**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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

##### ** **

**(MarkOne)**

**ý****Quarterly Report Pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934 For the Quarter Ended March 31,2005**

 

**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 of registrant as specified in its charter)

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

 
| **7500 Boone Avenue North, Minneapolis, Minnesota  55428**                                                            |
|-----------------------------------------------------------------------------------------------------------------------|
| (Address of principal 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 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.

 

YES ý  NOo

 

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

 

YES oNO  ý

 

5,342,615 Common Shareswere outstanding as of March 31, 2005

 

 

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MOCON, INC. AND SUBSIDIARIES

 

INDEX TO FORM 10-Q

For the Quarter Ended March 31, 2005

 
| PART I.  FINANCIAL INFORMATION                                                                           |   |
|---------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                          |   |
| Item 1.  Financial Statements                                                                            |   |
| Condensed  Consolidated Balance Sheets  March 31, 2005 (Unaudited) and December 31, 2004            |   |
|                                                                                                          |   |
| Condensed  Consolidated Statements of Income (Unaudited)  Three months ended March 31, 2005 and 2004     |   |
|                                                                                                          |   |
| Condensed  Consolidated Statements of Cash Flows (Unaudited)  Three months ended March 31, 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 5. Other Information                                                                                     |   |
|                                                                                                          |   |
| Item 6. Exhibits                                                                                              |   |
|                                                                                                          |   |
| Signatures                                                                                                    |   |

 

----

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

MOCON, INC. & SUBSIDIARIES

 

CONDENSEDCONSOLIDATED BALANCE SHEETS

 
| ** **                                                                                                                                        | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                        | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
| ASSETS                                                                                                                                            |       |                     |       |                        |       |
| Current assets:                                                                                                                                   |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                         |       | $                        | 1,709,249  |                        | $          | 2,648,879 |   |
| Marketable securities, current                                                                                                                    |       | 5,393,625                |       | 4,808,840                   |       |
| Trade accounts receivable, less allowance for  doubtful accounts of $212,613 in 2005 and $222,040 in 2004                                         |       | 4,166,591                |       | 4,297,884                   |       |
| Other receivables                                                                                                                                 |       | 74,676                   |       | 44,941                      |       |
| Inventories                                                                                                                                       |       | 4,154,253                |       | 3,778,376                   |       |
| Prepaid expenses                                                                                                                                  |       | 301,255                  |       | 362,607                     |       |
| Deferred income taxes                                                                                                                             |       | 435,864                  |       | 435,864                     |       |
| Assets of discontinued operations                                                                                                                 |       | 39,877                   |       | 221,793                     |       |
| Total current assets                                                                                                                              |       | 16,275,390               |       | 16,599,184                  |       |
|                                                                                                                                              |       |                     |       |                        |       |
| Marketable securities, noncurrent                                                                                                                 |       | 580,000                  |       | 231,000                     |       |
|                                                                                                                                              |       |                     |       |                        |       |
| Property, plant and equipment, net of accumulated depreciation  of $4,668,839 in 2005 and $4,558,195 in 2004                                      |       | 1,866,931                |       | 1,954,998                   |       |
|                                                                                                                                              |       |                     |       |                        |       |
| Other assets:                                                                                                                                     |       |                     |       |                        |       |
| Software development costs, net of accumulated amortization  of $830,383 in 2005 and $766,490 in 2004                                             |       | 176,038                  |       | 239,931                     |       |
| Goodwill                                                                                                                                          |       | 2,315,774                |       | 2,315,774                   |       |
| Technology rights and other intangibles, net                                                                                                      |       | 991,371                  |       | 1,030,847                   |       |
| Other                                                                                                                                             |       | 159,985                  |       | 143,803                     |       |
| Total other assets                                                                                                                                |       | 3,643,168                |       | 3,730,355                   |       |
|                                                                                                                                              |       |                     |       |                        |       |
| TOTAL ASSETS                                                                                                                                      |       | $                        | 22,365,489 |                        | $          | 22,515,537 |   |
|                                                                                                                                              |       |                     |       |                        |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                         |       |                     |       |                        |       |
| Current liabilities:                                                                                                                              |       |                     |       |                        |       |
| Accounts payable                                                                                                                                  |       | $                        | 2,059,697  |                        | $          | 2,107,268 |   |
| Accrued compensation and vacation                                                                                                                 |       | 843,499                  |       | 1,024,958                   |       |
| Other accrued expenses                                                                                                                            |       | 378,670                  |       | 457,640                     |       |
| Accrued product warranties                                                                                                                        |       | 348,740                  |       | 352,634                     |       |
| Accrued income taxes                                                                                                                              |       | 384,671                  |       | 455,718                     |       |
| Dividends payable                                                                                                                                 |       | 373,694                  |       | 373,694                     |       |
| Total current liabilities                                                                                                                         |       | 4,388,971                |       | 4,771,912                   |       |
