Overview

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 production-grade thermoplastics directly from a computer aided design ("CAD") workstation. Our systems and related consumable products are distributed mainly through a world-wide network of value added resellers and agents that sell our products to end users as well as service them. We also operate a service business that uses our systems and other RP systems to print parts from a customer's CAD file, typically in situations where these customers have not yet purchased a system from us or do not have enough capacity on their existing systems.

In May 2011, we acquired Solidscape, Inc. for $39.1 million in cash. Solidscape is a manufacturer of high precision 3D printers and is a proven leader in investment casting applications that require ultra-fine feature detail. This addition provides us with access to markets that we did not previously serve, including the under-penetrated jewelry, dental and precision industrial casting markets. We believe that this acquisition provides the potential to expand our technology platform into new applications and will create synergies, particularly in our respective sales channels, manufacturing, and research and development.

For the quarter ended September 30, 2012, we recorded net income of $5.2 million, or $0.24 per diluted share, as compared to net income of $5.9 million, or $0.27 per diluted share, for the quarter ended September 30, 2011. Net income decreased during the three and nine months ended September 30, 2012 as compared to the same prior year periods primarily due to expenses related to the pending Objet Ltd. transaction and a higher effective tax rate.

Our revenues in the third quarter of 2012 increased to $49.7 million as compared to revenues of $39.7 million that were reported in the third quarter of 2011. Gross profit of $27.9 million in the third quarter of 2012 increased as compared to $21.6 million reported in the prior year

Our balance sheet continues to be strong. As of September 30, 2012, our cash and investments balance was approximately $65.7 million, down slightly from $67.3 million at December 31, 2011. We used cash from operations of approximately $9.6 million during the quarter primarily driven by our increase in inventory due to increased volume, some last-time part purchases, as well as to fulfill third party distribution centers in Europe and Asia in anticipation of our merger with Objet Ltd. In addition, we used cash to fund our accounts receivable reflecting the growth in our business and the timing of our sales. We also have no debt and believe that we have adequate liquidity to fund our growth strategy throughout 2012 and 2013.

It is our belief that we are successfully implementing our overall marketing strategy in the 3D printing, RP and DDM markets through the expansion of our distribution channel and the introduction of new products.

Distribution Channel We use an extensive world-wide reseller network to market and sell our 3D printers, Fortus 3D production systems, and consumable materials, and to provide maintenance service and replacement parts. Most of the reseller outlets have 3D printers available for tradeshows, product demonstrations and other promotional activities. Many of them also enjoy a long-term presence in their respective territories making this distribution model highly effective relative to a direct sales model. In addition to our 3D Printers and 3D production systems, most resellers sell and service a third-party 3D solid CAD software package.

In addition to our reseller network, we have initiated a program to recruit and train a significant number of new selling agents who will focus exclusively on selling our most affordable products. We have now recruited and trained approximately 130 sales agents in the U.S. who are focused exclusively on selling our uPrint and Mojo 3D printer lines.

3D Printers We are the unit leader in the commercial 3D printing market and have followed a strategy of moving down the price elasticity curve, evidenced by our introduction of the Mojo, uPrint and uPrint Plus systems. We believe our strategy of offering low-priced 3D printing systems combined with high reliability, ease of use and increased functionality will allow for an increase of 3D printers in the market and continue to make our 3D printers an attractive alternative to our competitors' products.

We also believe our lower-priced systems and the expansion of our distribution channel will increase awareness of our technology and products. Lower-priced systems will reduce our margins as a percentage of revenue from the levels we have previously achieved, but we intend to compensate for these lower margins by expanding the market and unit volume for our 3D printers (and related proprietary consumables), thereby substantially increasing the number of 3D printers sold and our overall revenues and profits. Although we believe that there is a large market for our 3D printers, there can be no assurance that we will be able to increase our revenues sufficiently to maintain or increase our profitability.

RP and DDM Markets Our strategy in the high-performance market is to expand our installed base of RP and DDM systems by helping customers build stable, strong, accurate and durable parts for functional testing and end-use. We plan to grow our leadership position in this area by offering additional system capabilities and improved material properties. We also have growing opportunities in DDM applications. DDM involves fabricating parts used for fixtures and assembly tools in production. DDM also involves the manufacture of parts fabricated directly from our systems that are subsequently incorporated into the user's end product or production 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 cost effective due to small volumes.

Solidscape, which we acquired in April of 2011, is widely recognized as the leader for DDM wax casting applications that require high precision, ultra-fine feature detail, and a smooth surface finish. In the fourth quarter of 2012, we intend to expand Solidscape's distribution channel by selling it through our North American educational channel.

