Table of Contents

 

 

 

**UNITED STATES********SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

**x****      Quarterly Report Pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934**

 

**For the Quarter Ended September 30, 2010**

 

**or**

 

**o****         Transition ReportPursuant to Section 13 or 15(d) of the Securities Exchange Act of1934**

 

**For the transition period from                to**

 

**CommissionFile Number 000-09273**

 

**MOCON, INC.**

(Exact name of registrant as specified in its charter)

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

 

**7500 Mendelssohn Avenue North, Minneapolis, Minnesota55428**

(Address of principal executive offices)  (Zip code)

 

**(763) 493-6370**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. YES x  NO o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). YES  o  NO  o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See the definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large accelerated filer o                     |   | Accelerated filer o         |
|-----------------------------------------------|--------|-----------------------------|
|                                          |   |                        |
| Non-accelerated filer o                       |   | Smaller reporting company x |
| (do not check if a smaller reporting company) |   |                        |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  YES o NO x

 

5,247,448Common Shares were outstanding as of October 31, 2010.

 

 

 

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MOCON, INC. AND SUBSIDIARIES

 

INDEX TO FORM 10-Q

For the Quarter Ended September 30, 2010

 
| ** **                                     | **Page  Number**                                                                                                       |
|------------------------------------------------|------------------------------------------------------------------------------------------------------------------------|
| PART I.  FINANCIAL  INFORMATION |                                                                                                                   |
|                                           |                                                                                                                   |
| Item  1.                                       | Financial Statements                                                                                                   |   |
|                                           | Condensed Consolidated  Balance Sheets (Unaudited)  September 30, 2010 and December 31, 2009                 | 1 |
|                                           |                                                                                                                   |   |
|                                           | Condensed Consolidated  Statements of Income (Unaudited)  Three and nine months ended September 30, 2010 and 2009 | 2 |
|                                           |                                                                                                                   |   |
|                                           | Condensed Consolidated  Statements of Cash Flows (Unaudited)  Nine months ended September 30, 2010 and 2009       | 3 |
|                                           |                                                                                                                   |   |
|                                           | Notes to Condensed  Consolidated Financial Statements (Unaudited)                                                      | 4-11 |
|                                           |                                                                                                                   |   |
| Item 2.                                        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                            | 12-22 |
|                                           |                                                                                                                   |   |
| Item 3.                                        | Quantitative  and Qualitative Disclosures About Market Risk                                                            | 22 |
|                                           |                                                                                                                   |   |
| Item 4.                                        | Controls and  Procedures                                                                                               | 22-23 |
|                                           |                                                                                                                   |   |
|                                           |                                                                                                                   |   |
| PART II. OTHER  INFORMATION          |                                                                                                                   |
|                                           |                                                                                                                   |   |
| Item 1A.                                       | Risk Factors                                                                                                           | 23 |
|                                           |                                                                                                                   |   |
| Item 2.                                        | Unregistered  Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity  Securities                   | 23 |
|                                           |                                                                                                                   |   |
| Item  6.                                       | Exhibits                                                                                                               | 23-24 |
|                                           |                                                                                                                   |   |
| Signatures                                     | 25                                                                                                                     |
|                                           |                                                                                                                   |
| Exhibit Index                             | 26                                                                                                                     |

 

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

 

*All trademarks or trade names referred to in thisreport are the property of their respective owners.*

 

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PART I.  FINANCIAL INFORMATION

 

Item1.  Financial Statements

 

MOCON, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATEDBALANCE SHEETS

(Unaudited)

 
| ** **                                                                                                                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                        | ** ** | **2010**               | ** ** | **2009**              | ** ** |
|                                                                                                                                              |       |                   |       |                  |       |
| ASSETS                                                                                                                                            |       |                   |       |                  |       |
| Current assets:                                                                                                                                   |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                         |       | $                      | 6,145,317  |                  | $          | 9,393,127 |   |
| Marketable securities, current                                                                                                                    |       | 2,393,071              |       | 4,371,119             |       |
| Trade accounts receivable, less allowance for  doubtful accounts of $193,379 in 2010 and $162,315 in 2009                                         |       | 4,513,661              |       | 4,589,998             |       |
| Other receivables                                                                                                                                 |       | 450,831                |       | 92,738                |       |
| Inventories                                                                                                                                       |       | 4,346,418              |       | 4,265,470             |       |
| Prepaid income taxes                                                                                                                              |       | 121,850                |       | 223,648               |       |
| Prepaid expenses                                                                                                                                  |       | 573,253                |       | 357,911               |       |
| Deferred income taxes                                                                                                                             |       | 411,549                |       | 411,549               |       |
| Total current assets                                                                                                                              |       | 18,955,950             |       | 23,705,560            |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Marketable securities, noncurrent                                                                                                                 |       | 2,894,570              |       | 567,163               |       |
| Property, plant and equipment, net of accumulated depreciation  of $4,027,990 in 2010 and $4,601,480 in 2009                                      |       | 2,873,172              |       | 1,655,187             |       |
| Goodwill                                                                                                                                          |       | 3,209,997              |       | 3,300,088             |       |
| Investment in affiliated company                                                                                                                  |       | 3,403,000              |       | —                |       |
| Technology rights and other intangibles, net                                                                                                      |       | 734,072                |       | 738,035               |       |
| Deferred income taxes                                                                                                                             |       | 405,597                |       | 280,548               |       |
| Other assets                                                                                                                                      |       | 83,068                 |       | 80,427                |       |
|                                                                                                                                              |       |                   |       |                  |       |
| TOTAL ASSETS                                                                                                                                      |       | $                      | 32,559,426 |                  | $          | 30,327,008 |   |
|                                                                                                                                              |       |                   |       |                  |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                         |       |                   |       |                  |       |
| Current liabilities:                                                                                                                              |       |                   |       |                  |       |
| Accounts payable                                                                                                                                  |       | $                      | 1,898,307  |                  | $          | 1,343,739 |   |
| Compensation and related expenses                                                                                                                 |       | 1,614,657              |       | 1,479,398             |       |
| Other accrued expenses                                                                                                                            |       | 237,726                |       | 163,640               |       |
| Accrued product warranties                                                                                                                        |       | 202,123                |       | 209,710               |       |
| Dividends payable                                                                                                                                 |       | 497,565                |       | 465,302               |       |
| Deferred revenue                                                                                                                                  |       | 451,788                |       | 426,277               |       |
| Total current liabilities                                                                                                                         |       | 4,902,166              |       | 4,088,066             |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Obligations to former employees                                                                                                                   |       | 51,418                 |       | 54,141                |       |
| Accrued income taxes                                                                                                                              |       | 213,894                |       | 202,418               |       |
| Total noncurrent liabilities                                                                                                                      |       | 265,312                |       | 256,559               |       |
|                                                                                                                                              |       |                   |       |                  |       |
| Total liabilities                                                                                                                                 |       | 5,167,478              |       | 4,344,625             |       |
| Commitments and contingencies (Note 13)                                                                                                           |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                        |       |                   |       |                  |       |
| Capital stock — undesignated. Authorized 3,000,000  shares                                                                                   |       | —                 |       | —                |       |
| Common stock — $0.10 par value. Authorized  22,000,000 shares; issued and outstanding 5,237,524 shares in 2010 and  5,170,018 shares in 2009 |       | 523,752                |       | 517,002               |       |
| Additional paid-in capital                                                                                                                        |       | 565,342                |       | 114,021               |       |
| Retained earnings                                                                                                                                 |       | 26,246,437             |       | 24,690,293            |       |
| Accumulated other comprehensive income                                                                                                            |       | 56,417                 |       | 661,067               |       |
| Total stockholders’ equity                                                                                                                   |       | 27,391,948             |       | 25,982,383            |       |
|                                                                                                                                              |       |                   |       |                  |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                   |       | $                      | 32,559,426 |                  | $          | 30,327,008 |   |

 

See accompanying notes to consolidated financial statements.

 

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MOCON, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME

(Unaudited)

 
| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                   | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| Sales:                                       |       |                             |       |                            |       |   |   |   |   |
| Products                                     |       | $                                | 7,070,155  |                            | $          | 6,116,215 |   | $ | 20,268,190 |   | $ | 17,873,446 |   |
| Consulting services                          |       | 679,047                          |       | 484,344                         |       | 1,925,606 |   | 1,320,208 |   |
| Total sales                                  |       | 7,749,202                        |       | 6,600,559                       |       | 22,193,796 |   | 19,193,654 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Cost of sales:                               |       |                             |       |                            |       |   |   |   |   |
| Products                                     |       | 2,708,213                        |       | 2,385,444                       |       | 7,664,095 |   | 7,273,843 |   |
| Consulting services                          |       | 399,753                          |       | 297,020                         |       | 1,068,009 |   | 783,765 |   |
| Total cost of sales                          |       | 3,107,966                        |       | 2,682,464                       |       | 8,732,104 |   | 8,057,608 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Gross profit                                 |       | 4,641,236                        |       | 3,918,095                       |       | 13,461,692 |   | 11,136,046 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Selling, general and administrative expenses |       | 2,567,261                        |       | 2,267,755                       |       | 8,001,409 |   | 7,340,218 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Research and development expenses            |       | 521,108                          |       | 470,330                         |       | 1,591,634 |   | 1,439,961 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Operating income                             |       | 1,552,867                        |       | 1,180,010                       |       | 3,868,649 |   | 2,355,867 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Other income, net                            |       | 17,978                           |       | 91,729                          |       | 577,195 |   | 320,308 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Income before income taxes                   |       | 1,570,845                        |       | 1,271,739                       |       | 4,445,844 |   | 2,676,175 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Income taxes                                 |       | 541,976                          |       | 398,000                         |       | 1,403,083 |   | 888,000 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Net income                                   |       | $                                | 1,028,869  |                            | $          | 873,739 |   | $ | 3,042,761 |   | $ | 1,788,175 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Net income per common share:                 |       |                             |       |                            |       |   |   |   |   |
| Basic                                        |       | $                                | 0.20       |                            | $          | 0.17 |   | $ | 0.59 |   | $ | 0.33 |   |
| Diluted                                      |       | $                                | 0.19       |                            | $          | 0.16 |   | $ | 0.57 |   | $ | 0.32 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Weighted average common shares outstanding:  |       |                             |       |                            |       |   |   |   |   |
| Basic                                        |       | 5,205,667                        |       | 5,250,543                       |       | 5,194,637 |   | 5,467,507 |   |
| Diluted                                      |       | 5,371,989                        |       | 5,312,984                       |       | 5,336,492 |   | 5,533,108 |   |

 

See accompanying notes to consolidated financial statements.