|                                                                                                                                              |       |                     |       |                        |       |
| Obligations to former employees                                                                                                                   |       | 106,706                  |       | 112,720                     |       |
| Minimum earnout payable                                                                                                                           |       | 117,245                  |       | 247,708                     |       |
| Deferred income taxes                                                                                                                             |       | 165,961                  |       | 182,651                     |       |
| Total noncurrent liabilities                                                                                                                      |       | 389,912                  |       | 543,079                     |       |
|                                                                                                                                              |       |                     |       |                        |       |
| Total liabilities                                                                                                                                 |       | 4,778,883                |       | 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 5,342,615 shares in 2005 and  5,338,489 shares in 2004 |       | 534,262                  |       | 533,849                     |       |
| Capital in excess of par value                                                                                                                    |       | 227,426                  |       | 199,705                     |       |
| Retained earnings                                                                                                                                 |       | 16,798,185               |       | 16,377,709                  |       |
| Accumulated other comprehensive income                                                                                                            |       | 26,733                   |       | 89,283                      |       |
| Total stockholders’ equity                                                                                                                   |       | 17,586,606               |       | 17,200,546                  |       |
|                                                                                                                                              |       |                     |       |                        |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                   |       | $                        | 22,365,489 |                        | $          | 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  March 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                          | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                                                                                |       |                                   |       |   |   |
| Sales:                                                                              |       |                                   |       |   |   |
| Products                                                                            |       | $                                      | 6,112,087  |   | $ | 5,253,544 |   |
| Consulting services                                                                 |       | 332,308                                |       | 461,578 |   |
| Total sales                                                                         |       | 6,444,395                              |       | 5,715,122 |   |
|                                                                                |       |                                   |       |   |   |
| Cost of sales:                                                                      |       |                                   |       |   |   |
| Products                                                                            |       | 2,641,580                              |       | 2,468,003 |   |
| Consulting services                                                                 |       | 241,620                                |       | 219,843 |   |
| Total cost of sales                                                                 |       | 2,883,200                              |       | 2,687,846 |   |
|                                                                                |       |                                   |       |   |   |
| Gross profit                                                                        |       | 3,561,195                              |       | 3,027,276 |   |
|                                                                                |       |                                   |       |   |   |
| Selling, general, and administrative expenses                                       |       | 2,082,588                              |       | 2,119,383 |   |
|                                                                                |       |                                   |       |   |   |
| Research and development expenses                                                   |       | 420,628                                |       | 341,072 |   |
|                                                                                |       |                                   |       |   |   |
| Operating income                                                                    |       | 1,057,979                              |       | 566,821 |   |
|                                                                                |       |                                   |       |   |   |
| Other income                                                                        |       | 91,205                                 |       | 21,176 |   |
|                                                                                |       |                                   |       |   |   |
| Income before income taxes                                                          |       | 1,149,184                              |       | 587,997 |   |
|                                                                                |       |                                   |       |   |   |
| Income taxes                                                                        |       | 223,560                                |       | 200,496 |   |
|                                                                                |       |                                   |       |   |   |
| Income from continuing operations                                                   |       | $                                      | 925,624    |   | $ | 387,501 |   |
|                                                                                |       |                                   |       |   |   |
| Loss from discontinued operations, including impairment  charge in 2005 of $162,420 |       | (207,013                               | )          | (80,812 | ) |
| Income tax benefit on loss from discontinued  operations                            |       | 75,560                                 |       | 29,496 |   |
| Loss from discontinued operations, net of tax  benefit                              |       | (131,453                               | )          | (51,316 | ) |
|                                                                                |       |                                   |       |   |   |
| Net income                                                                          |       | $                                      | 794,171    |   | $ | 336,185 |   |
|                                                                                |       |                                   |       |   |   |
| Basic net income per common share:                                                  |       |                                   |       |   |   |
| Income from continuing operations                                                   |       | $                                      | 0.17       |   | $ | 0.07 |   |
| Loss from discontinued operations                                                   |       | (0.02                                  | )          | (0.01 | ) |
| Basic net income per common share:                                                  |       | $                                      | 0.15       |   | $ | 0.06 |   |
|                                                                                |       |                                   |       |   |   |
| Basic weighted average common shares outstanding                                    |       | 5,339,177                              |       | 5,406,952 |   |
|                                                                                |       |                                   |       |   |   |
| Diluted net income per common share:                                                |       |                                   |       |   |   |
| Income from continuing operations                                                   |       | $                                      | 0.16       |   | $ | 0.07 |   |
| Loss from discontinued operations                                                   |       | (0.02                                  | )          | (0.01 | ) |
| Diluted net income per common share:                                                |       | $                                      | 0.14       |   | $ | 0.06 |   |
|                                                                                |       |                                   |       |   |   |
| Diluted weighted average common shares outstanding                                  |       | 5,519,994                              |       | 5,526,670 |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

