**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

#### **Washington,D.C. 20549**

##### **FORM10-Q**

**(MarkOne)**

**x****Quarterly ReportPursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**

**For theQuarter Ended September 30, 2006**

**or**

**o****Transition ReportPursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**

**For the transition period from                 to                   **

**CommissionFile Number 000-09273**

**MOCON, INC.**

(Exact name of registrant as specified in its charter)

| **Minnesota**                    |   | **41-0903312**       |
|----------------------------------|--------|----------------------|
| (State or other  jurisdiction of |   | (I.R.S. employer     |
| incorporation or  organization)  |   | identification  no.) |

 

**7500 Boone Avenue North, Minneapolis,Minnesota 55428**

(Address of principal executiveoffices)           (Zipcode)

 

**(763) 493-6370**

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

YES x  NOo

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer: o                           Acceleratedfiler: o                             Non-accelerated filer: x

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

YES o  NOx

5,448,425Common Shares were outstanding as of October 31, 2006.

 

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MOCON, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q

For the Quarter EndedSeptember 30, 2006
|                                                                                                                          | ** ** | **Page  Number** |
|--------------------------------------------------------------------------------------------------------------------------|------------|------------------|
| PART I. FINANCIAL  INFORMATION                                                                                           |       |             |
|                                                                                                                     |       |             |
| Item 1. Financial  Statements                                                                                            |       |             |
| Condensed  Consolidated Balance Sheets  September 30, 2006 (Unaudited) and December 31, 2005                        |       | 1                |
|                                                                                                                     |       |             |
| Condensed  Consolidated Statements of Income (Unaudited)  Three months and nine months ended September 30, 2006 and 2005 |       | 2                |
|                                                                                                                     |       |             |
| Condensed  Consolidated Statements of Cash Flows (Unaudited)  Nine months ended September 30, 2006 and 2005              |       | 3                |
|                                                                                                                     |       |             |
| Notes to Condensed  Consolidated Financial Statements (Unaudited)                                                        |       | 4-11             |
|                                                                                                                     |       |             |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                     |       | 11-20            |
|                                                                                                                     |       |             |
| Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                                      |       | 20-21            |
|                                                                                                                     |       |             |
| Item 4. Controls and  Procedures                                                                                         |       | 21               |
|                                                                                                                     |       |             |
| PART II. OTHER  INFORMATION                                                                                              |       |             |
|                                                                                                                     |       |             |
| Item 1A. Risk Factors                                                                                                    |       | 22               |
|                                                                                                                     |       |             |
| Item 2.  Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases  of Equity Securities             |       | 22               |
|                                                                                                                     |       |             |
| Item 6. Exhibits                                                                                                         |       | 23               |
|                                                                                                                     |       |             |
| Signatures                                                                                                               |       | 24               |
|                                                                                                                     |       |             |
| Exhibit  Index                                                                                                           |       | 25               |

 

*In this report, references to “MOCON,” “the Company,”“we,” “our,” or “us,” unless the context otherwise requires, refer to MOCON,Inc. and its subsidiaries.*

 

*All trademarks or trade namesreferred to in this report are the property of their respective owners.*

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PARTI.  FINANCIAL INFORMATION

 

Item1.  Financial Statements

 

MOCON, INC. AND SUBSIDIARIES

 

CONDENSEDCONSOLIDATED BALANCE SHEETS

 
| ** **                                                                                                                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                        | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                        | ** ** | **(Unaudited)**        | ** ** | **(Audited)**         | ** ** |
| ASSETS                                                                                                                                            |       |                   |       |                  |       |
| Current assets:                                                                                                                                   |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                         |       | $                      | 3,562,245  |                  | $          | 2,889,323 |   |
| Marketable  securities, current                                                                                                                   |       | 8,024,578              |       | 5,961,793             |       |
| Trade accounts  receivable, less allowance for doubtful accounts of $157,448 in 2006 and  $192,446 in 2005                                        |       | 3,958,073              |       | 4,237,240             |       |
| Other  receivables                                                                                                                                |       | 176,073                |       | 124,403               |       |
| Inventories                                                                                                                                       |       | 3,689,387              |       | 4,057,514             |       |
| Prepaid expenses                                                                                                                                  |       | 305,920                |       | 313,042               |       |
| Deferred income  taxes                                                                                                                            |       | 587,468                |       | 582,948               |       |
| Assets held for  sale                                                                                                                             |       | —                 |       | 90,809                |       |
| Total current  assets                                                                                                                             |       | 20,303,744             |       | 18,257,072            |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Marketable  securities, noncurrent                                                                                                                |       | 99,317                 |       | 170,253               |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Property, plant  and equipment, net of accumulated depreciation of $4,422,350 in 2006 and  $4,460,559 in 2005                                     |       | 1,543,660              |       | 1,551,883             |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Other assets:                                                                                                                                     |       |                   |       |                  |       |
| Software  development costs, net of accumulated amortization of $995,025 in 2006 and $943,743  in 2005                                            |       | 11,396                 |       | 62,678                |       |
| Goodwill                                                                                                                                          |       | 2,641,599              |       | 2,641,599             |       |
| Technology  rights and other intangibles, net                                                                                                     |       | 660,514                |       | 808,266               |       |
| Other                                                                                                                                             |       | 170,290                |       | 165,137               |       |
| Total other  assets                                                                                                                               |       | 3,483,799              |       | 3,677,680             |       |
|                                                                                                                                              |       |                   |       |                  |       |
| TOTAL ASSETS                                                                                                                                      |       | $                      | 25,430,520 |                  | $          | 23,656,888 |   |
|                                                                                                                                              |       |                   |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                        |       |                   |       |                  |       |
| Current  liabilities:                                                                                                                             |       |                   |       |                  |       |
| Accounts payable                                                                                                                                  |       | $                      | 1,802,698  |                  | $          | 1,847,133 |   |
| Accrued  compensation and vacation                                                                                                                |       | 1,220,402              |       | 995,528               |       |
| Other accrued  expenses                                                                                                                           |       | 404,425                |       | 440,510               |       |
| Accrued product  warranties                                                                                                                       |       | 262,632                |       | 327,015               |       |
| Accrued income  taxes                                                                                                                             |       | 113,324                |       | 402,285               |       |
| Dividends  payable                                                                                                                                |       | 407,488                |       | 405,268               |       |
| Total current  liabilities                                                                                                                        |       | 4,210,969              |       | 4,417,739             |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Obligations to  former employees                                                                                                                  |       | 100,414                |       | 93,735                |       |
| Minimum earnout  payable                                                                                                                          |       | —                 |       | 107,514               |       |
| Deferred income  taxes                                                                                                                            |       | 189,212                |       | 239,282               |       |
| Total noncurrent  liabilities                                                                                                                     |       | 289,626                |       | 440,531               |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Total  liabilities                                                                                                                                |       | 4,500,595              |       | 4,858,270             |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Stockholders’  equity:                                                                                                                       |       |                   |       |                  |       |
| Capital stock –  undesignated – authorized 3,000,000 shares                                                                             |       | —                 |       | —                |       |
| Common stock –  $0.10 par value. Authorized 22,000,000 shares; issued and outstanding  5,433,175 shares in 2006 and 5,403,573 shares in 2005 |       | 543,317                |       | 540,357               |       |
| Capital in  excess of par value                                                                                                                   |       | 843,903                |       | 592,796               |       |
| Retained  earnings                                                                                                                                |       | 19,503,847             |       | 17,759,120            |       |
| Accumulated  other comprehensive gain (loss)                                                                                                      |       | 38,858                 |       | (93,655               | )          |
| Total  stockholders’ equity                                                                                                                  |       | 20,929,925             |       | 18,798,618            |       |
|                                                                                                                                              |       |                   |       |                  |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’  EQUITY                                                                                                  |       | $                      | 25,430,520 |                  | $          | 23,656,888 |   |

 

See accompanying notes tocondensed consolidated financial statements.

1

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MOCON,INC. AND SUBSIDIARIES

 

CONDENSEDCONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                             | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Sales:                                                 |       |                             |       |                            |       |   |   |   |   |
| Products                                               |       | $                                | 6,235,775  |                            | $          | 5,187,526 |   | $ | 18,180,592 |   | $ | 17,123,558 |   |
| Consulting services                                    |       | 411,316                          |       | 482,630                         |       | 1,325,934 |   | 1,373,295 |   |
| Total sales                                            |       | 6,647,091                        |       | 5,670,156                       |       | 19,506,526 |   | 18,496,853 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Cost of sales:                                         |       |                             |       |                            |       |   |   |   |   |
| Products                                               |       | 2,603,556                        |       | 2,188,766                       |       | 7,513,441 |   | 7,434,953 |   |
| Consulting services                                    |       | 237,044                          |       | 260,105                         |       | 706,057 |   | 742,143 |   |
| Total cost of sales                                    |       | 2,840,600                        |       | 2,448,871                       |       | 8,219,498 |   | 8,177,096 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Gross profit                                           |       | 3,806,491                        |       | 3,221,285                       |       | 11,287,028 |   | 10,319,757 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Selling, general  and administrative expenses          |       | 1,913,697                        |       | 1,978,839                       |       | 5,864,795 |   | 6,136,163 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Research and  development expenses                     |       | 507,933                          |       | 434,550                         |       | 1,417,639 |   | 1,252,402 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Operating income                                       |       | 1,384,861                        |       | 807,896                         |       | 4,004,594 |   | 2,931,192 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Other income                                           |       | 107,648                          |       | 61,973                          |       | 425,568 |   | 259,862 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Income from continuing operations before income  taxes |       | 1,492,509                        |       | 869,869                         |       | 4,430,162 |   | 3,191,054 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Income taxes                                           |       | 524,000                          |       | 309,606                         |       | 1,486,225 |   | 920,627 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Income from continuing operations                      |       | 968,509                          |       | 560,263                         |       | 2,943,937 |   | 2,270,427 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Gain (loss) from  discontinued operations, net of tax  |       | —                           |       | 33,740                          |       | 22,225 |   | (107,213 | ) |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Net income                                             |       | $                                | 968,509    |                            | $          | 594,003 |   | $ | 2,966,162 |   | $ | 2,163,214 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Basic net income  per common share:                    |       |                             |       |                            |       |   |   |   |   |
| Income from continuing operations                      |       | $                                | 0.18       |                            | $          | 0.10 |   | $ | 0.54 |   | $ | 0.42 |   |
| Gain (loss) from discontinued operations               |       | —                           |       | 0.01                            |       | 0.01 |   | (0.02 | ) |
| Basic net income per common share:                     |       | $                                | 0.18       |                            | $          | 0.11 |   | $ | 0.55 |   | $ | 0.40 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Basic weighted average common shares outstanding       |       | 5,431,008                        |       | 5,387,771                       |       | 5,420,267 |   | 5,361,129 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Diluted net  income per common share:                  |       |                             |       |                            |       |   |   |   |   |
| Income from continuing operations                      |       | $                                | 0.18       |                            | $          | 0.10 |   | $ | 0.53 |   | $ | 0.41 |   |
| Gain (loss) from discontinued operations               |       | —                           |       | 0.01                            |       | 0.01 |   | (0.02 | ) |
| Diluted net income per common share:                   |       | $                                | 0.18       |                            | $          | 0.11 |   | $ | 0.54 |   | $ | 0.39 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Diluted weighted  average common shares outstanding    |       | 5,527,663                        |       | 5,554,657                       |       | 5,512,318 |   | 5,535,244 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

2

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MOCON,INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 
| ** **                                                                                                  | ** ** | **Nine Months**              | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                  | ** ** | **Ended September 30,** | ** ** |
| ** **                                                                                                  | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                                                      |       |                              |       |   |   |
| Net income                                                                                                  |       | $                                 | 2,966,162  |   | $ | 2,163,214 |   |
| (Gain) loss from discontinued operations, net of tax                                                        |       | (22,225                           | )          | 107,213 |   |
| Income from continuing operations                                                                           |       | 2,943,937                         |       | 2,270,427 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities of continuing operations: |       |                              |       |   |   |
| Share-based compensation expense                                                                            |       | 143,349                           |       | — |   |
| Gain on disposition of long-term assets                                                                     |       | (150,651                          | )          | (22,412 | ) |
| Depreciation and amortization                                                                               |       | 561,842                           |       | 758,292 |   |
| Deferred income taxes                                                                                       |       | (35,640                           | )          | (50,070 | ) |
| Changes in operating assets and liabilities, net of  effect of divestitures in 2006 and 2005:               |       |                              |       |   |   |
| Trade accounts receivable                                                                                   |       | 231,466                           |       | 1,380,134 |   |
| Other receivables                                                                                           |       | (50,222                           | )          | (94,118 | ) |
| Inventories                                                                                                 |       | 242,641                           |       | (513,472 | ) |
| Prepaid expenses                                                                                            |       | 7,045                             |       | (60,577 | ) |
| Accounts payable                                                                                            |       | (90,752                           | )          | (644,498 | ) |
| Accrued compensation and vacation                                                                           |       | 13,919                            |       | (150,050 | ) |
| Other accrued expenses                                                                                      |       | (213,863                          | )          | (154,591 | ) |
| Accrued product warranties                                                                                  |       | (34,511                           | )          | — |   |
| Accrued income taxes                                                                                        |       | (105,969                          | )          | (214,322 | ) |
| Net cash provided by continuing operations                                                                  |       | 3,462,591                         |       | 2,504,743 |   |
| Net cash provided by discontinued operations                                                                |       | —                            |       | 114,580 |   |
| Net cash provided by operating activities                                                                   |       | 3,462,591                         |       | 2,619,323 |   |
|                                                                                                        |       |                              |       |   |   |
| Cash flows from  investing activities:                                                                      |       |                              |       |   |   |
| Proceeds from sale of subsidiary                                                                            |       | 478,721                           |       | — |   |
| Purchases of marketable securities                                                                          |       | (6,535,213                        | )          | (5,249,050 | ) |
| Proceeds from sales or maturities of marketable  securities                                                 |       | 4,543,328                         |       | 3,886,120 |   |
| Purchases of property and equipment                                                                         |       | (334,670                          | )          | (166,482 | ) |
| Proceeds from sale of property and equipment                                                                |       | 119,452                           |       | 94,415 |   |
| Purchases of patents and trademarks                                                                         |       | (69,875                           | )          | (30,755 | ) |
| Other                                                                                                       |       | (5,153                            | )          | (19,616 | ) |
| Net cash used in continuing operations                                                                      |       | (1,803,410                        | )          | (1,485,368 | ) |
| Net cash provided by discontinued operations                                                                |       | 22,225                            |       | — |   |
| Net cash used in investing activities                                                                       |       | (1,781,185                        | )          | (1,485,368 | ) |
|                                                                                                        |       |                              |       |   |   |
| Cash flows from  financing activities:                                                                      |       |                              |       |   |   |
| Proceeds from the exercise of stock options                                                                 |       | 473,843                           |       | 341,140 |   |
| Purchases and retirement of common stock                                                                    |       | (363,125                          | )          | — |   |
| Dividends paid                                                                                              |       | (1,219,214                        | )          | (1,124,625 | ) |
| Net cash used in financing activities of continuing  operations                                             |       | (1,108,496                        | )          | (783,485 | ) |
|                                                                                                        |       |                              |       |   |   |
| Effect of  exchange rate changes on cash                                                                    |       | 100,012                           |       | (115,814 | ) |
|                                                                                                        |       |                              |       |   |   |
| Net increase in  cash and cash equivalents                                                                  |       | 672,922                           |       | 234,656 |   |
|                                                                                                        |       |                              |       |   |   |
| Cash and cash  equivalents:                                                                                 |       |                              |       |   |   |
| Beginning of period                                                                                         |       | 2,889,323                         |       | 2,648,879 |   |
| End of period                                                                                               |       | $                                 | 3,562,245  |   | $ | 2,883,535 |   |
|                                                                                                        |       |                              |       |   |   |
| Supplemental  disclosures of cash flow information:                                                         |       |                              |       |   |   |
| Cash paid during the period for income taxes                                                                |       | $                                 | 1,638,038  |   | $ | 1,123,173 |   |
|                                                                                                        |       |                              |       |   |   |
| Supplemental  schedule of noncash investing and financing activities:                                       |       |                              |       |   |   |
| Unrealized holding loss on available-for-sale  securities                                                   |       | $                                 | (36        | ) | $ | (2,021 | ) |
| Dividends  accrued                                                                                          |       | $                                 | 407,488    |   | $ | 377,660 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

3

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MOCON, INC. AND SUBSIDIARIES

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 – Condensed Consolidated Financial Statements

The condensedconsolidated balance sheet as of September 30, 2006, the condensed consolidatedstatements of income for the third quarters and nine-month periods endedSeptember 30, 2006 and 2005, and the condensed consolidated statements of cashflows for the nine-month periods ended September 30, 2006 and 2005 have beenprepared by us, without audit.  However,all adjustments (consisting solely of normal recurring adjustments) which are,in the opinion of management, necessary to present fairly the financialposition, results of operations and cash flows at September 30, 2006, and forall periods presented, have been made. The results of operations for the third quarter and nine-month periodsended September 30, 2006 are not necessarily indicative of operating resultsfor the full year.

Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted. It is suggested that these condensed consolidated financial statementsbe read in conjunction with the consolidated financial statements and notesincluded in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2005, previously filed with the Securities and ExchangeCommission.

We operate in a singleindustry segment:  the development,manufacturing, and marketing of measurement, analytical, monitoring andconsulting products used to detect, measure, and analyze gases and chemicalcompounds for customers in the barrier packaging, food, pharmaceutical, andother industries throughout the world.

*Principles of Consolidation*

The condensedconsolidated financial statements include the accounts of MOCON, Inc. and oursubsidiaries after elimination of inter-company transactions and accounts.

*Foreign Currency Translation*

The financialstatements for operations outside the United States are maintained in theirlocal currency.  All assets andliabilities of our foreign subsidiary are translated to United States dollarsat period-end exchange rates, while revenue and expense accounts are translatedat the average exchange rates during the period transactions occurred.  Translation adjustments arising from the useof differing exchange rates are included in accumulated other comprehensiveincome or loss in stockholders’ equity. Gains and losses on foreign currency transactions are included in otherincome or loss.

*Use of Estimates*

The preparationof consolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from those estimates.