 

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MOCON, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(Unaudited)

 
| ** **                                                                         | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**          | ** ** |
| ** **                                                                         | ** ** | **2010**                        | ** ** | **2009** | ** ** |
| Cash flows from operating activities:                                              |       |                            |       |   |   |
| Net income                                                                         |       | $                               | 3,042,761  |   | $ | 1,788,175 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                            |       |   |   |
| Stock-based compensation expense                                                   |       | 196,852                         |       | 173,050 |   |
| Loss on disposition of long-term assets                                            |       | 4,399                           |       | 8,053 |   |
| Depreciation and amortization                                                      |       | 401,822                         |       | 440,284 |   |
| Deferred income taxes                                                              |       | (125,049                        | )          | — |   |
| Excess tax benefit from employee stock plans                                       |       | (8,623                          | )          | (25 | ) |
| Changes in operating assets and liabilities:                                       |       |                            |       |   |   |
| Trade accounts receivable                                                          |       | (7,376                          | )          | 78,020 |   |
| Other receivables                                                                  |       | (357,458                        | )          | 118,892 |   |
| Inventories                                                                        |       | (115,352                        | )          | 344,180 |   |
| Prepaid income taxes                                                               |       | 92,525                          |       | (98,825 | ) |
| Prepaid expenses                                                                   |       | (217,398                        | )          | (25,050 | ) |
| Accounts payable                                                                   |       | 274,980                         |       | (118,054 | ) |
| Compensation and related expenses                                                  |       | 147,548                         |       | (375,317 | ) |
| Other accrued expenses                                                             |       | 74,330                          |       | (25,331 | ) |
| Accrued product warranties                                                         |       | (4,892                          | )          | (20,008 | ) |
| Accrued income taxes                                                               |       | 20,099                          |       | (25,560 | ) |
| Deferred revenue                                                                   |       | 25,511                          |       | 103,585 |   |
| Net cash provided by operating activities                                          |       | 3,444,679                       |       | 2,366,069 |   |
|                                                                               |       |                            |       |   |   |
| Cash flows from investing activities:                                              |       |                            |       |   |   |
| Purchases of marketable securities                                                 |       | (3,890,040                      | )          | (979,101 | ) |
| Proceeds from maturities of marketable securities                                  |       | 3,540,681                       |       | 5,037,304 |   |
| Purchases of property, plant and equipment                                         |       | (1,251,158                      | )          | (258,816 | ) |
| Proceeds from sale of property and equipment                                       |       | 7,528                           |       | 3,066 |   |
| Cash paid for patent and trademark registrations                                   |       | (67,569                         | )          | (106,785 | ) |
| Other                                                                              |       | (2,641                          | )          | (2,641 | ) |
| Cash paid for investment in affiliated companies                                   |       | (3,633,909                      | )          | — |   |
| Net cash (used in) provided by investing  activities                               |       | (5,297,108                      | )          | 3,693,027 |   |
|                                                                               |       |                            |       |   |   |
| Cash flows from financing activities:                                              |       |                            |       |   |   |
| Proceeds from the exercise of stock options                                        |       | 252,596                         |       | 7,685 |   |
| Purchases and retirement of common stock                                           |       | —                          |       | (3,602,083 | ) |
| Excess tax benefit from employee stock plans                                       |       | 8,623                           |       | 25 |   |
| Dividends paid                                                                     |       | (1,454,354                      | )          | (1,493,473 | ) |
| Net cash used in financing activities                                              |       | (1,193,135                      | )          | (5,087,846 | ) |
|                                                                               |       |                            |       |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                      |       | (202,246                        | )          | 137,388 |   |
|                                                                               |       |                            |       |   |   |
| Net (decrease) increase in cash and cash  equivalents                              |       | (3,247,810                      | )          | 1,108,638 |   |
|                                                                               |       |                            |       |   |   |
| Cash and cash equivalents:                                                         |       |                            |       |   |   |
| Beginning of period                                                                |       | 9,393,127                       |       | 4,553,479 |   |
| End of period                                                                      |       | $                               | 6,145,317  |   | $ | 5,662,117 |   |
|                                                                               |       |                            |       |   |   |
| Supplemental disclosures of cash flow information:                                 |       |                            |       |   |   |
| Cash paid during the period for income taxes                                       |       | $                               | 1,415,508  |   | $ | 971,979 |   |
|                                                                               |       |                            |       |   |   |
| Supplemental schedule of noncash investing and  financing activities:              |       |                            |       |   |   |
| Amortization of cumulative unrealized gain on  marketable securities               |       | $                               | —     |   | $ | (2,527 | ) |
| Dividends accrued                                                                  |       | $                               | 497,565    |   | $ | 465,277 |   |
| Purchases of fixed assets and intangibles in  accounts payable                     |       | $                               | 318,946    |   | $ | 12,557 |   |

 

See accompanying notes to consolidated financial statements.

 

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MOCON, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note1 — Condensed Consolidated Financial Statements

 

Thecondensed consolidated balance sheet as of September 30, 2010, thecondensed consolidated statements of income for the three- and nine-monthperiods ended September 30, 2010 and 2009, and the condensed consolidatedstatements of cash flows for the nine-month periods ended September 30,2010 and 2009 have been prepared in accordance with accounting principlesgenerally accepted in the United States of America.  These interim unaudited condensedconsolidated financial statements reflect all adjustments which are, in theopinion of management, necessary to fairly present the financial position,results of operations and cash flows at September 30, 2010, and for allperiods presented.  Certain informationand footnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted.

 

Theresults of operations for the three- and nine-month periods ended September 30,2010 are not necessarily indicative of operating results for the fullyear.  It is suggested that thesecondensed consolidated financial statements be read in conjunction with theconsolidated financial statements and notes included in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2009, previously filed with theSecurities and Exchange Commission.

 

Weoperate in a single industry segment: the developing, manufacturing, andmarketing of measurement, analytical, monitoring and consulting products forcustomers in the barrier packaging, food, pharmaceutical, consumer products,industrial hygiene, air quality monitoring, oil and gas exploration and otherindustries throughout the world.

 

*Principles of Consolidation*

 

Theconsolidated financial statements include the accounts of MOCON, Inc. andits subsidiaries after elimination of inter-company transactions and accounts.

 

*Foreign Currency Translation*

 

Thefinancial statements for operations outside the United States are maintained intheir local currency.  All assets andliabilities of our foreign subsidiaries are translated to United States dollarsat period-end exchange rates, while revenue and expense accounts are translatedat the average exchange rates during the period transactions occurred.  Translation adjustments arising from the useof differing exchange rates are included in accumulated other comprehensive incomeor loss in stockholders’ equity.  Gainsand losses on foreign currency transactions are included in other income orloss.

 

*Use of Estimates*

 

Thepreparation of consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the consolidated financial statements and the reported amountsof revenues and expenses during the reporting period.  Management adjusts such estimates andassumptions when facts and circumstances change.  Illiquid credit markets, volatile equity,foreign currency and energy markets, and declines in business and consumerspending have combined to increase the uncertainty inherent in such

 

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estimatesand assumptions.  Actual results coulddiffer from those estimates.

 

*FairValue of Financial Instruments*

 

Thecarrying value of cash equivalents, accounts receivable, accounts payable andshort-term debt approximates fair value due to the short maturity of those instruments.  See marketable securities fair valuedisclosures at Note 5 and fair value disclosures of derivative instruments atNote 12.

 

*Recently Adopted Accounting Pronouncements*

 

In November 2008, the FASB issued EmergingIssues Task Force (EITF) No. 08-6, *Equity-MethodAccounting Considerations*, now codified in ASC Topic 323.  EITF 08-6 concludes that the cost basis of anew equity-method investment would be determined using a cost-accumulationmodel, which would continue the practice of including transaction costs in thecost of investment and would exclude the value of contingentconsideration.  It also requires that ashare issuance by an investee shall be accounted for by the investor as if theinvestor had sold a proportionate share of its investment, with any resultinggain or loss recognized in earnings. EITF 08-6 was effective for us January 1, 2010, and its adoptiondid not have a material impact on our consolidated financial statements.

 

In September 2009, the FASB ratified itsguidance on two revenue recognition standards which were to become effectivefor us beginning January 1, 2011. With earlier adoption permitted, we elected to adopt this guidance inthe first quarter 2010.  Under EITF 08-1,*Multiple-Deliverable Revenue Arrangements*,now codified in ASC Topic 605, when vendor specific objective evidence or thirdparty evidence for deliverables in an arrangement cannot be determined, a bestestimate of the selling price is required to separate deliverables and allocatearrangement consideration using the relative selling price method.  Under EITF 09-3, *Certain Revenue Arrangements That Include Software Elements*,now codified in ASC Topic 985, tangible products that have software componentsthat are essential to the functionality of the tangible product will no longerbe within the scope of the software revenue recognition guidance, andsoftware-enabled products will now be subject to the new guidance for multipledeliverable arrangements discussed above. The adoption of this guidance did not have a material impact on ourconsolidated financial statements.

