our high-performance systems and resulted in a commercial product, the 900mc. We delivered our first prototype in December 2006. 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 rapid manufacturing advances and are not recognized as revenue. During the three months ended March 31, 2008 and six months ended June 30, 2007, we offset approximately $280,000 and $630,000, respectively, of R&D expenses with payments received from this customer. No additional payments were received in the second or third quarter of 2008 as all of our obligations under the original order were met. Based on the success of this new technology, we announced on July 7, 2008 that we received an order in May 2008 from this company for an additional five units, all of which have shipped as of September 30, 2008.

Our balance sheet continues to be strong. As of September 30, 2008, our cash and investment position was $42.4 million, with no debt. We believe that we have adequate liquidity to fund our growth strategy for the remainder of 2008.

Our current and future growth is largely dependent upon our ability to penetrate new markets and develop and market new rapid prototyping and manufacturing systems, materials, applications, and services that meet the needs of our current and prospective customers. Our expense levels are based in part on our expectations of future revenues. While we have adjusted, and will continue to adjust, our expense levels based on both actual and anticipated revenues, fluctuations in revenues in a particular period could adversely impact our operating results. Our ability to implement our strategy for 2008 is subject to numerous uncertainties and risks, many of which are described in this Management's Discussion and Analysis of Financial Condition and Results of Operations, in the section below captioned "Forward Looking Statements and Factors That May Affect Future Results of Operations," and in Item 1A, "Risk Factors," of our Annual Report on Form 10-K for 2007. We cannot ensure that our efforts will be successful.

Results of Operations
(unaudited)

The following table sets forth certain consolidated statements of operations data as a percentage of net sales for the periods indicated. All items are included in or derived from our consolidated interim statements of operations.

                                             Three Months              Nine Months
                                          2008         2007         2008         2007
Net sales                                   100 %        100 %        100 %        100 %
Cost of sales                              48.3 %       49.0 %       45.5 %       46.6 %
Gross profit                               51.7 %       51.0 %       54.5 %       53.4 %
Research and development                    6.9 %        7.4 %        7.4 %        6.8 %
Selling, general, and administrative       27.5 %       28.1 %       29.2 %       30.1 %
Operating income                           17.3 %       15.5 %       18.0 %       16.5 %
Other income (expense)                      1.2 %        2.0 %        1.1 %        1.7 %
Income before income taxes                 18.6 %       17.4 %       19.1 %       18.3 %
Income taxes                                6.4 %        5.2 %        6.6 %        6.0 %
Net income                                 12.1 %       12.2 %       12.5 %       12.2 %

Net Sales

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

Three and Nine Month Periods Ended September 30,

(In Thousands)                                                      Three Months           Period-over-           Nine Months            Period-over-
                                                                 2008          2007       period change        2008          2007       period change
Products                                                      $   23,966    $   20,691            15.8 %    $   73,919    $   64,580            14.5 %
Services                                                           6,604         5,773            14.4 %        18,633        17,452             6.8 %
                                                              $   30,570    $   26,464            15.5 %    $   92,552    $   82,032            12.8 %

For three and nine months ended September 30, 2008 compared to the same year-ago periods, the decrease in unit volume was more than offset by a change in mix that favored high-end proprietary systems as well as higher priced 3D printers. We believe our unit volume was adversely impacted by domestic economic conditions. Several customers have delayed their purchasing decisions due to economic conditions, but we believe we continue to maintain our market leadership position. For three and nine months ended September 30, 2008 compared to the same year-ago periods, Dimension system revenue decreased 2% and increased 4% respectively. For the three and nine months ended September 30, 2008 compared to the same year-ago periods, sales of our high-productivity proprietary systems increased 68% and 48%, respectively, driven by new product introductions over the past twelve months and an expansion in marketing to DDM applications. The growth rate in our high-productivity systems accelerated in the third quarter of 2008 as we began commercial shipments of our 900mc system introduced in December 2007. For three and nine months ended September 30, 2008 compared to the same year-ago periods, revenues from our proprietary consumables increased 20% and 16%, respectively due to our expanding installed base of systems.

Overall service revenue increased 14% and 7% for the three and nine month periods ended September 30, 2008, respectively, compared to the same year-ago period led primarily by growth in our Paid Parts business. Paid parts revenue increased by 22% and 4% for the three and nine month periods ended September 30, 2008, respectively, compared to the same year-ago period. The accelerated third quarter 2008 growth is a result of new marketing initiatives implemented in the third quarter resulting in a 23% increase in new registrations and an increase of 53% in orders from new customers. We believe these initiatives will have a positive impact on the paid parts operations for the remainder of 2008.