4

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*Share-Based Compensation Expense*

EffectiveJanuary 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(revised 2004), *Share-Based Payment*(SFAS 123(R)) which requires the measurement and recognition of compensationexpense for all share-based payment awards made to employees anddirectors.  SFAS 123(R) supersedes ourprevious accounting under Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (APB 25).

We adopted themodified prospective transition method of applying SFAS 123(R) which requiresthe application of the standard as of January 1, 2006.   As a result, as of September 30, 2006, ourresults of operations reflected compensation expense for new stock optionsgranted and vested during the first nine months of 2006 and the unvestedportion of previous stock option grants vested during the first nine months of2006.  Our consolidated financialstatements for prior periods have not been restated to reflect, and do notinclude, the impact of SFAS 123(R).

Amountsrecognized in the consolidated financial statements related to stock-basedcompensation are as follows:

|                                                             | ** ** | **Third Quarter  Ended  September 30,  2006** | ** ** | **Nine Months  Ended  September 30,  2006** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------|------------|
| Total cost of  share-based compensation                     |       | $                                                       | 45,683     |                                                  | $          | 143,349 |   |
| Amount  capitalized in inventory and property and equipment |       | —                                                  |       | —                                                |       |
| Amounts charged  against income, before income taxes        |       | 45,683                                                  |       | 143,349                                               |       |
| Amount of income  tax benefit recognized in earnings        |       | —                                                  |       | —                                                |       |
| Amount charged  against net income                          |       | $                                                       | 45,683     |                                                  | $          | 143,349 |   |
|                                                        |       |                                                    |       |                                                  |       |
| Impact on net  income per common share:                     |       |                                                    |       |                                                  |       |
| Basic                                                       |       | $                                                       | 0.01       |                                                  | $          | 0.03 |   |
| Diluted                                                     |       | $                                                       | 0.01       |                                                  | $          | 0.03 |   |

 

Share-based compensationexpense was reflected in the statements of income for the third quarter andfirst nine months of 2006 as follows:

|                                               | ** ** | **Third Quarter  Ended  September 30,  2006** | ** ** | **Nine Months  Ended  September 30,  2006** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------|------------|
| Cost of sales                                 |       | $                                                       | 14,074     |                                                  | $          | 42,222 |   |
| Selling, general  and administrative expenses |       | 25,583                                                  |       | 83,048                                                |       |
| Research and  development expenses            |       | 6,026                                                   |       | 18,079                                                |       |
|                                          |       | $                                                       | 45,683     |                                                  | $          | 143,349 |   |

 

Prior to January 1, 2006, weaccounted for share-based employee compensation arrangements in accordance withthe provisions and related interpretations of APB 25, using the intrinsic-valuemethod.  Under the guidelines of APB 25,compensation cost for share-based employee compensation plans is recognizedbased on the difference, if any, between the quoted market price of the stockon the date of grant and the amount an employee must pay to acquire thestock.  We had adopted thedisclosure-only provisions for employee share-based compensation, and therefore,had not recorded compensation

5

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cost in our financialstatements.   Had compensation cost forshare-based compensation been determined consistent with SFAS 123(R), netincome and net income per share would have been adjusted to the following proforma amounts:

|                                                                                                                                              | ** ** | **Third Quarter  Ended  September 30,  2005** | ** ** | **Nine Months  Ended  September 30,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------|------------|
| Net income – as reported                                                                                                                |       | $                                                       | 594,003    |                                                  | $          | 2,163,214 |   |
| Deduct: Total share-based employee compensation expense determined  under fair value based method for all awards, net of related tax effects |       | (27,414                                                 | )          | (84,135                                               | )          |
| Net income – pro forma                                                                                                                  |       | $                                                       | 566,589    |                                                  | $          | 2,079,079 |   |
| Net income per common share – as reported:                                                                                              |       |                                                    |       |                                                  |       |
| Basic                                                                                                                                        |       | $                                                       | 0.11       |                                                  | $          | 0.40 |   |
| Diluted                                                                                                                                      |       | $                                                       | 0.11       |                                                  | $          | 0.39 |   |
| Net income per common share – pro forma:                                                                                                |       |                                                    |       |                                                  |       |
| Basic                                                                                                                                        |       | $                                                       | 0.11       |                                                  | $          | 0.39 |   |
| Diluted                                                                                                                                      |       | $                                                       | 0.10       |                                                  | $          | 0.38 |   |

 

The fair value of eachoption grant is estimated on the date of grant using the Black-Scholesoption-pricing model (Black-Scholes).  Weuse historical data to estimate the expected price volatility, expected optionlife and expected forfeiture rate.  Therisk-free interest rate is based on the U.S. Treasury yield curve in effect atthe time of grant for the estimated life of the option.  The dividend yield is calculated based uponthe dividend payments made during the prior four quarters as a percent of theaverage stock price for that period.  Thefollowing assumptions were used to estimate the fair value of options grantedduring the first nine months of 2006 and 2005 using the Black-Scholes model:

|                              | ** ** | **Third Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                   | ** ** | **  2006  **                      | ** ** | **  2005  **                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Stock options:               |       |                                                  |       |                                                |       |   |   |   |   |
| Volatility                   |       | 31                                                    | %          | 32                                                  | %          | 31 | % | 32 | % |
| Risk-free interest rate      |       | 4.0                                                   | %          | 3.4                                                 | %          | 4.0 | % | 3.4 | % |
| Expected option life (years) |       | 7.9                                                   |       | 7.8                                                 |       | 7.9 |   | 7.8 |   |
| Dividend yield               |       | 3.0                                                   | %          | 3.1                                                 | %          | 3.0 | % | 3.1 | % |

 

A summary of the optionactivity for the first nine months of 2006 is as follows:

|                                    | ** ** | **Number of  Shares** | ** ** | **Weighted-  average  Exercise  Price per  Share** | ** ** | **Weighted-  average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|----------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at  December 31, 2005  |       | 850,449                    |       | $                                                       | 7.70       |                                                 | 6.7        |                            |       |   |
| Options granted                    |       | 3,000                      |       | 8.90                                                    |       | 9.3                                                  |       |                            |       |
| Options cancelled                  |       | (30,562                    | )          | 9.12                                                    |       | —                                               |       |                            |       |
| Options expired                    |       | —                     |       | —                                                  |       | —                                               |       |                            |       |
| Options exercised                  |       | (82,675                    | )          | 7.09                                                    |       | —                                               |       |                            |       |
| Outstanding at  September 30, 2006 |       | 740,212                    |       | $                                                       | 7.72       |                                                 | 6.1        |                            | $          | 1,497,850 |   |
|                               |       |                       |       |                                                    |       |                                                 |       |                            |       |
| Exercisable at  September 30, 2006 |       | 576,087                    |       | $                                                       | 7.47       |                                                 | 5.5        |                            | $          | 1,323,132 |   |

 

6

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There were no optionsgranted in the third quarter of 2006. The weighted average grant date fair value based on the Black-Scholesmodel for options granted in the first nine months of 2006 was $2.10.  There were no options granted in the firstnine months of 2005.  We issue new sharesof common stock upon exercise of stock options. The total intrinsic value of options exercised was $8,075 and $33,231during the third quarters 2006 and 2005, respectively, and $167,228 and$202,798 during the first nine months of 2006 and 2005, respectively.

A summary of the status ofour unvested option shares as of September 30, 2006 is as follows:

|                                 | ** ** | **Number of  Shares** | ** ** | **Weighted-  average  Grant-Date  Fair Value** | ** ** |
|---------------------------------|------------|----------------------------|------------|-----------------------------------------------------|------------|
| Unvested at  December 31, 2005  |       | 175,887                    |       | $                                                   | 2.26       |   |
| Options granted                 |       | 3,000                      |       | 2.10                                                |       |
| Options cancelled               |       | (11,637                    | )          | 2.30                                                |       |
| Options vested                  |       | (3,125                     | )          | 2.11                                                |       |
| Unvested at September  30, 2006 |       | 164,125                    |       | $                                                   | 2.26       |   |

 

As of September 30, 2006,there was $233,987 of total unrecognized compensation cost related to unvestedshare-based compensation granted under our plans.  That cost is expected to be recognized over aweighted-average period of 1.5 years. The total fair value of option shares vested during the first ninemonths of 2006 was $6,584.

*NewAccounting Pronouncements*

In September 2005, the FASBissued SFAS No. 154, *Accounting Changes andError Corrections – a replacement of APB No. 20 and SFAS No. 3* (SFAS154).  SFAS 154 provides guidance on theaccounting for and reporting of accounting changes and error corrections. Itestablishes, unless impracticable, retrospective application as the requiredmethod for reporting a change in accounting principle in the absence ofexplicit transition requirements specific to the newly adopted accountingprinciple.  SFAS 154 also providesguidance for determining whether retrospective application of a change inaccounting principle is impracticable and for reporting a change whenretrospective application is impracticable. The correction of an error in previously issued financial statements isnot an accounting change.  However, thereporting of an error correction involves adjustments to previously issuedfinancial statements similar to those generally applicable to reporting anaccounting change retrospectively. Therefore, the reporting of a correction ofan error by restating previously issued financial statements is also addressedby SFAS 154.  SFAS 154 is required to beadopted in fiscal years beginning after December 15, 2005.  Accordingly, we have adopted SFAS 154 in ourfiscal year beginning January 1, 2006. Adoption of SFAS 154 did not have a material effect on our financialposition, results of operations or cash flows.