 

InJanuary 2010, the FASB updated the disclosure requirements for fair valuemeasurements, codified in ASC Topic 820, *Fair Value Measurementsand Disclosures*.  The updatedguidance requires companies to disclose separately the investments thattransfer in and out of Levels 1 and 2 and the reasons for those transfers.Additionally, in the reconciliation for fair value measurement usingsignificant unobservable inputs (Level 3), companies should present separatelyinformation about purchases, sales, issuances and settlements.  We adopted the updated guidance on January 1,2010, except for the disclosures about purchases, sales, issuances andsettlements in the Level 3 reconciliation, which are effective for fiscal yearsbeginning after December 15, 2010. We will adopt the remaining guidance on January 1, 2011.  The adoption of the required guidance did nothave an impact on our consolidated financial statements.  We do not expect that the adoption of theremaining guidance will have an impact on our consolidated financialstatements.

 

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Note2 — Inventories

 

Inventoriesconsist of the following:

 
| ** **        | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-------------------|------------|------------------------------|------------|-----------------------------|------------|
| Finished products |       | $                            | 702,934    |                        | $          | 939,385 |   |
| Work-in-process   |       | 1,776,536                    |       | 1,404,012                   |       |
| Raw materials     |       | 1,866,948                    |       | 1,922,073                   |       |
|              |       | $                            | 4,346,418  |                        | $          | 4,265,470 |   |

 

Note3 — Net Income Per Common Share

 

Basicnet income per common share is computed by dividing net income by the weightedaverage number of 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.

 

Thefollowing table presents a reconciliation of the denominators used in thecomputation of net income per common share — basic, and net income per commonshare — diluted, for the three- and nine-month periods ended September 30,2010 and 2009:

 
| ** **                                                              | ** ** | **Three Months Ended********September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Weighted shares of common stock outstanding —  basic               |       | 5,205,667                                                  |       | 5,250,543                                                 |       | 5,194,637 |   | 5,467,507 |   |
| Weighted shares of common stock assumed upon  exercise of stock options |       | 166,322                                                    |       | 62,441                                                    |       | 141,855 |   | 65,601 |   |
| Weighted shares of common stock outstanding —  diluted             |       | 5,371,989                                                  |       | 5,312,984                                                 |       | 5,336,492 |   | 5,533,108 |   |

 

Forthe three- and nine-month periods ended September 30, 2010, there were130,863 and 220,513, respectively, stock options outstanding that were excludedfrom the above computation because they were anti-dilutive.

 

Note4 — Goodwill and Intangible Assets

 

Asof September 30, 2010 and December 31, 2009, goodwill amounted to$3,209,997 and $3,300,088, respectively. The decrease was primarily due to foreign currency translation relatingto the acquisition of Paul Lippke Handels-GmbH. Other identifiable intangible assets (all of which are being amortizedexcept projects in process) are as follows:

 
| ** **                 | ** ** | **As of September 30, 2010** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|
| ** **                 | ** ** | **Cost**                                         | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** | **Estimated  Useful Lives** | ** ** |
| Patents                    |       | $                                                | 1,031,954  |   | $ | (404,475 | ) | $ | 627,479 |   | 10 to 17 years |   |
| Trademarks and trade names |       | 487,013                                          |       | (413,753 | ) | 73,260 |   | 5 to 17 years |   |
| Other intangibles          |       | 778,596                                          |       | (745,263 | ) | 33,333 |   | 3 years |   |
|                       |       | $                                                | 2,297,563  |   | $ | (1,563,491 | ) | $ | 734,072 |   |   |   |

 

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| ** **                 | ** ** | **As of December 31, 2009** | ** ** |
|----------------------------|------------|-------------------------------------------------|------------|
| ** **                 | ** ** | **Cost**                                        | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** | **Estimated  Useful Lives** | ** ** |
| Patents                    |       | $                                               | 1,008,032  |   | $ | (402,392 | ) | $ | 605,640 |   | 10 to 17 years |   |
| Trademarks and trade names |       | 477,486                                         |       | (398,424 | ) | 79,062 |   | 5 to 17 years |   |
| Other intangibles          |       | 778,596                                         |       | (725,263 | ) | 53,333 |   | 3 years |   |
|                       |       | $                                               | 2,264,114  |   | $ | (1,526,079 | ) | $ | 738,035 |   |   |   |

 

Totalamortization expense for the three-month periods ended September 30, 2010and 2009 was $23,198 and $21,588, respectively, and $71,352 and $63,285 for thenine-month periods ended September 30, 2010 and 2009.  Projects in process are not amortized untilthe patent or trademark is granted by the regulatory agency.  Estimated amortization expense for theremainder of 2010 and each of the four succeeding fiscal years and thereafterbased on the intangible assets as of September 30, 2010 is as follows:

 
| ** **          | ** ** | **Estimated  Expense** | ** ** |
|---------------------|------------|------------------------|------------|
| 2010                |       | $                      | 20,286     |   |
| 2011                |       | $                      | 80,496     |   |
| 2012                |       | $                      | 48,071     |   |
| 2013                |       | $                      | 43,756     |   |
| 2014                |       | $                      | 33,333     |   |
| 2015 and thereafter |       | $                      | 232,467    |   |

 

Note5 — Marketable Securities

 

Marketablesecurities at September 30, 2010 consist of municipal bonds andcertificates of deposits, and are classified as held-to-maturity.  Held-to-maturity securities are recorded atamortized cost, adjusted for the amortization or accretion of premiums ordiscounts.  A decline in the market valueof any held-to-maturity security below the amortized cost basis that is deemedother than temporary is charged to income, resulting in the establishment of anew cost basis for the security.  Therewas no impairment during the first nine months of 2010, therefore, noadjustment to the amortized cost basis was made.  Currently, all of our marketable securitiesmature within two and one-half years.

 

Theamortized cost and fair value for held-to-maturity securities by major securitytype at September 30, 2010 and December 31, 2009 were as follows:

 
| ** **              | ** ** | **September 30, 2010** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **Amortized  Cost**              | ** ** | **Gross  Unrealized  Holding  Gains** | ** ** | **Gross  Unrealized  Holding  Losses** | ** ** | **Fair Value** | ** ** |
| Certificates of deposit |       | $                                | 2,735,000  |   | $ | — |   | $ | — |   | $ | 2,735,000 |   |
| Municipal bonds         |       | 2,552,641                        |       | 4,651 |   | (759 | ) | 2,556,533 |   |
|                    |       | $                                | 5,287,641  |   | $ | 4,651 |   | $ | (759 | ) | $ | 5,291,533 |   |

 

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| ** **              | ** ** | **December 31, 2009** | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Holding  Gains** | ** ** | **Gross  Unrealized  Holding  Losses** | ** ** | **Fair Value** | ** ** |
| Certificates of deposit |       | $                               | 2,387,988  |   | $ | 12 |   | $ | — |   | $ | 2,388,000 |   |
| Municipal bonds         |       | 2,550,294                       |       | 36,031 |   | (1,408 | ) | 2,584,917 |   |
|                    |       | $                               | 4,938,282  |   | $ | 36,043 |   | $ | (1,408 | ) | $ | 4,972,917 |   |

 

Note6 — Comprehensive Income

 

Othercomprehensive income pertains to foreign currency translation adjustments thatare not included in net income but rather are recorded directly in stockholders’equity.

 
| ** **                                                           | ** ** | **Three Months Ended********September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net income                                                           |       | $                                                          | 1,028,869  |                                                      | $          | 873,739 |   | $ | 3,042,761 |   | $ | 1,788,175 |   |
| Foreign currency translation adjustment                              |       | 1,200,538                                                  |       | 293,571                                                   |       | (604,650 | ) | 283,573 |   |
| Amortization of cumulative unrealized gain on  marketable securities |       | —                                                     |       | —                                                    |       | — |   | (2,527 | ) |
| Comprehensive income                                                 |       | $                                                          | 2,229,407  |                                                      | $          | 1,167,310 |   | $ | 2,438,111 |   | $ | 2,069,221 |   |

 

Note7 — Investment in Affiliated Company

 

InJanuary 2010, we acquired a minority equity ownership interest in LuxcelBiosciences Limited (Luxcel) based in Cork, Ireland.  The investment of approximately $3,625,000(€2,500,000), which was made through our newly-formed subsidiary, MOCONNetherlands Holding B.V., amounted to a 16.9% equity interest in Luxcel.  In addition, we acquired warrants to purchasean additional 375,000 shares at €2.24 per share at any time within three yearsfrom the date of the initial investment.

 

Luxcelhas developed phosphorescence-based sensors that enable rapid, high-throughputscreening and detection of bacterial contamination of food samples andnon-invasive analysis of atmospheres in food, beverage and pharmaceuticalpackaging.  They also are innovators inan emerging high-throughput screening technique for measuring drug toxicity andmetabolism in drug discovery for pharmaceutical research.  The investment in Luxcel is carried on ourbalance sheet at the original purchase price, adjusted for currencyfluctuations.  We believe that it is notfeasible to readily determine the fair value of this investment as there is noestablished market for the securities.

 

Aspart of our relationship with Luxcel, we purchase sensors which accompany ourinstruments for sale to an end user and are required to pay a royalty to Luxcelon the sale of such instruments.  Inaddition, Luxcel has purchased R&D consulting services from us whichamounted to €59,000 (approximately $78,000) in the third quarter 2010.