North American sales, which include Canada and Mexico, accounted for approximately 54% and 57% of total revenue in the nine months ended September 30, 2008 and 2007, respectively. This decline in sales percentage is primarily due to the discontinuation of the North American product distribution agreements with Arcam and Objet as well as a strengthening of the Euro and other foreign currencies as compared the U.S. Dollar. We recognized no distributed system, consumable and maintenance revenue in the third quarter of 2008 compared to $310,000 in the third quarter of 2007. Distributed related system, consumable and maintenance sales were approximately $188,000 in the first nine months of 2008 compared to $1.6 million in the same year-ago period.

Whereas we expect to report higher revenues and profits in 2008 over the results achieved in 2007, declining economic conditions could adversely impact our future sales and profitability.

Gross Profit

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

Three and Nine Month Periods Ended September 30,

(In Thousands)                      Three Months          Period-over-          Nine Months          Period-over-
                                 2008         2007       period change       2008         2007      period change
Cost of Sales
Products                       $  11,917    $  10,904          9.3%        $  39,407    $ 35,434        11.2%
Services                           3,897        2,585        50.8%            11,080       8,361        32.5%
Total                          $  15,814    $  13,489        17.2%         $  50,487    $ 43,795        15.3%

Costs as Percentage of Sales
Products                           49.7%       $52.7%                          53.3%       54.9%
Services                           59.0%        44.8%                          59.5%       47.9%
Total                              51.7%        51.0%                          54.5%       53.4%

Total gross profit percentages grew compared to the prior year in both the third quarter and the nine month period due to favorable service gross margins which were partially offset by a decline in product gross margins.

Service gross margins were favorably impacted by a lower cost associated with our maintenance contracts as well as the increase in sales of our paid parts business. Service gross margins in 2007 were negatively impacted by services associated with our distributed products. We incurred no service costs in the third quarter of 2008 associated with distributed products.

Product gross margin for the third quarter was unfavorably impacted by a higher mix of sales weighted towards entry level high-end systems and 3D printers sold to the educational market where we experience a lower average selling price. This lower margin was partially offset by the growth in our proprietary consumables. The product gross margin for the nine month period was less impacted by this unfavorable mix because 3D printer sales to the educational market were not as significant in the first half of the year as compared to the third quarter.

Operating Expenses

Operating expenses and operating expense as a percentage of sales, as well as
the percentage changes in operating expenses, were as follows:

Three and Nine Month Periods Ended September 30,

(In Thousands)                   Three Months           Period-over-           Nine Months            Period-over-
                               2008         2007        period change       2008          2007        period change
Research & development      $    2,100    $   1,965         6.9%         $    6,842    $    5,571         22.8%
Selling, general & admin         8,416        7,435         13.2%            27,005        24,667         9.5%
                            $   10,516    $   9,400         11.9%        $   33,847    $   30,238         11.9%

Percentage of sales              34.4%        35.5%                           36.6%         36.4%

Research and development expense increased by 7% and 23% for the three and nine months ended September 30, 2008, respectively, compared to the same periods in the prior 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 and material spending partially offset by the capitalization of internally developed software during the nine months ended September 30, 2008. While research and development spending increased by 23% for the nine months ended September 30, 2008, it increased by only 7% for the third quarter of 2008 as we slowed our level of investment due to concerns about the economic environment. Capitalized research and development expenditures for the nine months ended September 30, 2008 relating to internally developed software increased to $1.6 million from $1.4 million for the same period in the prior year.

Selling, general and administrative expenses increased $981,000, or 13.2%, for the three months ended September 30, 2008, compared to the same year-ago period. This increase resulted from additional spending to support our growth including spending for process improvements. Selling, general and administrative expenses increased 9.5% for the nine months ended September 30, 2008 compared to the same period in the prior year. The increase resulted from additional spending to support our growth including spending for process improvements. We expect the growth in selling, general and administrative expenses to continue over the remainder of 2008.

Operating Income

Operating income and operating income as a percentage of sales, as well as the
percentage changes in operating income, were as follows:

Three and Nine Month Periods Ended September 30,

(In Thousands)                Three Months            Period-over-             Nine Months              Period-over-
                          2008           2007         period change        2008            2007         period change
Operating income       $   5,298      $   4,089          29.6%         $   16,640      $   13,557          22.7%

Percentage of sales         17.3 %         15.5 %                            18.0 %          16.5 %

Operating income increased by 30% and 23% for the three and nine months ended September 30, 2008, respectively, compared to the same period in the prior year. These increases are primarily due to the increase in net sales, changes in the product mix and other factors cited above.

