**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

##### **FORM 10-Q**

##### ** **

**(MarkOne)**

**ý****Quarterly Report Pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934**

**For the Quarter Ended September 30, 2005**

 

**or**

 

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

**For the transition period from                 to                 **

 

**Commission File Number 0-9273**

 

**MOCON, INC.**

(Exact name ofregistrant 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 executive  offices)           (Zip  code) |

 

**(763) 493-6370**

(Registrant’s telephone number, including area code)

 

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

 

YES ý  NOo

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

 

YES oNO  ý

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

 

YES oNO  ý

 

 

5,395,146 Common Shareswere outstanding as of October 31, 2005.

 

 

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MOCON, INC. AND SUBSIDIARIES

 

INDEX TO FORM 10-Q

For the Quarter Ended September 30, 2005

 
| PART I.  FINANCIAL INFORMATION                                                                                    |   |
|------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                   |   |
| Item 1. Financial Statements                                                                                           |   |
| Condensed  Consolidated Balance Sheets  September 30, 2005 (Unaudited) and December 31, 2004                 |   |
|                                                                                                                   |   |
| Condensed  Consolidated Statements of Income (Unaudited)  Three and nine months ended September 30, 2005 and 2004 |   |
|                                                                                                                   |   |
| Condensed  Consolidated Statements of Cash Flows (Unaudited)  Nine months ended September 30, 2005 and 2004       |   |
|                                                                                                                   |   |
| Notes to Condensed Consolidated Financial Statements  (Unaudited)                                                      |   |
|                                                                                                                   |   |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                    |   |
|                                                                                                                   |   |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                                    |   |
|                                                                                                                   |   |
| Item 4. Controls and Procedures                                                                                        |   |
|                                                                                                                   |   |
| PART II.  OTHER INFORMATION                                                                                       |   |
|                                                                                                                   |   |
| Item 2. Unregistered Sales of Equity Securities, Use  of Proceeds and Issuer Purchases of Equity Securities            |   |
|                                                                                                                   |   |
| Item 6. Exhibits                                                                                                       |   |
|                                                                                                                   |   |
| Signatures                                                                                                             |   |

 

 

*Inthis report, references to “MOCON,” “the Company,” “we,” “our,” or “us,” unlessthe context otherwise requires, refer to MOCON, Inc. and it subsidiaries.*

 

*Alltrademarks or trade names referred to in this report are the property of theirrespective owners.*

 

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PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

MOCON, INC. & SUBSIDIARIES

 

CONDENSEDCONSOLIDATED BALANCE SHEETS

 
| ** **                                                                                                                                        | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                        | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ASSETS                                                                                                                                            |       |                   |       |                  |       |
| Current assets:                                                                                                                                   |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                         |       | $                      | 2,883,535  |                  | $          | 2,648,879 |   |
| Marketable securities, current                                                                                                                    |       | 6,116,668              |       | 4,808,840             |       |
| Trade accounts receivable, less allowance for  doubtful accounts of $209,495 in 2005 and $222,040 in 2004                                         |       | 2,994,251              |       | 4,297,884             |       |
| Other receivables                                                                                                                                 |       | 137,001                |       | 44,941                |       |
| Inventories                                                                                                                                       |       | 4,238,477              |       | 3,778,376             |       |
| Prepaid expenses                                                                                                                                  |       | 420,966                |       | 362,607               |       |
| Deferred income taxes                                                                                                                             |       | 435,864                |       | 435,864               |       |
| Assets of discontinued operations                                                                                                                 |       | —                 |       | 221,793               |       |
| Total current assets                                                                                                                              |       | 17,226,762             |       | 16,599,184            |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Marketable securities, noncurrent                                                                                                                 |       | 284,081                |       | 231,000               |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Property, plant and equipment, net of accumulated  depreciation of $4,664,010 in 2005 and $4,558,195 in 2004                                      |       | 1,645,003              |       | 1,954,998             |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Other assets:                                                                                                                                     |       |                   |       |                  |       |
| Software development costs, net of accumulated  amortization of $926,649 in 2005 and $766,490 in 2004                                             |       | 79,772                 |       | 239,931               |       |
| Goodwill                                                                                                                                          |       | 2,315,774              |       | 2,315,774             |       |
| Technology rights and other intangibles, net                                                                                                      |       | 851,752                |       | 1,030,847             |       |
| Other                                                                                                                                             |       | 163,419                |       | 143,803               |       |
| Total other assets                                                                                                                                |       | 3,410,717              |       | 3,730,355             |       |
|                                                                                                                                              |       |                   |       |                  |       |
| TOTAL ASSETS                                                                                                                                      |       | $                      | 22,566,563 |                  | $          | 22,515,537 |   |
|                                                                                                                                              |       |                   |       |                  |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                         |       |                   |       |                  |       |
| Current liabilities:                                                                                                                              |       |                   |       |                  |       |
| Accounts payable                                                                                                                                  |       | $                      | 1,497,600  |                  | $          | 2,107,268 |   |
| Accrued compensation and vacation                                                                                                                 |       | 854,605                |       | 1,024,958             |       |
| Other accrued expenses                                                                                                                            |       | 487,296                |       | 457,640               |       |
| Accrued product warranties                                                                                                                        |       | 344,096                |       | 352,634               |       |
| Accrued income taxes                                                                                                                              |       | 240,823                |       | 455,718               |       |
| Dividends payable                                                                                                                                 |       | 377,660                |       | 373,694               |       |
| Total current liabilities                                                                                                                         |       | 3,802,080              |       | 4,771,912             |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Obligations to former employees                                                                                                                   |       | 99,535                 |       | 112,720               |       |
| Minimum earnout payable                                                                                                                           |       | 109,366                |       | 247,708               |       |
| Deferred income taxes                                                                                                                             |       | 132,581                |       | 182,651               |       |
| Total noncurrent liabilities                                                                                                                      |       | 341,482                |       | 543,079               |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Total liabilities                                                                                                                                 |       | 4,143,562              |       | 5,314,991             |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                        |       |                   |       |                  |       |
| Capital stock – undesignated – authorized 3,000,000  shares                                                                             |       | —                 |       | —                |       |
| Common stock – $0.10 par value. Authorized  22,000,000 shares; issued and outstanding 5,395,146 shares in 2005 and  5,338,489 shares in 2004 |       | 539,515                |       | 533,849               |       |
| Capital in excess of par value                                                                                                                    |       | 535,179                |       | 199,705               |       |
| Retained earnings                                                                                                                                 |       | 17,412,332             |       | 16,377,709            |       |
| Accumulated other comprehensive (loss) income                                                                                                     |       | (64,025                | )          | 89,283                |       |
| Total stockholders’ equity                                                                                                                   |       | 18,423,001             |       | 17,200,546            |       |
|                                                                                                                                              |       |                   |       |                  |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                   |       | $                      | 22,566,563 |                  | $          | 22,515,537 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

1

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MOCON, INC. & SUBSIDIARIES

 

CONDENSEDCONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Sales:                                                    |       |                   |       |                   |       |   |   |   |   |
| Products                                                  |       | $                      | 5,187,526  |                   | $          | 5,891,612 |   | $ | 17,123,558 |   | $ | 16,718,271 |   |
| Consulting services                                       |       | 482,630                |       | 458,388                |       | 1,373,295 |   | 1,438,685 |   |
| Total sales                                               |       | 5,670,156              |       | 6,350,000              |       | 18,496,853 |   | 18,156,956 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Cost of sales:                                            |       |                   |       |                   |       |   |   |   |   |
| Products                                                  |       | 2,188,766              |       | 2,608,024              |       | 7,434,953 |   | 7,523,439 |   |
| Consulting services                                       |       | 260,105                |       | 243,243                |       | 742,143 |   | 724,441 |   |
| Total cost of sales                                       |       | 2,448,871              |       | 2,851,267              |       | 8,177,096 |   | 8,247,880 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Gross profit                                              |       | 3,221,285              |       | 3,498,733              |       | 10,319,757 |   | 9,909,076 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Selling, general, and administrative expenses             |       | 1,978,839              |       | 2,036,701              |       | 6,136,163 |   | 6,190,747 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Research and development expenses                         |       | 434,550                |       | 293,474                |       | 1,252,402 |   | 1,000,603 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Operating income                                          |       | 807,896                |       | 1,168,558              |       | 2,931,192 |   | 2,717,726 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Other income                                              |       | 61,973                 |       | 38,296                 |       | 259,862 |   | 111,050 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Income before income taxes                                |       | 869,869                |       | 1,206,854              |       | 3,191,054 |   | 2,828,776 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Income taxes                                              |       | 309,606                |       | 410,867                |       | 920,627 |   | 962,701 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Income from continuing operations                         |       | 560,263                |       | 795,987                |       | 2,270,427 |   | 1,866,075 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Gain (loss) from discontinued operations                  |       | 53,134                 |       | (106,485               | )          | (168,840 | ) | (270,414 | ) |
| Income tax (expense) benefit from discontinued operations |       | (19,394                | )          | 38,867                 |       | 61,627 |   | 98,701 |   |
| Gain (loss) from discontinued operations, net of tax      |       | 33,740                 |       | (67,618                | )          | (107,213 | ) | (171,713 | ) |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Net income                                                |       | $                      | 594,003    |                   | $          | 728,369 |   | $ | 2,163,214 |   | $ | 1,694,362 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Basic net income per common share:                        |       |                   |       |                   |       |   |   |   |   |
| Income from continuing operations                         |       | $                      | 0.10       |                   | $          | 0.15 |   | $ | 0.42 |   | $ | 0.35 |   |
| Gain (loss) from discontinued operations                  |       | 0.01                   |       | (0.01                  | )          | (0.02 | ) | (0.03 | ) |
| Basic net income per common share:                        |       | $                      | 0.11       |                   | $          | 0.14 |   | $ | 0.40 |   | $ | 0.32 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Basic weighted average common shares outstanding          |       | 5,387,771              |       | 5,306,831              |       | 5,361,129 |   | 5,362,036 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Diluted net income per common share:                      |       |                   |       |                   |       |   |   |   |   |
| Income from continuing operations                         |       | $                      | 0.10       |                   | $          | 0.14 |   | $ | 0.41 |   | $ | 0.34 |   |
| Gain (loss) from discontinued operations                  |       | 0.01                   |       | (0.01                  | )          | (0.02 | ) | (0.03 | ) |
| Diluted net income per common share:                      |       | $                      | 0.11       |                   | $          | 0.13 |   | $ | 0.39 |   | $ | 0.31 |   |
|                                                      |       |                   |       |                   |       |   |   |   |   |
| Diluted weighted average common shares outstanding        |       | 5,554,657              |       | 5,418,440              |       | 5,535,244 |   | 5,473,336 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

2

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MOCON, INC. & SUBSIDIARIES

 

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 
| ** **                                                                                                                          | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                          | ** ** | **September 30,** | ** ** |
| ** **                                                                                                                          | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                                                                               |       |                   |       |   |   |
| Net income                                                                                                                          |       | $                      | 2,163,214  |   | $ | 1,694,362 |   |
| Loss from discontinued operations, net of tax                                                                                       |       | 107,213                |       | 171,713 |   |
| Income from continuing operations                                                                                                   |       | 2,270,427              |       | 1,866,075 |   |
| Adjustments to reconcile income from continuing  operations to net cash provided by operating activities of continuing  operations: |       |                   |       |   |   |
| (Gain) loss on disposition of long-term assets                                                                                      |       | (22,412                | )          | 2,212 |   |
| Depreciation and amortization                                                                                                       |       | 758,292                |       | 1,026,738 |   |
| Deferred income taxes                                                                                                               |       | (50,070                | )          | (162,165 | ) |
| Changes in operating assets and liabilities, net of  effect of acquisition in 2004:                                                 |       |                   |       |   |   |
| Trade accounts receivable                                                                                                           |       | 1,380,134              |       | 299,768 |   |
| Other receivables                                                                                                                   |       | (94,118                | )          | (57,954 | ) |
| Inventories                                                                                                                         |       | (513,472               | )          | 417,456 |   |
| Prepaid expenses                                                                                                                    |       | (60,577                | )          | (73,795 | ) |
| Accounts payable                                                                                                                    |       | (644,498               | )          | 353,109 |   |
| Accrued compensation and vacation                                                                                                   |       | (150,050               | )          | (153,244 | ) |
| Other accrued expenses                                                                                                              |       | (154,591               | )          | (177,975 | ) |
| Accrued product warranties                                                                                                          |       | —                 |       | 14,989 |   |
| Accrued income taxes                                                                                                                |       | (214,322               | )          | 8,583 |   |
| Net cash provided by operating activities of  continuing operations                                                                 |       | 2,504,743              |       | 3,363,797 |   |
|                                                                                                                                |       |                   |       |   |   |
| Cash flows from investing activities:                                                                                               |       |                   |       |   |   |
| Cash paid in acquisitions, net of cash acquired                                                                                     |       | —                 |       | (468,684 | ) |
| Purchases of marketable securities                                                                                                  |       | (5,249,050             | )          | (2,923,966 | ) |
| Proceeds from sales or maturities of marketable  securities                                                                         |       | 3,886,120              |       | 3,629,530 |   |
| Purchases of property and equipment                                                                                                 |       | (166,482               | )          | (269,876 | ) |
| Proceeds from sale of fixed assets                                                                                                  |       | 94,415                 |       | — |   |
| Purchases of patents and trademarks                                                                                                 |       | (30,755                | )          | (29,513 | ) |
| Other                                                                                                                               |       | (19,616                | )          | (5,065 | ) |
| Net cash used in investing activities of continuing  operations                                                                     |       | (1,485,368             | )          | (67,574 | ) |
|                                                                                                                                |       |                   |       |   |   |
| Cash flows from financing activities:                                                                                               |       |                   |       |   |   |
| Proceeds from the exercise of stock options                                                                                         |       | 341,140                |       | 95,263 |   |
| Purchases and retirement of common stock                                                                                            |       | —                 |       | (900,360 | ) |
| Dividends paid to former parent company of Paul  Lippke Handels                                                                     |       | —                 |       | (449,087 | ) |
| Dividends paid to MOCON shareholders                                                                                                |       | (1,124,625             | )          | (1,048,132 | ) |
| Net cash used in financing activities of continuing  operations                                                                     |       | (783,485               | )          | (2,302,316 | ) |
|                                                                                                                                |       |                   |       |   |   |
| Net cash provided by (used in) discontinued  operations                                                                             |       | 114,580                |       | (154,554 | ) |
|                                                                                                                                |       |                   |       |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                                                                       |       | (115,814               | )          | 5,957 |   |
|                                                                                                                                |       |                   |       |   |   |
| Net increase in cash and cash equivalents                                                                                           |       | 234,656                |       | 845,310 |   |
|                                                                                                                                |       |                   |       |   |   |
| Cash and cash equivalents:                                                                                                          |       |                   |       |   |   |
| Beginning of period                                                                                                                 |       | 2,648,879              |       | 1,399,837 |   |
| End of period                                                                                                                       |       | $                      | 2,883,535  |   | $ | 2,245,147 |   |
|                                                                                                                                |       |                   |       |   |   |
| Supplemental disclosures of cash flow information:                                                                                  |       |                   |       |   |   |
| Cash paid during the period for income taxes                                                                                        |       | $                      | 1,123,173  |   | $ | 1,124,823 |   |
|                                                                                                                                |       |                   |       |   |   |
| Supplemental schedule of noncash investing and  financing activities:                                                          |       |                   |       |   |   |
| Unrealized holding loss on available-for-sale  securities                                                                           |       | $                      | (2,021     | ) | $ | (4,515 | ) |
| Dividends accrued                                                                                                                   |       | 377,660                |       | 344,970 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

3

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MOCON, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1 – CondensedConsolidated Financial Statements

 

The condensedconsolidated balance sheet as of September 30, 2005, the condensedconsolidated statements of income for the three- and nine-month periods ended September 30,2005 and 2004, and the condensed consolidated statements of cash flows for thenine-month periods ended September 30, 2005 and 2004 have been prepared byus, without audit.  However, alladjustments (consisting solely of normal recurring adjustments) which are, inthe opinion of management, necessary to present fairly the financial position,results of operations and cash flows at September 30, 2005, and for allperiods presented, have been made.  Theresults of operations for the three- and nine-month periods ended September 30,2005 are not necessarily indicative of operating results for 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 ended December 31,2004, previously filed with the Securities and Exchange Commission.

 

We operate in a singleindustry segment:  the development,manufacturing, and marketing of measurement, analytical, monitoring, samplepreparation, and consulting products used to detect, measure, and analyze gasesand chemical compounds for customers in the barrier packaging, food,pharmaceutical, and other industries throughout the world.

