**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM 10-K**

**(Mark one)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe fiscal year ended December 31, 2004**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from                to                .**

**CommissionFile No.: 0-9273**

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MOCON, Inc.

(Exact name of registrantas specified in its charter)

| **Minnesota**                                                        | **41-0903312**                        |
|----------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) | (I.R.S. Employer  Identification No.) |
| **7500 Boone Avenue North   Minneapolis, Minnesota**                 | **55428**                             |
| (Address of  principal executive offices)                            | (Zip Code)                            |

 

Registrant’s telephone number, including area code:  **(763) 493-6370**

Securities registeredpursuant to Section 12(b) of the Act: **NONE**

Securities registeredpursuant to Section 12(g) of the Act:

**CommonStock, $0.10 Par Value**

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes  x   No  o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K.   x

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act). Yes  o   No  x

The aggregate market valueof the registrant’s common stock, excluding outstanding shares beneficiallyowned by directors and executive officers, computed by reference to the priceat which the common stock was last sold as of June 30, 2004 (the lastbusiness day of the registrant’s second quarter) as reported by the NasdaqNational Market System, was $41,795,444.

As of March 25, 2005, 5,342,615shares of common stock of the registrant were deemed outstanding.

**DOCUMENTS INCORPORATED BYREFERENCE**

Part III of thisAnnual Report on Form 10-K incorporates by reference information (tothe extent specific sections are referred to herein) from the registrant’sProxy Statement for its 2005 Annual Meeting of Shareholders to be held May 17,2005.

 

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**PART I**

This Annual Report on Form 10-Kincludes certain statements that are “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. All statements contained inthis Annual Report, other than statements of historical facts, areforward-looking statements. These statements are based on certain assumptionsand analyses made by us in light of our experience and our perception ofhistorical trends, current conditions, expected future developments, and otherfactors we believe are appropriate in the circumstances. Such statements aresubject to a number of assumptions, risks, and uncertainties, many of which arebeyond our control. You can identify forward-looking statements by those thatare not historical in nature, particularly those that use terminology such as “may,”“will,” “should,” “expects,” “believes,” “anticipates,” “estimates,” “continues,”“projects,” “potential,” or “plan” or the negative of these or other similarterms. We caution you that any such statements are not guarantees of futureperformance and that actual results or developments may differ materially fromthose projected in the forward-looking statements. In evaluating these forward-lookingstatements, you should consider various factors, including those listed belowunder the heading “Item 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Forward-Looking Statements.” These factorsmay cause our actual results to differ materially from any forward-lookingstatement.

As used in this AnnualReport on Form 10-K, references to “MOCON,” the “Company,” “we,” “our”or “us,” unless the context otherwise requires, refer to MOCON, Inc. andour subsidiaries.

**ITEM 1.     BUSINESS**

MOCON, Inc. designs,manufactures, markets, and services products and provides consulting servicesprimarily in the measurement and analytical instrument and services markets. Ourproducts include instruments that detect, measure and monitor gases andchemical compounds as well as products that prepare samples of varioussubstances for laboratory analysis. We also manufacture and sell vacuuminsulated panels. Sales associated with our vacuum insulated panel product lineare not significant.

Our principal businessstrategy is to employ our product development and technological capabilities,manufacturing processes, and marketing skills in market niches where we cansuccessfully penetrate the market and then strive to become a leader in themarket segment. Our management team continually emphasizes product innovation,product performance, quality improvements, cost reductions and othervalue-adding activities. Although some of the markets for our products arematuring, we continually seek growth opportunities through technological andproduct improvement, by acquiring and developing new products, and by acquiringnew companies.

MOCON, Inc. wasincorporated as a Minnesota corporation in February 1966 and was initiallyinvolved in the commercialization of technology developed for the measurementof water vapor permeating through various materials. Prior to 1998, we expandedour business primarily through internally developing new products andtechnologies, acquiring product lines and technology, and licensing ourproducts and technology. Since 1998, we have supplemented our internal growththrough a total of five acquisitions that have provided us with additionaltechnologies, products and product development expertise.

In January 1998, weacquired Microanalytics Instrumentation Corp., which is located near Austin,Texas. Microanalytics produces various gas chromatographic (GC) instruments andprovides services with an emphasis on multidimensional gas chromatography. Avariety of GC specific applications have been developed by Microanalyticspersonnel, ranging from petroleum and petrochemical purity assay to aroma andoff-odor analysis for the food and packaging fields.

In December 1998, weacquired Lab Connections, Inc. (LCI), located near Boston, Massachusetts. LCImanufactures hardware and software interfaces that allow the components of aparticular substance to be identified by spectrometry and spectroscopy afterthey have been separated through chromatography. 

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LCI’sproducts extend and enhance customers’ productivity by allowing for the rapidpreparation of samples for laboratory analysis furnishing information regardingthe identity, composition and configuration of complex mixtures. LCI’s productsare used by a variety of customers, including bio-pharmaceutical, polymer andconsumer products companies as well as companies that analyze proteins,pharmaceutical compounds, polymers, adhesives and other materials. In order toreduce costs and increase operating efficiencies, our LCI subsidiary wasrelocated in 2004 and consolidated with our operations in Texas and Minnesota.

In October 2001, weacquired Questar Baseline Industries, Inc. from Questar InfoComm, Inc.,a subsidiary of Questar Corporation. We have subsequently renamed this company “Baseline-MOCON, Inc.”(Baseline). Baseline is located near Denver, Colorado. Baseline producesadvanced gas analysis and monitoring instrumentation used in applications suchas oil and gas exploration, process gas analysis, and industrial hygiene and safetyapplications.

In November 2003, weacquired the Vaculok® vacuum insulated panel product line from Advantek, Inc.,a Minnesota-based provider of packaging products. Vacuum insulated panels(VIPs) are devices which utilize unique technologies to excel in packagingapplications requiring lengthy temperature protection. With this acquisition,we can now help our existing food, pharmaceutical, medical, and many other newcustomers in specialized packaging markets improve their handling oftemperature-sensitive products from the point of manufacture to theirdestinations.

We completed our mostrecent acquisition effective January 1, 2004, by acquiring Paul LippkeHandels-GmbH Prozess- und Laborsysteme (Lippke) which is located in Germany. Lippkehad been the primary distributor of our products in Europe for approximately 30years, and also served in the capacity of distributor or agent for severalcompanies in addition to MOCON. Our acquisition of Lippke provides us with adirect presence in Europe. We acquired all of the shares of Lippke for a basepurchase price of $802,688. In addition, we are obligated to make three future “earnout”payments to Lippke’s former parent company based on the net profits of Lippkein each of the years 2004, 2005, and 2006, with a minimum payment amount of100,000 euros per year. It is anticipated that the “earnout” payments will bemade to the former parent company of Lippke at or near the end of the firstquarter of each of the years 2005, 2006, and 2007. The earnout  payment due for 2004 based on Lippke’s 2004net profits is $549,257.

Our principal executiveoffices are located at 7500 Boone Avenue North, Minneapolis, Minnesota 55428,and our telephone number is (763) 493-6370. Our Internet website addressis *www.mocon.com*.

We make available, free of charge on our Internetwebsite www.mocon.com, our Annual Reports on Form 10-K, Quarterly Reports onForm 10-Q, Current Reports on Form 8-K, and amendments to those reports filedor furnished pursuant to Section 13(a) of 15(d) of the Securities Exchange Actof 1934, as amended, as soon as reasonably practicable after we electronicallyfile such material with, or furnish it to, the Securities and ExchangeCommission. The information contained on our website or connected to ourwebsite is not incorporated by reference into this Annual Report on Form 10-Kand should not be considered part of this report.

**Productsand Services**

We develop, manufacture,market, and service measurement, analytical, monitoring, sample preparation andconsulting products used to detect, measure, and analyze gases and chemicalcompounds. Please see our Consolidated Financial Statements beginning on page F-1for financial information concerning our business, including our revenues, netincome and net assets.

***Permeation Products***

Our permeation productsconsist of systems and services that measure the rate at which various gasesand vapors are transmitted through various materials. These products performmeasurements under precise temperature and relative humidity conditions. Theprincipal market for these products consists of 

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manufacturersof packaging materials (including manufacturers of papers, plastics andcoatings) and the users of such packaging materials, such as companies in thefood, beverage, pharmaceutical and chemical industries.

Wealso provide certain laboratory testing services to companies that use ourpermeation products. These services consist primarily of testing film andpackage permeation for companies that:

·       haveinsufficient business to justify the purchase of our products;

·       arenot familiar with such equipment; or

·       havepurchased our products but have a need for additional capacity.

Our permeation productsaccounted for approximately 57%, 60%, and 53% of our consolidated sales in2004, 2003, and 2002, respectively. Permeation instruments that we currentlymanufacture include OX-TRAN® systems for oxygen transmission rates,PERMATRAN-W® systems for water vapor transmission rates, and PERMATRAN-CTMsystems for carbon dioxide transmission rates.

***Weighing andPharmaceutical Products***

We manufacture weighingproducts that automatically determine the weight of pharmaceutical capsules andtablets and reject those that are out of acceptable limits. Our VERICAP®high-speed capsule weighing system runs at rates up to 2,000 capsules perminute and can be integrated into a capsule production line in pharmaceuticalfactories. The ABTM automatic balance weighing systems that we sell are designedfor off-line use for both tablets and capsules, and we market these productsprimarily to the pharmaceutical industry. In addition, we sell tabletinspection systems and blister packaging-related equipment through our Lippkesubsidiary, who is an agent for other manufacturers.

***Consulting andAnalytical Services***

Weprovide consulting and analytical services, on a special project basis, forcustomers that require custom solutions to unique problems. Services that wetypically provide relate to:

·       absorptionor diffusion of various compounds;

·       harshenvironment applications;

·       shelf-lifeconcerns;

·       flavoror odor detection; or

·       otherspecial permeation applications.

In providing consultingand analytical services, we use our most advanced measurement technologies,including proprietary TRANSORPTION® technology. The principal market for theconsulting and analytical services consists of manufacturers of foods,beverages, pharmaceuticals, plastics, chemicals, electronics, and personal careproducts.

***Headspace AnalyzerProducts***

Our headspace analyzers areused to analyze the amount of oxygen and carbon dioxide present in theheadspace of flexible and rigid packages. Some analyzers measure the oxygen andcarbon dioxide content in flushing gases used in modified or controlledatmosphere packaging. The principal market for these products consists ofpackagers of foods, beverages and pharmaceuticals. The headspace analyzerproducts that we currently manufacture include the PAC CHECK® series ofheadspace analyzers and the GSATM series of on-line gas stream analyzers forcontinuous and intermittent monitoring of modified atmosphere packaging (MAP)and other gas flushing operations.

***Sample PreparationProducts***

We design, manufacture,market, and service products used in sample preparation. These products consistof hardware and software interfaces that allow the components of a particularsubstance to be 

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identifiedby spectroscopy after they have been separated through chromatography. The mosttime-consuming part of chemical analysis is sample preparation and any productthat reduces total sample preparation time is of benefit to companies whoanalyze chemical compounds. Our products provide fully automatic samplecollection from various Liquid Chromatographs and Gel Permeation Chromatographsin a form suitable for immediate examination by Fourier transform infra-redspectroscopy (FTIR) and/or matrix-assisted laser desorption ionization massspectrometry (MALDI-MS). The principal market for these products islaboratories that analyze proteins, polymeric compounds and adhesives. Thesample preparation products that we currently manufacture are the LC-Transform®for interfacing to FTIR and the LC-Transform for interfacing to MALDI-MS.

***Gas ChromatographyAnalyzer Products***

We integrate gaschromatography (GC) components that we purchase from third parties, with GCspurchased from third parties, to form multidimensional GC analyzer systems. Themultidimensional GC analyzers that are formed through the integration ofgas chromatography components with GCs represent state-of-the-art technology ingas chromatographic separations and are used in identifying compounds causingoff-odors in various products, in identifying critical aroma compounds, and inhigh purity analysis of single component matrixes. The GC analyzer products thatwe currently manufacture are the AROMATRAX® systems for odor and aroma analysisand profiling, the PURI-TRAXTM systems consisting of a vinyl chloride monomerpurity analysis system and a system for measuring trace levels of oxygenatedhydrocarbons in a variety of hydrocarbon products and process streams such asliquefied petroleum gases, and the VAPO-JECTTM automated vaporizing injectorsystem for permanent and liquefied petroleum gases. The principal markets forour GC analyzer products consist of food, beverage, petroleum, chemical andpetrochemical manufacturers.

***Leak DetectionProducts***

Our leak detectionproducts that we manufacture detect leaks in sterile medical trays, pouches,blister packs and a wide range of other packages. We currently manufacture twotypes of leak detection instruments. The first type of instrument is anon-destructive leak detector that senses small amounts of carbon dioxideescaping from a package or tray. The second type of instrument detects leaksand checks for seal integrity by applying and measuring pressure within apackage. The principal market for these products are packagers of sterilemedical items, pharmaceuticals, and food products.

***Gas AnalyzerProducts***

We sell two categories ofgas analyzer products. Our permanent gas analyzers and systems are installed infixed locations at the monitoring sites and generally perform their functionscontinually or at regular intervals. Our portable gas analyzers are hand-held,compact and are used on occasions requiring mobile equipment. Our gas analyzerproducts are for use in (1) industrial hygiene (detection of hazardousgases in the workplace), (2) hydrocarbon gas analysis for oil and gasexploration, and gas pipeline monitoring, (3) contaminant detection in themanufacture of specialty gases, and (4) environmental monitoring (trackingthe release of, or the presence of, toxic substances).

We acquired our gasanalyzer product line in October 2001. Gas analyzer products accounted forapproximately 14%, 15%, and 19% of our consolidated sales in 2004, 2003, and2002, respectively.

**Competition**

Wehave several competitors in both foreign and domestic markets for all of ourproducts and services. The principal competitive factors for our products andservices are:

·       productquality and performance;

·       productreliability;

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·       productsupport; and

·       price.

We compete with a varietyof competitors in each market in which we sell our products. Some of ourcompetitors have greater assets and resources than we do, and some are smallerthan we are. To remain competitive, we must continue to invest in research anddevelopment, marketing, customer service and support, and manage our operatingexpenses. We believe that we have in place strategies to develop technologicaland other advantages over our competitors. However, there can be no assurancethat we will have sufficient resources to execute these strategies, or that ourcompetitors will not develop new technologies or other advantages which wouldrequire us to reduce our prices, result in lost orders, or otherwise adverselyaffect our financial results.

**Manufacturing andSupplies**

We manufacture products atour Minneapolis, Minnesota, Austin, Texas and Denver, Colorado locations. In February 2004,we closed our facility located near Boston, Massachusetts, and consolidatedthis operation with our operations in Texas and Minnesota. Our manufacturingcapabilities include electro-mechanical assembly, testing, integration ofcomponents and systems, calibration, and validation of systems. Certaincomponents that we use in our products are currently purchased from singlesource suppliers. An interruption of one of these sources could result indelays in our production while we locate an alternative supplier, which in turncould result in a loss of sales and income. There are other single sourcecomponents for which we have determined that other sources are readilyavailable. To date, we have experienced no significant production delaysbecause of a supplier’s inability to ship an acceptable component.

**Patents,Licenses, Trademarks and Other Intellectual Property Rights**

We believe that theprotection afforded us by our patent rights is important to our business and wewill continue to seek patent protection for our technology and products. Werequire all of our employees and consultants to assign to us all inventionsthat are conceived and developed during their employment, except to the extentprohibited by applicable law. We hold both United States and internationalpatents and have U.S. and international patents pending. We currently hold 45U.S. patents and 26 international patents. In addition, we hold license rightsunder four U.S. patents subject to royalty payments. These patents and licenseswill expire during the period from 2005 through 2022.

We own or have applied forcertain trademarks which protect and identify our products. Among thetrademarks we own is MOCON®, which we have designated as a house trademarkunder which all our products manufactured at our headquarters are sold. Inaddition, we hold the following trademarks and service marks: VERICAP®,OX-TRAN®, PERMATRAN-W®, PROFILER®, COULOX®, HERSCH®, VERITAB®, AROMATRAN®,SKYE®, PAC CHECK 200®, LC-Transform®, TRANSORPTION®, 1-TIME®, AROMATRAX®, PACGUARD®, INNOVATIVE TECHNOLOGY CONFERENCES®, VACULOK®, PAC CHECK®, andOPTIPERM®. Our trademarks and service marks have a life, subject to periodicmaintenance, of 10 to 20 years, which may be extended in accordance withapplicable law.

To protect our proprietaryinformation, we have entered into confidentiality and non-compete agreementswith those of our employees and consultants who have access to sensitiveinformation.

**Marketing andCustomers**

We market our products andservices throughout the United States and in over 60 foreign markets. We use adirect sales force to market our products and services in the United States,Canada and Germany, and use a network of independent sales representatives tomarket and service our products and services in other foreign countries. To ourknowledge, none of our independent sales representatives sells a materialamount of product manufactured by any of our competitors.

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We market products and services to researchlaboratories, production environments and quality control applications in thelife science, medical, food, pharmaceutical, plastics, paper, electronics, oiland gas, and other industries. No single customer accounted for 10% or more ofour consolidated sales in any of the fiscal years ended December 31, 2004,2003 and 2002, and we do not believe that the loss of any single customer wouldhave a material adverse effect on our business or financial performance. Aspreviously explained, we acquired Lippke effective January 1, 2004. Lippkeaccounted for approximately 24%, 10%, and 8% of our consolidated sales in 2004,2003, and 2002, respectively. In addition, one independent sales representativeaccounted for approximately 8%, 8%, and 7% of our consolidated sales in 2004,2003, and 2002, respectively.

For information concerningour export sales by geographic area, see Note 11 of the Notes to ConsolidatedFinancial Statements contained on page F-19. 