 

2

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MOCON, INC. & SUBSIDIARIES

 

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 
| ** **                                                                                                                         | ** ** | **Three Months  Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                         | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                                                                              |       |                                   |       |   |   |
| Net income                                                                                                                         |       | $                                      | 794,171    |   | $ | 336,185 |   |
| Loss from discontinued operations, net of tax                                                                                      |       | 131,453                                |       | 51,316 |   |
| Income from continuing operations                                                                                                  |       | 925,624                                |       | 387,501 |   |
| Adjustments to reconcile income from continuing  operations to net cash provided by operating activities of continuing operations: |       |                                   |       |   |   |
| Loss on disposition of long-term assets                                                                                            |       | 1,611                                  |       | — |   |
| Depreciation and amortization                                                                                                      |       | 288,516                                |       | 373,473 |   |
| Deferred income taxes                                                                                                              |       | (16,690                                | )          | (5,400 | ) |
| Changes in operating assets and liabilities, net of  effect of acquisition in 2004:                                                |       |                                   |       |   |   |
| Trade accounts receivable                                                                                                          |       | 257,547                                |       | 667,659 |   |
| Other receivables                                                                                                                  |       | (30,159                                | )          | (12,648 | ) |
| Inventories                                                                                                                        |       | (400,016                               | )          | 202,982 |   |
| Prepaid expenses                                                                                                                   |       | 60,071                                 |       | 43,283 |   |
| Accounts payable                                                                                                                   |       | (101,917                               | )          | 40,824 |   |
| Accrued compensation and vacation                                                                                                  |       | (170,856                               | )          | (228,417 | ) |
| Other accrued expenses                                                                                                             |       | (284,395                               | )          | (111,091 | ) |
| Accrued product warranties                                                                                                         |       | —                                 |       | 3,599 |   |
| Accrued income taxes                                                                                                               |       | (70,734                                | )          | 44,456 |   |
| Net cash provided by operating activities of  continuing operations                                                                |       | 458,602                                |       | 1,406,221 |   |
|                                                                                                                               |       |                                   |       |   |   |
| Cash flows from investing activities:                                                                                              |       |                                   |       |   |   |
| Cash paid in acquisitions, net of cash acquired                                                                                    |       | —                                 |       | (468,683 | ) |
| Purchases of marketable securities                                                                                                 |       | (2,431,781                             | )          | (1,194,817 | ) |
| Proceeds from sales or maturities of marketable  securities                                                                        |       | 1,494,131                              |       | 1,650,923 |   |
| Purchases of property and equipment                                                                                                |       | (58,133                                | )          | (46,610 | ) |
| Purchases of patents and trademarks                                                                                                |       | (34,211                                | )          | (10,007 | ) |
| Other                                                                                                                              |       | (16,182                                | )          | (1,749 | ) |
| Net cash used in investing activities of continuing  operations                                                                    |       | (1,046,176                             | )          | (70,943 | ) |
|                                                                                                                               |       |                                   |       |   |   |
| Cash flows from financing activities:                                                                                              |       |                                   |       |   |   |
| Proceeds from the exercise of stock options                                                                                        |       | 28,134                                 |       | 25,188 |   |
| Dividends paid to former owners of Paul Lippke  Handels                                                                            |       | —                                 |       | (449,087 | ) |
| Dividends paid to MOCON shareholders                                                                                               |       | (373,694                               | )          | (351,403 | ) |
| Net cash used in financing activities of continuing  operations                                                                    |       | (345,560                               | )          | (775,302 | ) |
|                                                                                                                               |       |                                   |       |   |   |
| Net cash provided by (used in) discontinued  operations                                                                            |       | 36,121                                 |       | (101,013 | ) |
|                                                                                                                               |       |                                   |       |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                                                                      |       | (42,617                                | )          | (5,407 | ) |
|                                                                                                                               |       |                                   |       |   |   |
| Net (decrease) increase in cash and cash equivalents                                                                               |       | (939,630                               | )          | 453,556 |   |
|                                                                                                                               |       |                                   |       |   |   |
| Cash and cash equivalents:                                                                                                         |       |                                   |       |   |   |
| Beginning of period                                                                                                                |       | 2,648,879                              |       | 1,399,837 |   |
| End of period                                                                                                                      |       | $                                      | 1,709,249  |   | $ | 1,853,393 |   |
|                                                                                                                               |       |                                   |       |   |   |
| Supplemental disclosures of cash flow information:                                                                                 |       |                                   |       |   |   |
| Cash paid during the period for income taxes                                                                                       |       | $                                      | 279,112    |   | $ | 22,945 |   |
|                                                                                                                               |       |                                   |       |   |   |
| Supplemental schedule of noncash investing and  financing activities:                                                         |       |                                   |       |   |   |
| Unrealized holding (loss) gain on available-for-sale  securities                                                                   |       | $                                      | (6,625     | ) | $ | 3,213 |   |
| Dividends accrued                                                                                                                  |       | 373,694                                |       | 351,402 |   |

 

See accompanying notes to condensed consolidatedfinancial 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 March 31, 2005, the condensedconsolidated statements of income for the three-month periods ended March 31,2005 and 2004, and the condensed consolidated statements of cash flows for thethree-month periods ended March 31, 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 March 31, 2005, and for allperiods presented, have been made.  Theresults of operations for the three-month period ended March 31, 2005 arenot 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 our subsidiariesafter 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 the intrinsic-valuemethod for employee stock-based compensation pursuant to Accounting PrinciplesBoard Opinion No. 25 (Opinion 25), *Accounting for StockIssued to Employees*.  Underthe guidelines of Opinion 25, compensation cost for stock-based employeecompensation plans is recognized based on the difference, if any, between thequoted market price of the stock on the date of grant and the amount anemployee 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 ofFinancial Accounting Standard (SFAS) No. 123, *Accountingfor Stock-Based Compensation*. These provisions require us to show, on a pro forma basis, our netincome and income per common share as if we had recorded an expense for ourstock options at the time of grant. Other than disclosure in this footnote, we do not use these pro formaresults for any purpose.  No stockoptions were granted during the three-month periods ended March 31, 2005and 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 share wouldhave been reduced to the pro forma amounts indicated below:

 
| ** **                                                                                                                                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Net income – as reported                                                                                                                 |       | $                                      | 794,171    |   | $ | 336,185 |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | (28,829                                | )          | (40,884 | ) |
| Net income – pro forma                                                                                                                   |       | $                                      | 765,342    |   | $ | 295,301 |   |
|                                                                                                                                          |       |                                   |       |   |   |
| Net income per common share – as reported:                                                                                               |       |                                   |       |   |   |
| Basic                                                                                                                                         |       | $                                      | 0.15       |   | $ | 0.06 |   |
| Diluted                                                                                                                                       |       | $                                      | 0.14       |   | $ | 0.06 |   |
| Net income per common share – pro forma:                                                                                                 |       |                                   |       |   |   |
| Basic                                                                                                                                         |       | $                                      | 0.14       |   | $ | 0.05 |   |
| Diluted                                                                                                                                       |       | $                                      | 0.14       |   | $ | 0.05 |   |

 

In December 2004,the FASB issued Statement of Financial Accounting Standards No. 123 (revised2004), *Share-Based Payments* (FAS 123(R)), whichis a revision of SFAS No.123 and supercedes 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.