 

*Principlesof Consolidation*

 

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

 

*ForeignCurrency Translation*

 

The financial statementsfor operations outside the United States are maintained in their localcurrency.  All assets and liabilities ofour foreign subsidiary are translated to United States dollars at period-endexchange rates, while revenue and expense accounts are translated at theaverage 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 ofEstimates*

 

The preparation ofconsolidated 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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*Stock-BasedCompensation*

 

We use theintrinsic-value method for employee stock-based compensation pursuant toAccounting Principles Board Opinion No. 25 (Opinion 25), *Accounting for Stock Issued to Employees*.  Under the guidelines of Opinion 25,compensation cost for stock-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 the stock.

 

We have adopted thedisclosure-only provisions for employee stock-based compensation and thefair-value method for nonemployee stock-based compensation of Statement of FinancialAccounting Standard (SFAS) No. 123, *Accounting for Stock-BasedCompensation*.  Theseprovisions require us to show, on a pro forma basis, our net income and incomeper common share as if we had recorded an expense for our stock options at thetime of grant.  Other than disclosure inthis footnote, we do not use these pro forma results for any purpose.  No stock options were granted during thethree- and nine-month periods ended September 30, 2005 and 2004.

 

Had we recordedcompensation cost based on the estimated fair value on the date of grant, asdefined by SFAS No. 123, our net income and net income per common sharewould have been reduced to the pro forma amounts indicated below:

 

| ** **                                                                                                                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income – as reported                                                                                                                 |       | $                                          | 594,003    |                                      | $          | 728,369 |   | $ | 2,163,214 |   | $ | 1,694,362 |   |
|                                                                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | (27,414                                    | )          | (38,200                                   | )          | (84,135 | ) | (118,378 | ) |
| Net income – pro forma                                                                                                                   |       | $                                          | 566,589    |                                      | $          | 690,169 |   | $ | 2,079,079 |   | $ | 1,575,984 |   |
|                                                                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Net income per common share – as reported:                                                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                                                                                         |       | $                                          | 0.11       |                                      | $          | 0.14 |   | $ | 0.40 |   | $ | 0.32 |   |
| Diluted                                                                                                                                       |       | $                                          | 0.11       |                                      | $          | 0.13 |   | $ | 0.39 |   | $ | 0.31 |   |
| Net income per common share – pro forma:                                                                                                 |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                                                                                         |       | $                                          | 0.11       |                                      | $          | 0.13 |   | $ | 0.39 |   | $ | 0.29 |   |
| Diluted                                                                                                                                       |       | $                                          | 0.10       |                                      | $          | 0.13 |   | $ | 0.38 |   | $ | 0.29 |   |

 

In December 2004,the FASB issued Statement of Financial Accounting Standards No. 123(revised 2004), *Share-Based Payments* (FAS123(R)), which is a revision of SFAS No.123 and supersedes Opinion 25.  FAS 123(R) requires all share-based paymentsto employees, including grants of employee stock options, to be recognized inthe income statement based on their fair values.  Pro forma disclosure is no longer analternative.  FAS 123(R) is effective atthe beginning of the first annual period beginning after June 15,2005.  We expect to adopt FAS 123(R) on January 1,2006.  The ultimate amount of increasedcompensation expense will be dependent on the number of options granted, theirtiming and vesting periods, and the method used to calculate the fair value ofthe awards, among other things.

 

5

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*Reclassifications*

 

Certain 2004 amounts havebeen reclassified to conform to the 2005 presentation.

 

Note 2 – Inventories

 

Inventoriesconsist of the following:

 

| ** **         | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------|------------|------------------------------|------------|-----------------------------|------------|
| Finished  products |       | $                            | 711,993    |                        | $          | 717,507 |   |
| Work-in-process    |       | 1,791,588                    |       | 1,395,364                   |       |
| Raw materials      |       | 1,734,896                    |       | 1,665,505                   |       |
|               |       | $                            | 4,238,477  |                        | $          | 3,778,376 |   |

 

Note 3 – Net Income PerCommon Share

 

Basic net income percommon share is computed by dividing net income by the weighted average numberof shares 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 tablepresents a reconciliation of the denominators used in the computation of netincome per common share – basic, and net income per common share – diluted, forthe three- and nine-month periods endedSeptember 30, 2005 and 2004:

 

| ** **                                                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                              | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted shares of common stock  outstanding – basic               |       | 5,387,771                                  |       | 5,306,831                                 |       | 5,361,129 |   | 5,362,036 |   |
| Weighted shares of common stock assumed upon  exercise of stock options |       | 166,886                                    |       | 111,609                                   |       | 174,115 |   | 111,300 |   |
| Weighted shares of common stock  outstanding – diluted             |       | 5,554,657                                  |       | 5,418,440                                 |       | 5,535,244 |   | 5,473,336 |   |

 

Note 4 – Goodwill andIntangible Assets

 

As of September 30,2005 and December 31, 2004, unamortized goodwill amounted to$2,315,774.  Other identifiableintangible assets are as follows:

 
| ** **                  | ** ** | **As of September 30, 2005** | ** ** |
|-----------------------------|------------|-----------------------------------|------------|
| ** **                  | ** ** | **Carrying  Amount**              | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** | **Estimated  Useful Lives** | ** ** |
| Patents                     |       | $                                 | 580,299    |   | $ | 240,530 |   | $ | 339,769 |   | 10 to 17 years |   |
| Trademarks and  trade names |       | 391,218                           |       | 142,005 |   | 249,213 |   | 5 to 17 years |   |
| Technology  rights          |       | 184,008                           |       | 140,197 |   | 43,811 |   | 7 to 10 years |   |
| Other  intangibles          |       | 715,043                           |       | 496,084 |   | 218,959 |   | Less than 1 year to 5 years |   |
|                        |       | $                                 | 1,870,568  |   | $ | 1,018,816 |   | $ | 851,752 |   |   |   |

 

6

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| ** **                  | ** ** | **As of December 31, 2004** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **Carrying  Amount**             | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** | **Estimated  Useful Lives** | ** ** |
| Patents                     |       | $                                | 548,748    |   | $ | 221,288 |   | $ | 327,460 |   | 10 to 17 years |   |
| Trademarks and  trade names |       | 392,015                          |       | 90,413 |   | 301,602 |   | 5 to 17 years |   |
| Technology  rights          |       | 184,008                          |       | 120,481 |   | 63,527 |   | 7 to 10 years |   |
| Other  intangibles          |       | 715,043                          |       | 376,785 |   | 338,258 |   | Less than 1 year to 5 years |   |
|                        |       | $                                | 1,839,814  |   | $ | 808,967 |   | $ | 1,030,847 |   |   |   |

 

Total amortizationexpense for the three and nine months ended September 30, 2005 was $73,655and $220,871, respectively.  Estimatedamortization expense for the remainder of 2005 and each of the four succeedingfiscal years based on the intangible assets as of September 30, 2005 is asfollows:

 

| ** ** | ** ** | **Estimated  Expense** | ** ** |
|------------|------------|------------------------|------------|
| 2005       |       | $                      | 72,637     |   |
| 2006       |       | $                      | 280,148    |   |
| 2007       |       | $                      | 163,372    |   |
| 2008       |       | $                      | 106,661    |   |
| 2009       |       | $                      | 43,960     |   |

###  

### 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.  A decline in themarket value of any available-for-sale security below cost that is deemed otherthan temporary is charged to income resulting in the establishment of a newcost basis for the security.  At September 30,2005 and September 30, 2004, this resulted in a net cumulative unrealizedloss of $4,781 and $1,297, respectively, within stockholders’ equity.

 

Note 6 – ComprehensiveIncome

 

Other comprehensiveincome pertains to net unrealized gains and losses on marketable securities andforeign currency translation adjustments that are not included in net incomebut rather are recorded directly in stockholders’ equity.

 
| ** **                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                                           |       | $                                          | 594,003    |                                      | $          | 728,369 |   | $ | 2,163,214 |   | $ | 1,694,362 |   |
| Foreign currency  translation adjustment             |       | (4,281                                     | )          | 12,495                                    |       | (151,287 | ) | (851 | ) |
| Net unrealized  (loss) gain on marketable securities |       | (851                                       | )          | 776                                       |       | (2,021 | ) | (4,515 | ) |
| Comprehensive  income                                |       | $                                          | 588,871    |                                      | $          | 741,640 |   | $ | 2,009,906 |   | $ | 1,688,996 |   |

 

7

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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 isaccrued at 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, 2005 and 2004 wereas follows:

 

| ** **           | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------|------------|-------------------------------------------|------------|
| ** **           | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Beginning  balance   |       | $                                         | 352,634    |   | $ | 279,639 |   |
| Warranty  provisions |       | 204,045                                   |       | 306,040 |   |
| Warranty claims      |       | (212,583                                  | )          | (244,193 | ) |
| Ending balance       |       | $                                         | 344,096    |   | $ | 341,486 |   |

 

Note 8 – DiscontinuedOperations

 

In July 2005,we sold substantially all of the assets used in our discontinued Vaculokproduct line.  As previously reported inthe first quarter of 2005, the decision had been made to cease production ofVaculok vacuum insulated panels and exit the product line.