In February 2011, we obtained ISO 9001:2008 certification by maintaining a highly developed quality management system and continually improving its effectiveness in accordance with the ISO requirements. We believe that ISO certification is a key requirement in expanding our products' applicability to the RP and DDM markets that we are focusing on, such as aerospace, defense, medical, and automotive. We will use this certification to demonstrate our ability to consistently provide products that meet customer and applicable regulatory requirements and enhance customer satisfaction through its effective application.

We continued to collaborate with a Fortune 500 global manufacturing company to advance our proprietary FDM technology for direct digital manufacturing applications. We expect to maintain this collaboration throughout 2012 and going forward long-term.

Recurring Revenues As our installed base of systems has increased, we expect an increasing amount of revenue from the sales of consumables, maintenance contracts, and other services. We have experienced an increase in consumable sales throughout 2011 and into 2012.

RedEye Paid Parts Service Our RedEye paid parts service makes and sells physical models, tooling and prototype parts for RP and DDM applications based on our customers' CAD files. We believe that a significant portion of RedEye sales have come from current system users that have had short-term capacity constraints on their own FDM systems. We believe that another part of RedEye sales has come from the rising demand for our technology in DDM applications, because of the production-grade thermoplastics used. To take advantage of the growth we see in our DDM customer base, we are adding staff to our existing sales force that will focus exclusively on large strategic accounts.

In May 2012, we introduced the Mojo 3D Printer, which comes in a complete system called a 3D Print Pack. The Mojo 3D Print Pack is the market's lowest-priced, professional-grade complete 3D printing system. Priced at $9,900 the Mojo 3D Print Pack contains everything needed to produce models, including material, supplies and a support-removal system. To produce a model, Mojo employs a variation on traditional FDM material extrusion. The ABS material spool and the print head are integrated into a single package, called the QuickPack print engine. To ensure reliability, the print engine is single-use only, and a fresh print head is part of each material change. Modeling operations are controlled with Mojo's preprocessing software, Print Wizard, which helps users manage workflow. Support material removal is also a simple process with the included WaveWash55. It is a self-contained, hands-free support removal system, and it requires no plumbing.

In April 2012, Stratasys and privately held Objet Ltd., a leading manufacturer of 3D printers for rapid prototyping, announced that the boards of directors of both companies had unanimously approved a definitive merger agreement under which the companies would combine in an all-stock transaction. The merger was approved by shareholders voting more than 99% of the shares on September 14, 2012, but is still pending CFIUS regulatory review. We expect the transaction to position the combined company as a leader within the high-growth 3D printing and direct digital manufacturing industry.

Under the terms of the merger agreement, Stratasys will merge with a subsidiary of Objet, and Stratasys stockholders will receive one Objet ordinary share for each share of Stratasys common stock they own. The receipt of this merger consideration generally will be taxable to Stratasys stockholders for U.S. federal income tax purposes. Upon closing of the transaction, Stratasys stockholders are expected to own approximately 55 percent and Objet shareholders are expected to own approximately 45 percent of the combined company on a fully diluted basis using the treasury stock method. Closing of the merger is subject to customary closing conditions, including approval under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and approval by our stockholders, both of which have been satisfied. However, the merger is still pending approval by the Committee on Foreign Investment in the United States ("CFIUS") in accordance with Section 721 of the Defense Production Act of 1950, as amended.

The combined company, which will operate under the name Stratasys Ltd. and retain the Stratasys ticker symbol, "SSYS", will have dual headquarters in Eden Prairie, Minnesota and Rehovot, Israel, the locations of Stratasys' and Objet's current headquarters, respectively, and will be registered in Israel.

In February 2012, RedEye obtained AS9100 certification. AS9100 is the quality management system for the aviation, space, and defense industries. AS9100 fully incorporates ISO 9001:2008 while adding nearly 100 additional requirements specific to quality and safety for aerospace. We believe that AS9100 certification in RedEye will help us expand our services' applicability to DDM in the aerospace and defense markets.

On August 1, 2012, we announced that Stratasys and Hewlett-Packard Company have agreed to discontinue their Master Original Equipment Manufacturer Agreement (the "OEM Agreement") for 3D printers, effective December 31, 2012. HP's exclusivity under the OEM Agreement will end on October 31, 2012, and we will begin selling equivalent Stratasys systems in the current HP territory after that date. The termination agreement also provides for continuity of consumables and service for end user customers that have purchased systems sold by HP under the OEM Agreement. We terminated the OEM Agreement because we no longer believed that it could achieve the financial benefits originally anticipated. We do not expect the termination of this agreement with HP to have a material impact on our financial results for the current year and intend to work closely with HP to ensure a smooth transition for customers.

