Overview

We are a worldwide leading manufacturer of three-dimensional ("3D") printers and high-performance rapid prototyping ("RP") systems for the office-based RP and direct digital manufacturing ("DDM") markets. Our 3D printers and high-performance RP systems provide users of 3D computer-aided design ("CAD") programs a fast, office-friendly, and low-cost alternative for building functional 3D parts. We develop, manufacture and sell a broad product line of 3D printers and DDM systems (and related proprietary consumable materials) that create physical models from CAD designs. We also offer rapid prototyping and production part manufacturing services through our centers located in North America, Europe and Australia.

For the quarter ended September 30, 2009, we recorded net income of $1.6 million, or $0.08 per diluted share, as compared to net income of $3.7 million, or $0.18 per diluted share, for the third quarter of 2008. The world-wide economic slow down that took hold in late 2008 continues to hold down demand for our products and services relative to the prior year. In addition to the cost reduction efforts that were taken in the first quarter of 2009, we have continued to control discretionary spending and aggressively manage our working capital. These efforts have resulted in sequential improvements in profitability and operating cash flow allowing us to continue our investment in product development and fully support our sales channels.

Our revenues decreased to $24.3 million in the third quarter of 2009, a 20.4% decrease from the $30.6 million that we reported in the third quarter of 2008. Gross profit also decreased by $3.9 million, or 25.0%, to $11.9 million as compared with $15.8 million in the prior year. These decreases were primarily attributable to lower product sales and margins.

Our balance sheet continues to be strong. As of September 30, 2009, our cash and investments balance was approximately $59.7 million, up from $47.7 million at December 31, 2008. We generated approximately $8.7 million of cash from operations during the quarter, primarily driven by earnings before depreciation and amortization and a reduction of accounts receivable and inventory levels. We also have no debt and believe that we have adequate liquidity to fund our growth strategy well into 2010.

3D Printers It is our belief that we are successfully implementing our overall marketing strategy by addressing the needs of both the high-performance and 3D printing ends of the market. Over the last three years, we have been the price leaders in the 3D printer market and have followed a strategy of continuing to move down the price elasticity curve as evidenced by our introduction of the uPrint in January 2009. We feel that this strategy is appropriate for the long-term success of our company while at the same time, we recognize the short-term challenges that this presents. While competitors have recently introduced low-cost 3D printers, we believe our strategy of offering low-priced 3D printing systems combined with higher reliability and increased functionality will continue to make our 3D printers an attractive alternative to our competitors' products. Furthermore, we believe our recent introduction of the uPrint should serve to increase awareness of our products, which would typically drive higher volume to offset the reduced margins for that system. However, due to the unprecedented world-wide economic challenges that our market is currently facing, we feel that revenues and margins will continue to be under pressure until the major economies recover from the worldwide recession.

Our strategy in the 3D printing market is to continue expanding our position through increased unit sales of our Dimension product line and particularly the uPrint system. Concurrent with the launch of the uPrint in January 2009, we lowered the price of our other Dimension systems and discontinued the production of our SST768 and BST768 models, although we will continue to provide support and service for these discontinued systems going forward. Our current 3D printing line now consists of four system types that range in price from $14,900 to $32,900. Based upon data and estimates furnished in the Wohlers Report released in May of 2009, we shipped approximately 43% of all RP systems globally in 2008 and 50% of all 3D printers shipped globally in 2008.

High-Performance 3D Production Systems Our strategy in the high-performance market is to expand our installed base of RP systems, represented principally by our Fortus 200mc, 360mc, 400mc, and 900mc models, by offering improved system capabilities and new and improved material properties. Prices for our Fortus systems range from $50,000 for the base model 200mc to $400,000 for the fully equipped 900mc.

We also have opportunities for the Fortus line in DDM applications. DDM involves the manufacture of parts fabricated directly from our 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 turnaround and for which tooling would not be appropriate due to small volumes.

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. We believe this fabrication and assembly tool market is substantially larger than the $1.1 billion rapid prototyping market we currently serve. In addition, we have seen a growing number of applications for end-use parts.