 

Note8 — Warranty

 

Weprovide a warranty for most of our products. Warranties are for periods ranging from ninety days to one year, andcover parts and labor for non-maintenance repairs.  Operator abuse, improper use, alteration,damage resulting from accident, or failure to follow manufacturer’s directionsare excluded from warranty coverage.

 

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Warrantyexpense is accrued at the time of sale based on historical claimsexperience.  Warranty reserves are alsoaccrued for special rework campaigns for known major productmodifications.  We also offer extendedwarranty service contracts for select products when the factory warranty periodexpires.

 

Warrantyprovisions and claims for the nine-month periods ended September 30, 2010 and2009 were as follows:

 
| ** **          | ** ** | **Nine Months Ended  September 30,** | ** **    |
|---------------------|------------|-----------------------------------------------------|---------------|
| ** **          | ** ** | **2010**                                            | ** **    | **2009** | ** ** |
| Beginning balance   |       | $                                                   |  209,710 |   | $ |  229,087 |   |
| Warranty provisions |       | 196,046                                             |          | 187,349 |   |
| Warranty claims     |       | (203,633                                            | )             | (205,328 | ) |
| Ending balance      |       | $                                                   |  202,123 |   | $ |  211,108 |   |

 

Note9 — Income Taxes

 

MOCON,Inc. or one of our subsidiaries files income tax returns in the U.S. federaljurisdiction, several state jurisdictions, China, Germany and theNetherlands.  With limited exceptions, weare no longer subject to income tax examinations by taxing authorities fortaxable years before 2007.

 

Asof December 31, 2009, the liability for gross unrecognized tax benefits was$175,000, which included potential benefits of $127,000 that, if recognized,would affect the effective tax rate. During the nine months ended September 30, 2010, there were nosignificant changes to the total gross unrecognized tax benefits that wouldhave a material effect on results of operations.  We recognize potential interest and penaltiesrelated to income tax positions, if any, as a component of provision for incometaxes on the consolidated statements of income. It is expected that the amount of unrecognized tax benefits forpositions which we have identified will not change significantly in the nexttwelve months.

 

Note 10 — Stock-Based Compensation

 

As of September 30, 2010, we have reserved 144,487 sharesof common stock for options and other stock-based incentive awards that arestill available for grant under our 2006 stock incentive plan, and 824,823shares for options that have been granted under either the 2006 stock incentiveplan or the 1998 stock option plan but have not yet been exercised.  We issue new shares of common stock uponexercise of stock options.  Therewere no options granted in the first nine months of 2010.

 

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

 
| ** **                                           | ** ** | **Three Months Ended********September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                           | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Total cost of stock-based compensation               |       | $                                                          | 65,006     |                                                      | $          | 57,319 |   | $ |  196,852 |   | $ |  173,050 |   |
| Amount of income tax benefit recognized in  earnings |       | (9,630                                                     | )          | (2,657                                                    | )          | (16,974 | ) | (8,306 | ) |
| Amount charged against net income                    |       | $                                                          | 55,376     |                                                      | $          | 54,662 |   | $ |  179,878 |   | $ |  164,744 |   |

 

Thefair value of each option grant is estimated on the date of grant using theBlack-Scholes option-pricing model (Black-Scholes).  We use historical data to estimate theexpected price volatility, expected option life and expected forfeiture rate.  We base our estimate of expected volatilityfor awards granted on daily historical trading data of our common stock for aperiod equivalent to the expected term of the award.  The risk-free interest rate is based on theU.S. Treasury yield curve in effect at the time of grant for the estimated lifeof the option.  We estimate the expectedterm consistent with historical exercise and

 

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cancellationactivity of our previous share-based grants with a ten-year contractualterm.  Forfeitures are based onhistorical experience.  The dividendyield is calculated based upon the dividend payments made during the prior fourquarters as a percent of the average stock price for that period.

 

Asummary of the option activity for the first nine months of 2010 is as follows:

 
| ** **                        | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price per  Share** | ** ** | **Weighted********Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------|------------|----------------------------|------------|--------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at December 31, 2009  |       | 937,250                    |       | $                                                      | 8.84       |                                                      | 4.2        |                            | $          | 881,656 |   |
| Options granted                   |       | —                     |       | —                                                 |       | —                                                    |       |                            |       |
| Options cancelled/expired         |       | (8,900                     | )          | $                                                      | 8.76       |                                                      | —     |                            |       |   |
| Options exercised                 |       | (103,527                   | )          | $                                                      | 6.46       |                                                      | —     |                            |       |   |
| Outstanding at September 30, 2010 |       | 824,823                    |       | $                                                      | 9.14       |                                                      | 3.8        |                            | $          | 2,843,353 |   |
|                              |       |                       |       |                                                   |       |                                                      |       |                            |       |
| Exercisable at September 30, 2010 |       | 695,561                    |       | $                                                      | 9.06       |                                                      | 3.5        |                            | $          | 2,458,101 |   |

 

Thetotal intrinsic value of options exercised was $377,770 and $0 during thethree-month periods ended September 30, 2010 and 2009, respectively, and$514,483 and $985 during the first nine months of 2010 and 2009, respectively.

 

Asummary of the status of our unvested option shares as of September 30, 2010 isas follows:

 
| ** **                     | ** ** | **Number of  Shares** | ** ** | **Weighted********Average  Grant Date  Fair Value** | ** ** |
|--------------------------------|------------|----------------------------|------------|---------------------------------------------------------------|------------|
| Unvested at December 31, 2009  |       | 162,312                    |       | $                                                             | 2.50       |   |
| Options granted                |       | —                     |       | —                                                        |       |
| Options cancelled              |       | (2,300                     | )          | $                                                             | 2.46       |   |
| Options vested                 |       | (30,750                    | )          | $                                                             | 2.72       |   |
| Unvested at September 30, 2010 |       | 129,262                    |       | $                                                             | 2.45       |   |

 

Asof September 30, 2010, there was $204,390 of total unrecognized compensationcost related to unvested stock-based compensation granted under our plans.  That cost is expected to be recognized over aweighted-average period of 1.4 years. The total fair value of option shares vested during the three-month periodsended September 30, 2010 and 2009 was $27,880 and $20,100, respectively, and$83,640 and $60,300 during the nine-month periods ended September 30, 2010 and2009, respectively.

 

Note 11 — Derivatives

 

Wehave entered into a foreign currency forward exchange contract, principally tohedge an intercompany loan denominated in euros.  This contract does not qualify for hedgeaccounting under the Derivatives and Hedging Topic of the Codification.  As a result, gains or losses related tomark-to-market adjustments on foreign currency forward exchange contracts arerecognized as other income or expense in the income statement during the periodin which the instrument is outstanding. The fair value of the foreign currency forward exchange contractrepresents the amount we would receive or pay to terminate the contract at thereporting date and is recorded in other current assets or liabilities dependingon whether the net amount is a gain or a loss. We do not utilize derivative instruments for trading or otherspeculative purposes.

 

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AtSeptember 30, 2010, we had one outstanding foreign currency forward exchangecontract with a notional amount totaling approximately $3,089,000.  This contract matures in January 2011 whichcoincides with the expected settlement of the intercompany loan.  As of September 30, 2010 the fair value ofthis contract resulted in a receivable of approximately $318,000, and wasrecorded in other income and other current receivables.  There were no outstanding foreign currencycontracts as of December 31, 2009.  Whilethe currency contract does not qualify for hedge accounting, we believe it iseffective in economically hedging the currency exposure on the intercompanyloan to which it relates.

 

Note 12 — Fair Value Measurements

 

Ahierarchy for inputs used in measuring fair value is in place thatdistinguishes market data between observable independent market inputs andunobservable market assumptions by the reporting entity. The hierarchy isintended to maximize the use of observable inputs and minimize the use ofunobservable inputs by requiring that the most observable inputs be used whenavailable. Level 1 provides the most reliable measure of fair value, whileLevel 3 generally requires significant management judgment. The three levelsare defined as follows:

 
| Level 1 — | Inputs are unadjusted quoted prices in active  markets for identical assets and liabilities.                                                                                                                                                                                               |
|----------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|           |                                                                                                                                                                                                                                                                                       |
| Level 2 — | Observable inputs other than quoted prices for the  asset or liability, either directly or indirectly. These include quoted  prices for similar assets or liabilities in active markets and quoted prices  for identical or similar assets or liabilities in markets that are not  active. |
|           |                                                                                                                                                                                                                                                                                       |
| Level 3 — | Unobservable inputs that reflect the reporting  entity’s own assumptions.                                                                                                                                                                                                             |

 

Our population of financial assets and liabilitiessubject to fair value measurement at September 30, 2010 is as follows:

 
| ** **                                  | ** ** | **Fair Value** | ** ** | **Level 2** | ** ** |
|---------------------------------------------|------------|---------------------|------------|------------------|------------|
| Assets:                                     |       |                |       |             |       |
| Foreign currency forward exchange contracts |       | $                   | 318,000    |             | $          | 318,000 |   |
|                                             |            |                     |            |                  |            |  |  |

 

Foreigncurrency forward exchange contracts are carried at fair value based onsignificant other observable market inputs, in this case, quoted foreigncurrency exchange rates.  Such valuationrepresents the amount we would receive or pay to terminate the forward exchangecontract at the reporting date.

 

Note 13 — Commitments and Contingencies

 

InMarch 2010, we signed a 15-year lease for a property which replaced our formerMinneapolis headquarters and operations center. The new lease commenced on June 1, 2010, and requires future minimumlease payments starting at $367,000 per year, increasing to $520,000 in thefinal year.