 

*Reclassifications*

* *

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

 

5

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Note 2 – Inventories

 

Inventories consist ofthe following:

 
| ** **        | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------|------------|--------------------------|------------|-----------------------------|------------|
| Finished products |       | $                        | 856,063    |                        | $          | 717,507 |   |
| Work-in-process   |       | 1,645,172                |       | 1,395,364                   |       |
| Raw materials     |       | 1,653,018                |       | 1,665,505                   |       |
|              |       | $                        | 4,154,253  |                        | $          | 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-month periods ended March 31,2005 and 2004:

 
| ** **                                                              | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                              | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Weighted shares of common stock outstanding – basic                |       | 5,339,177                              |       | 5,406,952 |   |
| Weighted shares of common stock assumed upon  exercise of stock options |       | 180,817                                |       | 119,718 |   |
| Weighted shares of common stock outstanding –  diluted             |       | 5,519,994                              |       | 5,526,670 |   |

 

Note 4 – Goodwill andIntangible Assets

 

As of March 31, 2005and December 31, 2004, unamortized goodwill amounted to $2,315,774.  Other identifiable intangible assets are asfollows:

 
| ** **                 | ** ** | **As of March 31, 2005** | ** ** |
|----------------------------|------------|-------------------------------|------------|
| ** **                 | ** ** | **Carrying  Amount**          | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** | **Estimated  Useful Lives** | ** ** |
| Patents                    |       | $                             | 581,694    |   | $ | 230,638 |   | $ | 351,056 |   | 10 to 17 years |   |
| Trademarks and trade names |       | 393,280                       |       | 108,411 |   | 284,869 |   | 5 to 17 years |   |
| Technology rights          |       | 184,008                       |       | 127,053 |   | 56,955 |   | 7 to 10 years |   |
| Other intangibles          |       | 715,043                       |       | 416,552 |   | 298,491 |   | Less than 1 year to 5 years |   |
|                       |       | $                             | 1,874,025  |   | $ | 882,654 |   | $ | 991,371 |   |   |   |

 

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 months ended March 31, 2005 was $73,687.  Estimated amortization expense for theremainder of 2005 and each of the four succeeding fiscal years based on theintangible assets as of March 31, 2005 is as follows:

 

| ** ** | ** ** | **Estimated  Expense** | ** ** |
|------------|------------|------------------------|------------|
| 2005       |       | $                      | 220,528    |   |
| 2006       |       | $                      | 280,334    |   |
| 2007       |       | $                      | 163,558    |   |
| 2008       |       | $                      | 106,847    |   |
| 2009       |       | $                      | 44,146     |   |

###  

### 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 March 31,2005, this resulted in a net unrealized loss of $6,625 and at March 31,2004 a net unrealized gain of $3,213, 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  March 31,** | ** ** |
|----------------------------------------------|------------|----------------------------------------|------------|
| ** **                                   | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Net income                                   |       | $                                      | 794,171    |   | $ | 336,185 |   |
| Foreign currency translation adjustment      |       | (58,685                                | )          | (10,090 | ) |
| Net unrealized loss on marketable securities |       | (3,865                                 | )          | (5 | ) |
| Comprehensive income                         |       | $                                      | 731,621    |   | $ | 326,090 |   |

 

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 three-month periods ended March 31, 2005 and 2004 were asfollows: 

 

| ** **          | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------|------------|----------------------------------------|------------|
|                |       | **2005**                               | ** ** | **2004** | ** ** |
| Beginning balance   |       | $                                      | 352,634    |   | $ | 279,639 |   |
| Warranty provisions |       | 44,360                                 |       | 140,964 |   |
| Warranty claims     |       | (48,254                                | )          | (89,648 | ) |
| Ending balance      |       | $                                      | 348,740    |   | $ | 330,955 |   |

 

Note 8 – DiscontinuedOperations

 

During the first quarterof 2005, we discontinued production of Vaculok® vacuum insulated panels andexited the Vaculok product line.  Werecorded a pretax loss from discontinued operations of $207,013 (includingimpairment charges of $162,420, primarily related to equipment) in the first quarterof 2005.  The revenues and expenses ofVaculoks operating activities have been reported as discontinuedoperations.  The after-tax loss fromdiscontinued operations for the first quarter of 2005 was $131,453.

 

We intend to sell the assets associated with the Vaculokproduct line and expect a disposition to occur by the end of 2005.  Although we have had discussions with thirdparties regarding their interest in acquiring the assets, we do not have anyacquisition commitments, and can give no assurance that such a sale will occur.

 

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 our financialcondition 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 Consolidated Financial Statements and the related notesthereto.

 

### *CompanyOverview*

###  

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 a total of five 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 netprofits of Lippke in the years 2005 and 2006, with a minimum payment amount of100,000 euros per year.  It isanticipated that these earnout payments will be made to the former parentcompany of Lippke at or near the 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 use adirect sales force to market our products and services in the United States,Canada and Germany and use a network of independent representatives to marketand service our products and services in 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, particularly on our permeation productssales.

 

During the firstquarter of 2005, we made the decision to discontinue production of Vaculokvacuum insulated panels, and exit this product line.  Included in the quarterly results are

 

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impairment andother charges of $162,000 related to this discontinuance.  In addition to the $162,000, we incurred$45,000 in losses from the discontinued Vaculok operations, bringing the totalloss from the discontinued Vaculok operations for the quarter to $207,000($131,000 net of tax benefit).

 

### *OverallSummary of Financial Results for First Quarter of 2005*

###  

Sales for thefirst quarter of 2005 were $6,444,395, an increase of 13% compared to$5,715,122 for 2004.  The increase isprimarily due to sales of permeation equipment into our foreign markets.  Net income was $794,171, a 136% increasecompared to $336,185 in the first quarter of 2004.  Net income per diluted share was $0.14 in thefirst quarter of 2005, a 133% increase compared to $0.06 for the same period in2004.