**Backlog**

As of December 31,2004, our total backlog was $2,250,816 for all of our products as compared to$1,048,465 and $1,722,421 as of December 31, 2003 and 2002, respectively. Weanticipate shipping the entire current backlog in 2005.

**Research and Development**

We are committed to an ongoing engineering programdedicated to innovating new products and improving the quality and performanceof our existing products. Our engineering expenses are primarily incurred inconnection with the improvement of existing products, cost reduction efforts,and the development of new products that may have additional applications orrepresent extensions of existing product lines.

We incurred expenses of$1,376,196, $1,313,379 and $1,286,220 during the fiscal years ended December 31,2004, 2003 and 2002, respectively, for research and development (R&D) ofour products. R&D costs were approximately 5% of our consolidated sales forthe fiscal year ended December 31, 2004 and approximately 7% and 6% of ourconsolidated sales for the fiscal years ended December 31, 2003 and 2002,respectively. For the foreseeable future, we expect to spend, on an annualbasis, approximately 6% to 8% of our consolidated sales on R&D.

**Working Capital Practices**

We strive to maintain alevel of inventory that is appropriate given our projected sales. Our standarddomestic payment terms are net 30 days and our international payment terms varybut generally range between 30 and 90 days. International sales are, in somecases, transacted pursuant to letters of credit.

**Seasonality**

Our business is notseasonal in nature.

**Employees**

As of December 31,2004, we had 116 full-time employees. Included in this total are approximately14 scientists and engineers who research and develop potential new products. Noneof our employees are represented by a labor union, and we consider our employeerelations to be satisfactory.

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**ITEM 2.**                PROPERTIES

We lease an aggregate of 59,825square feet of office, engineering, laboratory, and production space inMinnesota, Texas and Germany. We believe that all of our facilities aregenerally adequate for their present operations and that suitable space isreadily available if any of our leases are not extended.

Our headquarters andoperations occupy approximately 47,200 square feet of space in Minneapolis,Minnesota. This space is leased until June 2010.

Microanalytics’ operationsoccupy approximately 8,600 square feet of space in the metropolitan area ofAustin, Texas. This space is leased until June 2007.

Lippke’s operations arelocated in Neuwied, Germany, and occupy approximately 4,025 square feet. Thisspace is leased until March 2006.

In addition to our leasedfacilities described above, we own a building located within 40 miles ofDenver, Colorado that consists of approximately 9,300 square feet of office andproduction space in which our Baseline-MOCON, Inc. subsidiary conducts itsoperations. We also own the land, consisting of approximately two acres, onwhich this building is located.

**ITEM 3.**                LEGALPROCEEDINGS

There are no materialpending legal, governmental, administrative or other proceedings to which weare a party or of which any of our property is the subject.

**ITEM4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted toa vote of our security holders during the fourth quarter of 2004.

**ITEM4A.**        EXECUTIVEOFFICERS OF REGISTRANT

Ourexecutive officers, their ages and their offices held, as of March 25,2005, are as follows:
| **Name**             | ** ** | ** ** | ** ** | **Age**                                                              | ** ** | **Title** |
|----------------------|------------|------------|------------|----------------------------------------------------------------------|------------|-----------|
| Robert L. Demorest   |       | 59         |       | President and Chief  Executive Officer, Chairman of the Board        |
| Daniel W. Mayer      |       | 54         |       | Executive Vice President                                             |
| Dane D. Anderson     |       | 43         |       | Vice President and Chief  Financial Officer, Treasurer and Secretary |
| Douglas J. Lindemann |       | 47         |       | Vice President and  General Manager                                  |
| Ronald A. Meyer      |       | 54         |       | Vice President                                                       |

 

Mr. Robert L. Demorest has been our President,Chief Executive Officer, and Chairman of the Board since April 2000. Priorto that time, Mr. Demorest had been our President for more than fiveyears.

Mr. Daniel W. Mayer has been an Executive VicePresident for us since January 1995. Prior to that time, Mr. Mayerhad been our Vice President, Product Development for more than five years.

Mr. Dane D. Anderson has been our Chief FinancialOfficer, Vice President, Treasurer and Secretary since January 2001.Mr. Anderson had been our Chief Financial Officer, Treasurer and Secretarysince August 2000, and was our acting Vice President—Finance andAdministration, Treasurer and Secretary from May 2000 to August 2000.From July 1996 to May 2000, Mr. Anderson had been one of ourBusiness Managers.

Mr. Douglas J. Lindemann has been a VicePresident and General Manager for us since January 2001. From July 2000to December 2000 Mr. Lindemann served as a General Manager for us. Priorto that time Mr. Lindemann had been one of our Business Managers since1995.

Mr. Ronald A. Meyer has been a Vice President forus for more than five years. From 1995 to April 2000, Mr. Meyer alsoserved as our Chief Financial Officer, Treasurer and Secretary.

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**PART II**

**ITEM 5.**                MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES

**Market Information and Dividends**

Ourcommon stock is quoted on the Nasdaq National Market System under the symbolMOCO. The following table sets forth, for the fiscal periods indicated, thehigh and low bid quotations for our common stock as reported by the NasdaqNational Market System. These quotations reflect inter-dealer prices, withoutretail mark-up, mark-down or commission and may not necessarily representactual transactions. The following table also sets forth, for the fiscalperiods indicated, the amount of cash dividends declared on our common stock.
| ** **  | ** ** | **2004**   | ** ** | **2003** | ** ** |
|-------------|------------|------------|------------|----------|------------|
| **Quarter** | ** ** | ** ** | ** ** | **Low**  | ** ** | **High** | ** ** | **Dividend** | ** ** | **Low** | ** ** | **High** | ** ** | **Dividend** | ** ** |
| 1st Quarter |       | $          | 7.70       |     | $          | 8.97 |   |   | $ | .065 |   |   | $ | 6.38 |   | $ | 8.40 |   |   | $ | .065 |   |   |
| 2nd Quarter |       | $          | 7.70       |     | $          | 8.72 |   |   | $ | .065 |   |   | $ | 6.80 |   | $ | 7.93 |   |   | $ | .065 |   |   |
| 3rd Quarter |       | $          | 7.73       |     | $          | 8.65 |   |   | $ | .065 |   |   | $ | 7.00 |   | $ | 9.00 |   |   | $ | .065 |   |   |
| 4th Quarter |       | $          | 7.95       |     | $          | 10.49 |   |   | $ | .070 |   |   | $ | 7.89 |   | $ | 8.75 |   |   | $ | .065 |   |   |
|             |            |            |            |          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

MOCON has paid quarterlycash dividends without interruption or decline since 1988. Prior to the presentpolicy of quarterly dividends, we had been paying dividends on a semi-annualbasis since 1984. Cash dividends paid in 2004, 2003, and 2002 totaled$1,842,593 (including final dividend payments of $449,087 to Lippke’s formerparent company and dividend payments of $1,393,506 to our shareholders),$1,377,725 and $1,318,095, respectively. MOCON’s Board of Directors monitorsand evaluates our dividend practice quarterly, and the Board may elect at anytime to increase, decrease or not pay a dividend on MOCON common stock basedupon our financial condition, results of operations, cash requirements andfuture prospects and other factors deemed relevant by the Board.

**Record Holders**

As of March 21, 2005,there were 371 record holders of our common stock.

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

Thefollowing table summarizes outstanding options under the MOCON, Inc. 1998Stock Plan and the MOCON, Inc. 1992 Stock Option Plan as of December 31,2004. We do not have any non-plan options outstanding. Options granted in thefuture are within the discretion of the Compensation Committee of our Board ofDirectors and therefore cannot be ascertained at this time.
| ** **                                                        | ** ** | **(a)**    | ** ** | **(b)**                                                                                                                                                | ** ** | **(c)**                                                                                                 | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|
| **Plan Category**                                            | ** ** | ** ** | ** ** | **Number of Securities to  be Issued Upon  Exercise of Outstanding   Options, Warrants and  Rights** | ** ** | **Weighted-Average  Exercise Price of  Outstanding  Options, Warrants  and Rights** | ** ** | **Number of Securities  Remaining Available for  Future Issuance Under  Equity Compensation Plans  (excluding securities  reflected in column (a))** | ** ** |
| Equity  compensation plans approved by security holders      |       |       | 838,439    |                                                                                                                                                   |       |                                                                                                    | $          | 7.46 |   |   |   | 157,607 |   |   |
| Equity  compensation plans not approved by security holders  |       |       | 0          |                                                                                                                                                   |       |                                                                                                    | 0          |   |   |   | 0 |   |   |
| Total                                                             |       |       | 838,439    |                                                                                                                                                   |       |                                                                                                    | $          | 7.46 |   |   |   | 157,607 |   |   |
|                                                                   |            |            |            |                                                                                                                                                        |            |                                                                                                         |            |  |  |  |  |  |  |  |  |  |

 

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**IssuerRepurchases of Equity Securities**

We did not repurchase anyequity securities of MOCON, Inc. during the three months ended December 31,2004. In November 2002, our Board of Directors authorized the repurchaseof up to $2,000,000 in shares of our common stock in the open market at pricesnot exceeding the market price at the time of purchase. In May 2003, ourBoard of Directors authorized a $1,200,000 increase in our stock repurchaseprogram, increasing the total to $3,200,000. As of December 31, 2004, wehad repurchased 204,000 shares of MOCON common stock under the program at atotal cumulative cost of approximately $1,527,966. The repurchase program doesnot have an expiration date, and the Board may terminate it at any time.

**PreviousSales of Unregistered Securities**

During the fourth quarterended December 31, 2004, we did not issue any equity securities of MOCONwithout registration under the Securities Act of 1933, as amended.

**ITEM 6.**                SELECTEDFINANCIAL DATA
| ** **                                  | ** ** | **Years Ended December 31,**                        | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **2004**                                                           | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                  | ** ** | **(in thousands, except per share data)** | ** ** |
| CONSOLIDATED  STATEMENT OF OPERATIONS DATA: |       |                                                               |       |   |   |   |   |   |   |   |   |
| Sales                                       |       | $                                                                  | 25,108     |   | $ | 19,632 |   | $ | 19,931 |   | $ | 19,261 |   | $ | 17,319 |   |
| Net income                                  |       | $                                                                  | 2,429      |   | $ | 2,211 |   | $ | 2,297 |   | $ | 3,421 |   | $ | 3,270 |   |
| Net income per  common share:               |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                       |       | $                                                                  | 0.45       |   | $ | 0.41 |   | $ | 0.42 |   | $ | 0.62 |   | $ | 0.55 |   |
| Diluted                                     |       | $                                                                  | 0.44       |   | $ | 0.40 |   | $ | 0.41 |   | $ | 0.61 |   | $ | 0.55 |   |
| Cash dividends  declared per share          |       | $                                                                  | 0.265      |   | $ | 0.26 |   | $ | 0.24 |   | $ | 0.24 |   | $ | 0.225 |   |

 
| ** **                        | ** ** | **As of December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                        | ** ** | **(in thousands)**               | ** ** |
| CONSOLIDATED  BALANCE SHEET DATA: |       |                                  |       |   |   |   |   |   |   |   |   |
| Total assets                      |       | $                                     | 22,516     |   | $ | 19,978 |   | $ | 19,821 |   | $ | 18,958 |   | $ | 18,418 |   |
| Long-term liabilities             |       | $                                     | 543        |   | $ | 198 |   | $ | 326 |   | $ | 320 |   | $ | 187 |   |

 

Our acquisition of Lippke in 2004 affects thecomparability of the information in the table above. The results of thissubsidiary have been included from the effective date of purchase, whichincludes $3,824,782 in net incremental sales for 2004. Our acquisition ofBaseline-MOCON, Inc. in 2001 also affects the comparability of theinformation in the table above. The results of this subsidiary have beenincluded from the effective date of purchase, which includes sales of$3,560,351, $2,980,271, $3,881,781 and $1,348,101 for 2004, 2003, 2002 and2001, respectively.

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’sDiscussion and Analysis provides material historical and prospectivedisclosures intended to enable investors and other users to assess our financialcondition and results of operations. Statements that are not historical areforward-looking and involve risks and uncertainties discussed below under thecaption “Forward-Looking Statements.” The following discussion of the resultsof the operations and financial condition of MOCON should be read inconjunction with our Consolidated Financial Statements and the related notesthereto.

**Overview**

MOCON, Inc. designs,manufactures, markets, and services products and provides consulting servicesprimarily in the measurement and analytical instrument and services markets. Ourproducts include instruments that detect, measure and monitor gases andchemical compounds as well as products that prepare samples of varioussubstances for laboratory analysis. Although some of the markets for ourproducts are maturing, we continually seek growth opportunities throughtechnological and product improvement, by acquiring and developing newproducts, and by acquiring new companies.

We have three primaryoperating locations in the United States—Minnesota, Colorado and Texas—and onein Germany. We use a direct sales force to market our products and services inthe United States, Canada and Germany and use a network of independent sales representativesto market and service our products and services in other foreign countries.

**Overall Summary ofFinancial Results**

Sales for 2004 were$25,108,369, an increase of 28% compared to $19,632,366 for 2003. Net income in2004 was $2,428,688, a 10% increase compared to $2,211,305 in 2003, and netincome per diluted share was $0.44 in 2004, a 10% increase compared to $0.40for 2003. Our financial position as of December 31, 2004 reflects anincrease in working capital of $763,321 to $11,665,447, compared to $10,902,126at December 31, 2003.

**SignificantTransactions and Financial Trends**

Throughout these financialsections, you will read about significant transactions or events thatmaterially contribute to, or reduce, our earnings, and materially affect ourfinancial trends. Significant transactions and events that affected our 2004financial results and position included the acquisition of Paul LippkeHandels-GmbH Prozess- und Laborsysteme (Lippke) in Germany, an impairmentcharge related to intangible technology rights associated with our LabConnections, Inc. (LCI) subsidiary, and the movement of all of LCI’s, anda significant portion of our Baseline-MOCON, Inc. subsidiary’s, productionto our main manufacturing facility in Minneapolis, Minnesota, along with thecosts associated with these moves.

These significanttransactions result from unique facts and circumstances and, given theirnature, some of these items will likely not recur with similar materiality orimpact on our continuing operations. While these items are important in understandingand evaluating our financial results and trends, other transactions or eventssuch as those discussed later in this Management’s Discussion and Analysis mayalso have a material impact on financial trends.

Prior to 1998, we expandedour business primarily through internally developing new products andtechnologies, acquiring product lines and technology, and licensing ourproducts and technology. Since 1998, we have supplemented our internal growththrough a total of five acquisitions that have provided us with additionaltechnologies, products and product development expertise.

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We completed our mostrecent acquisition effective January 1, 2004, by acquiring Paul LippkeHandels-GmbH Prozess- und Laborsysteme (Lippke), which is located in Germany. Lippkehad been the primary distributor of our products in Europe for approximately 30years, and also served in the capacity of distributor or agent for severalcompanies in addition to MOCON. Our acquisition of Lippke provides us with adirect presence in Europe. We acquired all of the shares of Lippke for a basepurchase price of $802,688. In addition, we are obligated to make three future “earnout”payments to Lippke’s former parent company based on the net profits of Lippkein each of the years 2004, 2005, and 2006, with a minimum payment amount of100,000 euros per year. It is anticipated that the “earnout” payments will bemade to the former parent company of Lippke at or near the end of the firstquarter of each of the years 2005, 2006, and 2007. The earnout payment due for2004 based on Lippke’s 2004 net profits is $549,257.

Our international saleshave historically accounted for a significant portion of our revenues, and weexpect this trend to continue for the foreseeable future, especially as a resultof our acquisition of Lippke, which thus far has had, and is expected tocontinue to have, a positive impact on our sales, particularly on our foreignpermeation products sales.

**Critical AccountingPolicies**

Oursignificant accounting policies are described in Note 1 to our Consolidated FinancialStatements included in Item 8 of this Form 10-K. This Management’sDiscussion and Analysis is based upon our Consolidated Financial Statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these ConsolidatedFinancial Statements requires management to make estimates and judgments thataffect the reported amount of assets, liabilities, revenues and expenses, andrelated disclosure of contingent assets and liabilities. The Securities andExchange Commission has defined a company’s most critical accounting policiesas those that are most important to the portrayal of its financial conditionand results of operations, and which require the company to make its mostdifficult and subjective judgments, often as a result of the need to makeestimates of matters that are inherently uncertain. Based on this definition,we have identified the following critical accounting policies. Although webelieve that our estimates and assumptions are reasonable, they are based uponinformation available when they are made. Actual results may differsignificantly from these estimates under different assumptions or conditions.

***Allowance forDoubtful Accounts and Sales Returns***

This reserve is foraccounts receivable balances that are estimated to be uncollectible as well as estimatedsales returns. This reserve is based on a number of factors, including: (1) ananalysis of customer accounts and (2) our historical experience withaccounts receivable write-offs and sales returns. The analysis includes the ageof the receivable, the financial condition of a customer or industry, andgeneral economic conditions. We believe the results could be materiallydifferent if historical trends do not reflect actual results or if economicconditions worsened for our customers. In the event we determined that asmaller or larger allowance for doubtful accounts and sales returns isappropriate, we would record a credit or charge to selling, general, andadministrative expense in the period that we made such a determination. As of December 31,2004, we had $222,040 reserved against our accounts receivable for doubtfulaccounts and sales returns.

***Allowance forExcess and Obsolete Inventories***

We perform an analysis toidentify inventory shrinkage, and excess and obsolete inventory. We record acharge to cost of sales for amounts identified. Our analysis includes inventorylevels, the nature of the finished product and its inherent risk ofobsolescence, the gross margin of the product, and the on-hand quantitiesrelative to the sales history of that finished product. We believe that theresults could be materially different if historical trends do not reflectactual results or if demand for our products decreased 

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becauseof economic or competitive conditions or otherwise. Our allowance for excessand obsolete inventories at December 31, 2004 was $578,069.