Recurring Revenues As our installed base has increased, we expect an increasing amount of revenue from the sales of consumables, maintenance contracts, and other services, which represents recurring revenue for us. Despite a history of growth in this area, we have seen this trend decline recently as our existing customers have curtailed some discretionary or variable spending in response to the economic slow down.

During the third quarter, we experienced early signs that customer demand has stabilized and our resellers experienced an elevated level of quoting activity. Sequentially, we shipped slightly more systems than we did in the second quarter, which is unusual considering that the third quarter is seasonally our weakest of the year.

Our newest and lowest priced system, the uPrint, continues to be our best selling 3D printer. In January 2009, we launched the uPrint, a new personal 3D printer, at a new lower price point of $14,900. Although this represents a lower selling price and lower margin than our other system offerings, we believe that the launch of this product represents a significant milestone in our strategy of continuing to move down the price elasticity curve. Because the uPrint is proving to be a robust and reliable product, we believe it appeals to a broader network of resellers and we remain committed to expanding the distribution channel for this product.

Due to the continued weakness in the world economy, we reevaluated our fixed and variable cost structure in light of current sales expectations in the first quarter of 2009. As a result, we took certain cost-saving measures that lowered our fixed costs and curtailed some discretionary spending while maintaining a focus on the key goals and objectives of our long-term strategy. These cost-saving measures resulted in a charge of approximately $779,000, consisting primarily of severance costs related to a reduction in force. We expect these measures will amount to savings of approximately $2.7 million on an annualized basis.

At the end of 2008, we replaced our Fortus direct sales channel in the United States with a select group of existing resellers that more than triples our sales support for these high-end systems. We expect that lower revenues resulting from reseller discounts will be offset by reduced fixed costs that were previously associated with our direct sales force. Although there were many factors that affected our Fortus revenues and gross profits in the first nine months of 2009, we believe that this change to a variable cost structure has been neutral to our operating income.

In 2008, we satisfied our responsibilities under a three-year, $3.6 million agreement with a Fortune 500 global manufacturing company to jointly advance our proprietary FDM technology for rapid manufacturing applications. This agreement entitled us to receive reimbursement payments as we achieved specific milestones stated in the agreement. This effort was focused around our high-performance systems and resulted in the commercial release of the Fortus 900mc. Due to the success of this initial arrangement, we are continuing this relationship and have established a new agreement with similar terms and objectives. During the nine months ended September 30, 2009 and September 30, 2008, approximately $1.9 million and $300,000, respectively, of research and development expenses were offset by payments that were received from this company.

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 continue to implement our strategy for 2009 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 2008. 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- and Nine-Month Periods Ended September 30,
                                                Three Months             Nine Months
                                              2009        2008        2009        2008
Net sales                                    100.0 %     100.0 %     100.0 %     100.0 %
Cost of sales                                 51.2 %      48.3 %      54.2 %      45.5 %
Gross profit                                  48.8 %      51.7 %      45.8 %      54.5 %
Research and development                       8.2 %       6.9 %       7.6 %       7.4 %
Selling, general, and administrative          30.8 %      27.5 %      35.0 %      29.2 %
Operating income                               9.9 %      17.3 %       3.1 %      18.0 %
Other income (expense)                         0.9 %       1.2 %       0.8 %       1.1 %
Income before income taxes                    10.8 %      18.6 %       3.9 %      19.1 %
Income taxes                                   4.3 %       6.4 %       1.6 %       6.6 %
Net income                                     6.5 %      12.1 %       2.4 %      12.5 %

Net Sales

   Our revenues decreased to $24.3 million in the third quarter of 2009, a 20.4%
decrease from the $30.6 million that we reported in the third quarter of 2008.
Revenue for the first nine months of 2009 was $72.1 million, down $20.4 million,
or 22.1%, from $92.6 million in the prior year. The following is a breakdown of
our revenues by products and services:

Three- and Nine-Month Periods Ended September 30,
(In Thousands)                  Three Months                 Period-over-             Nine Months             Period-over-
                          2009                2008          period change         2009           2008        period change
Products             $        18,046       $     23,966           -24.7 %      $   53,198     $   73,919           -28.0 %
Services                       6,283              6,604            -4.9 %          18,925         18,633             1.6 %
                     $        24,329       $     30,570           -20.4 %      $   72,123     $   92,552           -22.1 %

Revenues from our service offerings in the quarter ended September 30, 2009 decreased approximately $321,000, or 4.9%, as compared to revenue from services in the third quarter of 2008. This third quarter variance was primarily due to lower revenues in our Paid Parts service due to an aggressive pricing environment. For the first nine months of 2009, revenue from our service offerings increased by $292,000, or 1.6%, as compared to the same prior-year period. This growth in service revenues over the prior-year period was mainly from higher maintenance revenue that resulted from our steadily growing installed system base partially offset by lower revenues in our Paid Parts service.