 

Pursuant to thesale agreement, we received an up-front payment of $125,000, along with theright to receive up to an additional $60,000 upon the occurrence of certainpost-closing events.  As a result of thesale, we recognized a pre-tax gain of approximately $69,000 in the thirdquarter ended September 30, 2005. When combined with additional operating expenses, this produced apre-tax gain of $53,134 which is reported in the discontinued operations section ofthe condensed consolidated statements of income.  After tax, we recognized a gain of approximately$34,000, or $0.01 per diluted share,  inthe third quarter of 2005.

 

8

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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 the relatednotes thereto.

 

### ***Company Overview***

###  

MOCON, Inc.designs, manufactures, markets, and services products and provides consultingservices primarily in the measurement and analytical instrument and servicesmarkets.  Our products includeinstruments that detect, measure and monitor gases and chemical compounds aswell as products that prepare samples of various substances for laboratoryanalysis.  Although some of the marketsfor our products are maturing, we continually seek growth opportunities throughtechnological and product improvement, by acquiring and developing newproducts, and by acquiring new companies.

 

Prior to 1998, weexpanded our business primarily through internally developing new products andtechnologies, acquiring product lines and technology, and licensing productsand technology.  Since 1998, we havesupplemented our internal growth through several acquisitions that haveprovided us with additional technologies, products and product developmentexpertise.

 

We completed ourmost recent acquisition effective January 1, 2004, by acquiring PaulLippke Handels GmbH Prozess- und Laborsysteme (Lippke), which is located inGermany.  Lippke had been the primarydistributor of our products in Europe for approximately thirty years, and alsoserved in the capacity of distributor or agent for several companies inaddition to MOCON.  The acquisition ofLippke provides us with a direct presence in Europe, which we plan to leverageto benefit many of our product and service offerings.  We acquired all of the shares of Lippke for abase purchase price of $802,688.  Inaddition, based on Lippke’s 2004 net profits, we made an earnout payment toLippke’s former parent company of $549,257 near the end of the first quarter of2005 and are obligated to make two future earnout payments based on the sharednet profits of Lippke in the years 2005 and 2006, with a minimum payment amountof 100,000 euros ($120,480 at September 30, 2005) per year, and nomaximum.  It is anticipated that theseearnout payments will be made to the former parent company of Lippke at or nearthe end of the first quarters of 2006 and 2007.

 

We have threeprimary operating locations in the United States – Minnesota, Colorado, andTexas – and one in Germany.  We primarilyuse a direct sales force to market our products and services in the UnitedStates, Canada and Germany and use a network of independent representatives tomarket and service our products and services in other foreign countries.  Our international sales have historicallyaccounted for a significant portion of our revenues and we expect this trend tocontinue for the foreseeable future, especially as a result of our acquisitionof Lippke, which thus far has had, and is expected to continue to have, apositive impact on our sales in 2005.

 

Recently, we havebegun to focus more on business development opportunities in our core productareas, including in particular our gas detection and measurementbusinesses.  In the first quarter of2005, we decided to exit our Vaculok vacuum insulated panel business as aresult of its poor financial performance since it was acquired in November 2003,and our plan to concentrate on our core businesses.  In addition, we have significantly increasedresearch and development spending in these core areas for both the thirdquarter and the first nine months of 2005.

 

9

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

 

The followingtable sets forth the relationship between various components of our results ofoperations, stated as a percent of sales, for the three- and nine-month periodsended September 30, 2005, and 2004.

 

| ** **                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Sales                                                              |       | 100.0                                      |       | 100.0                                     |       | 100.0 |   | 100.0 |   |
| Cost of sales                                                      |       | 43.2                                       |       | 44.9                                      |       | 44.2 |   | 45.4 |   |
| Gross profit                                                       |       | 56.8                                       |       | 55.1                                      |       | 55.8 |   | 54.6 |   |
| Selling, general, and administrative expenses                      |       | 34.9                                       |       | 32.1                                      |       | 33.2 |   | 34.1 |   |
| Research and development expenses                                  |       | 7.7                                        |       | 4.6                                       |       | 6.7 |   | 5.5 |   |
| Operating income                                                   |       | 14.2                                       |       | 18.4                                      |       | 15.9 |   | 15.0 |   |
| Other income                                                       |       | 1.1                                        |       | 0.6                                       |       | 1.4 |   | 0.6 |   |
| Income before income taxes                                         |       | 15.3                                       |       | 19.0                                      |       | 17.3 |   | 15.6 |   |
| Income taxes                                                       |       | 5.4                                        |       | 6.5                                       |       | 5.0 |   | 5.3 |   |
| Income from continuing operations                                  |       | 9.9                                        |       | 12.5                                      |       | 12.3 |   | 10.3 |   |
| Gain (loss) from discontinued operations                           |       | 0.9                                        |       | (1.7                                      | )          | (0.9 | ) | (1.5 | ) |
| Income tax (expense) benefit on loss from  discontinued operations |       | (0.3                                       | )          | 0.6                                       |       | 0.3 |   | 0.5 |   |
| Gain (loss) from discontinued operations, net of tax               |       | 0.6                                        |       | (1.1                                      | )          | (0.6 | ) | (1.0 | ) |
| Net income                                                         |       | 10.5                                       |       | 11.4                                      |       | 11.7 |   | 9.3 |   |

###  

### *Comparisonof Financial Results for the Three and Nine Months Ended September 30,2005 and September 30, 2004*

###  

### *Sales*

###  

Sales for thethird quarter of 2005 were $5,670,156, down 11% compared to $6,350,000 for thesame period in 2004.  On a product linebasis, this decrease was primarily due to decreased sales of our weighing andpharmaceutical products, permeation products and leak detection products,offset somewhat by an increase in sales of our headspace analyzer products.Year-to-date sales were $18,496,853, up 2% compared to $18,156,956 for the sameperiod in 2004.  The increase wasprimarily due to increased sales of our headspace analyzer and gas analyzerproducts, offset partially by reduced sales of sample preparation products andgas chromatography analyzer products. There were no significant price increases or decreases during the thirdquarter of 2005 compared to the same period in 2004.

 

10

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Thefollowing table summarizes total sales by product line for the three- andnine-month periods ended September 30, 2005 and 2004.

 

| ** **                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Permeation  Products and Services            |       | $                                          | 3,382,406  |                                      | $          | 3,531,563 |   | $ | 10,716,317 |   | $ | 10,701,258 |   |
| Gas, Headspace,  and Other Analyzer Products |       | 1,873,534                                  |       | 2,209,304                                 |       | 6,461,006 |   | 5,551,318 |   |
| Other                                        |       | 414,216                                    |       | 609,133                                   |       | 1,319,530 |   | 1,904,380 |   |
| Total sales                                  |       | $                                          | 5,670,156  |                                      | $          | 6,350,000 |   | $ | 18,496,853 |   | $ | 18,156,956 |   |

 

The followingtable sets forth the relationship between various components of domestic andforeign sales for the three- and nine-month periods ended September 30,2005 and 2004.

 
| ** **          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **          | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Domestic sales      |       | $                                          | 2,622,292  |                                      | $          | 2,813,320 |   | $ | 9,001,677 |   | $ | 8,037,212 |   |
| Foreign sales:      |       |                                       |       |                                      |       |   |   |   |   |
| Europe              |       | 1,501,559                                  |       | 1,558,156                                 |       | 4,669,561 |   | 4,875,704 |   |
| Asia                |       | 1,315,703                                  |       | 1,434,534                                 |       | 3,744,889 |   | 3,352,649 |   |
| Other               |       | 230,602                                    |       | 543,990                                   |       | 1,080,726 |   | 1,891,391 |   |
| Total foreign sales |       | 3,047,864                                  |       | 3,536,680                                 |       | 9,495,176 |   | 10,119,744 |   |
| Total sales         |       | $                                          | 5,670,156  |                                      | $          | 6,350,000 |   | $ | 18,496,853 |   | $ | 18,156,956 |   |

 

Sales of ourpermeation products and services which accounted for approximately 60% and 56%of our consolidated third quarter sales in 2005 and 2004, respectively,decreased 4% during the third quarter of 2005 compared to the same period in2004.  This was due to a slight decreasein demand in both our foreign and domestic markets.  Sales of our gas, headspace, and otheranalyzer products which accounted for 33% and 35% of our consolidated thirdquarter sales in 2005 and 2004, respectively, decreased 15% during the thirdquarter of 2005 compared to the same period in 2004.  Within this group, headspace analyzer productsincreased by 17% which was evenly spread between domestic and foreignmarkets.  Offsetting this increase,weighing and pharmaceutical products, leak detection and gas analyzer productsdecreased a combined 26% during the third quarter of 2005 compared to the sameperiod in 2004, primarily as a result of a decrease in demand in our foreignmarkets.