In November 2004, theFASB issued SFAS No. 151, *Inventory Costs*,an amendment of ARB No. 43, Chapter 4 (SFAS 151) to clarify that abnormalamounts of idle facility expense, freight, handling costs, and wasted material(spoilage) should be recognized as current period charges, and that fixedproduction overheads should be allocated to inventory based on normal capacityof production facilities.  This statementis effective for inventory costs incurred during fiscal years beginning afterJune 15, 2005.  Accordingly, we haveadopted SFAS 151 in our fiscal year beginning January 1, 2006.  Adoption of SFAS 151 did not have a materialeffect on our financial position, results of operations or cash flows.

In September 2006, the SECissued Staff Accounting Bulletin No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements* (SAB 108).  SAB 108 providesinterpretive guidance on how the effects of the carryover or reversal of prioryear

7

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misstatements should beconsidered in quantifying a current year misstatement.  The SEC staff believes that registrantsshould quantify errors using both a balance sheet and an income statementapproach and evaluate whether either approach results in quantifying amisstatement that, when all relevant quantitative and qualitative factors areconsidered, is material.  SAB 108 iseffective for fiscal years ending on or after November 15, 2006, withearly application encouraged. Accordingly, we have adopted SAB 108 for our fiscal year ended December31, 2006.  We have not yet determined theimpact, if any, that the adoption of SAB 108 will have on our consolidatedfinancial statements.

*Reclassifications*

Certain 2005 amounts have been reclassified toconform to the 2006 presentation.

Note 2 – Inventories

Inventories consist of the following:

|                    | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------|------------|------------------------------|------------|-----------------------------|------------|
| Finished  products |       | $                            | 474,669    |                        | $          | 656,587 |   |
| Work-in-process    |       | 1,479,028                    |       | 1,511,314                   |       |
| Raw materials      |       | 1,735,690                    |       | 1,889,613                   |       |
|               |       | $                            | 3,689,387  |                        | $          | 4,057,514 |   |

 

Note 3 – Net Income Per Common Share

Basic net income per commonshare is computed by dividing net income by the weighted average number ofshares of common stock outstanding during the period.  Diluted net income per common share iscomputed using the treasury stock method to compute the weighted average commonstock outstanding assuming the conversion of potential dilutive common shares.

The following table presentsa reconciliation of the denominators used in the computation of net income percommon share – basic, and net income per common share – diluted, for the thirdquarter and nine-month periods endedSeptember 30, 2006 and 2005:

|                                                                         | ** ** | **Third Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                              | ** ** | **2006**                                              | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted shares  of common stock outstanding – basic               |       | 5,431,008                                             |       | 5,387,771                                           |       | 5,420,267 |   | 5,361,129 |   |
| Weighted shares  of common stock assumed upon exercise of stock options |       | 96,655                                                |       | 166,886                                             |       | 92,051 |   | 174,115 |   |
| Weighted shares of  common stock outstanding – diluted             |       | 5,527,663                                             |       | 5,554,657                                           |       | 5,512,318 |   | 5,535,244 |   |

 

8

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Note 4 – Goodwill and Intangible Assets

As of September30, 2006 and December 31, 2005, unamortized goodwill amounted to $2,641,599.  Other identifiable intangible assets are asfollows:
| ** **                  | ** ** | **As of September 30, 2006** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| ** **                  | ** ** | **Carrying  Amount**                             | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** | **Estimated  Useful Lives** | ** ** |
| Patents                     |       | $                                                | 689,440    |   | $ | (279,666 | ) | $ | 409,774 |   | 10  to 17 years |   |
| Trademarks and  trade names |       | 392,781                                          |       | (215,666 | ) | 177,115 |   | 5  to 17 years |   |
| Technology  rights          |       | 184,008                                          |       | (166,483 | ) | 17,525 |   | 7  to 10 years |   |
| Other  intangibles          |       | 698,596                                          |       | (642,496 | ) | 56,100 |   | Less  than 1 year to 5 years |   |
|                        |       | $                                                | 1,964,825  |   | $ | (1,304,311 | ) | $ | 660,514 |   |   |   |

 
| ** **                  | ** ** | **As of December 31, 2005** | ** ** |
|-----------------------------|------------|-------------------------------------------------|------------|
| ** **                  | ** ** | **Carrying  Amount**                            | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** | **Estimated  Useful Lives** | ** ** |
| Patents                     |       | $                                               | 614,594    |   | $ | (249,713 | ) | $ | 364,881 |   | 10  to 17 years |   |
| Trademarks and  trade names |       | 385,053                                         |       | (160,069 | ) | 224,984 |   | 5  to 17 years |   |
| Technology  rights          |       | 184,008                                         |       | (146,768 | ) | 37,240 |   | 7  to 10 years |   |
| Other  intangibles          |       | 715,043                                         |       | (533,882 | ) | 181,161 |   | Less  than 1 year to 5 years |   |
|                        |       | $                                               | 1,898,698  |   | $ | (1,090,432 | ) | $ | 808,266 |   |   |   |

 

Totalamortization expense for the third quarter and nine months ended September 30,2006 was $75,026 and $219,838, respectively. Estimated amortization expense for the remainder of 2006 and each of thefour succeeding fiscal years based on the intangible assets as of September 30,2006 is as follows:

|      | ** ** | **Estimated  Expense** | ** ** |
|------|------------|------------------------|------------|
| 2006 |       | $                      | 59,589     |   |
| 2007 |       | $                      | 165,861    |   |
| 2008 |       | $                      | 109,129    |   |
| 2009 |       | $                      | 46,289     |   |
| 2010 |       | $                      | 30,669     |   |

 

### Note 5 – Marketable Securities

Available-for-salesecurities are recorded at fair value. Unrealized holding gains and losses on available-for-sale securities areexcluded from income and are reported as a separate component of stockholders’equity until realized.  At September 30,2006 and September 30, 2005, this resulted in a net cumulative unrealized lossof $7,168 and $4,781, respectively, within stockholders’ equity.  A decline in the market value of anyavailable-for-sale security below cost that is deemed other than temporary ischarged to income resulting in the establishment of a new cost basis for thesecurity.

Note 6 – Comprehensive Income

Othercomprehensive income pertains to net unrealized gains and losses on marketablesecurities and foreign currency translation adjustments that are not includedin net income but rather are recorded directly in stockholders’ equity.

9

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|                                                      | ** ** | **Third Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                              | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                           |       | $                                                     | 968,509    |                                                | $          | 594,003 |   | $ | 2,966,162 |   | $ | 2,163,214 |   |
|                                                 |       |                                                  |       |                                                |       |   |   |   |   |
| Foreign currency  translation adjustment             |       | 23,868                                                |       | (4,281                                              | )          | 132,549 |   | (151,287 | ) |
| Net unrealized  gain (loss) on marketable securities |       | 3,381                                                 |       | (851                                                | )          | (36 | ) | (2,021 | ) |
| Comprehensive income                                 |       | $                                                     | 995,758    |                                                | $          | 588,871 |   | $ | 3,098,675 |   | $ | 2,009,906 |   |

 

Note 7 – Warranty

We provide a warranty formost of our products.  Warranties are forperiods ranging from ninety days to one year, and cover parts and labor fornon-maintenance repairs, at our location. Operator abuse, improper use, alteration, damage resulting fromaccident, or failure to follow manufacturer’s directions are excluded fromwarranty coverage.

Warranty expense is accruedat the time of sale based on historical claims experience.  Special warranty reserves are also accruedfor special rework campaigns for known major product modifications.  We also offer service contracts for selectproducts when the factory warranty period expires.

Warranty provisions andclaims for the nine-month periods ended September 30, 2006 and 2005 were asfollows:

|                              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|
| ** **                   | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Beginning  balance           |       | $                                                   | 327,015    |   | $ | 352,634 |   |
| Warranty  provisions         |       | 242,686                                             |       | 204,045 |   |
| Warranty claims              |       | (273,821                                            | )          | (212,583 | ) |
| Decrease due to  sale of LCI |       | (33,248                                             | )          | — |   |
| Ending balance               |       | $                                                   | 262,632    |   | $ | 344,096 |   |

 

Note 8 – Sale of Subsidiary

In February 2006, we soldall the outstanding common stock of Lab Connections, Inc. (LCI), a wholly-ownedsubsidiary.  Pursuant to the saleagreement, we received a net cash payment of $478,721 in exchange for all theoutstanding shares of LCI.  As a resultof the sale, we recognized an after-tax gain of approximately $92,000 in thefirst quarter of 2006.  This gain wasreflected in the other income line on the condensed consolidated statements ofincome.  In addition, we have signed amanufacturing agreement with the purchaser which provides that we will be theexclusive manufacturer/supplier of the LCI equipment for at least one year.

Note 9 – Discontinued Operations

In July 2005, we soldsubstantially all of the assets used in our discontinued Vaculok productline.  Pursuant to the sale agreement, wereceived an up-front payment of $125,000, along with the right to receive anadditional amount upon the occurrence of certain post-closing events.  In the first quarter of 2006, we received anadditional $35,000 related to this previous sale.  The after-tax effect of this additionalpayment is a gain of $22,225 which is reflected on the gain (loss) fromdiscontinued operations line of the condensed consolidated statements ofincome.  In 2005, we reported anafter-tax

10

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loss of $107,213 relating toimpairment charges and ongoing operating losses of the discontinued operation.

Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

This Management’sDiscussion and Analysis provides material historical and prospectivedisclosures intended to enable investors and other users to assess ourfinancial condition and results of operations. Statements that are not historical are forward-looking and involve risksand uncertainties discussed below under the caption “Forward-LookingStatements.”  The following discussion ofthe results of operations and financial condition of MOCON should be read inconjunction with our condensed consolidated financial statements and therelated notes thereto included elsewhere in this report.

### ***Overview***

MOCON, Inc. designs, manufactures, markets andservices products and provides consulting services primarily in the measurementand analytical instrument and services markets. Our products include instruments that detect, measure and monitor gasesand chemical compounds.  Although some ofthe markets for our products are maturing, we continually seek growthopportunities through technological and product improvement, by acquiring anddeveloping new products, and by acquiring new companies.

We have three primary operating locations in theUnited States – Minnesota, Colorado and Texas – and one in Germany.  We use a direct sales force and independentsales representatives to market our products and services in the United States,Canada and Germany and use a network of independent sales representatives tomarket and service our products and services in other foreign countries.

Prior to 1998, we expanded our business primarilythrough internally developing new products and technologies and licensingproducts and technology.  Since 1998, wehave supplemented our internal growth through acquisitions that have providedus with additional technologies, products and product developmentexpertise.  During the last 15 months, wedivested two product lines to allow us to better concentrate on our core productlines, particularly our gas detection and measurement products.

We completed our most recent acquisition effectiveJanuary 1, 2004, by acquiring Paul Lippke Handels-GmbH Prozess- undLaborsysteme (Lippke), which is located in Germany.  We acquired all of the shares of Lippke for abase purchase price plus three earnout payments based on the net profits ofLippke in each of the years 2004, 2005 and 2006, with a minimum payment amountof 100,000 euros per year.  It isanticipated that the remaining earnout payment will be made at or near the endof the first quarter 2007.  The earnoutpayment due for 2005 in the amount of $433,339 was based on Lippke’s 2005 netprofits and was paid during the first quarter 2006.

In March 2005, we committed to a plan to discontinueproduction of our Vaculok® vacuum insulated panels and exit this product lineas the result of its poor financial performance since it was acquired inNovember 2003.  We recorded a one-timepre-tax charge to earnings in our first quarter 2005, totaling approximately$207,000, to reflect the results of operations and asset impairment write-downassociated with the discontinuation of our Vaculok business.  The $207,000 charge included a non-cash assetimpairment charge of $162,000 relating to equipment and inventory used in theVaculok business.  The after-tax lossreflected in the first quarter 2005 was $131,453.  We sold the assets associated with the vacuuminsulated panel product line in July 2005 in exchange for an upfront payment of$125,000, along with the right to receive up to an additional amount upon theoccurrence of certain post-closing events. As a result of the sale, we recognized a pre-tax gain of approximately$69,000 in the third quarter 2005.  Wereceived an additional $35,000 in the first quarter 2006, which resulted in anafter-tax gain of $22,225. The results of this line of business are shown inthe discontinued operations section of our consolidated statements of income.

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In February 2006, we sold the capital stock of LabConnections, Inc. in exchange for $517,296 in cash, subject to a purchase priceadjustment based on the amount of Lab Connections’ net tangible assets as ofthe closing date. As a result of the sale, after recognition of the purchaseprice adjustment, we recognized an after-tax gain of approximately $92,000 inthe first quarter 2006.

Effective January 1, 2006, we adopted Statement ofFinancial Accounting Standards No.123 (revised), *Share-Based Payment* (SFAS 123 (R)) which requires themeasurement and recognition of compensation expense for all share-based paymentawards made to employees and directors. As a result, as of September 30, 2006, our results of operationsreflected compensation expense for new stock options granted and vested duringthe first nine months of 2006 and the unvested portion of previous stock optiongrants which will vest during 2006.  Thetotal amount charged to operations in the third quarter and nine-month periodsended September 30, 2006 was $45,683 and $143,349, respectively.

### ***Results of Operations***

The following table sets forth the relationshipbetween various components of our results of operations, stated as a percent ofsales, for the third quarter and nine-month periods ended September 30, 2006,and 2005.

|                                                        | ** ** | **Third Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                              | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Sales                                                  |       | 100.0                                                 |       | 100.0                                               |       | 100.0 |   | 100.0 |   |
| Cost of sales                                          |       | 42.7                                                  |       | 43.2                                                |       | 42.1 |   | 44.2 |   |
| Gross profit                                           |       | 57.3                                                  |       | 56.8                                                |       | 57.9 |   | 55.8 |   |
| Selling, general  and administrative expenses          |       | 28.8                                                  |       | 34.9                                                |       | 30.1 |   | 33.2 |   |
| Research and  development expenses                     |       | 7.6                                                   |       | 7.7                                                 |       | 7.3 |   | 6.7 |   |
| Operating income                                       |       | 20.9                                                  |       | 14.2                                                |       | 20.5 |   | 15.9 |   |
| Other income                                           |       | 1.6                                                   |       | 1.1                                                 |       | 2.2 |   | 1.4 |   |
| Income from continuing operations before income  taxes |       | 22.5                                                  |       | 15.3                                                |       | 22.7 |   | 17.3 |   |
| Income taxes                                           |       | 7.9                                                   |       | 5.4                                                 |       | 7.6 |   | 5.0 |   |
| Income from continuing operations                      |       | 14.6                                                  |       | 9.9                                                 |       | 15.1 |   | 12.3 |   |
|                                                   |       |                                                  |       |                                                |       |   |   |   |   |
| Gain (loss) from  discontinued operations, net of tax  |       | —                                                |       | 0.6                                                 |       | 0.1 |   | (0.6 | ) |
| Net income                                             |       | 14.6                                                  |       | 10.5                                                |       | 15.2 |   | 11.7 |   |

 

### *Comparisonof Financial Results for the Third Quarter and Nine Months Ended September 30,2006 and 2005*

### *Sales*

Sales for the third quarter 2006 were $6,647,091, up17% compared to $5,670,156 for the same period in2005.  On a geographical basis, salesincreased 23% in our foreign markets and 10% in our domestic markets.  On a product line basis, this increase wasprimarily due to increased sales of our permeation, gas analyzer, and weighingand pharmaceutical products.  Sales forthe first nine months of 2006 were $19,506,526, a 5% increase compared to $18,496,853 for the sameperiod in 2005.  On a product line basis,this increase was primarily due to increased sales of our weighing andpharmaceutical products, gas analyzer and permeation products, offset somewhatby a decrease in sales of our sample preparation products.  The reduction in sample preparation productswas due to

12

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the sale of Lab Connections which occurred in thefirst quarter 2006.  There were nosignificant price increases or decreases during either the third quarter 2006or the first nine months of 2006 compared to the same respective periods in2005.

The following tablesummarizes total sales by product line for the third quarters and nine-monthperiods ended September 30, 2006 and 2005.
|                                              | ** ** | **Third Quarter Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------|------------|-----------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **September 30,**            | ** ** | **September 30,**          | ** ** |
| ** **                                   | ** ** | **2006**                          | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Permeation Products and  Services            |       | $                                 | 3,761,957  |                            | $          | 3,382,406 |   | $ | 10,992,607 |   | $ | 10,716,317 |   |
| Gas, Headspace, and  Other Analyzer Products |       | 2,540,640                         |       | 1,873,534                       |       | 7,361,352 |   | 6,461,006 |   |
| Other Instruments and  Services              |       | 344,494                           |       | 414,216                         |       | 1,152,567 |   | 1,319,530 |   |
| Total sales                                  |       | $                                 | 6,647,091  |                            | $          | 5,670,156 |   | $ | 19,506,526 |   | $ | 18,496,853 |   |

 

The following table setsforth the relationship between various components of domestic and foreign salesfor the third quarters and nine-month periods ended September 30, 2006 and2005.
|                      | ** ** | **Third Quarter Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------|------------|-----------------------------------|------------|---------------------------------|------------|
| ** **           | ** ** | **September 30,**            | ** ** | **September 30,**          | ** ** |
| ** **           | ** ** | **2006**                          | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Domestic sales       |       | $                                 | 2,889,646  |                            | $          | 2,622,292 |   | $ | 8,498,776 |   | $ | 9,001,677 |   |
| Foreign sales:       |       |                              |       |                            |       |   |   |   |   |
| Europe               |       | 1,789,097                         |       | 1,501,559                       |       | 5,339,239 |   | 4,669,561 |   |
| Asia                 |       | 1,441,035                         |       | 1,315,703                       |       | 4,173,539 |   | 3,744,889 |   |
| Other                |       | 527,313                           |       | 230,602                         |       | 1,494,972 |   | 1,080,726 |   |
| Total foreign  sales |       | 3,757,445                         |       | 3,047,864                       |       | 11,007,750 |   | 9,495,176 |   |
| Total sales          |       | $                                 | 6,647,091  |                            | $          | 5,670,156 |   | $ | 19,506,526 |   | $ | 18,496,853 |   |

 

Sales of our permeation products and services, whichaccounted for approximately 57% and 60% of our consolidated third quarter salesin 2006 and 2005, respectively, increased 11% during the third quarter 2006compared to the same period in 2005. This increase resulted from a 17% increase in shipments to ourinternational markets, which was impacted by a large order from China, where werecently had named a new sales representative organization.  Sales to our domestic markets in the thirdquarter 2006 were level with the same quarter in 2005.