 

### *Resultsof Operations*

 

The followingtable sets forth the relationship between various components of our results of operations,stated as a percent of sales, for the three-month periods ended March 31,2005, and 2004. 

 
| ** **                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                             | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Sales                                                  |       | 100.0                                  |       | 100.0 |   |
| Cost of sales                                          |       | 44.7                                   |       | 47.0 |   |
| Gross profit                                           |       | 55.3                                   |       | 53.0 |   |
| Selling, general, and administrative expenses          |       | 32.4                                   |       | 37.1 |   |
| Research and development expenses                      |       | 6.5                                    |       | 6.0 |   |
| Operating income                                       |       | 16.4                                   |       | 9.9 |   |
| Other income                                           |       | 1.4                                    |       | 0.4 |   |
| Income before income taxes                             |       | 17.8                                   |       | 10.3 |   |
| Income taxes                                           |       | 3.4                                    |       | 3.5 |   |
| Income from continuing operations                      |       | 14.4                                   |       | 6.8 |   |
| Loss from discontinued operations                      |       | (3.2                                   | )          | (1.4 | ) |
| Income tax benefit on loss from disc. operations       |       | 1.1                                    |       | 0.5 |   |
| Loss from discontinued operations, net of tax  benefit |       | (2.1                                   | )          | (0.9 | ) |
| Net income                                             |       | 12.3                                   |       | 5.9 |   |

###  

### *Net Sales*

###  

Sales for thefirst quarter of 2005 were $6,444,395, up 13% compared to $5,715,122 for thesame period in 2004.  On a product basis,this increase was primarily due to increased foreign sales of our permeationproducts, domestic and foreign sales of our leak detection products, anddomestic sales of our gas analyzer products, offset somewhat by decreases indomestic sales of our gas chromatography analyzer products.  These sales increases were generally theresult of increased demand.  The impactof price increases was not significant.

 

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The followingtable summarizes total sales by product line for the three-month periods ended March 31,2005 and 2004.

 
| ** **                  | ** ** | **March 31,** | ** ** |
|-----------------------------|------------|--------------------|------------|
| ** **                  | ** ** | **2005**           | ** ** | **2004** | ** ** |
| Permeation Products         |       | $                  | 3,838,332  |   | $ | 3,348,471 |   |
| Gas Analyzer Products       |       | 964,185            |       | 805,987 |   |
| Leak Detection Products     |       | 534,828            |       | 321,016 |   |
| Headspace Analyzer Products |       | 492,236            |       | 453,303 |   |
| Other                       |       | 614,814            |       | 786,345 |   |
| Total sales                 |       | $                  | 6,444,395  |   | $ | 5,715,122 |   |

 

The followingtable sets forth the relationship between various components of domestic andforeign sales, for the three-month periods ended March 31, 2005 and 2004.

 
| ** **          | ** ** | **Three Months Ended  March 31,** |
|---------------------|------------|----------------------------------------|
| ** **          | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Domestic sales      |       | $                                      | 3,104,802 |   | $ | 2,795,541 |   |
| Foreign sales:      |       |                                   |   |   |   |
| Western Europe      |       | 1,516,800                              |   | 1,552,059 |   |
| Asia                |       | 1,386,997                              |   | 841,958 |   |
| Other               |       | 435,796                                |   | 525,564 |   |
| Total foreign sales |       | 3,339,593                              |   | 2,919,581 |   |
| Total sales         |       | $                                      | 6,444,395 |   | $ | 5,715,122 |   |

 

Sales of ourpermeation products which accounted for approximately 60% and 59% of ourconsolidated first quarter sales in 2005 and 2004, respectively, increased 15%during the first quarter of 2005 compared to the same period in 2004.  This increase was due primarily to sales intoour foreign markets, specifically Asian countries other than Japan.  Sales of our gas analysis and monitoringinstrumentation products through our Baseline-MOCON, Inc, subsidiary, whichaccounted for 15% and 14% of our consolidated first quarter sales in 2005 and2004, respectively, increased 20%.  Thisincrease was directly related to an increase in sales of our piD-TECHTMminiaturized photoionization sensor to domestic markets.  Sales of our leak detection products, whichaccounted for 8% and 6% of our consolidated first quarter sales in 2005 and2004, respectively, increased 67%.  Thisincrease was fairly evenly spread between our domestic and foreignmarkets.  The domestic sales wereenhanced by increased market penetration of Lippke products in the U. S.market. Sales of our headspace analyzer products which accounted for 8% of ourconsolidated first quarter sales in both 2005 and 2004 increased 9%.  This increase was a result of increased salesin our domestic market, offset by a slight decrease in foreign sales.  The overall

 

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increase was primarilydue to sales of hand-held headspace analyzer products, which were originallyintroduced in 2003.  

 

On a geographicalbasis, total foreign sales accounted for 52% and 51% of our consolidated firstquarter sales in 2005 and 2004, respectively, and were up 14% during the firstquarter of 2005 compared to the same period in 2004.  This increase was due primarily to the saleof permeation products by Lippke.  Totaldomestic sales accounted for 48% and 49% of our consolidated first quartersales in 2005 and 2004, respectively, and were up 11%.  This domestic sales increase was primarilydue to increased sales of gas analyzer products and leak detection products. 

 

### *GrossProfit*

###  

Our gross profitmargin was 55.3% and 53.0% for the three-month periods ended March 31,2005 and 2004, respectively.  The grossprofit margin as a percentage of sales was higher for the three months ended March 31,2005 compared to the same period in 2004 due mostly to: (1) expenses in 2004related to the acquisition of Lippke, including the higher costs assigned toLippke finished goods inventory under purchase accounting rules of $96,000, (2)cost of sales in 2004 associated with the relocation of our Lab Connectionssubsidiary to Round Rock, Texas, and, (3) additional costs in 2004 associatedwith moving a portion of our Baseline subsidiary’s manufacturing toMinneapolis, Minnesota.

 

*Selling, General and Administrative Expenses*

 

### Selling, generaland administrative (SG&A) expenses in the first quarter of 2005 were$2,082,588, or 32.3% of sales, compared to $2,119,383, or 37.1% of sales in thefirst quarter of 2004.  The decrease inSG&A expenses was primarily due to costs in the first quarter of 2004associated with the acquisition of Lippke, including amortization of $57,000related to purchased backlog, which did not reoccur in the first quarter of2005.