 

For the nine-monthperiods, sales of our permeation products and services, which accounted forapproximately 58% and 59% of our consolidated sales in 2005 and 2004,respectively, increased by less than 1%. This increase was due primarily to an increase in sales to our domesticmarkets, offset by a decrease in sales to our foreign markets.  Sales of our gas, headspace, and otheranalyzer products, which accounted for 35% and 31% of our consolidatednine-month sales in 2005 and 2004, respectively, increased 16%. Within thisgroup, headspace analyzer, gas analyzer and leak detection products increased33%, 16% and 13% respectively.  Theseincreases were due mostly to increased sales in our domestic markets.

 

On a geographicalbasis, total foreign sales, which accounted for 54% and 56% of our consolidatedthird quarter sales in 2005 and 2004, respectively, were down 14% during thethird quarter of 2005 compared to the same period in 2004. This decrease wasdue primarily to a 69% decrease in sales of weighing and pharmaceuticalproducts and a 46% decrease in sales of leak detection products.  Total domestic sales accounted for 46% and44% of our consolidated third quarter sales in 2005 and 2004, respectively, andwere down 7%.  This domestic salesdecrease was primarily due to reduced sales of

 

11

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permeation, gaschromatography, and gas analyzer products partially offset by an increase inheadspace analyzer products.

 

Total foreignsales, which accounted for 51% and 56% of our consolidated sales during thefirst nine months of 2005 and 2004, respectively, were down 6% during the firstnine months of 2005 compared to the same period in 2004.  This decrease was due primarily to decreasedsales of our permeation, weighing and pharmaceutical, and sample preparationproducts, offset partially by an increase in leak detection and headspaceanalyzer products.  Total domestic salesaccounted for 49% and 44% of our consolidated sales during the first ninemonths in 2005 and 2004, respectively, and were up 12% during the first ninemonths of 2005 compared to the same period in 2004.  This domestic sales increase was primarilydue to increased sales of permeation, headspace analyzer, and gas analyzerproducts.

 

### *GrossProfit*

###  

Our gross profitmargins were 56.8% and 55.1% for the third quarters ended September 30,2005 and 2004, respectively.  Theslightly lower margin for the previous period was primarily due to increases inour inventory reserve for obsolescence and additional costs associated withmoving a portion of our Baseline subsidiary’s manufacturing to Minneapolis,Minnesota.

 

Our gross profitmargins for the nine-month periods ended September 30, 2005 and 2004 were55.8% and 54.6%, respectively.  Theslightly lower margin for the previous period was primarily due to costsrelated to the acquisition of Lippke, including the write-off of costs assignedto finished goods inventory under purchase accounting rules, costs associatedwith the relocation of our Lab Connections subsidiary to Texas in the firstquarter of 2004, and additional costs associated with moving a portion of ourBaseline subsidiary’s manufacturing to Minneapolis, Minnesota.  The gross profit margin for our consultingservices was 46.0% and 49.6%, respectively, for the nine-month periods ended September 30,2005 and 2004.  This decrease wasprimarily due to the slight reduction in sales and the related fixed costs.

 

*Selling, General and Administrative Expenses*

 

### Selling, generaland administrative (SG&A) expenses in the third quarter of 2005 were$1,978,839, or 34.9% of sales, compared to $2,036,701, or 32.1% of sales in thethird quarter of 2004.  The increase inSG&A expenses as a percentage of sales was primarily due to the combinationof reduced quarterly sales together with costs related to the Sarbanes-OxleyAct of 2002.  The decrease in actualdollars for the quarter was primarily due to non-recurring sales expenses in2004 related to the amortization of purchased intangibles associated with theLippke acquisition, as well as lower headcount and marketing costs in 2005.

 

### SG&A expensesin the first nine months of 2005 were $6,136,163, or 33.2% of sales, comparedto $6,190,747, or 34.1% of sales in the same period of 2004.  The decrease in SG&A expenses wasprimarily due to various non-recurring amortization costs (totaling $218,000)recorded in 2004 relating to the Lippke acquisition, as well as lower headcountand marketing costs in 2005.  This decreasewas partially offset by increased administrative expenses incurred, whichrelated to the Sarbanes-Oxley Act of 2002.

###  

### *Researchand Development Expenses*

###  

Research anddevelopment (R&D) expenses were $434,550, or approximately 7.7% of sales,in the third quarter of 2005, compared to $293,474, or approximately 4.6% ofsales, in the same period of 2004.  Forthe first nine months of 2005, R&D expenses were $1,252,402, or 6.7% ofsales, compared to $1,000,603, or 5.5% of sales, for the first nine months of 2004.  This planned increase in R&D expendituresis considered necessary to develop new products to expand in our nichemarkets.  For the foreseeable future, weexpect to allocate on an annual basis approximately 6% to 8% of sales to

 

12

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research anddevelopment.

 

### *OtherIncome*

###  

Other income forthe three months ended September 30, 2005 consisted of interest income of$53,081 and gain on foreign currency exchange of $9,120, offset by other lossesof $228.  Other income for the ninemonths ended September 30, 2005 consisted of interest income of $140,481,gain on foreign currency exchange of $71,810, gain on sale of fixed assets of$44,182, and other income of $3,389. Other income for the nine months ended September 30, 2004 consistedof interest income of $97,107 and gain on foreign currency exchange of$13,943.  Interest income increased forthe nine months ended September 30, 2005, due both to higher averageyields and higher average cash balances.

 

### *Income TaxExpense*

 

Our provision forincome taxes from continuing operations was 35.6% of income before income taxesfor the three months ended September 30, 2005, compared to 34.0% of incomebefore income taxes for the three months ended September 30, 2004.  The slightly higher rate for the most recentperiod was primarily due to a larger percentage of pre-tax income beingattributable to Lippke, which is taxed at a higher effective rate.

 

Our provision forincome taxes from continuing operations was 28.9% of income before income taxesfor the nine months ended September 30, 2005, compared to 34.0% of incomebefore income taxes for the nine months ended September 30, 2004. The ratefor the first nine months of 2005 was favorably impacted by the finalization ofan Internal Revenue Service examination which reduced income tax expense byapproximately $156,000 in the first quarter of 2005 as well as benefiting fromthe newly enacted tax law.  Based oncurrent operating conditions and income tax laws, we expect the tax rate forthe remaining quarter of 2005 to be in the range of 33% to 36%.

 

### *NetIncome*

###  

Net income was$594,003 in the third quarter of 2005, compared to $728,369 in the thirdquarter of 2004.  Diluted net income pershare was $0.11 per share in the third quarter of 2005 compared to $0.13 pershare in the third quarter of 2004.  Forthe nine months ended September 30, 2005, net income was $2,163,214, or$0.39 per diluted share, compared to net income of $1,694,362, or $0.31 perdiluted share in the prior year.

 

*Liquidityand Capital Resources*

 

We have historically financed our operations, capital expenditures andother liquidity needs through our cash flows generated from operations.  Total cash, cash equivalents and marketablesecurities increased $1,595,565 during the first nine months of 2005 to$9,284,284 as of September 30, 2005, compared to $7,688,719 at December 31,2004 due in part to a significant reduction in trade accounts receivable aswell as the exercise of stock options. Our working capital as of September 30, 2005 increased $1,597,410to $13,424,682 for the nine-month period, as compared to $11,827,272 at December 31,2004.  We believe that a combination ofour existing cash, cash equivalents and marketable securities, plus an expectedcontinuation of cash flow from operations, will continue to be adequate to fundour operations, capital expenditures, dividend payments, stock repurchases, andrequired earnout payments to the former parent company of Lippke, for at leastthe next twelve months.  However, one ofour strategic objectives is, as market and business conditions warrant, toconsider 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.

 

13

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*Cash Flow*

 

Cash Flow from Operating Activities

 

Our primary sourceof funds is cash provided by operations. Cash flow from operations totaled $2,504,743 and $3,363,797 in the firstnine months of 2005 and 2004, respectively. The net cash provided by trade accounts receivable was primarily due todecreased sales in the third quarter of 2005 as compared to the fourth quarterof 2004.  The net cash used for inventorywas primarily due to increases in work-in-process inventory. The net cash usedfor accounts payable reflected the use of cash generated from the decrease intrade accounts receivable.