Sales of our permeation products and services, whichaccounted for approximately 56% and 58% of our consolidated sales during thefirst nine months of 2006 and 2005, respectively, increased 3% during the firstnine months of 2006 compared to the same period in 2005.  This increase resulted from a 13% increase inshipments to our international markets offset somewhat by an 18% decrease insales to our domestic markets.  Althoughour domestic permeation market continues to be soft, we saw improvement in thethird quarter 2006 as sales increased 29% from the second quarter 2006.

Sales of our gas, headspace, and other analyzerproducts, which accounted for 38% and 33% of our consolidated third quartersales in 2006 and 2005, respectively, increased 36% during the third quarter2006 compared to the same period in 2005. Within this group, sales of our gas analyzer products through ourBaseline subsidiary increased 44% due in part to shipments of our new Series8900 analyzers.  Sales of our weighingand pharmaceutical products increased 84%, which increase was evenly spreadbetween domestic and foreign markets, and was due to increased demand.  Our weighing and pharmaceutical productsgroup consists of a relatively fewer number of products compared to our otherproduct groups and will typically experience significant fluctuations indemand.

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Sales of our headspace analyzer products wereapproximately the same in the third quarter 2006 compared to the same quarterin 2005, and a small increase in domestic shipments was offset by a similardecrease in international shipments.  Asa result of increased demand primarily in our domestic markets, sales of ourleak detection products increased 55% during the third quarter 2006 compared tothe same period in 2005.

Sales of our gas, headspace, and other analyzerproducts, which accounted for 38% and 35% of our consolidated sales for thefirst nine months of 2006 and 2005, respectively, increased 14% during thefirst nine months of 2006 compared to the same period in 2005.  Within this group, sales of our weighing andpharmaceutical products increased by 54%, which increase was evident in bothour domestic and foreign markets, and was due to increased demand.  Sales of our gas analyzer products throughour Baseline subsidiary increased 13% for the first nine months of 2006compared to the same period in 2005 with a 145% increase in internationalshipments being partially offset by a decrease in domestic shipments.  Sales of our headspace analyzer productsincreased 4% in the first nine months of 2006 compared to the same period in2005 primarily as a result of a 9% increase in domestic sales, partially offsetby a small decrease in foreign sales. Sales of our leak detection products increased 2% for the first ninemonths of 2006 compared to the same period in 2005, primarily as a result of a63% increase in domestic shipments offset by decreased foreign shipments.

Sales in our other instruments and services categorydecreased 17% in the third quarter 2006 compared to the same quarter in 2005due primarily to the sale of Lab Connections which occurred in the firstquarter 2006. This product group accounted for 5% and 7% of our consolidatedthird quarter sales in 2006 and 2005, respectively.

Sales in our other instruments and services categorydecreased 13% during the first nine months of 2006 compared to the same periodin 2005 due primarily to the sale of Lab Connections which occurred in thefirst quarter 2006. This decrease was offset by a 37% increase in contractanalytical testing services performed by our Microanalytics subsidiary.  This product group accounted for 6% and 7% ofour consolidated nine month sales in 2006 and 2005, respectively.

On a geographical basis, domestic and foreign salesaccounted for 43% and 57%, respectively, of our consolidated third quartersales in 2006, and 46% and 54%, respectively, for the same period in 2005.  Domestic and foreign sales accounted for 44%and 56%, respectively, of our sales for the first nine months of 2006, and 49%and 51% for the same period in 2005.

### *GrossProfit*

The gross profit margins for our products were 58.3%and 57.8% for the third quarters 2006 and 2005, respectively.  The higher margin for third quarter 2006 wasprimarily due to the shipment of new products which carry a higher profitmargin, the elimination of production inefficiencies due to the sale of our LabConnections subsidiary, and moving production of certain products in-house.

The gross profit margins for our consulting serviceswere 42.4% and 46.1%, respectively, for the third quarters ended September 30,2006 and 2005.  This decrease wasprimarily due to decreased demand for our consulting and developmental serviceswhich created the inability to fully absorb the related fixed overhead costs.

The gross profit margins for our products for thenine-month periods ended September 30, 2006 and 2005 were 58.7% and 56.6%,respectively.  The higher margin for thefirst nine months of 2006 was primarily due to the elimination of productioninefficiencies due to the sale of our Lab Connections subsidiary, movingproduction of certain products in-house, and a shift in product mix to highermargin items.

The gross profit margins for our consulting serviceswere 46.8% and 46.0% for the nine-month periods

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ended September 30, 2006 and 2005,respectively.  This increase wasprimarily due to normal fluctuations in pricing of contract developmental andanalytical services.

*Selling,General and Administrative Expenses*

### Selling,general and administrative (SG&A) expenses in the third quarter 2006 were$1,913,697, or 28.8% of sales, compared to $1,978,839, or 34.9% of sales in thethird quarter 2005.  The decrease inSG&A expenses was primarily due to lower headcount in 2006, reducedoperating costs in our Lab Connections subsidiary which was sold during thefirst quarter 2006, and reduced consulting costs related to Sarbanes-Oxley Actof 2002 (SOX) compliance in the third quarter 2006 compared to the same periodin 2005.

### SG&Aexpenses were $5,864,795, or 30.1% of sales, during the first nine months of2006, compared to $6,136,163, or 33.2% of sales, for the same period in2005.  The decrease in SG&A expenseswas primarily due to lower headcount in 2006, reduced operating costs in ourLab Connections subsidiary which was sold during the first quarter 2006, andlower SOX compliance costs in 2006 compared to 2005.

### *Researchand Development Expenses*

Research and development (R&D) expenses were$507,933, or approximately 7.6% of sales, in the third quarter 2006, comparedto $434,550, or approximately 7.7% of sales, in the same period of 2005.  R&D expenses as a percent of sales were7.3% and 6.7% for the nine-month periods ended September 30, 2006 and 2005,respectively.  This planned increase inR&D expenditures is considered by management to be necessary to develop newproducts to expand in our niche markets. For the foreseeable future, we expect to allocate on an annual basisapproximately 6% to 8% of sales to research and development.

### *OtherIncome*

Other income for the third quarter ended September30, 2006 of $107,648 consisted of interest income of $108,160 offset by othersmall losses.  Other income for the thirdquarter ended September 30, 2005 of $61,973 consisted of interest income of$53,081, a gain on foreign currency exchange of $9,120, offset by other lossesof $228.  For the nine months endedSeptember 30, 2006, other income of $425,568 consisted of interest income of$282,751, a $92,345 gain on the sale of Lab Connections, gain on sale of fixedassets of $60,481 and other income $1,631, offset by a loss on foreign currencyexchange of $11,640.  For the nine monthsended September 30, 2005, other income of $259,862 consisted of interest incomeof $140,481, gain on foreign currency exchange of $71,810, gain on sale offixed assets of $44,182 and other income of $3,389.  Interest income increased for the thirdquarter and nine months ended September 30, 2006 compared to the samerespective periods in 2005 due both to higher average yields and higher averagecash balances.

### *Income TaxExpense*

Our provision for income taxes from continuingoperations was 35.1% of income before income taxes for the third quarter endedSeptember 30, 2006, compared to 35.6% of income before income taxes for thethird quarter ended September 30, 2005.

For the nine months ended September 30, 2006, ourprovision for income taxes from continuing operations was 33.5% of incomebefore income taxes compared to 28.9% of income before income taxes for thenine months ended September 30, 2005. The rate for the first nine months of 2006 was favorably impacted by theresolution of a proposed income tax assessment in the state of New Jersey,which reduced income tax expense by approximately $50,000.  Also, because the sale of Lab Connections generateda taxable loss, there was no tax provision applicable to the $92,345 gain that

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was realized in the first quarter 2006. The rate forthe first nine months of 2005 was favorably impacted by the finalization of anInternal Revenue Service examination, which reduced income tax expense byapproximately $156,000 in the first quarter 2005 as well as benefiting from thenewly enacted tax law.  Based on currentoperating conditions and income tax laws, we expect the tax rate for theremaining quarter of 2006 to be in the range of 33% to 36%.

### *Net Income*

Net income was $968,509 in the third quarter 2006,compared to $594,003 in the third quarter 2005. Diluted net income was $0.18 per share in the third quarter 2006compared to $0.11 per share in the third quarter 2005.  For the nine months ended September 30, 2006,net income was $2,966,162, or $0.54 per diluted share, compared to net incomeof $2,163,214, or $0.39 per diluted share in the prior year period.

*Liquidityand Capital Resources*

We have historically financed our operations,capital expenditures and other liquidity needs through our cash flows generatedfrom operations.  Total cash, cashequivalents and marketable securities increased $2,664,771 during the firstnine months of 2006 to $11,686,140 as of September 30, 2006, compared to$9,021,369 at December 31, 2005. This was due in part to a significant reduction in inventory and tradeaccounts receivable, the receipt of the net proceeds from the sale of LabConnections of $478,721, and the exercise of stock options, offset by adecrease in current liabilities.  Ourworking capital as of September 30, 2006 increased $2,253,442 to $16,092,775,as compared to $13,839,333 at December 31, 2005.  We believe that a combination of our existingcash, cash equivalents and marketable securities, plus an expected continuationof cash flow from operations, will continue to be adequate to fund ouroperations, capital expenditures, dividend payments, stock repurchases, and thefinal required earnout payment to the former parent company of Lippke, for atleast the next twelve months.  However,one of our strategic objectives is, as market and business conditions warrant,to consider acquisitions of businesses, products or technologies.  We may need to fund such activities, shouldthey arise, with debt and/or equity financing, although no assurance can begiven that such debt and/or equity financing will be available at reasonableterms or at all.