Revenues in the Americas region, which includes North and South America, accounted for approximately 52.9% and 53.6% of total revenue for the quarters ended September 30, 2009 and 2008, respectively. Revenue in the Americas region accounted for approximately 56.0% and 52.4% of total revenue for the nine months ended September 30, 2009 and 2008, respectively. Although the third quarter split between Americas and international sales was fairly consistent compared to the prior year, the increase in sales percentage on a year-to-date basis is primarily due to the launch of a our new system, the uPrint, which had an earlier domestic launch than it did internationally.

Revenues outside the Americas region accounted for approximately 47.1% and 46.4% of total revenues for the quarters ended September 30, 2009 and 2008, respectively. These international revenues for the first nine months of 2009 accounted for approximately 44.0% of total revenues as compared to 47.6% for the same prior-year period. The international decrease was led by lower system volumes in both the high-performance systems as well as 3D Printers, particularly in the first quarter of 2009.

Gross Profit

Three- and Nine-Month Periods Ended September 30,
(In Thousands)                                Three Months             Period-over-             Nine Months              Period-over-
                                          2009            2008        period change         2009            2008        period change
Products                              $    8,128      $   11,917            -31.8 %     $   22,315      $   39,407            -43.4 %
Services                                   3,740           3,897             -4.0 %         10,699          11,080             -3.4 %
Total                                 $   11,868      $   15,814            -25.0 %     $   33,014      $   50,487            -34.6 %

Gross Profit as a Percentage of Sales
Products                                    45.0 %          49.7 %                            41.9 %          53.3 %
Services                                    59.5 %          59.0 %                            56.5 %          59.5 %
Total                                       48.8 %          51.7 %                            45.8 %          54.5 %

Gross profit decreased by $3.9 million, or 25.0%, to $11.9 million in the quarter ended September 30, 2009 as compared with $15.8 million in the same prior-year period. Gross profit decreased by $17.5 million, or 34.6%, to $33.0 million in the nine months ended September 30, 2009 as compared with $50.5 million in the same prior-year period. These decreases, for both the three- and nine-month periods, were primarily attributable to lower revenue volume as well as a current year product mix that favored the lower margin uPrint.

Product gross profit decreased by 31.8% and 43.4% for the three and nine months ended September 30, 2009, respectively, as compared to the same prior-year periods. This decrease is primarily attributable to lower system revenues. The decrease was also attributable to the launch of our new uPrint system, which has a lower direct margin than our other systems and added to our fixed manufacturing overhead. As production volumes increase for the uPrint, we expect to reduce material costs for this system up to 15% from its March 31, 2009 cost structure by the end of 2009.

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-
                                     2009             2008         period change          2009             2008         period change
Research & development            $   1,983       $    2,100              -5.6 %      $    5,510       $    6,842             -19.5 %
Selling, general & administrative     7,481            8,416             -11.1 %          25,257           27,005              -6.5 %
                                  $   9,464       $   10,516             -10.0 %      $   30,767       $   33,847              -9.1 %
Percentage of sales                    38.9 %           34.4 %                              42.7 %           36.6 %

Research and development expense decreased by 5.6% and 19.5% for the three and nine months ended September 30, 2009 compared to the same prior-year periods. The decrease resulted primarily from a lower level of spending due to economic concerns and reduced headcount. Capitalized research and development expenditures for the three and nine months ended September 30, 2009 relating to internally developed software were approximately $360,000 and $1.0 million, respectively, which represents a decrease of $285,000 and $560,000, respectively, from the same prior-year periods.