 

InMay 2010, we executed a standby letter of credit agreement in the amount of$25,000 which serves as a performance bank guarantee covering potentialwarranty claims for orders from one of our foreign customers.  This letter of credit will expire in November2011.

 

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Item2.    Management’s Discussion andAnalysis of Financial Condition and Results of Operations

 

ThisManagement’s Discussion and Analysis provides material historical andprospective disclosures intended to enable investors and other users to assessour financial condition and results of operations.  Statements that are not historical areforward-looking and involve risks and uncertainties discussed below under thecaption “Forward-Looking Statements.” The following discussion of the results of operations and financialcondition of MOCON should be read in conjunction with our consolidatedfinancial statements and the related notes thereto included elsewhere in thisreport.

 

***Overview***

 

*Description of Business*

 

MOCON,Inc. designs, manufactures, markets and services products, and providesconsulting services, primarily in the measurement and analytical instrument andservices markets.  Our products includeinstruments that detect, measure and monitor gases and chemical compounds, testproperties of materials, and detect bacteria in foods.

 

Wehave three primary operating locations in the United States — Minnesota,Colorado and Texas — and foreign facilities in Germany and China.  In addition, we recently made a minorityequity investment in an Irish company. We use a combination of a direct sales force and independent salesrepresentatives to market our products and services in 79 different countries.  We also operate or co-operate testinglaboratories in Mumbai, India, Shanghai, China, Koblenz, Germany, Texas andMinnesota.  In recent years, over half ofour revenues have come from international customers.

 

Ourcurrent plans for growth include continued strong funding for research anddevelopment (approximately 6% to 8% of our revenue) to foster new productdevelopment, together with strategic acquisitions and partnerships whereappropriate.  Our products are used bycustomers in many different markets.  Asignificant focus of our product development and marketing efforts in 2009 and2010 has been in the food and beverage markets. Our target customers in this market are primarily interested in threethings: developing successful new consumer products, maintaining high qualityin their products and ensuring the shelf life and safety of theirproducts.  Our newest products helpaddress the increased consumer emphasis on health and safety.

 

*Market Strategy*

 

OurBevAlert® system tests the purity of carbon dioxide usedto carbonate soft drinks, beer and mineral waters around the world.  As manufacturers of these consumer beveragesexpand their businesses and operations, especially into developing countries,they are increasingly investing in better instrumentation to ensure the finalproduct is free of contaminants.  OurBevAlert system is well suited to address the concerns of manufacturers ofbeverages, and we estimate that the addressable market for purity testingsystems in the beverage industry could be as much as an aggregate of $105million over the next ten years.  Webelieve this is a growth opportunity for us as our sales of the BevAlert systemhave been ramping up over the past two years.

 

Wehave recently developed and introduced our OpTechTM-O2 Platinum oxygen analyzer whichincorporates sensor technology developed by Luxcel Biosciences Limited.  This instrument is able to measure the oxygenconcentration in a food, beverage, pharmaceutical or medical device packagewithout piercing the package.  This newtechnology enables manufacturers in these industries to track and trace theirproducts during manufacture and distribution, and follow changes in oxygenlevels as they occur.  Applicationsinclude looking for poor heat seals or leaks, excessive package permeation,poor gas flushing and microbial growth. All of these issues affect product acceptance, product quality andproduct safety.  We believe theaddressable market for products in these industries that require thefunctionality of our OpTech-O2 Platinum oxygen analyzer couldbe as high as an aggregate of $75 million

 

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overthe next ten years.

 

Withthe new sensor technologies and expertise we acquired with our recentinvestment in Luxcel Biosciences Limited, coupled with our instrumentationexperience, we introduced the GreenLightTM food safety test apparatus in August,2010.  This breakthrough technologypermits, for the first time, determination of the presence or absence ofbacteria in food products or ingredients in as little as one to six hours.  This is a dramatic improvement over the 48 to72 hour tests currently being used by the food industry to perform TVC/APC(total viable counts/aerobic plate counts) testing.  Food products can now be cleared for shipmentthe same day they are tested, thereby lowering process times, reducinginventories, and reducing the chance of a costly recall.  There are two different models of theGreenLight currently available, with others to follow.  We believe the addressable market forinstruments of this type in the food safety industry is approximately $100million over the next ten years.

 

Inthe cases of the BevAlert, OpTech and GreenLight products, MOCON is targetingthe worldwide increase in concern for consumer safety in the food and beveragemarkets.  Our strategy is to continue toposition ourselves as a leader in the consumer and industrial safetymarketplace by offering unique products and services into large and growingmarkets.

 

***Results of Operations***

 

Thefollowing table sets forth the relationship between various components of ourresults of operations, stated as a percent of sales, for the three- andnine-month periods ended September 30, 2010 and 2009:

 
| ** **                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                   | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Sales                                        |       | 100.0                                                |       | 100.0                                               |       | 100.0 |   | 100.0 |   |
| Cost of sales                                |       | 40.1                                                 |       | 40.6                                                |       | 39.3 |   | 42.0 |   |
| Gross profit                                 |       | 59.9                                                 |       | 59.4                                                |       | 60.7 |   | 58.0 |   |
| Selling, general and administrative expenses |       | 33.1                                                 |       | 34.4                                                |       | 36.1 |   | 38.2 |   |
| Research and development expenses            |       | 6.8                                                  |       | 7.1                                                 |       | 7.2 |   | 7.5 |   |
| Operating income                             |       | 20.0                                                 |       | 17.9                                                |       | 17.4 |   | 12.3 |   |
| Other income, net                            |       | 0.3                                                  |       | 1.3                                                 |       | 2.6 |   | 1.6 |   |
| Income before income taxes                   |       | 20.3                                                 |       | 19.2                                                |       | 20.0 |   | 13.9 |   |
| Income taxes                                 |       | 7.0                                                  |       | 6.0                                                 |       | 6.3 |   | 4.6 |   |
| Net income                                   |       | 13.3                                                 |       | 13.2                                                |       | 13.7 |   | 9.3 |   |

 

*Comparison of Financial Results for the Three- andNine-Month Periods Ended September 30, 2010 and 2009*

 

*Sales*

 

Salesfor the three-month period ended September 30, 2010 were $7,749,000, up 17%compared to $6,601,000 for the same period in 2009.  We experienced increases in all four of ourmajor product groups as the global economic conditions that had negativelyaffected the prior year’s results showed signs of improvement.  Sales to foreign customers increased 31% overthe prior year third quarter primarily due to a strong showing in Asia.  Domestic and foreign sales accounted for 41%and 59%, respectively, of our consolidated third quarter sales in 2010, and 47%and 53% of our consolidated sales, respectively, for the same period in 2009.

 

Salesfor the nine-month period ended September 30, 2010 were $22,194,000, up 16%compared to $19,194,000 for the same period in 2009.  Sales increased in all four major productgroups with

 

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permeationinstruments accounting for the majority of the increase. On a geographicalbasis, sales increased 6% and 24% in our domestic and foreign markets,respectively.  Domestic and foreign salesaccounted for 42% and 58%, respectively, of our consolidated sales for thefirst nine months of 2010, and 46% and 54% for the same period in 2009.

 

Thefollowing table summarizes total sales by product line for the three- andnine-month periods ended September 30, 2010 and 2009:

 
| ** **                           | ** ** | **Three Months Ended********September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                           | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Permeation products and services     |       | $                                                          | 4,238,727  |                                                      | $          | 3,686,452 |   | $ | 12,432,778 |   | $ | 10,898,104 |   |
| Gas analyzers, sensors and detectors |       | 1,427,702                                                  |       | 1,278,247                                                 |       | 4,196,048 |   | 3,541,758 |   |
| Packaging products and services      |       | 1,272,434                                                  |       | 1,132,872                                                 |       | 3,589,901 |   | 3,448,400 |   |
| Other instruments and services       |       | 810,339                                                    |       | 502,988                                                   |       | 1,975,069 |   | 1,305,392 |   |
|                                 |       | $                                                          | 7,749,202  |                                                      | $          | 6,600,559 |   | $ | 22,193,796 |   | $ | 19,193,654 |   |

 

Thefollowing table sets forth the relationship between various components ofdomestic and foreign sales for the three- and nine-month periods endedSeptember 30, 2010 and 2009:

 
| ** **          | ** ** | **Three Months Ended********September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|---------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **          | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Domestic sales      |       | $                                                          | 3,198,629  |                                                      | $          | 3,134,175 |   | $ | 9,317,263 |   | $ | 8,797,511 |   |
| Foreign sales:      |       |                                                       |       |                                                      |       |   |   |   |   |
| Europe              |       | 1,649,873                                                  |       | 1,588,609                                                 |       | 5,202,053 |   | 4,951,756 |   |
| Asia                |       | 2,416,192                                                  |       | 1,531,533                                                 |       | 6,125,871 |   | 4,074,714 |   |
| Other               |       | 484,508                                                    |       | 346,242                                                   |       | 1,548,609 |   | 1,369,673 |   |
| Total foreign sales |       | 4,550,573                                                  |       | 3,466,384                                                 |       | 12,876,533 |   | 10,396,143 |   |
|                |       | $                                                          | 7,749,202  |                                                      | $          | 6,600,559 |   | $ | 22,193,796 |   | $ | 19,193,654 |   |

 

***Permeation Products and Services*** — Sales of ourpermeation products and services increased 15% for the third quarter endedSeptember 30, 2010 compared to the same period in the prior year, and accountedfor 55% and 56% of our consolidated third quarter sales in 2010 and 2009,respectively.  The increase in sales cameexclusively from our international markets as domestic shipments were downslightly from the prior year. International sales of permeation products and services increased 24%for the third quarter 2010 compared to the same period in 2009, and accountedfor 73% of the sales in this product group. The increase in international saleswas due partially to a large order from the Chinese government for 40 instruments,24 of which shipped in the third quarter 2010. We anticipate that the remaining 16 instruments from this order will beshipped in the fourth quarter.