*Cash Flow*

Cash Flow from OperatingActivities

Our primary source of funds is cash provided byoperating activities of continuing operations which totaled $3,462,591 and$2,504,743 in the first nine months of 2006 and 2005, respectively.  In the first nine months of 2006, the cashprovided by operating activities increased by $957,848, or 38%, compared to thefirst nine months of 2005.  The keycomponents of the increases in 2006 were net income of $2,966,162, the decreasein accounts receivable and inventories totaling $474,107 and the add-back ofnon-cash depreciation and amortization of $561,842.  Offsetting these increases were reductions inaccrued income taxes and other accrued expenses of $105,969 and $213,863,respectively, and the gain on disposition of long-term assets of $150,651.

### Cash Flow from Investing Activities

Cash used in investing activities of continuingoperations totaled $1,803,410 and $1,485,368 in the first nine months of 2006and 2005, respectively.  The proceedsfrom sale of subsidiary of $478,721 in the first nine months of 2006 related tothe sale of Lab Connections in the first quarter.  Purchases of marketable securities, net ofproceeds, were $1,991,885 in the first nine months of 2006.  Purchases of property, plant and equipmenttotaled $334,670 in the same period, primarily for additions of office, manufacturingand laboratory equipment, as compared to $166,482 in the first nine months of2005.  We had no material commitments forcapital expenditures as of September 30, 2006. We presently do

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not believe that any significant property, plant andequipment expenditures are required to accommodate our current level ofoperations.

Cash Flow from Financing Activities

Cash used in financing activities of continuingoperations consists primarily of the payment of dividends to ourshareholders.  During the first ninemonths of 2006 and 2005, we made dividend payments to our shareholders of$1,219,214 and $1,124,625, respectively, and purchases of our common stock inthe amount of $363,125 in 2006.  Partially offsetting these payments were theproceeds from the exercise of stock options in the amount of $473,843 and$341,140 in the first nine months of 2006 and 2005, respectively.

Our Board of Directors has authorized, dependingupon market conditions and other factors, the repurchase of up to a total of$2,000,000 of our common stock.  As ofSeptember 30, 2006, we had repurchased an aggregate of 41,500 shares of MOCONcommon stock under the program at a total cumulative cost of $363,125.  Therefore, as of September 30, 2006,$1,636,875 was remaining in this authorization.

***Contractual Obligations***

We refer you to our Annual Report on Form 10-K forthe year ended December 31, 2005 for a summary of our contractualobligations.  Except for the earnoutpayment paid in connection with the Lippke acquisition, there has been nomaterial change in this information.

### ***Off-BalanceSheet Arrangements***

Except foroperating leases entered into in the ordinary course of business and customaryindemnification obligations under certain of our agreements entered into in theordinary course of business, we do not have any material off-balance sheetarrangements.

***New Accounting Pronouncements***

InJune 2006, the FASB issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes* (FIN 48).  FIN 48 clarifies the accounting for incometaxes by prescribing the minimum recognition threshold a tax position isrequired to meet before being recognized in the financial statements.  FIN 48 also provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. The requirements are effective for fiscal years beginning after December15, 2006.  Although we are stillevaluating the impact that the adoption of FIN 48 will have on our consolidatedfinancial statements, we do not believe it will have a material impact.

InSeptember 2006, the FASB issued SFAS 157, *FairValue Measurement* (SFAS 157).  The standard provides guidancefor using fair value to measure assets and liabilities.  SFAS 157clarifies the principle that fair value should be based on the assumptionsmarket participants would use when pricing an asset or liability andestablishes a fair value hierarchy that prioritizes the information used todevelop those assumptions.  Under thestandard, fair value measurements would be separately disclosed by level withinthe fair value hierarchy.  The statementis effective for us beginning in 2008; however, early adoption is permitted. We have not yet determined the impact, if any, that the implementation ofSFAS 157 will have on our financial position, results of operations or cashflows.

***Critical Accounting Policies***

Our significant accounting policies are described inNote 1 to our condensed consolidated financial statements.  This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations is based upon our condensedconsolidated financial statements, which have been prepared

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in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these condensed consolidated financial statementsrequires management to make estimates and judgments that affect the reportedamount of assets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities.  TheSecurities and Exchange Commission has defined a company’s most criticalaccounting policies as those that are most important to the portrayal of itsfinancial condition and results of operations, and which require the company tomake its most difficult and subjective judgments, often as a result of the needto make estimates of matters that are inherently uncertain.  Based on this definition, we have identifiedthe following critical accounting policies. Although we believe that our estimates and assumptions are reasonable,they are based upon information available when they are made.  Actual results may differ significantly fromthese estimates under different assumptions or conditions.

*Allowance for doubtful accountsand sales returns* – Our allowance for doubtful accounts and salesreturns is for accounts receivable balances that are estimated to beuncollectible as well as sales returns. The reserve is based on a number of factors, including:  (1) an analysis of customer accounts and (2)our historical experience with accounts receivable write-offs and salesreturns.  The analysis includes the ageof the receivable, the financial condition of a customer or industry, andgeneral economic conditions.  We believeour financial results could be materially different if historical trends do notreflect actual results or if economic conditions worsened for ourcustomers.  In the event we determinedthat a smaller or larger allowance for doubtful accounts is appropriate, wewould record a credit or charge to selling, general and administrative expensein the period that we made such a determination.  As of September 30, 2006, we had $157,448reserved against our accounts receivable for doubtful accounts and salesreturns.

*Allowance for excess and obsoleteinventories*–**Weperform an analysis to identify excess and obsolete inventory.  We record a charge to cost of sales foramounts identified.  Our analysisincludes inventory levels, the nature of the finished product and its inherentrisk of obsolescence and the on-hand quantities relative to the sales historyof that finished product.  We believethat our financial results could be materially different if historical trendsdo not reflect actual results or if demand for our products decreased becauseof economic or competitive conditions or otherwise.

*Recoverability of long-livedassets*–**We assess therecoverability of goodwill and other long-lived assets annually or wheneverevents or changes in circumstances indicate that expected future undiscountedcash flows might not be sufficient to support the carrying amount of anasset.  We deem an asset to be impairedif a forecast of undiscounted future operating cash flows is less than an asset’scarrying amount.  If an asset isdetermined to be impaired, the loss is measured as the amount by which thecarrying value of the asset exceeds its fair value.  Changes in our business strategies, changesin the economic environment in which we operate, competitive conditions, andother factors could result in future impairment charges.

*Accrued product warranties*–**Our products are generally covered by awarranty, with warranty periods ranging from ninety days to one year from thedate of sale.  Estimated warranty costsare accrued in the same period in which the related revenue is recognized,based on anticipated parts and labor costs, utilizing historicalexperience.  Special warranty reservesare also accrued for major rework campaigns. We periodically assess the adequacy of our warranty reserves based onchanges in these factors and record any necessary adjustments if actual claimexperience indicates that adjustments are necessary.  Although we believe the likelihood to berelatively low, warranty claims experience could be materially different fromactual results due to manufacturing changes that could impact product quality,a change in our warranty policy in response to industry trends, as yetunrecognized defects in products sold, or other factors.  As of September 30, 2006, we had $262,632 accruedrelated to future estimated warranty claims.

*Income taxes*–**In the preparation of our consolidatedfinancial statements, management is required to estimate income taxes in eachof the jurisdictions in which we operate. This process involves estimating

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actual current tax exposures together with assessingtemporary differences resulting from differing treatment of items for tax andaccounting purposes. These differences result in deferred tax assets andliabilities, which are included in our consolidated balance sheet.

We have deferred tax assets which management reviewsfor recoverability on a quarterly basis and assesses the need for valuationallowances. These deferred tax assets are evaluated by considering historicallevels of income, estimates of future taxable income streams and the impact oftax planning strategies. A valuation allowance is recorded to reduce deferredtax assets when it is determined that it is more likely than not that we wouldnot be able to realize all or part of our deferred tax assets. We carried novaluation allowance against our net deferred tax assets at either September 30,2006 or 2005.

### ***Forward-LookingStatements***

This quarterlyreport on Form 10-Q contains not only historical information, but also forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933and Section 21E of the Securities Exchange Act of 1934, and are subject tothe safe harbor created by those statutes. In addition, we or others on our behalf may make forward-lookingstatements from time to time in oral presentations, including telephoneconferences and/or web casts open to the public, in press releases or reports,on our internet website or otherwise. Statements that are not historical are forward-looking and reflectexpectations and assumptions.  We try toidentify forward-looking statements in this report and elsewhere by using wordssuch as “may,” “will,” “should,” “expects,” “anticipates,” “contemplates,” “estimates,”“believes,” “plans,” “projected,” “predicts,” “potential” or “continue” or thenegative of these or similar terms. Examples of forward-looking statements in this report include, but arenot limited to, statements regarding our expectation of improved domestic salesdue to new product introductions, our allocation of 6% to 8% of our sales toresearch and development expenses, our expected tax rate for the remainingquarter of 2006 being in the range of 33% to 36%, our belief that nosignificant future capital expenditures are required to accommodate our currentlevel of operations, our expectations regarding future cash expenditures, andthe effect of new accounting pronouncements on our financial position, resultsof operations and cash flows.