 

### Cash Flow fromInvesting Activities

###  

Cash used ininvesting activities totaled $1,485,368 and $67,574 in the first nine months of2005 and 2004, respectively.  Purchasesof marketable securities, net of maturities, were $1,362,930 in the first ninemonths of 2005.  Purchases of property,plant and equipment totaled $166,482 in the first nine months of 2005,primarily for additions of office, manufacturing and laboratory equipment, ascompared to $269,876 in the first nine months of 2004.

 

As part of the purchase price for theacquisition of Lippke in 2004, we were obligated to make three future earnoutpayments to Lippke’s former parent company based on the shared net profits ofLippke in each of the years 2004, 2005, and 2006, with a minimum earnout paymentamount of 100,000 euros per year, and no maximum. The present value of thesefuture minimum earnout payments was included in cash paid in acquisitions, netof cash acquired, in the investing activities section of our consolidatedstatements of cash flows, at the time of the acquisition.  Actual earnout amounts due in excess of theminimums, if any, will be reflected as an increase in cash paid inacquisitions, net of cash acquired, in the cash flows from investing activitiessection of our consolidated statements of cash flows, in the fourthquarters of 2004, 2005 and 2006, respectively, when the actual earnout amountis calculated, and the related additional liability is accrued.  The earnout payment related to the 2004 netprofits was made in the first quarter of 2005, and it is anticipated that theremaining two earnout payments will be made in the first quarters of 2006 and2007, respectively.

 

We had no materialcommitments for capital expenditures as of September 30, 2005.  We presently do not believe that anysignificant property, plant and equipment expenditures are required toaccommodate our current level of operations.

 

Cash Flow fromFinancing Activities

###  

Cash provided fromthe exercise of stock options amounted to $341,140 and $95,263 during the firstnine months of 2005 and 2004, respectively.

 

Cash used infinancing activities consists primarily of the payment of dividends to ourshareholders.  During the first ninemonths of 2005 and 2004, we made dividend payments to our shareholders of $1,124,625and $1,048,132, respectively.

 

A final dividendpayment was also made to Lippke’s former parent company in the first quarter of2004 totaling $449,087.  This payment wasfor 2003 profits earned by Lippke prior to the acquisition, was paid by Lippke toits former parent company as a dividend in 2004, and has accordingly beenreflected in the financing activities section of our consolidatedstatements of cash flows as a dividend payment to former owners.

 

Our Board of Directorshas authorized, depending upon market conditions and other factors, therepurchase of up to a total of $3,200,000 of our common stock at prices notexceeding prevailing market prices at the time of purchase.  There were no repurchases of our common stockduring the

 

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third quarter of2005.  As of September 30, 2005,$1,672,034 was remaining in this authorization. On November 8, 2005, our Board of Directors authorized the Companyto repurchase up to $2,000,000 of its common stock.  This repurchase program supersedes theabove-mentioned repurchase authorization.

 

***Contractual Obligations***

 

We refer you toour Annual Report on Form 10-K for the year ended December 31, 2004for a summary of our contractual obligations. Except for the earnout payment paid in connection with the Lippkeacquisition, there has been no material change in this information.

 

### ***Off-Balance Sheet Arrangements***

###  

Except for operatingleases 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.

 

***Critical Accounting Policies***

 

The preparation ofour consolidated financial statements requires management to make estimates andjudgments that affect the reported amount of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities.  The Securities and Exchange Commission hasdefined a company’s most critical accounting policies as those that are mostimportant to the portrayal of its financial condition and results ofoperations, and which require the company to make its most difficult andsubjective judgments, often as a result of the need to make estimates ofmatters that are inherently uncertain. Based on this definition, we have identified the following criticalaccounting policies.  Although we believethat our estimates and assumptions are reasonable, they are based uponinformation available when they are made. Actual results may differ significantly from these estimates underdifferent assumptions or conditions.

 

*Allowancefor doubtful accounts and sales returns* – This reserve is for accounts receivable balancesthat are estimated to be uncollectible as well as estimated sales returns.  This reserve is based on a number of factors,including: (1) an analysis of customer accounts and (2) ourhistorical 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 believeactual results could be materially different if historical trends do notreflect actual results or if economic conditions worsened for our customers.  In the event we determined that a smaller orlarger allowance for doubtful accounts and sales returns 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, 2005, we had$209,495 reserved against our accounts receivable for doubtful accounts andsales returns.

 

*Allowancefor excess and obsolete inventories* – We perform an analysis to identify inventoryshrinkage, and excess and obsolete inventory. We record a charge to cost of sales for amounts identified.  Our analysis includes inventory levels, thenature of the finished product and its inherent risk of obsolescence, the grossmargin of the product, and the on-hand quantities relative to the sales historyof that finished product.  We believethat the operating 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.  Our allowance for excess and obsoleteinventories at September 30, 2005 was $711,021.

 

*Recoverabilityof long-lived assets* – We assess the recoverability ofgoodwill and other long-lived assets annually or whenever events or changes incircumstances indicate that expected future undiscounted cash flows might notbe sufficient to support the carrying amount of an asset.  We deem

 

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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.  During the first quarter of 2005, we incurreda non-cash asset impairment charge of $162,000 relating to equipment andinventory used in our Vaculok vacuum insulated panels business as a result ofour decision during that quarter to discontinue the product line.  Changes in our business strategies and/orchanges in the economic environment in which we operate may result in futureimpairment charges.

 

*Accruedproduct warranties*– Our products are generally covered by a warranty, with warranty periodsranging from ninety days to one year from the date of sale.  Estimated warranty costs are accrued in thesame period in which the related revenue is recognized, based on anticipatedparts and labor costs, utilizing historical experience.  Special warranty reserves are also accrued formajor rework campaigns.  We periodicallyassess the adequacy of our warranty reserves based on changes in these factorsand record any necessary adjustment if actual claim experience indicates thatadjustments are necessary.  Although webelieve the likelihood to be relatively low, our historical warranty claimsexperience could be materially different from actual results due tomanufacturing changes that could impact product quality, a change in ourwarranty policy in response to industry trends, as yet unrecognized defects inproducts sold, or other factors.  As of September 30,2005, we had $344,096 accrued related to future estimated warranty claims.

 

*Incometaxes* – In thepreparation of our consolidated financial statements, management is required toestimate income taxes in each of the jurisdictions in which we operate.  This process involves estimating actualcurrent tax exposures together with assessing temporary differences resultingfrom different treatment of items for tax and accounting purposes.  These differences result in deferred taxassets and liabilities, which are included in our consolidated balance sheet.

 

We havesignificant amounts of deferred tax assets. Management reviews the deferred tax assets for recoverability on aquarterly basis and assesses the need for valuation allowances.  These deferred tax assets are evaluated byconsidering historical levels of income, estimates of future taxable incomestreams and the impact of tax planning strategies.  A valuation allowance is recorded to reducedeferred tax assets when it is determined that it is more likely than not thatwe would not be able to realize all or part of its deferred tax assets.  We carried no valuation allowance against ournet deferred tax assets at either September 30, 2005 or 2004.

 

***NewAccounting Pronouncements***

 

In September 2005,the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections – a replacement of APB No. 20 and SFAS No. 3. *SFAS 154 provides guidance on theaccounting for and reporting of accounting changes and error corrections. It establishes,unless impracticable, retrospective application as the required method forreporting a change in accounting principle in the absence of explicittransition requirements specific to the newly adopted accounting principle.  SFAS 154 also provides guidance fordetermining whether retrospective application of a change in accountingprinciple is impracticable and for reporting a change when retrospectiveapplication is impracticable.  Thecorrection of an error in previously issued financial statements is not anaccounting 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 will adopt SFAS 154 in ourfiscal year beginning January 1, 2006. Adoption of SFAS 154 is not expected to have a material effect on ourfinancial position, results of operations or cash flows.

 

In November 2004,the FASB 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,

 

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and wastedmaterial (spoilage) should be recognized as current period charges, and thatfixed production overheads should be allocated to inventory based on normalcapacity of production facilities.  Thisstatement is effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005. Accordingly, we will adopt SFAS 151 in our fiscal year beginning January 1,2006.  Adoption of SFAS 151 is notexpected to have a material effect on our financial position, results ofoperations or cash flows.