***Recoverability ofLong-Lived Assets***

We assess therecoverability of goodwill and other long-lived assets annually or wheneverevents or changes in circumstances indicate that expected future undiscountedcash flows might not be sufficient to support the carrying amount of an asset. Wedeem an asset to be impaired if a forecast of undiscounted future operatingcash flows is less than an asset’s carrying amount. If an asset is determinedto be impaired, the loss is measured as the amount by which the carrying valueof the asset exceeds its fair value. In the fourth quarter of 2004, we recordeda $240,000 charge for the impairment of intangible technology rights associatedwith our Lab Connections, Inc. subsidiary. See Note 5 of Notes toConsolidated Financial Statements for a discussion of this charge. Changes inour business strategies, changes in the economic environment in which weoperate, competitive conditions, and other factors could result in futureimpairment charges.

***Accrued ProductWarranties***

Our products are generallycovered by a warranty, with warranty periods ranging from ninety days to oneyear from the date of sale. Estimated warranty costs are accrued in the sameperiod in which the related revenue is recognized, based on anticipated partsand labor costs, utilizing historical experience. Special warranty reserves arealso accrued for major rework campaigns. We periodically assess the adequacy ofour warranty reserves based on changes in these factors and record anynecessary adjustments if actual claim experience indicates that adjustments arenecessary. Although we believe the likelihood to be relatively low, warrantyclaims experience could be materially different from actual results due tomanufacturing changes that could impact product quality, a change in ourwarranty policy in response to industry trends, as yet unrecognized defects inproducts sold, or other factors. As of December 31, 2004, we had $352,634accrued related to future estimated warranty claims.

***Income Taxes***

In the preparation of ourConsolidated Financial Statements, management is required to estimate incometaxes in each of the jurisdictions in which we operate. This process involvesestimating actual current tax exposures together with assessing temporarydifferences resulting from differing treatment of items for tax and accountingpurposes. These differences result in deferred tax assets and liabilities,which are included in our consolidated balance sheet.

We have significantamounts of deferred tax assets. Management reviews the deferred tax assets forrecoverability on a quarterly basis and assesses the need for valuationallowances. These deferred tax assets are evaluated by considering historicallevels of income, estimates of future taxable income streams and the impact oftax planning strategies. A valuation allowance is recorded to reduce deferredtax assets when it is determined that it is more likely than not that we wouldnot be able to realize all or part of its deferred tax assets. We carried novaluation allowance against our net deferred tax assets at either December 31,2004 or 2003.

**Inflation**

We do not believe thatinflation has had a material effect on our results of operations in recentyears; however, there can be no assurance that our business will not beadversely affected by inflation in the future.

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**Results of Operations**

Thefollowing table sets forth the relationship between various components of ourresults of operations, stated as a percent of sales, for fiscal years 2004,2003 and 2002. Our historical financial data were derived from our ConsolidatedFinancial Statements and related notes included elsewhere in this report.
| ** **                                     | ** ** | **Percent of Sales** | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|
| ** **                                     | ** ** | **2004**                       | ** ** | **2003** | ** ** | **2002** | ** ** |
| Sales                                          |       | 100.0                          |       | 100.0 |   | 100.0 |   |
| Cost of sales                                  |       | 47.3                           |       | 45.2 |   | 46.7 |   |
| Gross profit                                   |       | 52.7                           |       | 54.8 |   | 53.3 |   |
| Selling, general, and  administrative expenses |       | 33.4                           |       | 31.9 |   | 30.6 |   |
| Research and development  expenses             |       | 5.4                            |       | 6.7 |   | 6.5 |   |
| Operating income                               |       | 13.9                           |       | 16.2 |   | 16.2 |   |
| Other income                                   |       | 0.5                            |       | 0.6 |   | 1.0 |   |
| Income before income  taxes                    |       | 14.4                           |       | 16.8 |   | 17.2 |   |
| Income taxes                                   |       | 4.7                            |       | 5.5 |   | 5.7 |   |
| Net income                                     |       | 9.7                            |       | 11.3 |   | 11.5 |   |

 

Thefollowing table sets forth the relationship between various components ofdomestic and foreign sales, stated as a percent of total sales, for fiscalyears 2004, 2003 and 2002.
| ** **          | ** ** | **Percent of Sales** | ** ** |
|---------------------|------------|--------------------------------|------------|
| ** **          | ** ** | **2004**                       | ** ** | **2003** | ** ** | **2002** | ** ** |
| Domestic Sales      |       | 47.9                           |       | 60.3 |   | 67.0 |   |
| Foreign Sales:      |       |                           |       |   |   |   |   |
| Western Europe      |       | 25.4                           |       | 12.5 |   | 8.6 |   |
| Japan               |       | 11.1                           |       | 10.5 |   | 8.8 |   |
| Canada              |       | 3.5                            |       | 4.4 |   | 2.2 |   |
| Other               |       | 12.1                           |       | 12.3 |   | 13.4 |   |
| Total foreign sales |       | 52.1                           |       | 39.7 |   | 33.0 |   |
| Total Sales         |       | 100.0                          |       | 100.0 |   | 100.0 |   |

 

***Net Sales***

Sales were $25,108,369 in2004, compared to $19,632,366 in 2003 and $19,931,065 in 2002. The $5,476,003,or 28%, increase in sales in 2004 versus 2003 was primarily the result of theLippke acquisition, which provided $3,824,782 in net incremental sales. On aproduct basis, the increase was primarily due to increased foreign sales volumeof our permeation products, foreign sales volume of our leak detectionproducts, domestic sales volume of our gas analyzer products, foreign salesvolume of our headspace analyzer products, and foreign sales volume of ourweighing and pharmaceutical products, offset somewhat by decreases in thedomestic sales volume of our permeation products and domestic sales volume ofour weighing and pharmaceutical products. These sales volume increases weregenerally the result of increased demand. The impact of price increases was notsignificant in 2004. The slight decrease in sales from 2002 to 2003 wasprimarily the result of decreases in the domestic sales volume of our samplepreparation products, domestic and foreign sales volume of our gas analyzerproducts, domestic sales volume of our gas chromatography analyzer products andforeign sales volume of our leak detection products, offset by increases in theforeign sales volume of our permeation products and domestic and foreign salesvolume of our weighing products. The impact of price increases in 2003 was notsignificant.

Domestic sales were$12,017,992, or 48% of total sales in 2004, a dollar increase of 1% compared to$11,847,295, or 60% of total sales in 2003. Domestic sales were $13,354,090, or67% of total sales in 2002. 

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Foreignsales were $13,090,377, or 52% of total sales in 2004, a dollar increase of 68%compared to $7,785,071, or 40% of total sales in 2003. Foreign sales were $6,576,975,or 33% of total sales in 2002.

*Permeation Products*

Sales of our permeationproducts were $14,290,547, $11,705,963 and $10,577,757, approximately 57%, 60%and 53% of our consolidated sales in 2004, 2003 and 2002, respectively. The$2,584,584, or 22%, increase in permeation sales in 2004 compared to 2003, wasprimarily due to increases in foreign sales, particularly in Western Europe andJapan, offset somewhat by decreases in sales to domestic customers. Theincrease in sales to Western Europe includes $1,962,576 in net incrementalsales from Lippke. Total sales of our permeation products increased $1,128,206,or 11%, in 2003 versus 2002, due primarily to increases in foreign sales,particularly in Western Europe, Japan, and Canada. We believe that the domesticmarket for our permeation products, which is where we initially introduced ourpermeation products when the Company was founded, is maturing, but that themarket for our permeation products outside of the United States, where thedemand for sophisticated packaging and other products is continuing to develop,and the use of our equipment is still in many areas somewhat limited, is likelyto continue to grow.

*Weighing and Pharmaceutical Products*

Sales of our weighing andpharmaceutical products were $1,314,851, $1,197,846 and $634,258, approximately5%, 6% and 3% of our consolidated sales in 2004, 2003 and 2002, respectively. Weighingand pharmaceutical product sales increased $117,005, or 10%, in 2004 versus2003, primarily due to increases in foreign sales, offset somewhat by decreasesin sales to domestic customers. The increase in foreign sales includes $225,089in net incremental sales from Lippke to customers in Western Europe, consistingprimarily of commissions earned relating to tablet inspection systems. Weighingproduct sales increased $563,588, or 89%, in 2003 over 2002 due to an increasein the sales of our AB weighing systems, and to a lesser extent increases inthe sales of our VERICAP systems. The increase in sales of the AB systems wasdue in part to AB systems being sold in markets outside of the traditionalpharmaceutical market. Because of significant competition in the market for weighingproducts, we do not expect the sales of our weighing and pharmaceutical productsto increase in 2005.

*Sample Preparation Products*

Sales of our sample preparationproducts through our Lab Connections, Inc. (LCI) subsidiary were $605,872,$395,865 and $1,251,980, approximately 2%, 2% and 6% of our consolidated salesin 2004, 2003 and 2002, respectively. Sales of sample preparation productsincreased $210,007, or 53%, in 2004 as compared to 2003, due primarily to anincrease in foreign sales, particularly foreign sales of a unit designed forhigh temperature polymer analysis. Sales of sample preparation productsdecreased $856,115, or 68%, in 2003 from 2002, primarily due to significantsales of a new unit to one particular customer for use in the drug discoveryand life sciences markets in 2002 not being repeated in 2003. As a result ofthe lower sales of our sample preparation products in 2003 and early 2004, weconsolidated our LCI operations into our Minneapolis, Minnesota, and Austin,Texas, locations, and closed our Boston LCI location effective February 1,2004. The total costs incurred in the first quarter of 2004 associated withthis relocation were $78,900. As anticipated, the closing of our Bostonlocation resulted in a reduction in certain operating costs, however, despitethese measures, LCI experienced an operating loss for 2004 as a whole. Therefore,as more fully outlined in Note 5 to the Consolidated Financial Statements, acharge for $240,000 related to the impairment of LCI’s intangible technologyrights was incurred in fourth quarter 2004.

*Gas Analyzer Products*

Sales of our gas analysisand monitoring instrumentation products through our Baseline-MOCON, Inc.subsidiary were $3,560,351, $2,980,271 and $3,881,781, approximately 14%, 15%and 19% 

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of ourconsolidated sales in 2004, 2003 and 2002, respectively. The $580,080, or 19%,increase in sales in 2004 as compared to 2003 was primarily due to increasedsales in 2004 of the piD-TECHTM photoionization detector on an OEM basis to othermanufacturers. We believe the $901,510, or 23%, decrease in sales in 2003 ascompared to 2002 was due mostly to slowness in some of the industries that Baselineserves. In order to reduce operating costs and increase operating efficiencies,we moved the majority of Baseline’s production to our facility in Minneapolis,Minnesota in 2004.

*Gas Chromatography Analyzer Products*

Sales of our gaschromatography analyzer products through our Microanalytics InstrumentationCorp. (Microanalytics) subsidiary were $717,486, $580,875 and $836,961,approximately 3%, 3% and 4% of our consolidated sales, in 2004, 2003, and 2002,respectively. The $136,611, or 24%, increase in sales in 2004 as compared to2003 was due primarily to increased revenues associated with sales ofMicroanalytics’ testing services. The $256,086, or 31%, decrease in sales in2003 as compared to 2002 was primarily due to decreased revenues associatedwith sales of Microanalytics’ testing services.

*Leak Detection Products*

Sales of our leakdetection products were $1,283,865, $459,814 and $583,507, approximately 5%, 2%and 3% of our consolidated sales, in 2004, 2003, and 2002, respectively. Leakdetection sales increased $824,051, or 179%, in 2004 compared to 2003,primarily due to increases in foreign sales, which includes $701,221 in net incrementalsales from Lippke. The $123,693, or 21%, decrease in 2003 versus 2002 wasprimarily due to foreign sales of our non-destructive leak detector unit in2002 not being repeated in 2003.

*Headspace Analyzer Products*

Sales of our headspaceanalyzer products were $1,924,884, $1,460,417 and $1,360,917, approximately 8%,7% and 7% of our consolidated sales, in 2004, 2003, and 2002, respectively. The$464,467, or 32%, increase in headspace analyzer sales in 2004 compared to 2003was primarily due to $391,645 net incremental sales from Lippke, and to alesser degree to continued increases in sales of hand-held headspace analyzerproducts, which were originally introduced in 2003. Sales of these handheldproducts were also a factor in the $99,500, or 7%, increase in sales in 2003over 2002.

*Consulting and Analytical Services*

Consulting and analytical services(CAS) sales were $722,947, $833,950 and $803,904, approximately 3%, 4% and 4%of our consolidated sales in 2004, 2003, and 2002, respectively. The majorityof CAS sales are to domestic customers.

***Gross Profit***

Our gross profits were$13,238,797, $10,755,810 and $10,632,032, approximately 53%, 55% and 53% of ourconsolidated sales, in 2004, 2003 and 2002, respectively. The 2004 gross profitmargin as a percentage of total sales was somewhat lower than 2003 dueprimarily to costs associated with the transfer of the majority of our Baselinesubsidiary’s production to our facility in Minneapolis, Minnesota in 2004, toexpenses associated with the amortization of intangible assets acquired as partof the Lippke purchase, to the scrapping of inventory that had become obsolete,and to production expenses associated with our Vaculok product line, which didnot have significant revenues in 2004, offset somewhat by the product mix in2004 including more permeation product sales, which on average carry a highergross margin. The 2003 gross profit margin was slightly higher than the prioryear due to the product mix in 2003 including more permeation and weighingproduct sales, which on average carry a higher gross margin.

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***Selling, Generaland Administrative Expenses***

Selling, general andadministrative (SG&A) expenses in 2004 were $8,384,361, or 33% of sales,compared to $6,268,837, or 32% of sales in 2003, and $6,107,066, or 31% ofsales in 2002. The increase in the dollar amount of SG&A expenses from 2003to 2004 was primarily due to the addition of Lippke’s SG&A expenses in2004, to the expense associated with the LCI intangible technology rightsone-time impairment charge in 2004, and to a lesser extent to recently enactedchanges in securities laws and regulations more fully described below under “Forward-LookingStatements,” which increased certain general and administrative costs in 2004. Theincrease in SG&A expenses from 2002 to 2003 was primarily due to anincrease in tradeshow expense in an effort to increase future sales, offsetsomewhat by a decrease in commission expense associated with domestic sales.

***Research andDevelopment Expenses***

Research and development(R&D) expenses were $1,376,196, or approximately 5% of sales in 2004,compared to $1,313,379, or approximately 7% of sales in 2003, and $1,286,220,or approximately 6% of sales in 2002. Continued R&D expenditures arenecessary as we develop new products to expand in our niche markets. For theforeseeable future, we expect to allocate on an annual basis approximately 6%to 8% of sales to research and development.

***Other Income***

Other income consistsprimarily of interest and investment income, and currency exchange rate gainsand losses. Other income decreased to $123,448 in 2004 from $126,711 in 2003and $195,468 in 2002. The slight decrease in 2004 compared to 2003 wasprimarily due to lower average investment balances and lower average investmentyields. The decrease in 2003 from 2002 was primarily due to lower averageinvestment yields, offset by higher average investment balances, during 2003versus 2002.

***Income Tax Expense***

Our provision for incometaxes was 32.6% of income before income taxes in 2004 and 33.0% and 33.1% in2003 and 2002, respectively. Based on current operating conditions and incometax laws, we expect our core tax rate for 2005 to be in the range of 33% to 35%.In addition, we believe that we are close to finalizing an Internal RevenueService examination, which is expected to have a favorable effect on our overall2005 effective income tax rate.

The American Jobs CreationAct of 2004 (the Act) was passed in October 2004 and included numerous lawchanges that will also affect our tax computations. The provisions of the Actinclude a new deduction for U.S. manufacturers, the repeal of theextraterritorial income exclusion and a provision regarding the repatriation offoreign earnings. We are studying the new law to determine what impact the Actwill have on our effective tax rate.

***Net Income***

Net income was $2,428,688in 2004 compared to $2,211,305 in 2003, and $2,297,214 in 2002. Diluted netincome per share was $0.44 per share in 2004 compared to $0.40 per share in2003, and $0.41 per share in 2002.

**Liquidity andCapital Resources**

We have historicallyfinanced our operations and capital equipment requirements through cash flowsgenerated from operations. Total cash, cash equivalents and marketablesecurities increased $897,069 during 2004 to $7,688,719 as of December 31,2004, compared to $6,791,650 at December 31, 2003. Our working capital asof December 31, 2004 increased $763,321 to $11,665,447, compared to$10,902,126 at December 31, 2003. We believe that a combination of ourexisting cash, cash equivalents and marketable securities, plus an expectedcontinuation of cash flow from operations, will continue to be adequate to fund

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operations,capital expenditures, dividend payments, stock repurchases, and requiredearnout payments to the former parent company of Lippke, for at least the nexttwelve months. However, one of our strategic objectives is, as market andbusiness conditions warrant, to consider acquisitions of businesses, productsor technologies. We may need to fund such activities, should they arise, withdebt and/or equity financing.

***Cash Flow***

*Cash Flows from Operating Activities*

Our primary source offunds is cash provided by operations. Cash flow from operations totaled $5,136,229,$3,398,377 and $3,424,407 in 2004, 2003 and 2002, respectively. In 2004, cashprovided by operating activities increased by $1,737,852, or 51%, compared to2003. This change was due primarily to higher net income, addback ofdepreciation and amortization and the changes in inventories and accountspayable, offset somewhat by the change in deferred income taxes and theincrease in trade accounts receivable.