Forward-lookingstatements are based on current expectations about future events affecting usand are subject to uncertainties and factors that affect all businessesoperating in a global market as well as matters specific to MOCON.  These uncertainties and factors are difficultto predict and many of them are beyond our control. The following are some ofthe uncertainties and factors known to us that could cause our actual resultsto differ materially from what we have anticipated in our forward-lookingstatements:

·                  Increases in prices for rawmaterials;

·                  Risks inherent in operatinginternationally and selling and shipping our products and purchasing ourproducts and components internationally;

·                  Fluctuations in foreigncurrency exchange rates and interest rates;

·                  Failure to develop newproducts and technologies, delays in new product introduction and lack ofmarket acceptance of new products;

·                  Failure to effect strategicacquisitions and integrate effectively newly acquired operations;

·                  Incurrence of additionaldebt, contingent liabilities and expenses in connection with futureacquisitions;

·                  Decreases in capitalspending;

·                  Exposure to assertions ofintellectual property claims and failure to protect our intellectual property;

·                  Disruption in our ability tomanufacture our products or the ability of our key suppliers to provide usproducts or components or raw materials for products resulting in our inabilityto supply market demand for our products;

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·                  Reliance on independentsales distributors and sales associates to market and sell our products;

·                  Highly competitive nature ofthe markets in which we sell our products and the introduction of competingproducts;

·                  Loss of customers;

·                  Failure to retain seniormanagement or replace lost senior management;

·                  Employee slowdowns, strikesor similar actions;

·                  Reliance on our managementinformation systems for inventory management, distribution and other functions;

·                  Effects of any pending orthreatened litigation;

·                  Failure to comply withapplicable laws and regulations and adverse changes in applicable laws orregulations;

·                  Changes in generallyaccepted accounting principles; or

·                  Conditions and changes ingeneral economic and business conditions.

 

For moreinformation regarding these and other uncertainties and factors that couldcause our actual results to differ materially from what we have anticipated inour forward-looking statements or otherwise could materially adversely affectour business, financial condition or operating results, see our annual reporton Form 10-K for the fiscal year ended December 31, 2005 under the heading “PartI – Item 1A.  Risk Factors” on pages 8through 13 of such report.

Allforward-looking statements included in this report are expressly qualified intheir entirety by the foregoing cautionary statements.  We wish to caution readers not to place unduereliance on any forward-looking statement that speaks only as of the date madeand to recognize that forward-looking statements are predictions of futureresults, which may not occur as anticipated. Actual results could differ materially from those anticipated in theforward-looking statements and from historical results, due to the risks anduncertainties described above, as well as others that we may considerimmaterial or do not anticipate at this time. Although we believe that theexpectations reflected in our forward-looking statements are reasonable, we donot know whether our expectations will prove correct.  Our expectations reflected in ourforward-looking statements can be affected by inaccurate assumptions we mightmake or by known or unknown uncertainties and factors, including thosedescribed above.  The risks anduncertainties described above are not exclusive and further informationconcerning us and our business, including factors that potentially could materiallyaffect our financial results or condition, may emerge from time to time.  We assume no obligation to updateforward-looking statements to reflect actual results or changes in factors orassumptions affecting such forward-looking statements.  We advise you, however, to consult anyfurther disclosures we make on related subjects in our quarterly reports onForm 10-Q and current reports on Form 8-K we file with or furnish to theSecurities and Exchange Commission.

Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk

*Equity Price and Interest RateRisk*

Substantiallyall of our marketable securities are at fixed interest rates and all of ourmarketable securities mature within two years or less; therefore, we believethat the market risk arising from the holding of these financial instruments isminimal.

### *ForeignCurrency Exchange Risk*

Because ourproducts are manufactured or sourced primarily from the United States, astronger U.S. dollar generally has a negative impact on our results fromoperations outside of the United States while a weaker dollar generally has apositive effect.  We currently sell ourproducts and services in United

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States dollarsor the local currency of our foreign subsidiary (euros).  Accordingly, our foreign operations expose usto foreign currency exchange risk when the euro currency results of operationsare translated to United States dollars. While we historically have not experienced any material foreign currencytranslation losses, we may engage in hedging activity in the future to minimizethis risk.  Our net investment in foreignsubsidiary translated into U.S. dollars is not hedged.  Any changes in foreign currency exchangerates will be reflected as a foreign currency translation adjustment, acomponent of accumulated other comprehensive income in stockholders’ equity,and would not impact our net income.

Item 4.  Controls and Procedures

*Evaluation of Disclosure Controlsand Procedures*

We maintaindisclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)and 15d-15(e)) that are designed to ensure that information required to bedisclosed by us in the reports we file or submit under the Securities ExchangeAct of 1934, as amended, is recorded, processed, summarized, and reported,within the time periods specified in the Securities and Exchange Commission’srules and forms and that such information is accumulated and communicated toour management, including our principal executive and principal financialofficers, or persons performing similar functions, as appropriate to allowtimely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, werecognize that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and we necessarily are required to apply our judgment inevaluating the cost-benefit relationship of possible controls andprocedures.  Our management evaluated,with the participation of our Chief Executive Officer and Chief FinancialOfficer, the effectiveness of the design and operation of our disclosurecontrols and procedures as of the end of the period covered in this QuarterlyReport on Form 10-Q.  Based on thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective as of the end ofsuch period, to provide reasonable assurance that information required to bedisclosed in our Exchange Act reports is recorded, processed, summarized, andreported within the time periods specified in the SEC’s rules and forms, andthat material information relating to our Company and our consolidatedsubsidiaries is made known to management, including our Chief ExecutiveOfficer, and Chief Financial Officer, particularly during the period when ourperiodic reports are being prepared.

*Changes in Internal Control OverFinancial Reporting*

There was nochange in our internal control over financial reporting that occurred duringour quarter ended September 30, 2006 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

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PART II.  OTHER INFORMATION

Item1A.  Risk Factors

Weare affected by risks specific to us as well as factors that affect allbusinesses operating in a global market. The significant factors known to us that could materially adverselyaffect our business, financial condition or operating results are described inour annual report on Form 10-K for the fiscal year ended December 31, 2005under the heading “Part I — Item 1A. Risk Factors.”  There has been no material change in thoserisk factors.

Item2.  Unregistered Sales of EquitySecurities, Use of Proceeds and Issuer Purchases of Equity Securities

*UnregisteredSales of Equity Securities*

Wedid not sell any equity securities of MOCON, Inc. during the third quarterended September 30, 2006 that were not registered under the Securities Act of1933.

*IssuerRepurchases of Equity Securities*

Wedid not repurchase any equity securities of MOCON, Inc. during the thirdquarter ended September 30, 2006.

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Item 6.  Exhibits

Thefollowing exhibits are being filed or furnished with this quarterly report onForm 10-Q:
| Exhibit  No. | ** ** | **Description**                                                                                     |
|--------------|------------|-----------------------------------------------------------------------------------------------------|
| 31.1         |       | Certification of Chief Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |
|         |       |                                                                                                |
| 31.2         |       | Certification of Chief Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |
|         |       |                                                                                                |
| 32.1         |       | Certification of Chief Executive Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
|         |       |                                                                                                |
| 32.2         |       | Certification of Chief Financial Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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SIGNATURES

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned hereunto duly authorized.

 
|                               | MOCON, INC.                                  |   |
|-------------------------------|----------------------------------------------|--------|
|                          |                                         |   |
|                          |                                         |   |
| Date:  November 13, 2006 | /s/ Robert L. Demorest                       |   |   |
|                          | Robert L. Demorest                           |   |
|                          | Chairman, President and Chief                |   |
|                          | Executive Officer                            |   |
|                          | (Principal Executive Officer)                |   |
|                          |                                         |   |
|                          |                                         |   |
| Date:  November 13, 2006 | /s/ Darrell B. Lee                           |   |   |
|                          | Darrell B. Lee                               |   |
|                          | Vice President, Treasurer and Chief          |   |
|                          | Financial Officer                            |   |
|                          | (Principal Financial and Accounting Officer) |   |

 

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MOCON, INC.

QUARTERLY REPORT ON FORM 10-Q

QUARTER ENDED SEPTEMBER 30,2006

EXHIBITINDEX
| Exhibit  No. | ** ** | **Description**                                                                                               | ** ** | **Method of  Filing** |
|--------------|------------|---------------------------------------------------------------------------------------------------------------|------------|-----------------------|
| 31.1         |       | Certification of Chief Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002      |       | Filed herewith        |
|         |       |                                                                                                          |       |                  |
| 31.2         |       | Certification of Chief Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002      |       | Filed herewith        |
|         |       |                                                                                                          |       |                  |
| 32.1         |       | Certification of Chief Executive Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |       | Furnished  herewith   |
|         |       |                                                                                                          |       |                  |
| 32.2         |       | Certification of Chief Financial Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |       | Furnished  herewith   |

 

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