###  

### *Researchand Development Expenses*

###  

Research anddevelopment (R&D) expenses were $420,628, or approximately 6.5% of sales,in the first quarter of 2005, compared to $341,072, or approximately 6.0% ofsales, in the first quarter of 2004. This planned increase in R&D expenditures is considered necessary todevelop new products to expand in our niche markets.  For the foreseeable future, we expect toallocate on an annual basis approximately 6% to 8% of sales to research anddevelopment.

 

### *OtherIncome*

###  

Other income forthe three months ended March 31, 2005 consisted of interest income of$37,927, gain on foreign currency exchange of $41,569, and other income of$11,709.  Interest income increased from$21,176 for the three months ended March 31, 2004.

 

### *IncomeTax Expense*

 

Our provision forincome taxes from continuing operations was 19.5% of income before income taxesfor the three months ended March 31, 2005, compared to 34.1% of incomebefore income taxes for the three months ended March 31, 2004.  The results for the first quarter of 2005were favorably impacted by the finalization of an Internal Revenue Serviceexamination which reduced income tax expense by approximately $156,000 for thequarter.  Based on current operating

 

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conditions andincome tax laws, we expect the tax rate for the remaining three quarters of2005 to be in the range of 33% to 35%.

 

### *NetIncome*

###  

Net income was $794,171in the first quarter of 2005, compared to $336,185 in the first quarter of2004.  Diluted net income per share was$0.14 per share in the first quarter of 2005 compared to $0.06 per share in thefirst quarter of 2004.

 

*Liquidityand Capital Resources*

 

We have historically financed our operations and capital equipmentrequirements through our cash flows generated from operations.  Total cash, cash equivalents and marketablesecurities decreased $5,845 during the first quarter of 2005 to $7,682,874 as ofMarch 31, 2005, compared to $7,688,719 at December 31, 2004 due in part toan earnout payment to the former parent company of Lippke totaling $549,257.  Our working capital as of March 31, 2005increased $59,147 to $11,886,419, 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.

 

*Cash Flow*

 

Cash Flow from Operating Activities

 

Our primary sourceof funds is cash provided by operations. Cash flow from operations totaled $458,602 and $1,406,221 in the firstquarters of 2005 and 2004, respectively inclusive of the loss from discontinuedoperations, net of tax, of $131,453 and $51,316 in the respective periods.

 

The net cash provided by trade accounts receivable was primarily due todecreased sales in the first quarter of 2005 as compared to the fourth quarterof 2004.  The net cash used by inventorywas primarily due to increases in work-in-process and finished goodsinventory.  The net cash used by otheraccrued expenses was due primarily to the reclassification of the second ofthree required minimum earnout payments to the former parent company of Lippkefrom noncurrent liabilities to accounts payable.

 

### Cash Flow fromInvesting Activities

###  

Cash used ininvesting activities totaled $1,046,176 and $70,943 in the first quarters of2005 and 2004, respectively.  Purchasesof marketable securities, net of maturities, were $937,650 in the first quarterof 2005.  Purchases of property, plantand equipment totaled $58,133 in the first quarter of 2005, primarily foradditions of office, manufacturing and laboratory equipment, as compared to $46,610in the first quarter of 2004.

 

We had no materialcommitments for capital expenditures as of March 31, 2005.  We presently do not believe that any majorproperty, plant and equipment expenditures are required to accommodate ourcurrent level of operations.

 

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### Cash Flow fromFinancing Activities

###  

Cash used infinancing activities consists primarily of the purchase and retirement ofcommon stock and payment of dividends to our shareholders.

 

During the firstthree months of 2005 and 2004, we made dividend payments to our shareholders of$373,694 and $351,403, respectively. During the first quarter of 2004, we also made final dividend paymentsof $449,087 to the former parent company of Lippke.

 

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 first quarter of 2005.  As of March 31,2005, $1,672,034 was remaining in this authorization.

 

*ContractualObligations*

 

We refer you toour Annual Report on Form 10-K for the year ended December 31, 2004 for asummary 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-BalanceSheet 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.

 

*CriticalAccounting 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 and subjectivejudgments, often as a result of the need to make estimates of matters that areinherently uncertain.  Based on thisdefinition, we have identified the following critical accounting policies.  Although we believe that our estimates andassumptions are reasonable, they are based upon information available when theyare made.  Actual results may differsignificantly from these estimates under different assumptions or conditions.

 

Allowance fordoubtful accounts and sales returns – This reserve is for accounts receivablebalances that are estimated to be uncollectible as well as estimated salesreturns.  This reserve is based on anumber 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 believethe results could be materially different if historical trends do not reflectactual 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, we

 

14

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would record acredit or charge to selling, general, and administrative expense in the periodthat we made such a determination.  As ofMarch 31, 2005, we had $212,613 reserved against our accounts receivablefor doubtful accounts and sales returns.

 

Allowance forexcess 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 results could be materially different if historical trends do notreflect actual results or if demand for our products decreased because ofeconomic or competitive conditions or otherwise.  Our allowance for excess and obsolete inventoriesat March 31, 2005 was $617,178.

 

Recoverability oflong-lived assets – We assess the recoverability of goodwill and otherlong-lived assets annually or whenever events or changes in circumstancesindicate that expected future undiscounted cash flows might not be sufficientto support the carrying amount of an asset. We deem an asset to be impaired if a forecast of undiscounted futureoperating cash flows is less than an asset’s carrying amount.  If an asset is determined to be impaired, theloss is measured as the amount by which the carrying value of the asset exceedsits fair value.  During the first quarterof 2005, we incurred a non-cash asset impairment charge of $162,000 relating toequipment and inventory used in our Vaculok vacuum insulated panels business asa result of our decision during the quarter to discontinue the product line.See “Part II – Other Information – Item 5 – Other Information” of this reportfor a discussion of this charge.  Changesin our business strategies and/or changes in the economic environment in whichwe operate may result in future impairment charges.