The increase in trade accountsreceivable in 2004 versus 2003 is primarily due an increase in sales in thefourth quarter of 2004 versus the fourth quarter of 2003 (mostly due to theaddition of Lippke), offset somewhat by improved accounts receivable collection.Inventory remained generally consistent in 2004 compared to 2003, despiteincreased sales in 2004, due in part to the consolidation of Baseline and LCIinventory in our Minneapolis, Minnesota location. The increase in accountspayable and accrued compensation and vacation is primarily due to the additionof Lippke.

*Cash Flows from Investing Activities*

Cash used in investingactivities totaled $1,498,890 in 2004 as compared to $3,225,818 in 2003. Cashflow provided by investing activities totaled $5,818 in 2002. Net proceeds (purchases)from maturities of marketable securities were $345,995, ($2,312,942) and$819,567 in 2004, 2003 and 2002, respectively. Purchases of property, plant andequipment totaled $527,260 in 2004, primarily for additions of manufacturingand laboratory equipment, as compared to $335,794 and $378,392 in 2003 and2002, respectively. We expect purchases of property, plant and equipment in2005 to be similar to the levels in 2004.

Effective January 1,2004, we acquired all of the shares of Lippke for a base purchase price of$802,688. In addition, we are obligated to make three future “earnout” paymentsto Lippke’s former parent company based on the net profits of Lippke in each ofthe years 2004, 2005, and 2006, with a minimum payment amount of 100,000 eurosper year. It is anticipated that the “earnout” payments will be made to theformer parent company of Lippke at or near the end of the first quarter of eachof the years 2005, 2006, and 2007. The earnout payment due for 2004 based onLippke’s 2004 net profits is $549,257.

*Cash Flows from Financing Activities*

Cash used in financingactivities consists primarily of the purchase and retirement of common stock,payment of dividends to our shareholders, and a dividend payment to Lippke’sformer parent company.

During 2004, we made finaldividend payments of $449,087 to Lippke’s former parent company and dividendpayments of $1,393,506 to our shareholders, for total dividend payments of$1,842,593. During 2003, we made dividend payments of $1,377,725 to ourshareholders.

Our Board of Directors hasauthorized, depending upon market conditions and other factors, the repurchaseof up to a total of $3,200,000 of our common stock at prices not exceedingprevailing market prices at the time of purchase. We made repurchases of ourcommon stock totaling $900,360 and $627,606 in 2004 and 2003, respectively,related to this authorization and $196,000 in 2002 related to a previousauthorization. As of December 31, 2004, $1,672,034 was remaining in thecurrent authorization.

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We had no materialcommitments for capital expenditures as of December 31, 2004. We do notbelieve that any major property, plant and equipment expenditures are requiredto accommodate our current level of operations.

***ContractualObligations***

Thefollowing table summarizes our future contractual cash obligations as of December 31,2004 (in thousands):
| ** **                          | ** ** | **Payments Due By Period** | ** ** |
|-------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**    | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less than 1 year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **After 5 years** | ** ** |
| Operating leases                    |       | $                                         | 1,656      |   |   | $ | 379 |   |   |   | $ | 870 |   |   |   | $ | 407 |   |   |   | $ | — |   |   |
| Total contractual cash  obligations |       | $                                         | 1,656      |   |   | $ | 379 |   |   |   | $ | 870 |   |   |   | $ | 407 |   |   |   | $ | — |   |   |
|                                     |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

In January 2004, weacquired all of the shares of Lippke for a base purchase price of $802,688. Inaddition, we are obligated to make three future “earnout” payments to Lippke’sformer parent company based on the net profits of Lippke in each of the years2004, 2005, and 2006, with a minimum payment amount of 100,000 euros per yearwhich is included in the financial statements. It is anticipated that the “earnout”payments will be made to the former parent company of Lippke at or near the endof the first quarter of each of the years 2005, 2006, and 2007. Based upon the netprofit calculation of Lippke as of December 31, 2004, we have recorded anobligation for the first payment due to Lippke’s former parent company in theamount of $549,257 as of December 31, 2004, and $247,708 for the minimumpayable for 2005 and 2006.

***Off-Balance Sheet Arrangements***

Exceptfor operating leases entered in the ordinary course of business, we do not haveany material off-balance sheet arrangements.

**New AccountingPronouncements**

In December 2004, theFASB issued FASB Staff Position No. 109-1 “Application of FASBStatement No. 109, *Accounting forIncome Taxes,* to the Tax Deduction on Qualified ProductionActivities Provided by the American Jobs Creation Act of 2004” (FSP 109-1).FSP 109-1 provides accounting guidance for companies that will beeligible for a tax deduction resulting from “qualified production activitiesincome” as defined in the American Jobs Creation Act of 2004 (the Act). FSP 109-1requires this deduction be treated as a special deduction in accordance withSFAS 109, which does not require a revaluation of our U.S. deferredtax assets. We will apply the guidance in FSP 109-1 upon recognition ofthis tax deduction beginning January 1, 2005. The application of FSP 109-1is not currently expected to have a material impact on our financialstatements.

In December 2004, the FASB issued FASB StaffPosition No. 109-2 "Accounting and Disclosure Guidance for theForeign Earnings Repatriation Provision within the American Jobs Creation Actof 2004" (FSP 109-2). FSP 109-2 provides accounting guidance for theone-time tax deduction of 85% of certain non-U.S. earnings that arerepatriated in excess of a base amount as defined in the Act. SFAS 109requires a company to reflect in the period of enactment the effect of a newtax law. Due to the lack of clarification of certain provisions within the Act,FSP 109-2 allows companies time beyond the financial reporting period ofenactment to evaluate the effect of the Act.

We have started anevaluation of the effects of the repatriation provision. However, we do notexpect to be able to complete this evaluation until after Congress and theTreasury Department provide additional clarification on key elements of theprovision. We expect to complete our evaluation of the effects of therepatriation provision within a reasonable period of time following thepublication of all relevant guidance. The range of possible amounts, includingthe base, which we are considering for 

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repatriationunder this provision, is between zero and $400,000. The related incrementalprovision for income taxes would be zero due to foreign tax credits availableto offset any resulting taxes.

In November 2004, theFASB issued SFAS No. 151, “Inventory Costs,” an amendment of ARB No. 43,Chapter 4 (SFAS 151), to clarify that abnormal amounts of idle facilityexpense, freight, handling costs, and wasted material (spoilage) should berecognized as current period charges, and that fixed production overheadsshould be allocated to inventory based on normal capacity of productionfacilities. This statement is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. Accordingly, we will adoptSFAS 151 in the fiscal year beginning January 1, 2006. We arecurrently in the process of evaluating whether the adoption of SFAS 151will have a significant impact on our results of operations or financialposition.

In December 2004, theFASB issued Statement of Financial Accounting Standards No. 123 (revised2004) “Share-Based Payments” (FAS 123(R)), which is a revision of FASBStatement No. 123 “Accounting for Stock-Based Compensation” (Statement123). This statement supersedes APB Opinion No. 25, “Accounting for StockIssued to Employees” (Opinion 25) which allowed companies to use the intrinsicvalue method of valuing share-based payment transactions and amends FASStatement No. 95, “Statement of Cash Flows”. FAS 123(R) requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values. Pro formadisclosure is no longer an alternative. FAS 123(R) is effective at thebeginning of the first interim or annual period beginning after June 15,2005. We expect to adopt Statement 123 (R) on July 1, 2005. The adoptionof FAS 123(R)’s fair value method is expected to have an impact on our resultsof operations, though it will have no impact on our overall financial position.

FAS 123(R) permits publiccompanies to adopt its requirements using one of two methods. A “modifiedprospective” method in which compensation cost is recognized beginning with theeffective date (a) based on the requirements of FAS 123(R) for allshare-based payments granted after the effective date and (b) based on therequirements of Statement 123 for all awards granted to employees prior to theeffective date of FAS 123(R) that remain unvested on the effective date. A “modifiedretrospective” method which includes the requirements of the modifiedprospective method described above, but also permits entities to restate basedon the amounts previously recognized under Statement 123 for purposes of proforma disclosures either (a) all prior periods presented or (b) priorinterim periods of the year of adoption. We expect to adopt Statement 123 (R)effective July 1, 2005 using the modified prospective method.

The impact of adoption ofFAS 123(R) cannot be accurately predicted at this time since it will depend onlevels of share-based payments granted in the future. However, had we adopted FAS123(R) in prior periods, the impact of the standard would have approximated theimpact of FAS 123 as described in the disclosure of pro forma net income andearnings per share in Note 1 to our consolidated financial statements.Statement 123(R) also requires the benefits of tax deductions in excess ofrecognized compensation cost to be reported as a financing cash flow, ratherthan as an operating cash flow as required under current literature. Thisrequirement will reduce net operating cash flows and increase net financingcash flows in periods after adoption. While we cannot estimate what thoseamounts will be in the future (because they depend on, among other things, whenemployees exercise stock options), there were no amounts of operating cash flowsrecognized in prior periods for such excess tax deductions in 2002, 2003 and2004.

As permitted by Statement123, we currently account for share-based payments using the APB Opinion No. 25,“Accounting for Stock Issued to Employees” intrinsic value method of valuingshare-based payment transactions and, as such, generally recognize nocompensation cost for employee stock options.

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**Forward-LookingStatements**

This Annual Report on Form 10-Kcontains or incorporates by reference not only historical information, but alsoforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934. In addition, we or others on our behalf may make forward-lookingstatements from time to time in oral presentations, including telephoneconferences and/or web casts open to the public, in press releases or reports,on our Internet website or otherwise. Statements that are not historical areforward-looking and reflect expectations and assumptions. We try to identifyforward-looking statements in this report and elsewhere by using words such as “may,”“will,” “should,” “expects,” “anticipates,” “contemplates,” “estimates,” “believes,”“plans,” “projected,” “predicts,” “potential” or “continue” or the negative ofthese or similar terms. Forward-looking statements involve risks anduncertainties. These uncertainties include factors that affect all businessesas well as matters specific to MOCON. Below are some of the factors known to usthat could cause our actual results to differ materially from what we haveanticipated in our forward-looking statements.

We wish to caution readersnot to place undue reliance on any forward-looking statement that speaks onlyas of the date made and to recognize that forward-looking statements arepredictions of future results, which may not occur as anticipated. Actualresults could 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. The foregoing risks and uncertainties are notexclusive and further information concerning us and our business, includingfactors that potentially could materially affect our financial results orcondition, may emerge from time to time. We assume no obligation to updateforward-looking statements to reflect actual results or changes in factors orassumptions affecting such forward-looking statements. We advise you, however,to consult any further disclosures we make on related subjects in our quarterlyreports on Form 10-Q and current reports on Form 8-K wefile with or furnish to the Securities and Exchange Commission.

***If we experienceany increase in the cost of raw materials or supplies, we may experience adecrease in profit margins.***

In the past, the overallcost of the materials that we purchase has not risen much more than the rate ofinflation, although the price of some of the components that we purchase hasincreased in the past several years due in part to our purchasing fewer of suchcomponents. Certain other material and labor costs have increased, but webelieve that such increases are approximately consistent with overall inflationrates. We believe that the price of our products and the prices of ourcompetitors’ products is a significant factor affecting our customers’ buyingdecisions and consequently, we may not be able to pass along any cost increasesin raw materials and supplies in the form of price increases or sustain profitmargins that we have achieved in prior years.

***The markets inwhich we operate have experienced minimal growth in recent years, and ourability to increase our revenues will depend in part on our ability to developnew products, develop new applications for our existing products and to acquirecomplementary businesses and product lines.***

The analytical andmeasurement instrument markets in which we operate have not shown significantgrowth in recent years. Although we have identified a number of strategies thatwe believe will allow us to grow our business and increase our sales, includingdeveloping new products and technologies, developing new applications for ourtechnologies, acquiring complementary businesses and product lines, andstrengthening our sales force, we cannot assure you that we will be able tosuccessfully implement these strategies, or that these strategies will resultin the growth of our business or an increase in our sales.

***If we acquirebusinesses in the future, we could experience a decrease in our profit margins,a decrease in our net income, and other adverse consequences.***

One of our growthstrategies is to supplement our internal growth with the acquisition ofbusinesses and technologies that complement or augment our existing products. Someof the businesses that we 

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previouslyacquired have produced net operating losses or low levels of profitability. Businessesthat we may acquire in the future may be marginally profitable or unprofitable.We will likely have to successfully change the operations of any companies thatwe acquire in the future and improve the market penetration of such companiesin order to achieve the level of profitability that we desire. This couldresult in the diversion of management’s attention from other business concerns.In addition, acquisitions that we believe will be beneficial to our businessand financial results are difficult to identify and complete for a number ofreasons, including the competition among prospective buyers. We may not be ableto complete acquisitions in the future and any acquisitions that we do completemay have an adverse effect on our financial performance and liquidity. It maybe necessary for us to raise additional funds either through public or privatedebt or equity financing in order to finance any future acquisitions. Anyequity or debt financing, if available at all, may be on terms that are notfavorable to us and may dilute the percentage ownership of our existingshareholders.

***We face risks of technological changes that may render our productsobsolete.***

The markets for ourproducts and services are characterized by rapid and significant technologicalchange and evolving industry standards. As a result of such changes andevolving standards, our products may become noncompetitive or obsolete and wemay have to develop new products in order to maintain or increase our revenues.New product introductions that are responsive to these factors requiresignificant planning, design, development and testing at the technological,product, and manufacturing process levels, and we may not be able to timelydevelop new products. In addition, industry acceptance of new technologies thatwe may develop may be slow to develop due to, among other things, existingregulations or standards written specifically for older technologies andgeneral unfamiliarity of users with new technologies. As a result, any newproducts that we may develop may not generate any meaningful revenues orprofits for us for a number of years, if at all.

***Any reduction inthe level of capital expenditures by our customers could negatively impact oursales.***

Our customers includepharmaceutical, food, medical, and chemical companies, laboratories, governmentagencies, and public and private research institutions. The capital spending ofthese entities can have a significant effect on the demand for our products. Anydecrease in capital spending by any of these customer groups could have amaterial adverse effect on our business and results of operations.

***A significantportion of our sales are generated from foreign countries and selling inforeign countries entails a number of risks which could result in a decrease toour sales or an increase in our operating expenses.***

Salesoutside the United States accounted for approximately 52% of our sales in 2004and approximately 40% and 33% of our sales in 2003 and 2002, respectively. Weexpect that foreign sales will continue to account for a significant portion ofour revenues in the future. Sales to customers in foreign countries are subjectto a number of risks, including the following:

·       agreementsmay be difficult to enforce;

·       receivablesmay be difficult to collect;

·       certainregions are experiencing political unrest and conflict;

·       foreigncustomers may have longer payment cycles;

·       thecountries into which we sell may impose tariffs or adopt other restrictions onforeign trade;

·       currencyfluctuations could reduce reported profitability in future periods;

·       fluctuationsin exchange rates may affect product demand;

·       exportlicenses, if required, may be difficult to obtain; and

·       protectionof intellectual property in foreign countries may be more difficult to enforce.

If any of these risks wereto materialize, our sales into foreign countries could decline, or ouroperating costs could increase, which would adversely affect our financialresults.

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***Some of our competitors have greater resources than wedo, which may provide our competitors with an advantage in the development andmarketing of new products.***

We currently encounter, and expect to continue toencounter, competition in the sale of our products. We believe that theprincipal competitive factors affecting the market for our products includeproduct quality and performance, price, reliability and customer service. Ourcompetitors include large multinational corporations. Some of our competitorshave substantially greater financial, marketing, and other resources than we do.As a result, they may be able to adapt more quickly to new or emergingtechnologies and changes in customer requirements, or to devote greaterresources to the promotion and sale of their products than we can. In addition,competition could increase if new companies enter the market or if existingcompetitors expand their product lines or intensify efforts within existingproduct lines. Our current products, products under development and our abilityto discover new technologies may be insufficient to enable us to competeeffectively with our competitors.

***Our reliance upon patents,domestic trademark laws and contractual provisions to protect our proprietaryrights may not be sufficient to protect our intellectual property from otherswho may sell similar products.***

We hold patents relating to various aspects of ourproducts and believe that proprietary technical know-how is critical to many ofour products. Proprietary rights relating to our products are protected fromunauthorized use by third parties only to the extent that they are covered byvalid and enforceable patents or are maintained in confidence as trade secrets.We cannot be certain that we will be issued any patents from any pending orfuture patent applications owned by or licensed to us or that the claimsallowed under any issued patents will be sufficiently broad to protect ourtechnology. In the absence of patent protection, we may be vulnerable tocompetitors who attempt to copy our products or gain access to our tradesecrets and know-how. Our competitors may initiate litigation to challenge thevalidity of our patents, or they may use their resources to design comparableproducts that do not infringe our patents. We may incur substantial costs ifour competitors initiate litigation to challenge the validity of our patents orif we initiate any proceedings to protect our proprietary rights and if theoutcome of any such litigation is unfavorable to us, our business and resultsof operations could be materially adversely affected. There may also be pendingor issued patents held by parties not affiliated with us that relate to ourproducts or technologies and we may need to acquire licenses to any suchpatents to continue selling some or all of our products. If we had to obtainany such license in order to be able to continue to sell some or all of ourproducts, we may not be able to do so on terms that were favorable to us, if atall.

In addition, we rely on trade secrets and proprietaryknow-how that we seek to protect, in part, by confidentiality agreements withour collaborators, employees, and consultants. These agreements may be breachedand we may not have adequate remedies for any such breach. Even if these confidentialityagreements are not breached, our trade secrets may otherwise become known or beindependently developed by competitors.