 

In December 2004,the FASB issued SFAS No. 123 (revised 2004), *Share–BasedPayments* (FAS 123(R)), which is a revision of FASB Statement No. 123,*Accounting for Stock-Based Compensation*.  FAS 123(R) supersedes APB Opinion No. 25,*Accounting for Stock Issued to Employees*and amends FAS Statement No. 95, *Statement of Cash Flows*.  FAS 123(R) requires all share-based paymentsto employees, including grants of employee stock options, to be recognized inthe income statement based on their fair values and the pro forma disclosure isno longer allowable.  FAS 123(R) is effectiveat the beginning of the first annual period after June 15, 2005.  Accordingly, we will adopt FAS 123(R) on January 1,2006.  We are currently evaluating theimpact of our adoption of FAS 123(R), which will result in additionalpre-tax compensation expense in fiscal 2006 for remaining unvested stockoptions and any future stock option grants. The ultimate amount of increased compensation expense will be dependenton the number of options granted, their timing and vesting periods, and themethod used to calculate the fair value of the awards, among other things.

 

### ***Forward-Looking Statements***

###  

This quarterly report onForm 10-Q contains not only historical information, but alsoforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934, and are subject to the safe harbor created by those statutes.  In addition, we or others on our behalf maymake forward-looking statements from time to time in oral presentations,including telephone conferences and/or web casts open to the public, in pressreleases or reports, on our internet website or otherwise.  Statements that are not historical areforward-looking and reflect expectations and assumptions.  We try to identify forward-looking statementsin this report and elsewhere by using words such as “may,” “will,” “should,” “expects,”“anticipates,” “contemplates,” “estimates,” “believes,” “plans,” “projected,” “predicts,”“potential” or “continue” or the negative of these or similar terms.  Examples of forward-looking statements inthis report include, but are not limited to, statements regarding ourinternational sales continuing to account for a significant portion of ourrevenues, our acquisition of Lippke continuing to have a positive impact on oursales in 2005, our expected Section 404 compliance costs and increasedgeneral and administrative expenses associated with the Sarbanes-Oxley Act of2002 and other securities and corporate governance rules and regulationscompliance, our allocation of 6% to 8% of our sales to research and developmentexpenses, our expected tax rate for the remaining quarter of 2005 being in therange of 33% to 36%, our belief that no significant future capital expendituresare required to accommodate our current level of operations, our expectationsregarding future cash expenditures, and the effect of new accountingpronouncements on our financial position, results of operations and cash flows.

 

Forward-lookingstatements involve risks and uncertainties. These uncertainties include factors that affect all businesses as wellas matters specific to MOCON.  Below aresome of the factors known to us that could cause our actual results to differmaterially from what we have anticipated in our forward-lookingstatements.  We wish to caution readersnot to place undue reliance on any forward-looking statement that speaks onlyas of the date made and to recognize that forward-looking statements arepredictions of future results, which may not occur as anticipated.  Actual results could differ materially fromthose anticipated in the forward-looking statements and from historicalresults, due to the risks and uncertainties described below, as well as othersthat we may consider immaterial or do not anticipate at this time.  The following risks and uncertainties are notexclusive and further information concerning us and our business, includingfactors that potentially could materially affect our financial results orcondition, may emerge from time to time. We assume no obligation to update forward-looking statements to reflectactual results or changes in factors or assumptions affecting suchforward-looking

 

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statements.  We advise you, however, to consult anyfurther disclosures we make on related subjects in our quarterly reports on Form 10-Qand current reports on Form 8-K we file with or furnish to the Securitiesand Exchange Commission.

 

***If we experience any increase in the cost of rawmaterials or supplies, we may experience a decrease in profit margins.***

 

In the past, the overall cost of the materials that we purchase has notrisen much more than the rate of inflation, although the price of some of thecomponents that we purchase has increased in the past several years due in partto our purchasing a fewer number of such components.  Certain other material and labor costs haveincreased, but we believe that such increases are approximately consistent withoverall inflation rates.  We believe thatthe price of our products and the prices of our competitors’ products is asignificant factor affecting our customers’ buying decisions and consequently,if we experience any increases in the cost of materials or supplies, we may notbe able to pass along any cost increases in the form of price increases or sustainprofit margins that we have achieved in prior years.

 

***Themarkets in which we operate have experienced minimal growth in recent years,and our ability to increase our revenues will depend in part on our ability todevelop new products, develop new applications for our existing products and toacquire complementary businesses and product lines.***

 

The analytical and measurement instrument markets in which we operatehave not shown significant growth in recent years. Although we have identifieda number of strategies that we believe will allow us to grow our business andincrease our sales, including developing new products and technologies,developing new applications for our technologies, acquiring complementarybusinesses and product lines, and strengthening our sales force, we cannotassure you that we will be able to successfully implement these strategies, orthat these strategies will result in the growth of our business or an increasein our sales.

 

***If weacquire businesses in the future, we may experience a decrease in our profitmargins, a decrease in our net income, and other adverse consequences.***

 

One of our growth strategies is to supplement our internal growth withthe acquisition of businesses and technologies that complement or augment our existingproducts.  Some of the businesses that wepreviously acquired have produced net operating losses or low levels ofprofitability.  For example, the Vaculokvacuum insulated panel business that we acquired in November 2003financially performed poorly, resulting in our decision to discontinue theproduct line during the first quarter of 2005. Businesses that we may acquirein the future may be marginally profitable or unprofitable.  We will likely have to successfully changethe operations of any companies that we acquire in the future and improve themarket penetration of such companies in order to achieve the level ofprofitability that we desire.  Inaddition, the benefits of an acquisition may take more time than expected todevelop or integrate into our operations, and we cannot guarantee that ourprevious acquisitions or any future acquisitions will in fact produce theintended benefits.  Acquisitions alsoinvolve a number of additional risks, including, but not limited to:

 

•                  diversion ofmanagement’s attention;

•                  difficulties inassimilating the operations and products of an acquired business or inrealizing projected efficiencies, cost savings, and revenue synergies;

•                  potential lossof key employees or customers of the acquired businesses or adverse effects onexisting business relationships with suppliers and customers;

•                  adverse impacton overall profitability if acquired businesses do not achieve the financialresults projected in our valuation models;

 

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•                  reallocation ofamounts of capital from other operating initiatives and/or an increase in ourleverage and debt service requirements to pay the acquisition purchase prices,which could in turn restrict our ability to access additional capital whenneeded or to pursue other important elements of our business strategy;

•                  inaccurateassessment of undisclosed, contingent or other liabilities or problems andunanticipated costs associated with the acquisition; and

•                  incorrectestimates made in the accounting for acquisitions, incurrence of non-recurringcharges and write-off of significant amounts of goodwill that could adverselyaffect our operating results.

 

Our ability to grow through acquisitions will depend, in part, on theavailability of suitable acquisition candidates at an acceptable cost, ourability to compete effectively for these acquisition candidates, and theavailability of capital to complete such acquisitions.  These risks could be heightened if wecomplete several acquisitions within a relatively short period of time.   We may not be able to complete acquisitionsin the future and any acquisitions that we do complete may have an adverseeffect on our financial performance and liquidity.  It may be necessary for us to raise additionalfunds either through public or private equity or debt financing in order tofinance any future acquisitions.  Anyequity or debt financing, if available at all, may be on terms that are notfavorable to us and may dilute the ownership of our existing shareholders.

 

***We face risks of technological changesthat may render our products obsolete.***

 

The markets for our products and services are characterized by rapidand significant technological change and evolving industry standards.  As a result of such changes and evolvingstandards, our products may become noncompetitive or obsolete and we may haveto develop new products in order to maintain or increase our revenues.  New product introductions that are responsiveto these factors require significant planning, design, development and testingat the technological, product, and manufacturing process levels and we may notbe able to timely develop new products. In addition, industry acceptance of new technologies that we may developmay be slow to develop due to, among other things, existing regulations orstandards written specifically for older technologies and general unfamiliarityof users with new technologies.  As aresult, any new products that we may develop may not generate any meaningfulrevenues or profits for us for a number of years, if at all.

 

***Anyreduction in the level of capital expenditures by our customers couldnegatively impact our sales.***

 

Our customers include pharmaceutical, food, medical, and chemicalcompanies, laboratories, government agencies, and public and private researchinstitutions.  The capital spending ofthese entities can have a significant effect on the demand for ourproducts.  Any decrease in capitalspending by any of these customer groups could have a material adverse effecton our business and results of operations.