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 in 2012 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 2011 and our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K filed with the SEC. 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
                                            2012            2011            2012            2011
Net sales                                    100.0 %         100.0 %         100.0 %         100.0 %
Cost of sales                                 43.8 %          46.1 %          46.5 %          47.0 %
Gross profit                                  56.2 %          53.9 %          53.5 %          53.0 %
Research and development                       8.2 %           9.0 %           8.7 %           9.5 %
Selling, general, and administrative          29.7 %          25.2 %          29.4 %          25.6 %
Operating income                              18.3 %          19.7 %          15.4 %          17.9 %
Other income                                   0.3 %           2.0 %           0.4 %           2.3 %
Income before income taxes                    18.6 %          21.7 %          15.7 %          20.2 %
Income tax expense                             8.2 %           7.0 %           6.9 %           7.0 %
Net income                                    10.4 %          14.7 %           8.8 %          13.2 %

Net Sales

Our net sales of $49.7 million in the quarter ended September 30, 2012 increased by 24.5% as compared to net sales of $40.0 million in the quarter ended September 30, 2011. Net sales of $144.1 million in the nine months ended September 30, 2012 increased by 28.3% as compared to net sales of $112.3 million in the same prior-year period. 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-
                      2012           2011        period change        2012            2011         period change
Products           $   41,318     $   32,513         27.1%         $   120,301     $    91,273         31.8%
Services                8,406          7,440         13.0%              23,792          21,049         13.0%
                   $   49,724     $   39,953         24.5%         $   144,093     $   112,322         28.3%

Sales derived from products increased $8.8 million, or 27.1%, in the quarter ended September 30, 2012, as compared with the quarter ended September 30, 2011. System revenue grew by 27.4% as a result of strong sales of our higher- priced Fortus 3D production systems. We shipped 911 units in the third quarter of 2012 as compared with 600 units shipped in the third quarter of 2011. The increase in total units shipped as compared to the prior year is primarily due to strong unit sales of our Fortus 3D production systems and introduction of the Mojo 3D printer. Sales of the Mojo 3D printer were helped by our new program to recruit sales agents who focus exclusively on selling our most-affordable 3D printer lines. Currently, we have expanded the sales agent program to include approximately 130 individuals. Fortus 3D production system revenue increased by 37.2% in the quarter ended September 30, 2012 as compared to the prior year driven by demand created by new direct digital manufacturing applications across multiple industries. Consumable revenue increased 23.2%, primarily driven by acceleration in customer usage and our growing installed base of systems.

For the nine months ended September 30, 2012, sales derived from products increased $29.0 million, or 31.8%, as compared with the same prior-year period. System revenue grew by 30.7% as a result of strong sales of our higher-priced Fortus 3D production systems. We shipped 2,509 units in the nine months ended September 30, 2012 as compared with 1,902 units shipped in the same prior-year period. The increase in total units shipped as compared to the prior year is primarily due strong unit sales of our Fortus 3D production systems and the introduction of our Fortus 250mc and Mojo 3D printer. Consumable revenue increased 28.9%, primarily driven by acceleration in customer usage and our growing installed base of systems. The increases were also due to a full nine months of operations of Solidscape in 2012, in contrast to five months of 2011 of operations of Solidscape, which was acquired in May 2011.

Sales from our service offerings increased by approximately $1.0 million, or 13.0%, in the quarter ended September 30, 2012 and $2.7 million, or 13.0%, in the nine months ended September 30, 2012 as compared to the same prior-year periods. Maintenance revenue was relatively flat, growing by 0.6% and 4.5% for the three and nine months ended September 30, 2012, respectively, as compared with the same prior-year periods. Sales from our RedEye paid parts service increased by 25.7% and 20.9% for the three and nine months ended September 30, 2012, respectively, as compared to the prior year, primarily resulting from increased new customer business and an increase in average sales price. RedEye has experienced strong demand for large, strong and complex production parts within the automotive and aerospace industries, which have been instrumental to RedEye's recent growth.

Revenues in the Americas region, which includes North and South America, accounted for approximately 59.1% and 56.3% of total revenue for the quarters ended September 30, 2012 and 2011, respectively. Revenues in the Americas region accounted for approximately 54.8% and 54.6% of total revenue for the nine months ended September 30, 2012 and 2011, respectively.

Revenue in the Americas, Europe and Asia grew by 31%, 16% and 17% for the three months ended September 30, 2012, respectively. Revenue in the Americas, Europe and Asia grew by 29%, 23% and 37% for the nine months ended September 30, 2012. Revenues outside the Americas region accounted for approximately 40.9% and 43.7% of total revenue for the quarters ended September 30, 2012 and 2011, respectively. Revenues outside the Americas region accounted for approximately 45.2% and 45.4% of total revenues for the nine months ended September 30, 2012 and 2011, respectively.