***The market price of our commonstock has fluctuated significantly in the past and will likely continue to doso in the future and any broad market fluctuations may materially adverselyaffect the market price of our common stock.***

The market price of our common stock has been volatile in the past,ranging from a high sales price of $10.49 and a low sales price of $7.70 during2004, and several factors could cause the price to fluctuate substantially inthe future. These factors include:

·       announcementsof new products by us or our competitors;

·       quarterlyfluctuations in our financial results;

·       customercontract awards;

·       developmentsin regulation; and

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·       generaleconomic and political conditions in the various markets where our products aresold.

In addition, the stock prices of instrumentationcompanies have experienced significant price and volume fluctuations that oftenhave been unrelated to the operating performance of such companies. This marketvolatility may adversely affect the market price of our common stock.

***Recently enacted and future changes in securities lawsand regulations are likely to increase our costs.***

Changing laws, regulationsand standards relating to corporate governance and public disclosure, includingthe Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Marketrules, are creating challenges for publicly-held companies including us. We arecommitted to maintaining high standards of corporate governance and publicdisclosure. As a result, our efforts to comply with evolving laws, regulationsand standards have resulted in, and are likely to continue to result in,increased general and administrative expenses and a diversion of managementtime and attention from revenue-generating activities to compliance activities.In particular, our efforts to comply with Section 404 of theSarbanes-Oxley Act of 2002 and the related regulations regarding our assessmentof our internal control over financial reporting and our external auditors’audit of that assessment will require the commitment of significant financialand managerial resources in 2005, and is expected to require ongoing financialand managerial resources in 2006 and beyond.

**Item 7A.**                QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

**InterestRate Risk**

Substantially all of ourmarketable securities are at fixed interest rates. However, virtually all ofthe marketable securities mature in two years or less; therefore, we believethat the market risk arising from the holding of these financial instruments isminimal.

**Foreign Currency Exchange Risk**

Because our products aremanufactured or sourced primarily from the United States, a stronger U.S.dollar generally has a negative impact on our results from operations outsideof the United States while a weaker dollar generally has a positive effect. Wecurrently sell our products and services in United States dollars or the localcurrency of our foreign subsidiary (Euros). Accordingly, our foreign operationsexpose us to foreign currency exchange risk when the Euro currency results ofoperations are translated to United States dollars. While we historically havenot experienced any material foreign currency translation losses, we may engagein hedging activity in the future to minimize this risk. Our net investment inforeign subsidiary translated into U.S. dollars is not hedged. Any changes inforeign currency exchange rates would be reflected as a foreign currencytranslation adjustment, a component of accumulated other comprehensive incomein stockholders’ equity, and would not impact our net income.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

Our Consolidated FinancialStatements and Report of Independent Registered Public Accounting Firm areincluded on pages F-1 to F-21 of this Annual Report on Form 10-K andare incorporated herein by reference.

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**SELECTED QUARTERLYFINANCIAL DATA (UNAUDITED)(in thousands, except per share data)**
| ** **                   | ** ** | **Quarter** | ** ** |
|------------------------------|------------|-------------|------------|
| ** **                   | ** ** | **1st**     | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
| 2004                         |       |        |       |   |   |   |   |   |   |
| Sales                        |       | $           | 5,753      |   | $ | 6,123 |   | $ | 6,411 |   | $ | 6,821 |   |
| Gross profit                 |       | $           | 2,985      |   | $ | 3,338 |   | $ | 3,426 |   | $ | 3,490 |   |
| Net income                   |       | $           | 336        |   | $ | 630 |   | $ | 728 |   | $ | 735 |   |
| Net income per  common share |       |        |       |   |   |   |   |   |   |
| Basic                        |       | $           | 0.06       |   | $ | 0.12 |   | $ | 0.14 |   | $ | 0.14 |   |
| Diluted                      |       | $           | 0.06       |   | $ | 0.12 |   | $ | 0.13 |   | $ | 0.13 |   |
| 2003                         |       |        |       |   |   |   |   |   |   |
| Sales                        |       | $           | 5,029      |   | $ | 5,132 |   | $ | 4,778 |   | $ | 4,693 |   |
| Gross profit                 |       | $           | 2,758      |   | $ | 2,890 |   | $ | 2,609 |   | $ | 2,499 |   |
| Net income                   |       | $           | 607        |   | $ | 609 |   | $ | 534 |   | $ | 461 |   |
| Net income per  common share |       |        |       |   |   |   |   |   |   |
| Basic                        |       | $           | 0.11       |   | $ | 0.11 |   | $ | 0.10 |   | $ | 0.09 |   |
| Diluted                      |       | $           | 0.11       |   | $ | 0.11 |   | $ | 0.10 |   | $ | 0.08 |   |

 

**ITEM 9.**                CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLS AND PROCEDURES

**Evaluation of Disclosure Controls and Procedures**

We maintain disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)) that are designed to ensure that information required to bedisclosed by us in the reports we file or submit under the Securities ExchangeAct of 1934, as amended, is recorded, processed, summarized, and reported,within the time periods specified in the Securities and Exchange Commission’s rules andforms and that such information is accumulated and communicated to ourmanagement, including our principal executive and principal financial officers,or persons performing similar functions, as appropriate to allow timelydecisions regarding required disclosure. Our management evaluated, with theparticipation of our Chief Executive Officer and Chief Financial Officer, theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered in this Annual Report of Form 10-K.Based on that evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective asof the end of such period.

**Changes in Internal Control Over Financial Reporting**

There was no change in ourinternal control over financial reporting that occurred during our fourthquarter of the year ended December 31, 2004 that has materially affected,or is reasonably likely to materially affect our internal control overfinancial reporting.

**ITEM 9B.**       OTHER INFORMATION

None.

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**PARTIII**

**ITEM 10.**         DIRECTORS AND EXECUTIVEOFFICERS OF THE REGISTRANT

*A.* Directors of the Registrant.

Theinformation under the captions “Election of Directors—Information AboutNominees” and “Election of Directors—Other Information About Nominees” in our proxystatement to shareholders in connection with our 2005 annual meeting ofshareholders is incorporated herein by reference.

*B.* Executive Officers of theRegistrant.

Informationabout our executive officers is included in this Report under Item 4A,“Executive Officers of the Registrant.”

*C.* Compliance with Section 16(a)of the Exchange Act.

Theinformation under the caption “Section 16(a) Beneficial Ownership ReportingCompliance” in our proxy statement to shareholders in connection with our 2005annual meeting of shareholders is incorporated herein by reference.

*D.* Audit Committee FinancialExpert.

Theinformation under the caption “Election of Directors—Information about theBoard and its Committees” in our proxy statement to shareholders in connectionwith our 2005 annual meeting of shareholders is incorporated herein byreference.

*E.* Identification of the AuditCommittee.

Theinformation in the “Election of Directors—Information about the Board and itsCommittees” section of our proxy statement to shareholders in connection withour 2005 annual meeting of shareholders is incorporated herein by reference.

*F.* Code of Ethics.

Our Code of Ethics applies to all of our officers,directors and employees, including our principal executive officer andprincipal financial officer, and meets the requirements of the rules andregulations of the Securities and Exchange Commission. We will provide, free ofcharge, a copy of our Code of Ethics to any person who requests a copy. Torequest a copy of our Code of Ethics, write to us at:

MOCON,Inc.

7500Boone Avenue North

Minneapolis,Minnesota 55428

Attention: Chief Financial Officer

**ITEM 11.**         EXECUTIVE COMPENSATION

Theinformation under the captions “Election of Directors—Director Compensation”and “Executive Compensation and Other Benefits” in our proxy statement toshareholders in connection with our 2005 annual meeting of shareholders isincorporated herein by reference.

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**ITEM 12.**         SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Theinformation under the caption “Principal Shareholders and Beneficial Ownershipof Management” and “Executive Compensation and Other Benefits—Equity CompensationPlan Information” in our proxy statement in connection with our 2005 annualmeeting of shareholders is incorporated herein by reference.

**ITEM 13.**         CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS

The information under thecaption “Election of Directors—Other Information About Nominees” in our proxystatement in connection with our 2005 annual meeting of shareholders isincorporated herein by reference.

**Item 14.**         PRINCIPAL ACCOUNTANT FEES AND SERVICES

Theinformation under the caption “Independent Registered Public Accounting Firm”in our proxy statement in connection with our 2005 annual meeting ofshareholders is incorporated herein by reference.

**PART IV**

**ITEM 15.**         EXHIBITS AND FINANCIALSTATEMENT SCHEDULES

**(a)   1.           FinancialStatements**

Thefollowing Consolidated Financial Statements of MOCON and its subsidiaries areincluded herein:
|                                                                                                                  | ** ** | **Page** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered  Public Accounting Firm                                                         | F-1        |     |
| Consolidated Balance Sheets as of  December 31, 2004 and 2003                                               | F-2        |     |
| Consolidated Statements of  Income for the years ended December 31, 2004,  2003 and 2002                    | F-3        |     |
| Consolidated Statements of  Stockholders’ Equity for the years ended December 31, 2004, 2003 and  2002 | F-4        |     |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2004,  2003 and 2002                | F-5        |     |
| Notes to Consolidated Financial  Statements                                                                      | F-6        |     |

 

**2.     FinancialStatement Schedules**

The following financial statement schedules areincluded herein and should be read in conjunction with the consolidatedfinancial statements referred to above:

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**Report of Independent Registered Public AccountingFirm**

The Board of Directors and StockholdersMOCON, Inc.:

Under date of February 23, 2005, we reported onthe consolidated balance sheets of MOCON, Inc. and subsidiaries as of December 31,2004 and 2003, and the related consolidated statements of income, stockholders’equity and cash flows for each of the years in the three-year period ended December 31,2004, as contained in this annual report on Form 10-K for the year 2004. Inconnection with our audits of the aforementioned consolidated financialstatements, we also audited the related consolidated financial statementschedule. This financial statement schedule is the responsibility of theCompany’s management. Our responsibility is to express an opinion on thisfinancial statement schedule based on our audits.

In ouropinion, such financial statement schedule, when considered in relation to thebasic consolidated financial statements taken as a whole, presents fairly, inall material respects, the information set forth therein.
|                        | /s/ KPMG LLP |
|------------------------|--------------|
| Minneapolis, Minnesota |
| February 23, 2005 |

 

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**Financial Statement Schedule:**

**II—Valuationand Qualifying Accounts**

All other schedules areomitted as the required information is inapplicable or the information ispresented in the Consolidated Financial Statements or related notes.

**SCHEDULE IIMOCON, INC. AND SUBSIDIARIESValuation and Qualifying Accounts**
| **Description**                                    | ** ** | ** ** | ** ** | **Balance at  beginning of  year** | ** ** | **Charged to costs  and expenses** | ** ** | **Deductions** | ** ** | **Balance at  end of year** | ** ** |
|----------------------------------------------------|------------|------------|------------|----------------------------------------------|------------|---------------------------------------------------|------------|----------------|------------|--------------------------------------------|------------|
| Year ended  December 31, 2004                 |       |       |       |                                         |       |                                              |       |           |       |                                       |       |   |   |   |   |   |   |
| Allowance for doubtful accounts and sales returns  |       |       | $          | 243,677                                      |       |                                              |       | 173,147        | (1)        |                                       |       | 194,784 |   |   |   | 222,040 |   |   |
| Year ended  December 31, 2003                 |       |       |       |                                         |       |                                              |       |           |       |                                       |       |   |   |   |   |   |   |
| Allowance for doubtful accounts and sales returns  |       |       | $          | 202,074                                      |       |                                              |       | 43,500         |       |                                       |       | 1,897 |   |   |   | 243,677 |   |   |
| Year ended  December 31, 2002                 |       |       |       |                                         |       |                                              |       |           |       |                                       |       |   |   |   |   |   |   |
| Allowance for  doubtful accounts and sales returns |       |       | $          | 199,739                                      |       |                                              |       | 187,225        |       |                                       |       | 184,890 |   |   |   | 202,074 |   |   |

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(1)          Includes adjustment foracquisition.

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**3.      Exhibits**

The exhibits to this Annual Report on Form 10-Kare listed in the Exhibit Index.

A copy of any of the exhibits listed or referred toabove will be furnished at a reasonable cost to any person who was ashareholder of MOCON as of March 21, 2005, upon receipt from any suchperson of a written request for any such exhibit. Such request should be sentto MOCON, Inc., 7500 Boone Avenue North, Minneapolis, Minnesota 55428;Attn: Shareholder Information.

The following is alist of each management contract or compensatory plan or arrangement requiredto be filed as an exhibit to this Annual Report on Form 10-Kpursuant to Item 14(c):

A.             1990 Non-EmployeeDirector Stock Option Plan (incorporated by reference to the Company’sRegistration Statement on Form S-8 (File No. 33-42255)).

B.              1992 Stock OptionPlan (incorporated by reference to the Company’s Registration Statement on Form S-8(File No. 33-49752)).

C.              1998 Stock OptionPlan (incorporated by reference to the Company’s Registration Statement on Form S-8(File No. 33-58789)).

D.             1999 CompensationCommittee resolutions setting forth the Incentive Compensation Plan(incorporated by reference to the Company’s Quarterly Report on Form 10-Qfor the quarter ended June 30, 1999 (File No. 0-9273)).

E.              Paired ProfitSharing Plan effective July 1, 1996 (incorporated by reference to theCompany’s Annual Report on Form 10-K for the fiscal year ended December 31,1996 (File No. 0-9273)).

F.               Form ofExecutive Severance Agreement (incorporated by reference to our Annual Reporton Form 10-K for the fiscal year ended December 31, 2000 (File No. 0-9273)).

G.            2003 CompensationCommittee resolution setting forth the Incentive Compensation Plan for 2003 andsubsequent years (incorporated by reference to our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2002 (File No. 0-9273)).

H.            MOCON, Inc.Savings and Retirement Plan (incorporated by reference to our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2002 (File No. 0-9273)).

I.                  1998 StockOption Plan, as amended on May 21, 2002 (incorporated by reference to theCompany’s Registration Statement on Form S-8 (File No. 33-58789)).

J.                 Amendment to theMOCON, Inc. Savings and Retirement Plan (filed herewith).

K.             Form ofIncentive Stock Option Agreement betweenMOCON, Inc. and its Executive Officers (incorporated by referenceto our Current Report on Form 8-K filed on December 29, 2004(File No. 0-9273)).

L.               Form ofNon-Statutory Stock Option Agreement betweenMOCON, Inc. and its Non-Employee Directors and Executive Officers(incorporated by reference to our Current Report on Form 8-K filedon December 29, 2004 (File No. 0-9273)).

M.           Description ofNon-Employee Director Retirement Plan (filed herewith).

N.             Description ofNon-Employee Director Compensation Arrangements (filed herewith).

O.            Descriptionof Executive Officer Compensation Arrangements (filed herewith).

30

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**(b)   Exhibits**

The exhibits to thisAnnual Report on Form 10-K are listed in the Exhibit Index.

**(c)   FinancialStatement Schedules**

See Item 15 (a)(2) above for the financial statementschedules filed herewith.

31

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
| Date: March 31, 2005 | MOCON, INC. |
|---------------------------|-------------|
|                      | By:         | /s/ ROBERT L. DEMOREST |
|                      |        | Robert L. Demorest,*President, Chief Executive Officer and Chairman  of the Board (principal executive officer)* |
|                      | By:         | /s/ DANE D. ANDERSON |
|                      |        | Dane D. Anderson,*Vice President, Chief Financial Officer, Treasurer  and Secretary (principal financial and accounting officer)* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities indicated and on March 31, 2005.
| ** ** | Signature and Title                                                  | ** ** | ** ** |
|------------|----------------------------------------------------------------------|------------|------------|
|       | /s/ ROBERT L. DEMOREST                                               |
|       | Robert L. Demorest, President, Chief Executive  Officer and Director |
|       | /s/ DEAN B. CHENOWETH                                                |
|       | Dean B. Chenoweth, Director                                          |
|       | /s/ J. LEONARD FRAME                                                 |
|       | J. Leonard Frame, Director                                           |
|       | /s/ DANIEL W. MAYER                                                  |
|       | Daniel W. Mayer, Executive Vice President and  Director              |
|       | /s/ RONALD A. MEYER                                                  |
|       | Ronald A. Meyer, Vice President and Director                         |
|       | /s/ RICHARD A. PROULX                                                |
|       | Richard A. Proulx, Director                                          |
|       | /s/ TOM C. THOMAS                                                    |
|       | Tom C. Thomas, Director                                              |

 

32

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**MOCON, INC. AND SUBSIDIARIESConsolidated Financial StatementsDecember 31, 2004, 2003, and 2002**

**Table of Contents**
|                                                          | ** ** | ** ** | **Page** | ** ** |
|----------------------------------------------------------|------------|------------|----------|------------|
| Report of Independent Registered  Public Accounting Firm |       | F-1        |
| Consolidated Balance Sheets                              |       | F-2        |
| Consolidated Statements of  Income                       |       | F-3        |
| Consolidated Statements of  Stockholders’ Equity    |       | F-4        |
| Consolidated Statements of  Cash Flows                   |       | F-5        |
| Notes to Consolidated Financial  Statements              |       | F-6        |

 

33

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**Report of Independent Registered Public AccountingFirm**

The Board of Directors and StockholdersMOCON, Inc.:

We have audited the accompanying consolidated balancesheets of MOCON, Inc. and subsidiaries as of December 31, 2004 and2003, and the related consolidated statements of income, stockholders’ equityand cash flows for each of the years in the three-year period ended December 31,2004. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of MOCON, Inc.and subsidiaries as of December 31, 2004 and 2003, and the results oftheir operations and their cash flows for each of the years in the three-yearperiod ended December 31, 2004, in conformity with U.S. generally acceptedaccounting principles.
|                        | /s/ KPMG LLP |
|------------------------|--------------|
| Minneapolis, Minnesota |         |
| February 23, 2005 |         |

 