 

Accrued productwarranties – Our products are generally covered by a warranty, with warrantyperiods ranging 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 accruedfor major 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, warranty claims experience couldbe materially different from actual results due to manufacturing changes thatcould impact product quality, a change in our warranty policy in response toindustry trends, as yet unrecognized defects in products sold, or other factors.  As of March 31, 2005, we had $348,740accrued related to future estimated warranty claims.

 

Income taxes – Inthe preparation of our Consolidated Financial Statements, management isrequired to estimate income taxes in each of the jurisdictions in which weoperate.  This process involvesestimating actual current tax exposures together with assessing temporarydifferences resulting from different treatment of items for tax and accountingpurposes.  These differences result indeferred tax assets and liabilities, which are included in our consolidatedbalance 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 March 31, 2005 or 2004.

 

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### *New Accounting Pronouncements*

###  

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, and wasted material(spoilage) should be recognized as current period charges, and that fixedproduction overheads should be allocated to inventory based on normal capacityof production facilities.  This statementis effective for inventory costs incurred during fiscal years beginning after June 15,2005.  Accordingly, we will adopt SFAS151 in the fiscal year beginning January 1, 2006.  We are currently in the process of evaluatingwhether the adoption of SFAS 151 will have a significant impact on our resultsof operations or financial position.

 

In December 2004,the FASB issued SFAS No. 123 (revised 2004) *Share–Based Payments*(FAS 123(R)), which is a revision of FASB Statement No. 123, *Accounting for Stock-Based Compensation*.  FAS 123(R) supercedes  APB Opinion No. 25, *Accountingfor Stock Issued to Employees* and amends FAS Statement No. 95, *Statement of Cash Flows*. FAS 123(R) requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the income statementbased on their fair values and the pro forma disclosure is no longerallowable.  FAS 123(R) is effective atthe beginning of the first annual period after June 15, 2005.  We expect to adopt FAS 123(R) on January 1,2006.  We are currently evaluating the impactof the adoption of FAS 123(R), which will result in additional pre-taxcompensation expense in fiscal 2006 for remaining unvested stock options andany future stock option grants.  Theultimate amount of increased compensation expense will be dependent on the numberof option shares granted, their timing and vesting periods, and the method usedto calculate the fair value of the awards, among other things.

 

### *Forward-Looking Statements*

###  

This Quarterly Report onForm 10-Q contains or incorporates by reference not only historicalinformation, but also forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934.  In addition, we or otherson our behalf may make forward-looking statements from time to time in oralpresentations, including telephone conferences and/or web casts open to thepublic, in press releases or reports, on our internet website orotherwise.  Statements that are nothistorical are forward-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 statements regarding our international sales continuing toaccount for a significant portion of our revenues, our acquisition of Lippkecontinuing to have a positive impact on our sales in 2005, our allocation of 6%to 8% of our sales to research and development expenses, our expected tax ratefor the remaining three quarters of 2005 being in the range of 33% to 35%, ourneed not to make future capital expenditures to accommodate our current levelof operations, the timing of the expected sale of the Vaculok assets, thedivestiture of the Vaculok operations allowing us to better concentrate on ourcore businesses, our expectations regarding future cash expenditures, expensesor write-downs relating to the discontinuation of the Vaculok business, our gasdetection and measurement businesses having greater long-term growth and profitpotential.

 

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-looking statements.  We wish to caution readers not to place unduereliance on any forward-looking statement that speaks only as of the date madeand to recognize that forward-looking statements are predictions of futureresults, which may not occur as anticipated. Actual results could differ materially from those anticipated in theforward-looking statements and from historical results, due to the risks

 

16

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and uncertaintiesdescribed below, as well as others that we may consider immaterial or do notanticipate at this time.  The followingrisks and uncertainties are not exclusive and further information concerning usand our business, including factors that potentially could materially affectour financial results or condition, may emerge from time to time.  We assume no obligation to updateforward-looking statements to reflect actual results or changes in factors orassumptions affecting such forward-looking statements.  We advise you, however, to consult anyfurther disclosures we make on related subjects in our quarterly reports onForm 10-Q and current reports on Form 8-K we file with or furnish to theSecurities and Exchange Commission.

 

***If we experience any increase in the cost of raw materials 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 fewer of such components. Certain other material and labor costs have increased, but we believethat such increases are approximately consistent with overall inflationrates.  We believe that the price of ourproducts and the prices of our competitors’ products is a significant factoraffecting our customers’ buying decisions and consequently, we may not be ableto pass along any cost increases in the form of price increases or sustainprofit margins that we have achieved in prior years.

 

***The markets in which we operate have experienced minimal growth inrecent years, and our ability to increase our revenues will depend in part onour ability to develop new products, develop new applications for our existingproducts and to acquire 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 can notassure 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 sales.

 

***If we acquire businesses in the future, we may experience a decrease inour profit margins, a decrease in our net income, and other adverseconsequences.***

 

One of our growth strategies is to supplement our internal growth withthe acquisition of businesses and technologies that complement or augment ourexisting products.  Some of thebusinesses that we previously acquired have produced net operating losses orlow levels of profitability.  Forexample, the Vaculok vacuum insulated panel business that we acquired inNovember 2003 financially performed poorly, resulting in our decision todiscontinue the product line during the first quarter of 2005. Businesses thatwe may acquire in 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.  This couldresult in the diversion of management’s attention from other businessconcerns.  In addition, acquisitions thatwe believe will be beneficial to our business and financial results aredifficult to identify and complete for a number of reasons, including thecompetition among prospective buyers.  Wemay not be able to complete acquisitions in the future and any acquisitions thatwe do complete may have an adverse effect on our financial performance andliquidity.  It may be necessary for us toraise additional funds either through public or private financing in order tofinance any future acquisitions.  Anyequity or

 

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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 changes thatmay 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.