 

Salesof our permeation products and services, which accounted for 56% and 57% of ourconsolidated sales during the first nine months of 2010 and 2009, respectively,increased 14% during the first nine months of 2010 compared to the same periodin 2009.  International sales ofpermeation products and services accounted for 74% of sales in this product groupand increased 27% over last year. Domestic sales of this product group declined 11% in the first ninemonths of 2010 compared to the same period last year and accounted for 26% ofsales in this product group.

 

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***Gas Analyzers, Sensors and Detectors*****— Sales of ourgas analyzers, sensors and detector products and services, which accounted for19% of our consolidated third quarter sales in both 2010 and 2009, increased12% during the third quarter 2010 compared to the same period in 2009.  Within this group, sales of our piD-TECHsensors for OEM applications and total hydrocarbon analyzer instruments for useprimarily in the environmental monitoring area, accounted for the majority ofthe increase.  Sales of gaschromatographs were slightly lower in the current quarter as a result ofreduced orders for the oil and gas exploration market.

 

Salesof our gas analyzers, sensors and detector products and services, whichaccounted for 19% and 18% of our consolidated sales during the first ninemonths in 2010 and 2009, respectively, increased 18% during the first ninemonths of 2010 compared to the same period in 2009.  This increase is primarily due to sales ofgas chromatographs to the oil and gas exploration, industrial hygiene andenvironmental monitoring markets, as well as sales of the BevAlert instrumentto the carbonated beverage industry.

 

***Packaging Products and Services*****— Sales of ourpackaging products and services, which accounted for 16% and 17% of ourconsolidated third quarter sales in 2010 and 2009, respectively, increased 12%during the third quarter 2010 compared to the same period in 2009.  This group consists of headspace analyzersand leak detection instruments.  Thegrowth in the current quarter came exclusively in our international markets dueprimarily to increased sales of headspace analyzers to customers in Asia andSouth America.

 

Salesof our packaging products and services, which accounted for 16% and 18% of ourconsolidated sales during the first nine months in 2010 and 2009, respectively,increased 4% during the first nine months of 2010 compared to the same periodin 2009.  The growth in the currentperiod was due primarily to increased shipments of leak detection instrumentsto our domestic markets.

 

Forthe current nine-month period, domestic sales increased 7% while international saleswere relatively flat compared to the same period in the prior year.

 

***Other Instruments and Services*****— Sales in ourother instruments and services category, which accounted for 10% and 8% ourconsolidated third quarter sales in 2010 and 2009, respectively, increased 61%in the third quarter 2010, compared to the same period in 2009.  This increase was primarily the result ofincreased sales of our weighing and pharmaceutical instruments, and morespecialty projects performed by our analytical testing and consulting groups.

 

Salesin our other instruments and services category, which accounted for 9% and 7%of our consolidated sales during the first nine months in 2010 and 2009,respectively, increased 51% during the first nine months of 2010, compared tothe same period in 2009.  This increasewas due primarily to increased demand for our gas chromatography analyzerproducts and services, more specialty projects performed by our analyticaltesting and consulting groups, and increased shipments of our weighing andpharmaceutical equipment.

 

*Gross Profit*

 

Thegross profit margin for our product sales was 61.7% for the three-month periodended September 30, 2010, consistent with 61.0% for the three-month periodended September 30, 2009.  The grossprofit margins for our consulting services were 41.1% and 38.7%, respectively,for the three-month periods ended September 30, 2010 and 2009.  This increase was due primarily to the highersales volume in the current quarter which more adequately covered our fixed costs.

 

Forthe nine months ended September 30, 2010 and 2009, the gross profit margins forour products were 62.2% and 59.3%, respectively.  This improvement was the result of afavorable sales mix and manufacturing efficiencies realized through higher productionvolumes.  For the nine months ended

 

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September30, 2010 and 2009, the gross profit margins for our consulting services were44.5% and 40.6%, respectively.  Thisincrease was primarily due to the increase in volume in the first nine monthsof 2010 relative to our fixed costs.

 

*Selling, General and Administrative Expenses*

 

Selling,general and administrative (SG&A) expenses were $2,567,000 in the three-monthperiod ended September 30, 2010, compared to $2,268,000 in the same period of2009.  The increase was primarily relatedto higher compensation expense as a result of increased headcount and higherincentive compensation, as well as increased sales commissions, travel andmarketing expenses.

 

SG&Aexpenses were $8,001,000 in the nine-month period ended September 30, 2010,compared to $7,340,000 in the same period of 2009.  As a percentage, SG&A expenses were 36.1%and 38.2% of consolidated sales in the first nine months of 2010 and 2009,respectively, due to the higher sales level in 2010.  The 2010 dollar increase was primarilyrelated to costs associated with moving our Minneapolis headquarters andoperations center, increases in wages, benefits, incentive compensation, andhigher professional fees related to the Luxcel investment as compared to thesame period in the prior year.

 

*Research and Development Expenses*

 

Researchand development (R&D) expenses were $521,000, or 6.8% of sales in the thirdquarter 2010, compared to $470,000, or 7.1% of sales, in the same period of2009.  The current period expense of$521,000 is net of approximately $78,000 received from Luxcel for consultingservices.  The increase in spending inthe current quarter is primarily related to the development of products for thenew food safety market.

 

R&Dexpenses were $1,592,000, or 7.2% of sales in the first nine months of 2010,compared to $1,440,000, or 7.5% of sales, in the same period of 2009.  The increase in spending in the first ninemonths of 2010 reflects our practice of increasing R&D spending as ourrevenues increase, as our intent is to continue to spend between 6% and 8% ofconsolidated sales on R&D.

 

*Other Income*

 

Otherincome for the three- and nine-month periods ended September 30, 2010 and 2009was as follows:

 
| ** **                            | ** ** | **Three Months Ended********September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                            | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| Interest income                       |       | $                                                          | 15,973     |                                                      | $          | 92,251 |   | $ | 68,626 |   | $ | 313,167 |   |
| Foreign currency exchange gain (loss) |       | 3,225                                                      |       | (102                                                      | )          | 504,717 |   | 4,491 |   |
| Other                                 |       | (1,220                                                     | )          | (420                                                      | )          | 3,852 |   | 2,650 |   |
|                                  |       | $                                                          | 17,978     |                                                      | $          | 91,729 |   | $ | 577,195 |   | $ | 320,308 |   |

 

Interestincome decreased for both the third quarter and nine months ended September 30,2010, compared to the same periods in 2009, due to lower average yields onlower average interest bearing investments. The foreign currency gain in the nine months ended September 30, 2010 wasprimarily the result of adjusting a euro-based intercompany loan obligation tomarket value.

 

*Income Tax Expense*

 

Ourprovision for income taxes was 34.5% and 31.3% of income before income taxesfor the third

 

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quartersended September 30, 2010 and 2009, respectively.  The higher rate in the current quarter wasthe result of an adjustment to our available foreign tax credits due to aforeign currency fluctuation as well as a larger percentage of incomeattributable to a higher tax jurisdiction.

 

Ourprovision for income taxes was 31.6% and 33.2% of income before income taxesfor the nine months ended September 30, 2010 and 2009, respectively.  The decrease in the effective tax rate forthe current period was primarily due to foreign tax credits generated by therepatriation of funds from our German subsidiary and the increase in the allowablededuction for domestic production activity for federal income tax purposes.

 

Basedon current projected annual operating results and current income tax rates, weexpect the effective tax rate for the remainder of 2010 to be in the range of29% to 32%.  This rate fluctuates overtime based on the income tax rates in the various jurisdictions in which weoperate, and also the level of profits in those jurisdictions.

 

*Net Income*

 

Netincome was $1,029,000 in the third quarter 2010, compared to $874,000 in thethird quarter 2009.  Diluted net incomeper share was $0.19 and $0.16 in the third quarters of 2010 and 2009,respectively.  For the nine months endedSeptember 30, 2010, net income was $3,043,000, or $0.57 per diluted share,compared to net income of $1,788,000, or $0.32 per diluted share in the prioryear.

 

*Liquidity and Capital Resources*

 

Wehave historically financed our operations, capital equipment and other cashrequirements through our cash flows generated from operations.  Total cash, cash equivalents and marketablesecurities decreased $2,898,000 during the first nine months of 2010 to$11,433,000 as of September 30, 2010, compared to $14,331,000 at December 31,2009.  The primary reason for thisdecrease was due to the investment of approximately $3,625,000 (€2,500,000) toacquire a minority equity ownership interest in Luxcel Biosciences Limited inIreland.  Our working capital as ofSeptember 30, 2010 decreased $5,563,000 to $14,054,000 as compared to$19,617,000 at December 31, 2009.  Thisdecrease was primarily the result of the investment in Luxcel Biosciences,having a larger portion of our marketable securities classified as long-term,as well as the timing of certain large vendor obligations included in accountspayable at September 30, 2010.

 

Weinvest our excess cash in marketable securities consisting primarily ofmunicipal bonds, certificates of deposits and U.S. treasury obligations.  We believe that a combination of our existingcash, cash equivalents and marketable securities, and an expected continuationof cash flow from operations, will continue to be adequate to fund ouroperations and working capital, capital expenditures, dividend payments and anyauthorized stock repurchases for at least the next twelve months.  We currently do not have any committed linesof credit or other credit facilities.

