| STRATASYS INC 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 RP 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 RP 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 not successfully enhance existing systems and materials or develop new systems or materials, and any of our products may be rendered obsolete or uneconomical by our or others’ technological advances |
| If the market for 3-D 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 RP systems and 3D printers to expand the market and improve sales |
| In conjunction with that strategy, we are constantly seeking to reduce or 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 RP systems, our revenues and profits could be adversely affected |
| We presently sell substantially all of the consumables that our customers use in our RP 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 RP systems |
| If our customers were to purchase consumables from our competitors, we would lose some of our sales and would 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, a substantial number of our FDM systems used exclusively for Paid Parts, and the development and launch of our new 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 |
| 14 Termination of our North American Distributor Agreements with Objet or Arcam would adversely affect our sales and profitability |
| We have invested significant resources in sales and marketing of the Eden Systems that we distribute for Objet and the EDM Systems that we distribute for Arcam in North America |
| Sales of the Eden Systems and related consumables and maintenance contracts contributed to our sales growth in 2005, and we expect that such sales along with sales of the EDM System will continue to contribute to sales growth in 2006 |
| The termination of either of our agreements to distribute those systems and related products and services would have an adverse effect on our sales and earnings |
| 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 US 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, 2005, the net book value of our intangible assets was approximately dlra4dtta4 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 |
| We operate a global business that exposes us to additional risks |
| Our sales outside of the United States accounted for approximately 43prca of our consolidated net sales in 2005 |
| We continue to expand into foreign 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 from 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 |
| 15 • 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 |
| 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 accounting rules, such as those requiring the recording of expenses for employee stock options and other stock-based compensation expense commencing in the first quarter of 2006; • 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; • the mix of high-performance RP systems, 3D printers, and Eden and Arcam Systems 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, including changes in interest rates affecting returns on cash balances and investments, that affect customer demand; 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 |
| Changes in accounting treatment of stock-based awards will adversely affect our reported results of operations |
| In December 2004, the Financial Accounting Standards Board (“FASB”), issued a Statement of Financial Accounting Standards Nodtta 123® (“SFAS 123R”), “Share Based Payment,” which is a revision to SFAS Nodtta 123 |
| SFAS 123R requires all share-based payments to employees, including grants to employee stock options, to be recognized in the financial statements based on their grant date fair values and does not allow the previously permitted disclosure-only method as an alternative to financial statement recognition |
| Effective January 1, 2006, we adopted SFAS 123R The adoption of SFAS 123R fair value method will have a significant impact on our reported results of operations because the stock-based compensation expense will be charged directly against our reported earnings |
| Previously, these amounts were only required to be disclosed within the footnotes to our consolidated financial statements and had no impact on our reported net income |
| Using the Black-Scholes method of valuing stock options, the amount of compensation expense that we expect to recognize for share-based awards unvested and outstanding as of December 31, 2005 is approximately dlra1dtta7 million for 2006, dlra1dtta6 million for 2007, and $ |
| 16 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 |
| Certain international distributors and North American resellers carry high account receivable balances, some of which exceed our normal payment terms |
| Many of these distributors and resellers are small, thinly capitalized companies that rely upon sales of our products to cover their operating expenses |
| 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 |
| Our common stock price has been and may continue to be highly volatile |
| 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 by securities analysts; • the employment and termination of key personnel; and sales or repurchases of our common stock Many of these factors are beyond our control |
| These factors may materially adversely affect 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 attest to, and to report on, management’s assessment 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 |
| 17 Although our management has determined, and our independent registered public accounting firm has attested, that our internal controls over financial reporting were effective as of December 31, 2005, 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 |
| 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 |