Gross Profit

Three- and Nine-Month Periods Ended September 30,

(In Thousands)                                           Three Months           Period-over-            Nine Months            Period-over-
                                                     2012           2011        period change       2012           2011        period change
Products                                          $  23,754      $  17,228          37.9%        $  65,609      $  47,520          38.1%
Services                                              4,202          4,326          -2.9%           11,463         12,020          -4.6%
Total                                             $  27,956      $  21,554          29.7%        $  77,072      $  59,540          29.4%

Gross Profit as a Percentage of Related Sales
Products                                               57.5 %         53.0 %                          54.5 %         52.1 %
Services                                               50.0 %         58.1 %                          48.2 %         57.1 %
Total                                                  56.2 %         53.9 %                          53.5 %         53.0 %

Gross profit increased by $6.4 million, or 29.7%, to $28.0 million in the quarter ended September 30, 2012 as compared with $21.6 million in the same prior-year period. Gross profit increased by $17.5 million, or 29.4%, to $77.1 million in the nine months ended September 30, 2012 as compared with $59.5 million in the same prior-year period. The increase is primarily attributable to increased sales of our higher-margin Fortus 3D production systems and consumables.

Product gross profit increased by 37.9% and 38.1% for the three and nine months ended September 30, 2012, respectively, as compared to the same prior-year periods. This increase is primarily due to increased sales volume to cover fixed overhead, a build-up of finished goods inventory to stock third-party distribution centers in Asia and Europe, and a product mix that favored our higher priced Fortus systems, which included the introduction of our new Fortus 250mc 3D production system. The increase in gross profit as a percentage of related sales was primarily due to growth in our higher-margin Fortus systems and consumables sales as well as a build-up of finished goods inventory to stock third-party distribution centers in Asia and Europe in anticipation of our pending merger with Objet Ltd.

Gross profit from services decreased by 2.9% and 4.6% for the three and nine months ended September 30, 2012, respectively, as compared to the same prior-year periods primarily due to lower margin auxiliary RedEye paid parts service sales and higher cost of sales on Fortus 3D production system maintenance contracts.

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-
                                         2012             2011         period change        2012             2011         period change
Research & development               $     4,067      $     3,614          12.5%        $    12,576      $    10,688          17.7%
Selling, general & administrative         14,781           10,083          46.6%             42,365           28,738          47.4%
                                     $    18,848      $    13,697          37.6%        $    54,941      $    39,426          39.4%
Percentage of sales                         37.9 %           34.3 %                            38.1 %           35.1 %

Research and development expense increased by 12.5% and 17.7% for the three and nine months ended September 30, 2012, respectively, as compared to the same prior-year periods. The overall increase was driven primarily by new product initiatives within 3D printing, 3D production systems and Solidscape. Capitalized research and development expenditures for the quarter ended September 30, 2012 relating to internally developed software was approximately $235,000 as compared to $273,000 for the same prior-year period. Capitalized research and development expenditures for the nine months ended September 30, 2012 relating to internally developed software was approximately $1,098,000 as compared to $897,000 for the same prior-year period.

In 2008, we fulfilled 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. Because receipt of these payments represented reimbursements of costs actually incurred under this joint development project, all payments received were recorded as offsets to the research and development expenditures and are therefore not recognized as revenue.

Due to the success of this initial arrangement, we have continued this relationship under similar terms and objectives. During the three months ended September 30, 2012 and 2011, approximately $438,000 and $170,000, respectively, of research and development expenses were offset by payments that were received from that company. During the nine months ended September 30, 2012 and 2011, approximately $755,000 and $509,000, respectively, of research and development expenses were offset.

Selling, general and administrative expenses increased by 46.6% and 47.4% for the three and nine months ended September 30, 2012, respectively, as compared to the same prior-year periods. The increase is primarily due to legal, advisory, accounting and integration expenses related to the Objet Ltd. merger. In addition, the nine months ended September 30, 2012 included significant expenses surrounding our new Mojo 3D printer launch, which included an international reseller meeting.

Operating Income

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

Three- and Nine-Month Periods Ended September 30,

(In Thousands)                  Three Months              Period-over-                Nine Months               Period-over-
                            2012             2011         period change         2012              2011          period change
Operating income        $    9,109       $    7,857           15.9%         $    22,131       $    20,114           10.0%

Percentage of sales           18.3 %           19.7 %                              15.4 %            17.9 %

Operating income increased by $1.3 million, or 15.9%, in the quarter ended September 30, 2012 as compared with the same prior-year period. Operating income for the nine months ended September 30, 2012 increased by $2.0 million, or . . .