F-1

----

**MOCON, INC. AND SUBSIDIARIESConsolidated Balance SheetsDecember 31, 2004 and 2003**
| ** **                                                                                                                                      | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Assets**                                                                                                                                      |       |       |       |       |       |
| Current assets:                                                                                                                                 |       |       |       |       |       |
| Cash and cash  equivalents                                                                                                                      |       | $          | 2,648,879  |       | 1,399,837  |   |
| Marketable securities,  current                                                                                                                 |       | 4,808,840  |       | 4,541,725  |       |
| Trade accounts  receivable, less allowance for doubtful accounts of $222,040 in 2004 and  $243,677 in 2003                                      |       | 4,297,884  |       | 3,542,927  |       |
| Other receivables                                                                                                                               |       | 44,941     |       | 50,662     |       |
| Inventories                                                                                                                                     |       | 3,838,344  |       | 3,762,481  |       |
| Prepaid expenses                                                                                                                                |       | 362,607    |       | 347,245    |       |
| Deferred income taxes                                                                                                                           |       | 435,864    |       | 322,435    |       |
| Total current assets                                                                                                                            |       | 16,437,359 |       | 13,967,312 |       |
| Marketable securities,  noncurrent                                                                                                              |       | 231,000    |       | 850,088    |       |
| Property, plant, and  equipment, net                                                                                                            |       | 2,116,823  |       | 2,099,462  |       |
| Other assets:                                                                                                                                   |       |       |       |       |       |
| Software development  costs, net of accumulated amortization of $766,490 in 2004 and $435,430 in  2003                                          |       | 239,931    |       | 570,991    |       |
| Goodwill                                                                                                                                        |       | 2,315,774  |       | 1,346,795  |       |
| Technology rights and  other intangibles, net                                                                                                   |       | 1,030,847  |       | 991,928    |       |
| Other                                                                                                                                           |       | 143,803    |       | 151,689    |       |
| Total other assets                                                                                                                              |       | 3,730,355  |       | 3,061,403  |       |
|                                                                                                                                            |       | $          | 22,515,537 |       | 19,978,265 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                  |       |       |       |       |       |
| Current liabilities:                                                                                                                            |       |       |       |       |       |
| Accounts payable                                                                                                                                |       | $          | 2,107,268  |       | 1,013,615  |   |
| Accrued compensation and  vacation                                                                                                              |       | 1,024,958  |       | 775,669    |       |
| Other accrued expenses                                                                                                                          |       | 457,640    |       | 349,421    |       |
| Accrued product  warranties                                                                                                                     |       | 352,634    |       | 279,639    |       |
| Accrued income taxes                                                                                                                            |       | 455,718    |       | 295,951    |       |
| Dividends payable                                                                                                                               |       | 373,694    |       | 350,891    |       |
| Total current  liabilities                                                                                                                      |       | 4,771,912  |       | 3,065,186  |       |
| Obligations to former  employees                                                                                                                |       | 112,720    |       | —     |       |
| Minimum earnout payable                                                                                                                         |       | 247,708    |       | —     |       |
| Deferred income taxes                                                                                                                           |       | 182,651    |       | 198,381    |       |
| Total non-current  liabilities                                                                                                                  |       | 543,079    |       | 198,381    |       |
|                                                                                                                                            |       | 5,314,991  |       | 3,263,567  |       |
| Stockholders’ equity:                                                                                                                      |       |       |       |       |       |
| Capital  stock—undesignated—authorized 3,000,000 shares                                                                               |       | —     |       | —     |       |
| Common stock—$0.10 par  value. Authorized 22,000,000 shares; issued and outstanding 5,338,489 shares  in 2004 and 5,406,189 shares in 2003 |       | 533,849    |       | 540,619    |       |
| Capital in excess of par  value                                                                                                                 |       | 199,705    |       | 118,333    |       |
| Retained earnings                                                                                                                               |       | 16,377,709 |       | 16,052,528 |       |
| Accumulated other  comprehensive income                                                                                                         |       | 89,283     |       | 3,218      |       |
| Total stockholders’  equity                                                                                                                |       | 17,200,546 |       | 16,714,698 |       |
| Commitments and contingencies (note 7)                                                                                                          |       |       |       |       |       |
|                                                                                                                                            |       | $          | 22,515,537 |       | 19,978,265 |   |

 

See accompanying notes to consolidated financial statements.

F-2

----

**MOCON, INC. AND SUBSIDIARIESConsolidated Statements ofIncomeYears ended December 31, 2004, 2003, and 2002**
| ** **                                    | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Sales:                                        |       |       |       |       |       |       |       |
| Products                                      |       | $          | 23,167,964 |       | 17,751,263 |       | 17,848,806 |   |
| Consulting services                           |       | 1,940,405  |       | 1,881,103  |       | 2,082,259  |       |
| Total sales                                   |       | 25,108,369 |       | 19,632,366 |       | 19,931,065 |       |
| Cost of sales:                                |       |       |       |       |       |       |       |
| Products                                      |       | 10,870,199 |       | 7,959,228  |       | 8,225,876  |       |
| Consulting services                           |       | 999,373    |       | 917,328    |       | 1,073,157  |       |
| Total cost of sales                           |       | 11,869,572 |       | 8,876,556  |       | 9,299,033  |       |
| Gross profit                                  |       | 13,238,797 |       | 10,755,810 |       | 10,632,032 |       |
| Selling, general, and administrative expenses |       | 8,384,361  |       | 6,268,837  |       | 6,107,066  |       |
| Research and  development expenses            |       | 1,376,196  |       | 1,313,379  |       | 1,286,220  |       |
| Operating income                              |       | 3,478,240  |       | 3,173,594  |       | 3,238,746  |       |
| Other income                                  |       | 123,448    |       | 126,711    |       | 195,468    |       |
| Income before income taxes                    |       | 3,601,688  |       | 3,300,305  |       | 3,434,214  |       |
| Income taxes                                  |       | 1,173,000  |       | 1,089,000  |       | 1,137,000  |       |
| Net income                                    |       | $          | 2,428,688  |       | 2,211,305  |       | 2,297,214  |   |
| Net income per  common share:                 |       |       |       |       |       |       |       |
| Basic                                         |       | $          | 0.45       |       | 0.41       |       | 0.42       |   |
| Diluted                                       |       | 0.44       |       | 0.40       |       | 0.41       |       |
| Weighted average  shares outstanding:         |       |       |       |       |       |       |       |
| Basic                                         |       | 5,351,106  |       | 5,410,010  |       | 5,487,915  |       |
| Diluted                                       |       | 5,471,420  |       | 5,503,911  |       | 5,606,332  |       |

 

See accompanying notes to consolidated financial statements.

F-3

----

**MOCON, INC. AND SUBSIDIARIESConsolidated Statements ofStockholders’ EquityYears ended December 31, 2004, 2003, and 2002**
| ** **                                                        | ** ** | ** **            | ** ** | ** **          | ** ** | ** **         | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------|------------|---------------------|------------|--------------------|------------|--------------|------------|-------------------|------------|------------|------------|
| ** **                                                        | ** ** | **Common stock** | ** ** | **Capital in** | ** ** | ** **         | ** ** | **other**    | ** ** | ** **        | ** ** |
| ** **                                                        | ** ** | **Number**            | ** ** | ** **          | ** ** | **excess of** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                        | ** ** | **of shares**    | ** ** | **Amount**          | ** ** | **par value** | ** ** | **earnings** | ** ** | **income**        | ** ** | **Total**  | ** ** |
| Balance,  December 31, 2001                                  |       | 5,476,453             |       | $547,645            |       | 105,057            |       | 14,806,169   |       |              | 9,101      |       |       | 15,467,972 |   |
| Stock options exercised                                           |       | 21,736                |       | 2,174               |       | 133,710            |       | —       |       |              | —     |       |       | 135,884 |   |
| Purchase and retirement of common stock                           |       | (28,000               | )          | (2,800              | )          | (193,200           | )          | —       |       |              | —     |       |       | (196,000 | ) |
| Dividends declared ($.24 per share)                               |       | —                |       | —              |       | —             |       | (1,317,782   | )          |              | —     |       |       | (1,317,782 | ) |
| Net income                                                        |       | —                |       | —              |       | —             |       | 2,297,214    |       |              | —     |       |       | 2,297,214 |   |
| Adjustment for unrealized (loss) on marketable  equity securities |       | —                |       | —              |       | —             |       | —       |       |              | (7,466     | )          |       | (7,466 | ) |
| Comprehensive income                                              |       |                  |       |                |       |               |       |         |       |              |       |       |       | 2,289,748 |   |
| Balance,  December 31, 2002                                  |       | 5,470,189             |       | 547,019             |       | 45,567             |       | 15,785,601   |       |              | 1,635      |       |       | 16,379,822 |   |
| Stock options exercised                                           |       | 28,501                |       | 2,850               |       | 167,375            |       | —       |       |              | —     |       |       | 170,225 |   |
| Purchase and retirement of common stock                           |       | (92,501               | )          | (9,250              | )          | (94,609            | )          | (540,342     | )          |              | —     |       |       | (644,201 | ) |
| Dividends declared ($.26 per share)                               |       | —                |       | —              |       | —             |       | (1,404,036   | )          |              | —     |       |       | (1,404,036 | ) |
| Net income                                                        |       | —                |       | —              |       | —             |       | 2,211,305    |       |              | —     |       |       | 2,211,305 |   |
| Adjustment for unrealized gain on marketable equity  securities   |       | —                |       | —              |       | —             |       | —       |       |              | 1,583      |       |       | 1,583 |   |
| Comprehensive income                                              |       |                  |       |                |       |               |       |         |       |              |       |       |       | 2,212,888 |   |
| Balance,  December 31, 2003                                  |       | 5,406,189             |       | 540,619             |       | 118,333            |       | 16,052,528   |       |              | 3,218      |       |       | 16,714,698 |   |
| Stock options exercised                                           |       | 46,300                |       | 4,630               |       | 283,134            |       | —       |       |              | —     |       |       | 287,764 |   |
| Purchase and retirement of common stock                           |       | (114,000              | )          | (11,400             | )          | (201,762           | )          | (687,198     | )          |              | —     |       |       | (900,360 | ) |
| Dividends declared ($.265 per share)                              |       | —                |       | —              |       | —             |       | (1,416,309   | )          |              | —     |       |       | (1,416,309 | ) |
| Net income                                                        |       | —                |       | —              |       | —             |       | 2,428,688    |       |              | —     |       |       | 2,428,688 |   |
| Cumulative translation adjustment                                 |       | —                |       | —              |       | —             |       | —       |       |              | 92,043     |       |       | 92,043 |   |
| Adjustment for unrealized (loss) on marketable  equity securities |       | —                |       | —              |       | —             |       | —       |       |              | (5,978     | )          |       | (5,978 | ) |
| Comprehensive income                                              |       |                  |       |                |       |               |       |         |       |              |       |       |       | 2,514,753 |   |
| Balance, December 31, 2004                                   |       | 5,338,489             |       | $                   | 533,849    |               | 199,705    |         | 16,377,709 |              |       | 89,283     |       |   | 17,200,546 |   |
|                                                                   |            |                       |            |                     |            |                    |            |              |            |                   |            |            |            |  |  |  |

 

See accompanying notes to consolidated financial statements.

F-4

----

**MOCON, INC. AND SUBSIDIARIESConsolidated Statements ofCash FlowsYears ended December 31, 2004, 2003, and 2002**
| ** **                                                                         | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Cash flows from operating  activities:                                             |       |       |       |       |       |       |       |
| Net income                                                                         |       | $          | 2,428,688  |       | 2,211,305  |       | 2,297,214  |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |       |       |       |       |       |       |
| Loss on disposition of long-term assets                                            |       | 7,375      |       | 35,494     |       | 2,824      |       |
| Depreciation and amortization                                                      |       | 1,450,627  |       | 987,712    |       | 875,940    |       |
| Impairment of technology rights and other intangibles                              |       | 240,000    |       | —     |       | —     |       |
| Deferred income taxes                                                              |       | (502,202   | )          | (183,998   | )          | 170,000    |       |
| Changes  in operating assets and liabilities, net of effect of acquisitions:       |       |       |       |       |       |       |       |
| Trade accounts receivable                                                          |       | (152,696   | )          | 422,517    |       | 305,986    |       |
| Other receivables                                                                  |       | 40,711     |       | (12,826    | )          | (7,309     | )          |
| Inventories                                                                        |       | 469,621    |       | 35,311     |       | (92,746    | )          |
| Prepaid expenses                                                                   |       | (641       | )          | (24,195    | )          | (72,731    | )          |
| Accounts payable                                                                   |       | 615,418    |       | (157,960   | )          | (129,522   | )          |
| Accrued compensation and vacation                                                  |       | 63,627     |       | 145,348    |       | (143,585   | )          |
| Other accrued expenses                                                             |       | 313,326    |       | (4,871     | )          | 32,641     |       |
| Accrued product warranties                                                         |       | 19,280     |       | 12,706     |       | 15,615     |       |
| Accrued income taxes                                                               |       | 143,095    |       | (68,166    | )          | 170,080    |       |
| Net cash provided by operating activities                                          |       | 5,136,229  |       | 3,398,377  |       | 3,424,407  |       |
| Cash flows from  investing activities:                                             |       |       |       |       |       |       |       |
| Purchases of marketable securities                                                 |       | (4,519,996 | )          | (5,303,838 | )          | (4,172,557 | )          |
| Proceeds from sales or maturities of marketable  securities                        |       | 4,865,991  |       | 2,990,896  |       | 4,992,124  |       |
| Cash paid in acquisitions, net of cash acquired                                    |       | (1,265,648 | )          | (253,514   | )          | —     |       |
| Purchases of property, plant and equipment                                         |       | (527,260   | )          | (335,794   | )          | (378,392   | )          |
| Purchases and development of software                                              |       | —     |       | (205,127   | )          | (374,220   | )          |
| Purchases of patents and trademarks                                                |       | (45,320    | )          | (111,950   | )          | (54,658    | )          |
| Other                                                                              |       | (6,657     | )          | (6,491     | )          | (6,479     | )          |
| Net cash (used in) provided by investing activities                                |       | (1,498,890 | )          | (3,225,818 | )          | 5,818      |       |
| Cash flows from  financing activities:                                             |       |       |       |       |       |       |       |
| Proceeds from the exercise of stock options                                        |       | 287,764    |       | 149,999    |       | 135,884    |       |
| Purchase and retirement of common stock                                            |       | (900,360   | )          | (627,606   | )          | (196,000   | )          |
| Dividends paid to former parent company of Paul  Lippke Handels                    |       | (449,087   | )          | —     |       | —     |       |
| Dividends paid to MOCON shareholders                                               |       | (1,393,506 | )          | (1,377,725 | )          | (1,318,095 | )          |
| Net cash used in financing activities                                              |       | (2,455,189 | )          | (1,855,332 | )          | (1,378,211 | )          |
| Effect of exchange rate changes on cash                                            |       | 66,892     |       | —     |       | —     |       |
| Net increase (decrease) in cash and cash equivalents                               |       | 1,249,042  |       | (1,682,773 | )          | 2,052,014  |       |
| Cash and cash equivalents:                                                         |       |       |       |       |       |       |       |
| Beginning of year                                                                  |       | 1,399,837  |       | 3,082,610  |       | 1,030,596  |       |
| End of year                                                                        |       | $          | 2,648,879  |       | 1,399,837  |       | 3,082,610  |   |
| Supplemental disclosures of cash flow information:                                 |       |       |       |       |       |       |       |
| Cash paid during the year for income taxes                                         |       | $          | 1,010,222  |       | 1,341,163  |       | 797,180    |   |
| Supplemental schedule of noncash investing and  financing activities:              |       |       |       |       |       |       |       |
| Dividends accrued                                                                  |       | $373,694   |       | 350,891    |       | 328,211    |       |
| Unrealized holding (loss) gain on available-for-sale  securities                   |       | (5,978     | )          | 1,583      |       | (7,466     | )          |
| Noncash purchase and retirement of common stock                                    |       | —     |       | 16,595     |       | —     |       |
| Noncash exercise of stock options                                                  |       | —     |       | 20,226     |       | —     |       |

 

See accompanying notes to consolidated financial statements.

F-5

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2004, 2003 and 2002**

**(1)**   Summaryof Significant Accounting Policies

MOCON, Inc.(the Company) operated in a single industry segment: the development, manufacturing,and marketing of measurement, analytical, monitoring, sample preparation, andconsulting products used to detect, measure, and analyze gases and chemicalcompounds for customers in the barrier packaging, food, pharmaceutical, andother industries throughout the world. The following is a summary of thesignificant accounting policies used in the preparation of the Company’sconsolidated financial statements.

***(a)   Principles of Consolidation***

The consolidated financialstatements include the accounts of the Company and its wholly ownedsubsidiaries. All material intercompany balances and transactions have beeneliminated in consolidation.

***(b)   Foreign Currency Translation***

The financial statementsfor operations outside the United States are maintained in their localcurrency. All assets and liabilities of our foreign subsidiary are translatedto United States dollars at period-end exchange rates, while revenue and expenseaccounts are translated at the average exchange rates during the periodtransactions occurred. Translation adjustments arising from the use ofdiffering exchange rates are included in accumulated other comprehensive incomeor loss in stockholders’ equity. Gains and losses on foreign currencytransactions are included in other income or loss.

***(c)   Statements of Cash Flows***

The Company considers all highly liquid investmentspurchased with an original maturity of three months or less to be cashequivalents.

Cash equivalents consistof short-term investments which are readily convertible to cash.

***(d)   Marketable Securities***

Marketable securities at December 31, 2004consist of United States government obligations, municipal bonds, andcertificates of deposit. The Company classifies its debt and marketable equitysecurities as available-for-sale.