Other Income (Expense)

Other income (expense) as a percentage of sales and changes in other income
(expense) were as follows:

Three and Nine Month Periods Ended September 30,

(In Thousands)                              Three Months            Period-over-             Nine Months              Period-over-
                                         2008          2007         period change        2008           2007          period change
Interest income                        $   499      $    629              (20.7 %)    $   1,647      $   1,731               (4.9 %)
Foreign currency transaction losses        (84 )        (101 )            (16.8 %)         (300 )         (347 )            (13.5 %)
Other                                      (34 )          (3 )          1,033.3 %          (287 )           35             (920.0 %)
                                       $   381      $    525              (27.4 %)    $   1,060      $   1,419              (25.3 %)

Percentage of sales                        1.2 %         2.0 %                              1.1 %          1.7 %

Interest income decreased for the three and nine month periods ended September 30, 2008 compared to the same year-ago periods due to a decrease in our cash and investments and lower interest rates. Foreign currency transaction gains and losses are principally due to currency fluctuations between the US dollar and the Euro. We enter into 30-day forward contracts to hedge our foreign currency exposure. We hedged only a portion of our foreign currency exposure and the resulting loss was due to the weakening of the US dollar relative to the Euro. Our strategy is to continue to hedge our estimated Euro denominated accounts receivable position throughout the remainder of 2008. At September 30, 2008, we had approximately €5.8 million in Euro-denominated receivables and a €4.5 million 30-day forward contract.

Approximately $2.5 million of our auction rate securities held at September 30, 2008, are double A rated and insured by a highly rated insurance company. The remaining $1.9 million in auction rate securities is an investment in a Jefferson County, Alabama, municipal bond that has seen its rating reduced to triple C from triple A. In order to help us determine the carrying value of these investments, we hired outside consultants to qualitatively and quantitatively evaluate our auction rate securities portfolio.

With the assistance of the outside consultants, we determined that, as of September 30, 2008, our initial $2.6 million investment in the Jefferson County, Alabama, municipal bond had incurred both a temporary and other-than-temporary impairment. As a result, we took a pre-tax charge of $50,000 and $440,000 for the three and nine month periods ended September 30, 2008, respectively, to "Other income (expense)" for the other-than-temporary impairment and recognized an additional pre-tax fair value adjustment of $195,000 in "Other comprehensive income" for the temporary impairment. The resulting fair value of the Jefferson County, Alabama, municipal bond of approximately $1.9 million is included in the Balance Sheet caption "Long term investments - Available for sale securities."

Income Taxes

Income taxes and income taxes as a percentage of net income before income taxes,
as well as the percentage changes, were as follows:

Three and Nine Month Periods Ended September 30,

(In Thousands)                               Three Months            Period-over-            Nine Months             Period-over-
                                         2008           2007         period change       2008           2007         period change
Income taxes                          $   1,970      $   1,377          43.1%         $   6,096      $   4,948          23.2%

Percentage of income before taxes          34.7 %         29.8 %                           34.4 %         33.0 %

Income tax expense increased with the increase in income before income taxes. The effective tax rate for the three months ended September 30, 2008 is higher than the 2007 period because of favorable impacts from disqualifying dispositions of incentive stock options and an increase in the estimated research and development credit available during the quarter ended September 30, 2007. The effective tax rate of 34.4% for the nine months ended September 30, 2008 is higher than the 33.0% effective rate for the same year-ago period due to the expiration of the research and development credit, partially offset by the favorable impacts from the manufacturer's tax deduction and tax-free interest income.

On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the "Act"), which included a retroactive reinstatement of the federal research and development credit, was signed into law. The Act extends the federal research and development credit to December 31, 2009 and we are in the process of assessing the tax impact of this extension.

Net Income

Net income and net income as a percent of sales, as well as the percentage
changes in net income, were as follows:

Three and Nine Month Periods Ended September 30,

(In Thousands)                 Three Months            Period-over-             Nine Months              Period-over-
                           2008           2007         period change        2008            2007         period change
Net income              $   3,710      $   3,237          14.6%         $   11,604      $   10,028          15.7%

Percentage of sales          12.1 %         12.2 %                            12.5 %          12.2 %

Net income increased for the three and nine months ended September 30, 2008 compared to the same year-ago periods primarily due to a favorable product mix.

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