 

Oneof our strategic objectives is, as market and business conditions warrant, toconsider acquisitions of businesses, products or technologies.  In this regard, in January 2010, we made aminority equity investment of €2,500,000 in Luxcel Biosciences Limited, anIrish company, to help us establish a stronger presence in the food safetymarket.  If we consummate one or moreadditional acquisition opportunities, the cost of which exceeds our existingcash resources, we may need to fund such activities with a portion of our cashbalances and debt and/or equity financing. If we need to raise additional capital, an equity-based or equity-linkedfinancing may be used which could be dilutive to existing shareholders.  If we raise additional funds by issuing debt,we may be subject to restrictive covenants that could limit our operationalflexibility and higher interest expense could dilute earnings per share.

 

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*Cash Flow*

 

CashFlow from Operating Activities

 

Ourprimary source of funds is cash provided by operating activities which totaled$3,445,000 and $2,366,000 in the first nine months of 2010 and 2009,respectively.  The key components of thecash provided by operating activities in 2010 were the income for the period,and an increase in accounts payable and accrued compensation and relatedexpenses, partially offset by an increase in other receivables, prepaidexpenses and inventories.  The increasein accounts payable is primarily due to the timing of certain vendor invoicesassociated with the recent move of our Minneapolis headquarters.

 

CashFlow from Investing Activities

 

Cash(used in) provided by investing activities totaled ($5,297,000) and $3,693,000in the first nine months of 2010 and 2009, respectively.  The primary reason for cash used in investingactivities in 2010 was the investment of approximately $3,625,000 (€2,500,000)to acquire a minority equity ownership interest in Luxcel Biosciences Limitedin Ireland and capital expenditures of approximately $1,251,000, the majorityof which relates to our move to new offices in Minnesota.

 

CashFlow from Financing Activities

 

Cashused in financing activities totaled $1,193,000 and $5,088,000 in the firstnine months of 2010 and 2009, respectively. During the first nine months of 2010 and 2009, we made dividend paymentsto our shareholders of $1,454,000 and $1,493,000, respectively. Partially offsetting the impact of the dividend payments in 2010 werethe proceeds from the exercise of stock options in the amount of $253,000.

 

Wecurrently are not authorized by our Board of Directors to make repurchases ofour common stock.

 

***Contractual Obligations***

 

Werefer you to our Annual Report on Form 10-K for the year ended December 31,2009 for a summary of our contractual obligations.  In addition, in March 2010, we signed a15-year lease for a property which replaced our former Minneapolis headquartersand operations center.  The new leasecommenced on June 1, 2010, and requires future minimum lease payments startingat $367,000 per year, subject to annual increases.  In May 2010, we entered into a foreigncurrency forward exchange contract to act as a hedge against fluctuations in aeuro-denominated intercompany note.  Thiscontract has a notional amount totaling approximately $3,089,000, bears anexchange rate of 1.2358 U.S. dollars per euro and matures in January 2011.

 

***Off-Balance Sheet Arrangements***

 

Exceptfor operating leases entered into in the ordinary course of business andcustomary indemnification obligations under certain of our agreements enteredinto in the ordinary course of business, we do not have any materialoff-balance sheet arrangements.

 

***Recently Issued Accounting Pronouncements***

 

InJune 2009, new guidance was issued by the FASB, now codified in ASC Topic 810,which amends the consolidation guidance applicable to variable interestentities and was effective for us beginning July 1, 2010. The adoption of thisguidance did not have a material impact on our consolidated financialstatements.

 

InJanuary 2010, the FASB updated the disclosure requirements for fair valuemeasurements.  The updated guidancerequires companies to disclose separately the investments that transfer in andout of

 

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Levels1 and 2 and the reasons for those transfers. Additionally, in thereconciliation for fair value measurement using significant unobservable inputs(Level 3), companies should present separately information about purchases,sales, issuances and settlements.  Weadopted the updated guidance on January 1, 2010, except for the disclosuresabout purchases, sales, issuances and settlements in the Level 3reconciliation, which are effective for fiscal years beginning after December15, 2010.  We will adopt the remainingguidance on January 1, 2011.  Theadoption of the required guidance did not have an impact on our consolidatedfinancial statements.  We do not expectthat the adoption of the remaining guidance will have an impact on ourconsolidated financial statements.

 

***Critical Accounting Policies***

 

Oursignificant accounting policies are described in Note 1 to our consolidatedfinancial statements.  This Management’sDiscussion and Analysis of Financial Condition and Results of Operations isbased upon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America.  The preparation of theseconsolidated financial statements requires management to make estimates andjudgments that affect the reported amount of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities.  The Securities and Exchange Commission hasdefined a company’s most critical accounting policies as those that are mostimportant to the portrayal of its financial condition and results ofoperations, and which require the company to make its most difficult andsubjective judgments, often as a result of the need to make estimates ofmatters that are inherently uncertain. Based on this definition, we have identified the following criticalaccounting policies.  Although we believethat our estimates and assumptions are reasonable, they are based uponinformation available when they are made. Actual results may differ significantly from these estimates underdifferent assumptions or conditions.

 

*Revenue recognition* — We recognize revenue whenit is realized or realizable and earned. We consider revenue realized or realizable when persuasive evidence ofan arrangement exists, the product has been shipped or the services have beenprovided to the customer, title and risk of loss of products has passed to thecustomer, the sales price is fixed or determinable, and collectability isreasonably assured.  Our terms are F.O.B.shipping point with no right of return, except in rare cases, and customeracceptance of our products is not required. The revenue recognition policy does not differ among the various productlines, the marketing venues, or various geographic destinations.  We do not have distributors who stock ourequipment.  We do not offer rebates,price protection, or other similar incentives, and discounts when offered arerecorded as a reduction in revenue.  Werecord revenue net of sales tax charged to the customer.

 

Revenuefor preventive maintenance agreements is recognized on a per visit basis andextended warranties on a straight-line basis over the life of the contracts.

 

Ouraccounting treatment for recognizing revenue from shipments with multipleelement arrangements was changed in the first quarter 2010, as we adopted ASCTopic 605.  This guidance provides thatthe overall arrangement fee will be allocated to each element (both deliveredand undelivered items) based on their relative selling prices, as demonstratedby vendor-specific objective evidence (VSOE) or third-party evidence(TPE).  Where VSOE or TPE is notavailable, revenue will be allocated using an estimated selling price.  This change did not have a material impact onour consolidated financial statements.

 

*Allowance for doubtful accounts and sales returns* — Ourallowance for doubtful accounts and sales returns is for accounts receivablebalances that are estimated to be uncollectible as well as anticipated salesreturns.  The reserve is based on anumber of factors, including:  (1) ananalysis of customer accounts and (2) our historical experience with accountsreceivable write-offs and sales returns. The analysis includes the age of the receivable, the financial conditionof a customer or industry and general economic conditions.  We believe our financial results could bematerially different if historical trends are not predictive of future resultsor if economic conditions worsened for our customers.

 

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Inthe event we determine that a smaller or larger allowance for doubtful accountsis appropriate, we would record a credit or charge to selling, general andadministrative expense in the period that we made such a determination.  As of September 30, 2010, we had $193,000reserved against our accounts receivable for doubtful accounts and salesreturns.

 

*Accrual for excess and obsolete inventories*—**We perform a quarterly analysis toidentify excess and obsolete inventory. We record a charge to cost of sales for amounts identified.  Our analysis includes inventory levels, thenature of the components and their inherent risk of obsolescence and theon-hand quantities relative to the sales history of that component.  We believe that our financial results couldbe materially different if historical trends are not predictive of futureresults or if demand for our products decreased because of economic orcompetitive conditions or otherwise.  Asof September 30, 2010, we had $358,000 accrued for excess and obsoleteinventories.

 

*Recoverability of long-lived assets*—**We assess the recoverability of goodwilland other long-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.  Changes in our businessstrategies, changes in the economic environment in which we operate, competitiveconditions, and other factors could result in future impairment charges.

 

*Accrued product warranties*—**Our products are generally covered by a warranty, withwarranty periods ranging from ninety days to one year from the date ofsale.  Estimated warranty costs areaccrued in the same period in which the related revenue is recognized, based onanticipated parts and labor costs, utilizing historical experience.  Additional warranty reserves are also accruedfor major rework campaigns.  Weperiodically assess the adequacy of our warranty reserves based on changes inthese factors and record any necessary adjustments if actual claim experienceindicates that adjustments are necessary. Although we believe the likelihood to be relatively low, warranty claimsexperience could be materially different from actual results due tomanufacturing changes that could impact product quality, a change in ourwarranty policy in response to industry trends, as yet unrecognized defects inproducts sold, or other factors.  As ofSeptember 30, 2010, we had $202,000 accrued for future estimated warrantyclaims.

 

*Income taxes*—**In the preparation of our consolidated financialstatements, management is required to estimate income taxes in each of thejurisdictions in which we operate.  Thisprocess involves estimating actual current tax exposures together withassessing temporary differences resulting from differing treatment of items fortax and accounting purposes.  Thesedifferences result in deferred tax assets and liabilities, which are includedin our Consolidated Balance Sheets.

 

Managementreviews the deferred tax assets for recoverability on a quarterly basis andassesses the need for valuation allowances. These deferred tax assets are evaluated by considering historical levelsof income, estimates of future taxable income streams and the impact of taxplanning strategies.  A valuationallowance is recorded to reduce deferred tax assets when it is determined thatit is more likely than not that we would not be able to realize all or part ofour deferred tax assets.  At September30, 2010 and December 31, 2009, we provided a valuation allowance in theapproximate amount of $320,000 against our net deferred tax assets, relatedprimarily to the capital loss carryforward.