Available-for-sale securities are recorded at fairvalue. Unrealized holding gains and losses on available-for-sale securities areexcluded from income and are reported as a separate component of stockholders’equity until realized.

A decline in the market value of anyavailable-for-sale security below cost that is deemed other than temporary ischarged to income resulting in the establishment of a new cost basis for thesecurity.

Premiums and discounts areamortized or accreted over the life of the related available-for-sale securityas an adjustment to yield. Dividend and interest income are recognized whenearned. Realized gains and losses for securities classified as available-for-saleare included in income and are derived using the specific identification methodfor determining the cost of securities sold.

F-6

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

***(e)   Inventories***

Inventories are stated atthe lower of cost or market. Cost is determined by the first-in, first-out(FIFO) method, and market represents the lower of replacement cost or estimatednet realizable value.

***(f)   Property, Plant, and Equipment***

Property, plant, andequipment are carried at cost. Depreciation and amortization are typicallycomputed using the straight-line method. When assets are retired or otherwisedisposed of, the cost and related accumulated depreciation are removed from theaccounts, and any resulting gain or loss is recognized in income for theperiod. The cost of maintenance and repairs is charged to income as incurredand significant renewals and betterments are capitalized.

***(g)   Goodwill, Other Intangible Assets, andSoftware Development Costs***

Goodwill represents the excess of the purchase priceover the fair value of assets acquired. The Company adopted the provisions ofFASB Statement No. 142, *Goodwill and OtherIntangible Assets*, as of January 1, 2002. Pursuant to Statement 142,goodwill and intangible assets acquired in a purchase business combination anddetermined to have an indefinite useful life are not amortized, but insteadtested for impairment at least annually in accordance with the provisions ofStatement 142. Statement 142 also requires that intangible assets withestimable useful lives be amortized over their respective estimated usefullives to their estimated residual values, and reviewed for impairment inaccordance with FASB Statement No. 144, *Accounting for Impairmentor Disposal of Long-Lived Assets.*

Intangible assets consist of technology rights,patents, trademarks, and other intangibles. Technology rights, patents,trademarks, and other intangibles are carried at cost less accumulatedamortization. Costs incurred in connection with applications for new patentsare deferred until a final determination, with respect to the application, ismade by appropriate regulatory agencies. Costs of patents abandoned are chargedto income in the period of abandonment. Technology rights costs are amortizedon a straight-line basis over 7 to 10 years. Patent costs are amortized overthe lesser of 17 years or their estimated useful lives using thestraight-line method. Trademarks are amortized over five years.

Software development costsare carried at cost less accumulated amortization. Software development costsare amortized on a straight-line basis over 3 years.

***(h)   Income Taxes***

The Company uses theasset-and-liability method for computing its deferred taxes. Under the asset-and-liabilitymethod, deferred taxes are based on the difference between the financialstatement and tax basis of assets and liabilities and the enacted tax ratesthat will be in effect when these differences reverse. Deferred tax expenserepresents the change in deferred tax assets and liabilities during the year.

F-7

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

***(i)   Use of Estimates***

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

***(j)   Impairment of Long-Lived Assets andLong-Lived Assets to be Disposed Of***

The Company reviews itslong-lived assets and certain identifiable intangibles for impairment annuallyor whenever events or changes in circumstances indicate that the carryingamount of an asset may not be recoverable. Recoverability of assets to be heldand used is measured by a comparison of the carrying amount of an asset tofuture undiscounted net cash flows expected to be generated by the asset. Ifsuch assets are considered to be impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the assets exceeds thefair value of the assets. Assets to be disposed of are reported at the lower ofthe carrying amount or fair value less costs to sell.

***(k)   Fair Value of Financial Instruments***

The Company’s financialinstruments are recorded in its consolidated balance sheet. The carrying amountfor cash and cash equivalents, accounts receivable, accounts payable, andaccrued liabilities approximates fair value due to the immediate or short-termmaturity of these financial instruments. The fair values of investments inmarketable securities are based on quoted market prices and are summarized inNote 2.

***(l)   Revenue Recognition***

Revenue is recognized whenpersuasive evidence of an arrangement exists, when title and risk of ownershippasses, the sales price is fixed or determinable, and collectibility isprobable. Generally, these criteria are met upon shipment of product or uponcompletion of services. The Company provides for estimated warranty costs inthe period revenue is recognized. The Company generally does not allow a rightof return. Shipping and handling charges billed are recognized in revenues andthe related costs are classified in cost of sales.

***(m)   Advertising Costs***

The Company incursadvertising costs associated with trade shows, print advertising, andbrochures. Such costs are charged to expense as incurred. Advertising expensewas $432,000, $420,000, and $325,000 in 2004, 2003, and 2002, respectively.

***(n)   Net Income Per Common Share***

Basic net income percommon share is computed by dividing net income by the weighted average ofcommon shares outstanding during the year. Diluted net income per share iscomputed by dividing net income by the weighted average of common and dilutivepotential common shares outstanding during the year.

F-8

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

***(o)   Stock-Based Employee Compensation***

The Company uses theintrinsic-value method for employee stock-based compensation pursuant toAccounting Principles Board Opinion No. 25 (Opinion 25), *Accounting for Stock Issued to Employees*. Under theguidelines of Opinion 25, compensation cost for stock-based employeecompensation plans is recognized based on the difference, if any, between thequoted market price of the stock on the date of grant and the amount anemployee must pay to acquire the stock. The Company has adopted thedisclosure-only provisions for employee stock-based compensation and the fair-valuemethod for non-employee stock-based compensation of Statement of FinancialAccounting Standards No. 123 (SFAS 123), *Accountingfor Stock-based Compensation*. Accordingly, no compensation cost hasbeen recognized with respect to the Company’s stock option plans. Hadcompensation cost for these plans been determined based on the fair valuemethodology prescribed by SFAS 123, the Company’s net income and netincome per common share would have been reduced to the pro forma amountsindicated below:
| ** **                                                                                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income—as  reported                                                                                                                       |       | $        | 2,428,688  |     | 2,211,305  |     | 2,297,214  |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (196,203 | )          | (253,317 | )          | (253,251 | )          |
| Net income—pro  forma                                                                                                                         |       | $        | 2,232,485  |     | 1,957,988  |     | 2,043,963  |   |
| Net income per common share—as reported:                                                                                                      |       |     |       |     |       |     |       |
| Basic                                                                                                                                              |       | $        | 0.45       |     | 0.41       |     | 0.42       |   |
| Diluted                                                                                                                                            |       | 0.44     |       | 0.40     |       | 0.41     |       |
| Net income per  common share—pro forma:                                                                                                       |       |     |       |     |       |     |       |
| Basic                                                                                                                                              |       | 0.42     |       | 0.36     |       | 0.37     |       |
| Diluted                                                                                                                                            |       | 0.41     |       | 0.36     |       | 0.36     |       |

 

The pro forma amounts maynot be representative of the effects on reported net income for future years.The fair value of each option grant is estimated on the date of grant using thebinomial option-pricing model with the following weighted average assumptionsused for grants in 2004, 2003, and 2002:
| ** **                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend yield             |       | 3.1      | %          | 3.3      | %          | 3.0      | %          |
| Expected  volatility       |       | 32       | %          | 37       | %          | 38       | %          |
| Risk-free  interest rate   |       | 3.4      | %          | 3.0      | %          | 4.0      | %          |
| Expected lives (in  years) |       | 7.8      |       | 7.9      |       | 7.9      |       |

 

In December 2004, the FASB issued Statement ofFinancial Accounting Standards No. 123 (revised 2004) “Share-Based Payments”(FAS 123(R)), which is a revision of FASB Statement No. 123 “Accounting forStock-Based Compensation” (Statement 123). This statement supersedes APBOpinion No. 25, “Accounting for Stock Issued to Employees” (Opinion 25) whichallowed companies to use the intrinsic value method of valuing share-basedpayment transactions and amends FAS 

F-9

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

Statement No. 95,“Statement of Cash Flows”. FAS 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be recognized in theincome statement based on their fair values. Pro forma disclosure is no longeran alternative. FAS 123(R) is effective at the beginning of the first interimor annual period beginning after June 15, 2005. The Company expects to adoptStatement 123(R) on July 1, 2005. The adoption of FAS 123(R)’s fair valuemethod is expected to have an impact on the Company’s results of operations,though it will have no impact on the Company’s overall financial position.

FAS 123(R) permits public companies to adopt itsrequirements using one of two methods. A “modified prospective” method in whichcompensation cost is recognized beginning with the effective date (a) based onthe requirements of FAS 123(R) for all share-based payments granted after theeffective date and (b) based on the requirements of Statement 123 for allawards granted to employees prior to the effective date of FAS 123(R) thatremain unvested on the effective date. A “modified retrospective” method whichincludes the requirements of the modified prospective method described above,but also permits entities to restate based on the amounts previously recognizedunder Statement 123 for purposes of pro forma disclosures either (a) all priorperiods presented or (b) prior interim periods of the year of adoption. Weexpect to adopt Statement 123 (R) effective July 1, 2005 using the modifiedprospective method.

The impact of adoption of FAS 123(R) cannot beaccurately predicted at this time since it will depend on levels of share-basedpayments granted in the future. However, had the Company adopted FAS 123(R) inprior periods, the impact of the standard would have approximated the impact ofFAS 123 as described in the disclosure of pro forma net income and net incomeper share above. Statement 123(R) also requires the benefits of tax deductionsin excess of recognized compensation cost to be reported as a financing cashflow, rather than as an operating cash flow as required under currentliterature. This requirement will reduce net operating cash flows and increasenet financing cash flows in periods after adoption. While the Company cannotestimate what those amounts will be in the future (because they depend on,among other things, when employees exercise stock options), there were noamounts of operating cash flows recognized in prior periods for such excess taxdeductions in 2002, 2003 and 2004.

As permitted by Statement123, we currently account for share-based payments using the APB Opinion No.25, “Accounting for Stock Issued to Employees” intrinsic value method ofvaluing share-based payment transactions and, as such, generally recognize nocompensation cost for employee stock options.

***(p)***   Reclassifications

Certain 2003 and 2002amounts have been reclassified to conform to the 2004 presentation.

F-10

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

**(2)   Marketable Securities**

Theamortized cost, gross unrealized holding gains, gross unrealized holdinglosses, and fair value for available-for-sale securities by major security typeat December 31, 2004 and 2003 were as follows:
| ** **              | ** ** | **2004**      | ** ** |
|-------------------------|------------|---------------|------------|
| ** **              | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **    | ** ** | **unrealized** | ** ** | **unrealized** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **Amortized** | ** ** | **holding** | ** ** | **holding** | ** ** | **Fair** | ** ** |
| ** **              | ** ** | **cost**      | ** ** | **gains** | ** ** | **losses** | ** ** | **value** | ** ** |
| Available for sale:     |       |          |       |   |   |   |   |   |   |   |   |   |   |
| Municipal bonds         |       | $             | 1,996,790  |   |   | 972 |   |   |   | (3,864 | ) |   | 1,993,898 |   |
| Certificates of deposit |       | 3,045,810     |       |   | 175 |   |   |   | (43 | ) |   | 3,045,942 |   |
|                    |       | $5,042,600    |       |   | 1,147 |   |   |   | (3,907 | ) |   | 5,039,840 |   |
|                         |            |               |            |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **              | ** ** | **2003**      | ** ** |
|-------------------------|------------|---------------|------------|
| ** **              | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **    | ** ** | **unrealized** | ** ** | **unrealized** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **Amortized** | ** ** | **holding** | ** ** | **holding** | ** ** | **Fair** | ** ** |
| ** **              | ** ** | **cost**      | ** ** | **gains** | ** ** | **losses** | ** ** | **value** | ** ** |
| Available for sale:     |       |          |       |   |   |   |   |   |   |   |   |   |   |
| Municipal bonds         |       | $             | 2,110,501  |   |   | 3,146 |   |   |   | (70 | ) |   | 2,113,577 |   |
| Certificates of deposit |       | 3,128,094     |       |   | 142 |   |   |   | — |   |   | 3,128,236 |   |
| Federal bonds           |       | 150,000       |       |   | — |   |   |   | — |   |   | 150,000 |   |
|                    |       | $5,388,595    |       |   | 3,288 |   |   |   | (70 | ) |   | 5,391,813 |   |
|                         |            |               |            |  |  |  |  |  |  |  |  |  |  |  |

 

F-11

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

There were no gross realized gains or losses for theyears ended December 31, 2004, 2003, and 2002.

Maturitiesof investment securities classified as available-for-sale were as follows at December 31,2004 and 2003:
| ** **          | ** ** | **2004**      | ** ** | **2003**  | ** ** |
|---------------------|------------|---------------|------------|-----------|------------|
| ** **          | ** ** | **Amortized** | ** ** | **Fair**  | ** ** | **   Amortized   ** | ** ** | **Fair** | ** ** |
| ** **          | ** ** | **cost**      | ** ** | **value** | ** ** | **cost** | ** ** | **value** | ** ** |
| Available-for-sale: |       |          |       |      |       |   |   |   |   |   |   |
| Due within one year |       | $             | 4,811,600  |      | 4,808,840  |   |   | 4,540,453 |   |   | 4,541,725 |   |
| Due after one year  |       | 231,000       |       | 231,000   |       |   | 848,142 |   |   | 850,088 |   |
|                |       | $5,042,600    |       | 5,039,840 |       |   | 5,388,595 |   |   | 5,391,813 |   |
|                     |            |               |            |           |            |  |  |  |  |  |  |  |

 

**(3)   Inventories**

Themajor components of inventories at December 31, 2004 and 2003 were asfollows:
| ** **        | ** ** | **2004**   | ** ** | **2003**  | ** ** |
|-------------------|------------|------------|------------|-----------|------------|
| Finished products |       | $          | 717,507    |      | 369,883    |   |
| Work-in-process   |       | 1,398,551  |       | 1,497,909 |       |
| Raw materials     |       | 1,722,286  |       | 1,894,689 |       |
|              |       | $3,838,344 |       | 3,762,481 |       |
|                   |            |            |            |           |            |  |

 

**(4)**   Property,Plant, and Equipment

Property,plant, and equipment at December 31, 2004 and 2003 consisted of thefollowing:
| ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | **Estimated**         | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2004**   | ** ** | **2003**   | ** ** | **useful lives** | ** ** |
| Land                                 |       | $          | 200,000    |       | 200,000    |                  | —     |   |
| Buildings                            |       | 445,833    |       | 445,833    |       | 27 years              |       |
| Machinery and  equipment             |       | 4,394,325  |       | 3,730,590  |       | 3 to 10 years         |       |
| Office equipment                     |       | 797,715    |       | 675,075    |       | 2 to 15 years         |       |
| Leasehold  improvements              |       | 735,955    |       | 676,826    |       | 1 to 5 years          |       |
| Vehicles                             |       | 163,032    |       | 147,153    |       | 3 to 5 years          |       |
| Total property, plant, and equipment |       | 6,736,860  |       | 5,875,477  |       |                  |       |
| Less accumulated depreciation        |       | (4,620,037 | )          | (3,776,015 | )          |                  |       |
| Net property,  plant, and equipment  |       | $          | 2,116,823  |       | 2,099,462  |                  |       |   |

 

Depreciation andamortization of property, plant, and equipment charged to income was $611,034,$534,512, and $539,387 for the years ended December 31, 2004, 2003, and2002, respectively.

F-12

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

**(5)**   Goodwill and Other Intangible Assets

We adopted SFAS 142effective January 1, 2002. As required by SFAS 142, we performed atransitional goodwill impairment assessment to determine whether there was anindication that goodwill was impaired at the date of adoption. In connectiontherewith, the Company determined that it consisted of a single reporting unitand determined the Company’s fair value and compared it to the Company’scarrying amount. As of January 1, 2002, the Company’s fair value exceededits carrying amount. Therefore, there was no indication that goodwill wasimpaired, and the Company did not record any transitional impairment loss. Inaddition to its transitional goodwill impairment assessment, the Company alsocompleted its annual impairment tests during the fourth quarters of 2004 and2003 and determined there was no impairment.

*Goodwill*

As of December 31,2004, goodwill amounted to $2,315,774, which includes the current year additionof $968,979 related to the acquisition of Paul Lippke Handels-GmbH. There wasno change in the carrying amount of goodwill for the years ended December 31,2003 and December 31, 2002.

*Impairment of OtherIntangible Assets*

During 2004, the Companycompleted a review and analysis of its Lab Connections, Inc. (LCI)subsidiary and the carrying amount of the remaining net balance of intangibletechnology rights. LCI experienced operating losses during 2003 and 2004, andforecasted operating results indicated that the subsidiary’s undiscounted cashflows were not adequate to allow LCI sufficient cash flow to fully realize theremaining intangible technology rights value. In accordance with Statement ofFinancial Accounting Standards No. 144 *“Accountingfor the Impairment or Disposal of Long-Lived Assets,”* the Companyrecorded an impairment charge of $240,000. The charge, recorded in selling,general, and administrative expenses, is equal to the difference between the carryingamount of the intangible technology rights and its fair value as estimated,based on discounted projected cash flows.