 

***Any reduction in the level of capital expenditures by our customerscould negatively impact our sales.***

 

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

 

***A significant portion of our sales are generated from foreign countriesand selling in foreign countries entails a number of risks which could resultin a decrease in our sales or an increase in our operating expenses.***

 

Sales outside the United States accounted for approximately 52% of ourrevenues for the three months ended March 31, 2005 and approximately 51%of our revenues for the same period in 2004. We expect that foreign sales will continue to account for a significantportion of our revenues in the future. Sales to customers in foreign countries are subject to a number ofrisks, including the following:

 

•                  agreements may be difficult to enforce;

•                  receivables may difficult to collect;

•                  certain regions are experiencing politicalunrest and conflict;

•                  foreign customers may have longer paymentcycles;

•                  the countries into which we sell may imposetariffs or adopt other restrictions on foreign trade;

•                  currency fluctuations could reduce reportedprofitability in future periods;

•                  fluctuations in exchange rates may affectproduct demand;

•                  export licenses, if required, may bedifficult to obtain and;

•                  protection of intellectual property inforeign countries may be more difficult to enforce.

 

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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.

 

***Some of our competitors have greater resources than we do, which mayprovide our competitors with an advantage in the development and marketing ofnew 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 thepromotion and sale of their products than we can.  In addition, competition could increase ifnew companies enter the market or if existing competitors expand their productlines or intensify efforts within existing product lines.  Our current products, products underdevelopment and our ability to discover new technologies may be insufficient toenable us to compete effectively with our competitors. 

 

***Our reliance upon patents, domestictrademark laws and contractual provisions to protect our proprietary rights maynot be sufficient to protect our intellectual property from others who may sellsimilar 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 incursubstantial costs if our competitors initiate litigation to challenge thevalidity of our patents or if we initiate any proceedings to protect ourproprietary rights and if the outcome of any such litigation is unfavorable tous, our business and results of operations could be materially adverselyaffected.  There may also be pending or issuedpatents held 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 confidentiality agreementsare not breached, our trade secrets may otherwise become known or be independentlydeveloped by competitors.

 

***The market price of our common stock hasfluctuated significantly in the past and will likely continue to do so in thefuture and any broad market fluctuations may materially adversely affect themarket price of our common stock.***

 

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The market price of our common stock has beenvolatile in the past, ranging from a high sales price of $10.20 and a low salesprice of $8.98 during the first quarter of 2005, and several factors couldcause the price to fluctuate substantially in the future.  These factors include:

 

•                  announcements of new products by us or ourcompetitors;

•                  quarterly fluctuations in our financialresults;

•                  customer contract awards;

•                  developments in regulation; and

•                  general economic and political conditions inthe various markets where our products are sold.

 

In addition, the stock prices of instrumentation companies haveexperienced significant price and volume fluctuations that often have beenunrelated to the operating performance of such companies.  This market volatility may adversely affectthe market price of our common stock.

 

***Recently enacted and future changes insecurities laws and regulations are likely to increase 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 accountingfirm’s report on that assessment will require the commitment of significantfinancial and managerial resources.  Wecurrently estimate that Section 404 compliance costs will be approximately$350,000 in 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.  However, virtually all of our marketablesecurities mature within one year or less; therefore, we believe that themarket risk arising from the holding of these financial instruments is minimal.

 

### *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 positiveeffect.  We currently sell our productsand services in United States dollars or the local currency of our foreignsubsidiary (Euros).  Accordingly, ourforeign operations expose us to foreign currency exchange risk when the Eurocurrency results 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 the 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’srules and forms and that such information is accumulated and communicated toour management, including our principal executive and principal financialofficers, or persons performing similar functions, as appropriate to allowtimely decisions regarding required disclosure. Our management evaluated, with the participation of our Chief ExecutiveOfficer and Chief Financial Officer, the effectiveness of the design andoperation of our disclosure controls and procedures as of the end of the periodcovered in this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective asof the end of such period.

 

*Changesin Internal Control Over Financial Reporting*

 

There was no change inour internal control over financial reporting that occurred during our quarterended March 31, 2005 that has materially affected, or is reasonably likelyto 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 months endedMarch 31, 2005 that were not registered under the Securities Act of 1933.

 

*Issuer Repurchases of Equity Securities*

 

We did not repurchase any equity securities ofMOCON, Inc. during the three months ended March 31, 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 March 31,2005, 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.

 

Item 5. OtherInformation

 

On March 31, 2005, we committed to a plan todiscontinue production of Vaculok® vacuum insulated panels and exit thisproduct line.  The decision to exit theVaculok business was the result of its poor financial performance since it wasacquired in November 2003 and our plan to concentrate on our corebusinesses, particularly our gas detection and measurement businesses, which webelieve have greater long-term growth and profit potential.

 

We intend to sell the assets associated with theVaculok product line and expect a disposition to occur by the end of 2005.  Although we have had discussions with thirdparties regarding their interest in acquiring the assets, we do not have anyacquisition commitments, and can give no assurance that such a sale will occur.

 

We recorded a pre-tax charge to earnings in thefirst quarter of 2005, totaling approximately $207,000, to reflect the resultsof operations and asset impairment write-down associated with thediscontinuation of the Vaculok business. This $207,000 charge included a non-cash asset impairment charge of$162,000 relating to equipment and inventory used in the Vaculok business.  The $207,000 pre-tax charge negativelyimpacted our first quarter 2005 net income per common share by approximately$0.02 per basic and diluted weighted average common share.  We currently expect to incur no significantcash expenditures, expenses or write-downs in future periods relating to thediscontinuation of the Vaculok business.

 

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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: May 16,  2005 | /s/ Robert L.  Demorest                       |   |   |
|                | Robert L. Demorest                            |   |
|                | Chairman,  President and Chief                |   |
|                | Executive  Officer                            |   |
|                | (Principal  Executive Officer)                |   |
|                |                                          |   |
|                |                                          |   |
| Date: May 16,  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 MARCH 31, 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 |       | Filed herewith        |
| 32.2             |       | Certification of Chief Financial Officer Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 |       | Filed herewith        |

 

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