In 2008, we satisfied our responsibilities under a three-year, $3.6 million agreement with a Fortune 500 global manufacturing company to jointly advance our proprietary FDM technology for rapid manufacturing applications. This agreement entitled us to receive reimbursement payments as we achieved specific milestones stated in the agreement. This effort was focused around our high-performance systems and resulted in the commercial release of the Fortus 900mc. Due to the success of this initial arrangement, we are continuing this relationship and have established a new agreement with similar terms and objectives. During the three months ended September 30, 2009, approximately $405,000 of research and development expenses were offset by payments that were received from this company and no payments were received during the three months ended September 30, 2008. During the nine months ended September 30, 2009 and September 30, 2008, approximately $1.9 million and $300,000, respectively, of research and development expenses were offset by payments that were received from this company.

Selling, general and administrative expenses decreased by 11.1% and 6.5%, for the three and nine months ended September 30, 2009 and 2008, respectively, compared to the same prior-year periods. The decreases in the third quarter and first nine months of 2009 were primarily attributable to: 1) a reduction in our direct sales force in January of 2009, which converted some of our selling expenses to a variable cost structure; 2) additional headcount reductions made in the first quarter of 2009; and 3) a continued effort to lower discretionary spending.

The cost-saving measures taken in the first quarter of 2009 lowered our fixed costs and curtailed some discretionary spending while maintaining a focus on the key goals and objectives of our long-term strategy. These cost-saving measures resulted in a charge of approximately $779,000 in the first quarter of 2009, consisting primarily of severance costs related to a reduction in force. Final severance payments were completed during the third quarter of 2009.

Operating Income

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

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Three- and Nine-Month Periods Ended September 30,
(In Thousands)                     Three Months               Period-over-              Nine Months              Period-over-
                               2009              2008        period change         2009            2008         period change
Operating income          $      2,404       $    5,298            -54.6 %     $    2,246      $    16,640            -86.5 %
Percentage of sales                9.9 %           17.3 %                             3.1 %           18.0 %

We recorded operating income of $2.4 million for the three months ended September 30, 2009 as compared to $5.3 million for the same prior-year period. We recorded operating income of $2.2 million for the nine months ended September 30, 2009 as compared to $16.6 million in operating income for the same prior-year period. This decrease was primarily due to reduced revenues from a weak world economy and a product mix shift towards lower margin 3D printing systems.

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-
                                       2009          2008        period change         2009           2008         period change
Interest income                      $   230       $   499              -54 %       $    755       $   1,647              -54 %
Foreign currency transaction losses       (6 )         (84 )             93 %           (169 )          (300 )             44 %
Other                                     (9 )         (34 )             74 %             17            (287 )            106 %
                                     $   215       $   381              -44 %       $    603       $   1,060              -43 %
Percentage of sales                      0.9 %         1.2 %                             0.8 %           1.1 %

While cash and investment balances increased over the prior-year periods. interest income decreased for the three- and nine-month periods ended September 30, 2009 compared to the same prior-year periods due to the lower effective interest rate of our investment portfolio. As of September 30, 2009, we had approximately $12.6 million invested in US Treasury money market accounts with a current annualized yield of approximately 0.35%.

We invoice sales to certain European distributors in Euros and reported results are therefore subject to fluctuations in the exchange rates of that currency in relation to the United States dollar. Our strategy is to hedge most of our Euro-denominated accounts receivable positions by entering into 30-day foreign currency forward contracts on a month-to-month basis to reduce the risk that our earnings will be adversely affected by changes in currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.

We will continue to monitor exposure to currency fluctuations. Instruments to hedge risks may include foreign currency forward, swap, and option contracts. These instruments will be used to selectively manage risks, but there can be no assurance that we will be fully protected against material foreign currency fluctuations.

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-
                              2009               2008        period change        2009           2008        period change
Income taxes              $     1,040        $    1,970            -47.2 %     $   1,124      $   6,096            -81.6 %
Effective tax rate               39.7 %            34.7 %                           39.5 %         34.4 %

Income tax expense was recorded for the three and nine months ended September 30, 2009 with a higher effective tax rate as the same prior year period due to a higher effective foreign tax rate due to a nondeductible loss incurred by a foreign subsidiary.

Net Income

   Net income and net income as a percentage 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-
                        2009            2008         period change         2009             2008         period change
. . .