 

***Asignificant portion of our sales are generated from foreign countries andselling in foreign countries entails a number of risks which could result in adecrease in our sales or an increase in our operating expenses.***

 

Sales outside the United States accounted for approximately 54% of oursales for the three months ended September 30, 2005 and approximately 56%of our sales for the same period in 2004. We expect that foreign sales will continue to account for a significantportion of our sales in the future. Sales to customers in foreign countries are subject to a number ofrisks, including the following:

 

**•**                  agreements may be difficultto enforce;

•                  receivables may be difficultto collect;

 

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•                  certain regions areexperiencing political unrest and conflict;

•                  foreign customers may havelonger payment cycles;

•                  the countries into which wesell may impose tariffs or adopt other restrictions on foreign trade;

•                  currency fluctuations couldreduce reported profitability in future periods;

•                  fluctuations in exchangerates may affect product demand;

•                  export licenses, ifrequired, may be difficult to obtain and;

•                  protection of intellectualproperty in foreign countries may be more difficult to enforce.

 

If any of theserisks were to materialize, our sales into foreign countries could decline, orour operating costs could increase, which would adversely affect our financialresults.

 

***Someof our competitors have greater resources than we do, which may provide ourcompetitors with an advantage in the development and marketing of new products.***

 

We currently encounter, and expect to continue to encounter,competition in the sale of our products. We believe that the principal competitive factors affecting the marketfor our products include product quality and performance, price, reliabilityand customer service.  Our competitorsinclude large multinational corporations. Some of our competitors have substantially greater financial, marketing,and other resources than we do.  As aresult, they may be able to adapt more quickly to new or emerging technologiesand changes in customer requirements, or to devote greater resources to the promotionand sale of their products than we can. In addition, competition could increase if new companies enter themarket or if existing competitors expand their product lines or intensifyefforts within existing product lines. Our current products, products under development and our ability todiscover new technologies may be insufficient to enable us to competeeffectively with our competitors.

 

***Our reliance upon patents, domestic trademark laws and contractualprovisions to protect our proprietary rights may not be sufficient to protectour intellectual property from others who may sell similar products.***

 

We hold patents relating to various aspects of our products and believethat proprietary technical know-how is critical to many of our products.  Proprietary rights relating to our productsare protected from unauthorized use by third parties only to the extent thatthey are covered by valid and enforceable patents or are maintained inconfidence as trade secrets.  We cannotbe certain that we will be issued any patents from any pending or future patentapplications owned by or licensed to us or that the claims allowed under anyissued patents will be sufficiently broad to protect our technology.  In the absence of patent protection, we maybe vulnerable to competitors who attempt to copy our products or gain access toour trade secrets and know-how.  Ourcompetitors may initiate litigation to challenge the validity of our patents,or they may use their resources to design comparable products that do notinfringe our patents.  We may incur substantialcosts if our competitors initiate litigation to challenge the validity of ourpatents or if we initiate any proceedings to protect our proprietary rights andif the outcome of any such litigation is unfavorable to us, our business andresults of operations could be materially adversely affected.  There may also be pending or issued patentsheld by parties not affiliated with us that relate to our products ortechnologies and we may need to acquire licenses to any such patents tocontinue selling some or all of our products. If we had to obtain any such license in order to be able to continue tosell some or all of our products, we may not be able to do so on terms thatwere favorable to us, if at all.

 

In addition, we rely on trade secrets and proprietary know-how that weseek to protect, in part, by confidentiality agreements with our collaborators,employees, and consultants.  Theseagreements may be breached and we may not have adequate remedies for any suchbreach.  Even if these confidentialityagreements are not breached, our trade secrets may otherwise become known or beindependently developed by competitors.

 

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***The market price of our common stock has fluctuated significantly inthe past and will likely continue to do so in the future and any broad marketfluctuations may materially adversely affect the market price of our commonstock.***

 

The market price of our common stock has beenvolatile in the past, ranging from a high sales price of $10.10 and a low salesprice of $9.08 during the third quarter of 2005, and several factors couldcause the price to fluctuate substantially in the future.  These factors include:

•                  announcements of newproducts by us or our competitors;

•                  quarterly fluctuations inour financial results;

•                  customer contract awards;

•                  developments in regulation;and

•                  general economic andpolitical conditions in the various markets where our products are sold.

 

In addition, the stock prices of instrumentation companies have experiencedsignificant price and volume fluctuations that often have been unrelated to theoperating performance of such companies. This market volatility may adversely affect the market price of ourcommon stock.

 

***Recently enacted and future changes insecurities laws and regulations have increased and are likely to continue toincrease our costs.***

 

Changing laws, regulations and standards relatingto corporate governance and public disclosure, including the Sarbanes-Oxley Actof 2002, new SEC regulations and Nasdaq National Market rules, are creatingchallenges for publicly-held companies including us.  We are committed to maintaining highstandards of corporate governance and public disclosure.  As a result, our efforts to comply withevolving laws, regulations and standards have resulted in, and are likely tocontinue to result in, increased general and administrative expenses and adiversion of management time and attention from revenue-generating activitiesto compliance activities.  In particular,our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002and the related regulations regarding our assessment of our internal controlover financial reporting and our independent registered public accounting firm’sreport on that assessment will require the commitment of significant financialand managerial resources.  We currentlyestimate that Section 404 compliance costs will be approximately $200,000in 2005, and expect that Section 404 compliance will require significantongoing financial and managerial resources in 2006 and beyond.

 

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Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk

 

*EquityPrice and Interest Rate Risk*

 

Substantially all of ourmarketable securities are at fixed interest rates and virtually all of ourmarketable securities mature within one year or less; therefore, we believethat the market risk arising from the holding of these financial instruments isminimal.

 

### *ForeignCurrency Exchange Risk*

###  

Because our products aremanufactured or sourced primarily from the United States, a stronger U.S.dollar generally has a negative impact on our results from operations outsideof the United States while a weaker dollar generally has a positive effect.  We currently sell our products and servicesin United States dollars or the local currency of our foreign subsidiary(Euros).  Accordingly, our foreignoperations expose us to foreign currency exchange risk when the Euro currencyresults of operations are translated to United States dollars.  While we historically have not experiencedany material foreign currency translation losses, we may engage in hedgingactivity in the future to minimize this risk. Our net investment in foreign subsidiary translated into U.S. dollars isnot hedged.  Any changes in foreigncurrency exchange rates will be reflected as a foreign currency translationadjustment, a component of accumulated other comprehensive income instockholders’ equity, and would not impact our net income.

 

Item 4.  Controls and Procedures

 

*Evaluationof Disclosure Controls and Procedures*

 

We maintain disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-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’s rules andforms and that such information is accumulated and communicated to ourmanagement, including our principal executive and principal financial officers,or persons performing similar functions, as appropriate to allow timelydecisions 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.

 

*Changesin Internal Control Over Financial Reporting*

 

There was no change inour internal control over financial reporting that occurred during our quarterended September 30, 2005 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

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PART II.  OTHER INFORMATION

 

Item 2. UnregisteredSales of Equity Securities, Use of Proceeds and Issuer Purchases of EquitySecurities

 

*Unregistered Sales of Equity Securities*

 

Wedid not sell any equity securities of MOCON, Inc. during the three monthsended September 30, 2005 that were not registered under the Securities Actof 1933.

 

*Issuer Repurchases of Equity Securities*

 

We did not repurchase any equity securities of MOCON, Inc.during the three months ended September 30, 2005.  In November 2002, our Board of Directorsauthorized the repurchase of up to $2,000,000 of our common stock in the openmarket at prices not exceeding the market price at the time of purchase.  In May 2003, our Board of Directorsauthorized a $1,200,000 increase in our stock repurchase program, increasingthe total to $3,200,000.  As of September 30,2005, we had repurchased 204,000 shares of MOCON common stock under the programat a total cumulative cost of approximately $1,527,966.  The repurchase program does not have anexpiration date and the Board may terminate it at any time.  On November 8, 2005, our Board ofDirectors authorized the Company to repurchase up to $2,000,000 of its commonstock.  This repurchase programsupersedes the above-mentioned repurchase authorization.

 

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Item 6.             Exhibits

 
| 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 therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                          | MOCON, INC.                                   |   |
|-------------------------------|-----------------------------------------------|--------|
|                          |                                          |   |
|                          |                                          |   |
| Date: November 14,  2005 | /s/ Robert L.  Demorest                       |   |   |
|                          | Robert L.  Demorest                           |   |
|                          | Chairman,  President and Chief                |   |
|                          | Executive  Officer                            |   |
|                          | (Principal  Executive Officer)                |   |
|                          |                                          |   |
|                          |                                          |   |
| Date: November 14,  2005 | /s/ Dane D.  Anderson                         |   |   |
|                          | Dane D. Anderson                              |   |
|                          | 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, 2005

 

EXHIBIT INDEX

 
| **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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