 

***Forward-Looking Statements***

 

Thisquarterly report on Form 10-Q contains or incorporates by reference not onlyhistorical information, but also forward-looking statements within the meaningof Section 27A of the Securities Act of 1933, as amended, and Section 21E ofthe Securities Exchange Act of 1934, as amended, and are subject to the safeharbor created by those sections.  Inaddition, we or others on our behalf may make forward-looking

 

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statementsfrom time to time in oral presentations, including telephone conferences and/orweb casts open to the public, in press releases or reports, on our website orotherwise.  All statements other thanstatements of historical facts included in this report that address activities,events or developments that we expect, believe or anticipate will or may occurin the future are forward-looking statements including, in particular, thestatements about our plans, objectives, strategies and prospects regarding,among other things, our financial condition, results of operations, addressablemarket size estimates and business.  Wehave identified some of these forward-looking statements with words like “believe,”“may,” “could,” “might,” “forecast,” “possible,” “potential,” “project,” “will,”“should,” “expect,” “intend,” “plan,” “predict,” “anticipate,” “estimate,” “approximate”or “continue” and other words and terms of similar meaning.  These forward-looking statements may becontained in the notes to our consolidated financial statements and elsewherein this report, including under the heading “Management’s Discussion andAnalysis of Financial Condition and Results of Operations.”

 

Forward-lookingstatements involve risks and uncertainties. These uncertainties include factors that affect all businesses as wellas matters specific to us.  Some of thefactors known to us that could cause our actual results to differ materiallyfrom what we have anticipated in our forward-looking statements are describedbelow.

 

·                  Increases in prices for raw materials;

·                  Risks inherent in operating internationallyand selling and shipping our products and purchasing our products andcomponents internationally;

·                  Fluctuations in foreign currency exchangerates and interest rates;

·                  Failure to develop new products andtechnologies, delays in new product introduction and lack of market acceptanceof new products;

·                  Failure to effect strategic acquisitions andintegrate effectively newly acquired operations;

·                  Incurrence of additional debt, contingentliabilities and expenses in connection with future acquisitions;

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

·                  Disruption in our ability to manufacture ourproducts or the ability of our key suppliers to provide us products orcomponents or raw materials for products resulting in our inability to supplymarket demand for our products;

·                  Reliance on independent sales distributorsand sales associates to market and sell our products;

·                  Highly competitive nature of the markets inwhich we sell our products and the introduction of competing products;

·                  Loss of customers;

·                  Failure to retain senior management orreplace lost senior management;

·                  Employee slowdowns, strikes or similar actions;

·                  Reliance on our management informationsystems for inventory management, distribution, accounting and other functions;

·                  Effects of any pending or threatenedlitigation;

·                  Failure to comply with applicable laws andregulations and adverse changes in applicable laws or regulations;

·                  Changes in generally accepted accountingprinciples; or

·                  Conditions and changes in general economicand business conditions.

 

Formore information regarding these and other uncertainties and factors that couldcause our actual results to differ materially from what we have anticipated inour forward-looking statements or could otherwise materially adversely affectour business, financial condition or operating results, see our annual reporton Form 10-K for the fiscal year ended December 31, 2009 under the heading “PartI — Item 1A.  Risk Factors” on pages 9through 14 of such report.

 

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Wewish to caution readers not to place undue reliance on any forward-lookingstatement that speaks only as of the date made and to recognize thatforward-looking statements are predictions of future results, which may notoccur as anticipated.  Actual resultscould differ materially from those anticipated in the forward-lookingstatements and from historical results, due to the risks and uncertaintiesdescribed above, as well as others that we may consider immaterial or do notanticipate at this time.  Although webelieve that the expectations reflected in our forward-looking statements arereasonable, we do not know whether our expectations will prove correct.  The expectations reflected in ourforward-looking statements can be affected by inaccurate assumptions we mightmake or by known or unknown risks and uncertainties, including those describedabove.  The risks and uncertaintiesdescribed above are not exclusive and further information concerning us and ourbusiness, including factors that potentially could materially affect ourfinancial results or condition, may emerge from time to time.  We assume no obligation to updateforward-looking statements to reflect actual results or changes in factors orassumptions affecting such forward-looking statements.  We advise you, however, to consult anyfurther disclosures we make on related subjects in our quarterly reports onForm 10-Q and current reports on Form 8-K we file with or furnish to theSecurities and Exchange Commission.

 

Item 3.                                         Quantitativeand Qualitative Disclosures About Market Risk

 

*Equity Price and Interest Rate Risk*

 

Allof our marketable securities, some of which are insured by the FDIC, are atfixed interest rates and mature within two and one-half years; therefore, webelieve that the market risk arising from the holding of these financialinstruments is minimal.

 

*Foreign Currency Risk*

 

Historically,in excess of 50% of our consolidated sales have been to internationaldestinations.  Since we invoice most ofthese customers in U.S. dollars, we do not have significant exposure to foreigncurrency transaction risk relating to trade accounts receivable.  We invoice a small amount to ourinternational customers in their local currency which exposes us to sometransaction gain or loss when converting their payments into U.S. dollars.  We also pay a small number of ourinternational suppliers in their local currency which exposes us to transactiongain or loss.  However, these have notresulted in material amounts in the past. Our foreign operations expose us to foreign currency exchange risk whenthe euro and yuan currency results of operations are translated to U.S.dollars.  These fluctuations are recordedin our consolidated balance sheet as an adjustment to accumulated othercomprehensive income or loss.  Wehistorically have not experienced any material foreign currency transactiongains or losses, however, we realized a foreign currency transaction gain forthe first nine months of 2010 relating to the valuation of a euro-denominatedintercompany loan which originated in the first quarter 2010.  To mitigate the effect of any currencyfluctuations in the future, we have purchased a foreign currency forwardcontract which acts as a hedge against potential gains or losses.  Our investment in foreign subsidiariestranslated into U.S. dollars is not hedged. Any changes in foreign currency exchange rates would be reflected as aforeign currency translation adjustment, a component of accumulated other comprehensiveincome in stockholders’ equity, and would not impact our net income.

 

Item 4.              Controlsand Procedures

 

*Evaluation of Disclosure Controls and Procedures*

 

Wemaintain disclosure controls and procedures (as defined in Exchange Act Rules13a-15(e) and 15d-15(e)) that are designed to ensure that information requiredto be disclosed by us in the reports we file or submit under the SecuritiesExchange Act of 1934, as amended, is recorded, processed, summarized, andreported, 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

 

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toallow timely decisions regarding required disclosure.  In designing and evaluating our disclosurecontrols and procedures, we recognize that any controls and procedures, nomatter how well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and we necessarily are required toapply our judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures.  Our managementevaluated, with the participation of our Chief Executive Officer and ChiefFinancial Officer, the effectiveness of the design and operation of ourdisclosure controls and procedures as of the end of the period covered in thisQuarterly Report on Form 10-Q.  Based onthat evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective as of theend of such period, to provide reasonable assurance that information requiredto be disclosed in our Exchange Act reports is recorded, processed, summarized,and reported within the time periods specified in the SEC’s rules and forms,and that material information relating to our Company and our consolidatedsubsidiaries is made known to management, including our Chief Executive Officerand Chief Financial Officer, particularly during the period when our periodicreports are being prepared.

 

*Changes in Internal Control Over Financial Reporting*

 

Therewas no change in our internal control over financial reporting that occurredduring our quarter ended September 30, 2010 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

PART II.      OTHERINFORMATION

 

Item 1A.           Risk Factors

 

We are affected by risks specific to us as well as factors that affectall businesses operating in a global market. The significant factors known to us that could materially adverselyaffect our business, financial condition or operating results are described inour annual report on Form 10-K for the fiscal year ended December 31, 2009under the heading “Part I — Item 1A. Risk Factors.”  There has been no material change in thoserisk factors.

 

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

 

*Unregistered Sales of Equity Securities*

 

We did not sell any equity securities of MOCON, Inc. during the thirdquarter ended September 30, 2010 that were not registered under the SecuritiesAct of 1933.

 

*Issuer Repurchases of Equity Securities*

 

Other than the withholding of 26,198 shares of our common stock inconnection with the cashless net exercise of stock options to pay the exerciseprice of such options, we did not repurchase any equity securities of MOCON,Inc. during the third quarter ended September 30, 2010.

 

Item 6.              Exhibits

 

Thefollowing exhibits are being filed or furnished with this quarterly report onForm 10-Q:

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                           |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------|
| 31.1             |       | Certification  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002 (filed herewith)     |
|             |       |                                                                                                                      |
| 31.2             |       | Certification  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002 (filed herewith)     |
|             |       |                                                                                                                      |
| 32.1             |       | Certification  of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002 (furnished herewith) |
|             |       |                                                                                                                      |
| 32.2             |       | Certification  of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002 (furnished herewith) |

 

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SIGNATURES

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned hereuntoduly authorized.

 

 
|                     |   | MOCON,  INC.                                           |
|--------------------------|--------|--------------------------------------------------------|
|                     |   |                                                   |
|                     |   |                                                   |
| Date:  November 12, 2010 |   | /s/  Robert L. Demorest                                |
|                     |   | Robert  L. Demorest                                    |
|                     |   | Chairman,  President and Chief Executive Officer       |
|                     |   | (Principal  Executive Officer)                         |
|                     |   |                                                   |
|                     |   |                                                   |
| Date:  November 12, 2010 |   | /s/  Darrell B. Lee                                    |
|                     |   | Darrell  B. Lee                                        |
|                     |   | Vice  President, Treasurer and Chief Financial Officer |
|                     |   | (Principal  Financial and Accounting Officer)          |

 

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Tableof Contents

 

MOCON, INC.

QUARTERLY REPORT ON FORM 10-Q

QUARTER ENDED SEPTEMBER 30, 2010

 

EXHIBIT INDEX

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

 

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