*Other IntangibleAssets*

Otherintangible assets (all of which are being amortized except projects in process)are as follows:
| ** **                 | ** ** | **As of December 31, 2004** | ** ** |
|----------------------------|------------|-------------------------------------------------|------------|
| ** **                 | ** ** | **Carrying  Amount**                            | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Patents                    |       | $                                               | 548,748    |   | $ | (221,288 | ) | $ | 327,460 |   |
| Trademarks and  tradenames |       | 392,015                                         |       | (90,413 | ) | 301,602 |   |
| Technology rights          |       | 184,008                                         |       | (120,481 | ) | 63,527 |   |
| Other intangibles          |       | 715,043                                         |       | (376,785 | ) | 338,258 |   |
|                       |       | $1,839,814                                      |       | $ | (808,967 | ) | $ | 1,030,847 |   |
|                            |            |                                                 |            |  |  |  |  |  |  |  |

 

F-13

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

 
| ** **                 | ** ** | **As of December 31, 2003** | ** ** |
|----------------------------|------------|-------------------------------------------------|------------|
| ** **                 | ** ** | **Carrying  Amount**                            | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Patents                    |       | $                                               | 524,401    |   | $ | (184,103 | ) | $ | 340,298 |   |
| Trademarks and  tradenames |       | 49,489                                          |       | (18,378 | ) | 31,111 |   |
| Technology rights          |       | 784,008                                         |       | (394,194 | ) | 389,814 |   |
| Other intangibles          |       | 268,000                                         |       | (133,219 | ) | 134,781 |   |
| Projects in  process       |       | 95,924                                          |       | — |   | 95,924 |   |
|                       |       | $1,721,822                                      |       | $ | (729,894 | ) | $ | 991,928 |   |
|                            |            |                                                 |            |  |  |  |  |  |  |  |

 

Amortization expense was $439,073, $180,403 and$178,597 in 2004, 2003 and 2002, respectively.

Estimated amortizationexpense for the fiscal years 2005 to 2009 and thereafter is $293,693, $280,334,$163,558, $106,847, and $44,146, respectively.

**(6)**   Warranty

The Company provides a warranty for most of itsproducts. Warranties are for periods ranging from ninety days to one year, andcover parts and labor for non-maintenance repairs, at our location. Operatorabuse, improper use, alteration, damage resulting from accident, or failure tofollow manufacturer’s directions, are excluded from warranty coverage.

Warranty expense is accrued at the time of sale basedon historical claims experience. Special warranty reserves are also accrued forspecial rework campaigns for known major product modifications. The Companyalso offers service contracts for select products when the factory warrantyperiod expires.

Warrantyprovisions and claims for the years ended December 31, 2004, 2003, and2002 were as follows:
| ** **                                                           | ** ** | **Balance at** | ** ** | ** **       | ** ** | ** **     | ** ** | **Balance**     | ** ** |
|----------------------------------------------------------------------|------------|---------------------|------------|------------------|------------|----------------|------------|-----------------|------------|
| ** **                                                           | ** ** | **beginning**       | ** ** | **Warranty**     | ** ** | **Warranty**   | ** ** | **at end** | ** ** |
| **Years:**                                                           | ** ** | ** **          | ** ** | **of year** | ** ** | **Provisions** | ** ** | **Claims**      | ** ** | **of year** | ** ** |
| Year ended  December 31, 2004  Allowance for product warranties |       | $                   | 279,639    |             | 480,132    | (1)            | 407,137    |            | 352,634    |   |
| Year ended December 31, 2003  Allowance for product warranties  |       | $                   | 266,933    |             | 336,346    |           | 323,640    |            | 279,639    |   |
| Year ended  December 31, 2002  Allowance for product warranties |       | $                   | 251,318    |             | 401,087    |           | 385,472    |            | 266,933    |   |
|                                                                      |            |                     |            |                  |            |                |            |                 |            |  |  |  |

----

(1)          Includesadjustment for acquisition.

**(7)**   Commitmentsand Contingencies

***(a)***   Leases

The Company leases its facilities and certainequipment pursuant to operating leases. The facility leases expire at varioustimes through June 2010 and require the Company to pay operating costs,including real estate taxes.

F-14

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

Rental expense, including charges for operating costs,was $487,776, $443,929, and $440,580 in 2004, 2003 and 2002, respectively.

The following is aschedule of future minimum lease payments, excluding charges for operatingcosts, for operating leases as of December 31, 2004:

| Year ending  December 31: |   |    |      |
|--------------------------------|--------|---------|-----------|
| 2005                           |   | $       | 379,390   |   |
| 2006                           |   | 320,956 |      |
| 2007                           |   | 283,044 |      |
| 2008                           |   | 265,545 |      |
| 2009                           |   | 271,446 |      |
| Later years                    |   | 135,723 |      |
|                           |   | $       | 1,656,104 |   |

 

***(b)***   ExecutiveSeverance Agreements

The Company has enteredinto severance agreements with four executives that require payment of twotimes their annual salary if they are terminated within 24 months after achange of control occurs or upon the occurrence of other events as described inthe agreements.

**(8)   Income Taxes**

Incomebefore income taxes was as follows:
| ** **                  | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002**  | ** ** |
|-----------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Income before  income taxes |       |      |       |      |       |      |       |
| Domestic                    |       | $         | 2,893,000  |      | 3,300,000  |      | 3,434,000  |   |
| Foreign                     |       | 708,000   |       | —    |       | —    |       |
| Total                       |       | 3,601,000 |       | 3,300,000 |       | 3,434,000 |       |
|                             |            |           |            |           |            |           |            |  |

 

Theprovision for income taxes consists of the following:
| ** **                       | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002** | ** ** |
|----------------------------------|------------|-----------|------------|-----------|------------|----------|------------|
| Current tax  expense:            |       |      |       |      |       |     |       |
| Federal                          |       | $         | 1,031,000  |      | 1,140,000  |     | 803,000    |   |
| State                            |       | 131,000   |       | 133,000   |       | 164,000  |       |
| Foreign                          |       | 513,000   |       | —    |       | —   |       |
| Total current expense            |       | 1,675,000 |       | 1,273,000 |       | 967,000  |       |
| Deferred tax (benefit)  expense: |       |      |       |      |       |     |       |
| Federal                          |       | (256,000  | )          | (177,000  | )          | 152,000  |       |
| State                            |       | (21,000   | )          | (7,000    | )          | 18,000   |       |
| Foreign                          |       | (225,000  | )          | —    |       | —   |       |
| Total deferred (benefit) expense |       | (502,000  | )          | (184,000  | )          | 170,000  |       |
| Provision for  income taxes      |       | $         | 1,173,000  |      | 1,089,000  |     | 1,137,000  |   |

 

F-15

----

**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

Theeffective income tax rate varies from the federal statutory tax rate for thefollowing reasons:
| ** **                                       | ** ** | **Percentage of pretax income**       | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                       | ** ** | **for years ended December 31,** | ** ** |
| ** **                                       | ** ** | **2004**                                             | ** ** | **2003** | ** ** | **2002** | ** ** |
| Tax at statutory  federal income tax rate        |       | 34.0                                                 | %          | 34.0 | % | 34.0 | % |
| Increases  (reductions) in taxes resulting from: |       |                                                 |       |   |   |   |   |
| State income taxes, net of federal benefit       |       | 2.0                                                  |       | 2.5 |   | 3.5 |   |
| Export incentives                                |       | (3.5                                                 | )          | (3.8 | ) | (3.3 | ) |
| Effect of foreign operations                     |       | 1.3                                                  |       | — |   | — |   |
| Tax-exempt investment earnings                   |       | (0.3                                                 | )          | (0.2 | ) | (0.2 | ) |
| Other                                            |       | (0.9                                                 | )          | 0.5 |   | (0.9 | ) |
| Effective income  tax rate                       |       | 32.6                                                 | %          | 33.0 | % | 33.1 | % |

 

Thetax effect of significant temporary differences representing deferred taxassets and liabilities at December 31, 2004 and 2003 were as follows:
| ** **                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  assets:           |       |     |       |     |       |
| Allowance for doubtful accounts |       | $        | 78,000     |     | 89,000     |   |
| Inventory costs                 |       | 63,000   |       | 39,000   |       |
| Inventory reserves              |       | 174,000  |       | 220,000  |       |
| Warranty reserves               |       | 111,000  |       | 102,000  |       |
| Other accruals                  |       | 97,000   |       | 100,000  |       |
| Total deferred tax assets       |       | 523,000  |       | 550,000  |       |
| Deferred tax liabilities:       |       |     |       |     |       |
| Technology rights               |       | —   |       | (110,000 | )          |
| Fixed assets and intangibles    |       | (270,000 | )          | (316,000 | )          |
| Total deferred tax liabilities  |       | (270,000 | )          | (426,000 | )          |
| Net deferred tax  asset         |       | $        | 253,000    |     | 124,000    |   |

 

The Company has determined that establishing avaluation allowance for the deferred tax assets is not required since it ismore likely than not that the deferred tax assets will be realized throughfuture taxable income.

As of December 31,2004, there were approximately $400,000 of accumulated undistributed earningsof subsidiaries outside the United States that are considered to be reinvestedindefinitely. No deferred tax liability has been provided on such earnings. Ifthey were remitted to the Company, applicable U.S. federal and foreignwithholding taxes would be partially offset by available foreign tax credits.

**(9)**   Stockholders’ Equity

From time to time, the Company’s board of directorsauthorizes the repurchase of common stock. In May 2003, the Company’sboard of directors authorized a $1.2 million increase in its stock repurchaseprogram. Under the terms of the increased program, up to a cumulative total of$3.2 million of the 

F-16

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**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

Company’s common stock maybe purchased. As of December 31, 2004, $1,672,034 was remaining in thisauthorization.

As of December 31, 2004, the Company has reserved157,607 shares of common stock for options that are still available for grantunder the Company’s stock option plans, and 838,439 shares for options thathave been granted but have not yet been exercised.

Under the stock option plans, option exercise pricesare 100% of the market value of the common stock at the date of grant, exceptfor incentive options granted under the 1992 and 1998 plans to persons owningmore than 10% of the Company’s stock, in which case the option price is 110% ofthe market value, and nonqualified options granted under the 1992 and 1998plans, which may be granted at option prices no less than 25% of the marketvalue. Exercise periods are generally for five to ten years. Certain of theplans allow for the granting of nonqualified stock options. Upon the exerciseof these nonqualified options, the Company may realize a compensation deductionallowable for income tax purposes. The after-tax effect of these tax deductionsis included in the accompanying consolidated financial statements as anaddition to capital in excess of par value.

Informationregarding the Company’s stock option plans for 2004, 2003, and 2002 was asfollows:
| ** **                                   | ** ** | ** ** | ** ** | **Weighted** | ** ** |
|----------------------------------------------|------------|------------|------------|--------------|------------|
| ** **                                   | ** ** | ** ** | ** ** | **average**  | ** ** |
| ** **                                   | ** ** | ** ** | ** ** | **exercise** | ** ** |
| ** **                                   | ** ** | **Shares** | ** ** | **price**    | ** ** |
| Options  outstanding, December 31, 2001 |       | 539,795    |       |         | $          | 6.73 |   |   |
| Granted                                      |       | 177,750    |       |         | 7.30       |   |   |
| Exercised                                    |       | (21,736    | )          |         | 6.25       |   |   |
| Canceled or expired                          |       | (9,222     | )          |         | 6.89       |   |   |
| Options  outstanding, December 31, 2002 |       | 686,587    |       |         | 6.89       |   |   |
| Granted                                      |       | 174,250    |       |         | 8.08       |   |   |
| Exercised                                    |       | (28,501    | )          |         | 5.97       |   |   |
| Canceled or expired                          |       | (21,924    | )          |         | 6.86       |   |   |
| Options outstanding,  December 31, 2003 |       | 810,412    |       |         | 7.17       |   |   |
| Granted                                      |       | 102,000    |       |         | 9.18       |   |   |
| Exercised                                    |       | (46,300    | )          |         | 6.22       |   |   |
| Canceled or expired                          |       | (27,673    | )          |         | 7.38       |   |   |
| Options outstanding,  December 31, 2004 |       | 838,439    |       |         | $          | 7.46 |   |   |

 
| ** **                                                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Weighted average  fair value of options, granted during the  year       |       | $        | 2.58       |     | 2.46       |     | 2.51       |   |
| Weighted average  exercise price of options, exercisable at end of year |       | 7.24     |       | 7.06     |       | 6.90     |       |
| Options exercisable, at  end of year                                    |       | 636,943  |       | 563,921  |       | 451,879  |       |
|                                                                         |            |          |            |          |            |          |            |  |

 

At December 31, 2004,the weighted average remaining contractual life of outstanding options was 7.1years.

F-17

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**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

**(10)**   Net Income Per Common Share

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 years ended December 31, 2004, 2003, and 2002:
| ** **                                                              | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002**  | ** ** |
|-------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Weighted shares  of common stock outstanding—basic                 |       | 5,351,106 |       | 5,410,010 |       | 5,487,915 |       |
| Weighted shares  of common stock assumed upon exercise of stock options |       | 120,314   |       | 93,901    |       | 118,417   |       |
| Weighted shares of  common stock outstanding—diluted               |       | 5,471,420 |       | 5,503,911 |       | 5,606,332 |       |

 

Outstanding stock optionstotaling 157,120, 64,695 and 250,020 at December 31, 2004, 2003, and 2002,have been excluded from the net income per common share calculations becausethe effect on net income per common share would not have been dilutive.

**(11)**   Product Line, Geographical andSignificant Customer Information

The Company operates in a single industry segment: thedevelopment, manufacturing, and marketing of measurement, analytical,monitoring, sample preparation, and consulting products used to detect,measure, and analyze gases and chemical compounds for customers in the barrierpackaging, food, pharmaceutical, and other industries throughout the world.

Thefollowing table summarizes total sales by product line for 2004, 2003 and 2002respectively:
| ** **                            | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|
| ** **                            | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Permeation  Products                  |       | $                                           | 14,290,547 |   | $ | 11,705,963 |   | $ | 10,577,757 |   |
| Weighing and  Pharmaceutical Products |       | 1,314,851                                   |       | 1,197,846 |   | 634,258 |   |
| Sample  Preparation Products          |       | 605,872                                     |       | 395,865 |   | 1,251,980 |   |
| Gas Analyzer  Products                |       | 3,560,351                                   |       | 2,980,271 |   | 3,881,781 |   |
| Gas  Chromatography Analyzer Products |       | 717,486                                     |       | 580,875 |   | 836,961 |   |
| Leak Detection  Products              |       | 1,283,865                                   |       | 459,814 |   | 583,507 |   |
| Headspace  Analyzer Products          |       | 1,924,884                                   |       | 1,460,417 |   | 1,360,917 |   |
| Consulting and  Analytical Services   |       | 722,947                                     |       | 833,950 |   | 803,904 |   |
| Other                                 |       | 687,566                                     |       | 17,365 |   | — |   |
| Total Sales                           |       | $                                           | 25,108,369 |   | $ | 19,632,366 |   | $ | 19,931,065 |   |

 

F-18

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**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

Thefollowing table summarizes total sales, based upon the country to which salesto external customers were made for fiscal years 2004, 2003 and 2002. All ofthe Company’s tangible long-lived assets are located in the United States,except for an insignificant amount of property and equipment in Germany.
| ** **          | ** ** | **Years Ended December 31,** | ** ** |
|---------------------|------------|---------------------------------------------|------------|
| ** **          | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Domestic Sales      |       | $                                           | 12,017,992 |   | $ | 11,847,295 |   | $ | 13,354,090 |   |
| Foreign Sales:      |       |                                        |       |   |   |   |   |
| Western Europe      |       | 6,367,139                                   |       | 2,457,411 |   | 1,716,372 |   |
| Japan               |       | 2,796,830                                   |       | 2,057,904 |   | 1,752,285 |   |
| Canada              |       | 870,640                                     |       | 854,261 |   | 442,323 |   |
| Other               |       | 3,055,768                                   |       | 2,415,495 |   | 2,665,995 |   |
| Total foreign sales |       | 13,090,377                                  |       | 7,785,071 |   | 6,576,975 |   |
| Total Sales         |       | $                                           | 25,108,369 |   | $ | 19,632,366 |   | $19,931,065 |   |
|                     |            |                                             |            |  |  |  |  |  |  |  |

 

The Company’s products are marketed outside of NorthAmerica through various independent representatives. Paul Lippke Handels-GmbHProzess- und Laborsysteme (Lippke) accounted for 24%, 10%, and 8% of sales in2004, 2003, and 2002 respectively. Lippke was acquired effective January 1,2004. See Note 13. In addition, one independent representative accounted forapproximately 8%, 8%, and 7% of sales in 2004, 2003, and 2002, respectively.

No single customeraccounted for 10% or more of our consolidated revenues in any of the fiscalyears ended December 31, 2004, 2003, and 2002.

**(12)   Savingsand Retirement Plan**

The Company has a 401(k) Savingsand Retirement Plan covering substantially all of its employees. The Companyprovides matching contributions in accordance with the plan. The Company’scontributions to this plan in 2004, 2003, and 2002 were $72,749, $75,862, and$74,085, respectively.

**(13)   Acquisitions**

Effective January 1, 2004, we acquired PaulLippke Handels-GmbH Prozess- und Laborsysteme (Lippke) which is located inGermany. Lippke had been the primary distributor of our products in Europe forapproximately 30 years, and also served in the capacity of distributor or agentfor several companies in addition to MOCON. The acquisition of Lippke providesus with a direct presence in Europe. We acquired all of the shares of Lippke fora base purchase price of $802,688. In addition, we are obligated to make threefuture “earnout” payments to Lippke’s former parent company based on the netprofits of Lippke in each of the years 2004, 2005, and 2006, with a minimumpayment amount of 100,000 euros per year which is included in the financialstatements. It is anticipated that the “earnout” payments will be made to theformer parent company of Lippke at our near the end of first quarter of each ofthe years 2005, 2006, and 2007, upon agreement of the net profits of Lippke. Basedupon the net profit calculation of Lippke as of December 31, 2004, theCompany has recorded an obligation for the first payment due to Lippke’s formerparent company in the amount of $549,257 as of December 31, 2004, and$247,708 for the minimum payable for 2005 and 2006.

F-19

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**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

Thepurchase price of the acquisition was:
| Cash  consideration (625,000 euros)               |   | $       | 802,688   |   |
|---------------------------------------------------|--------|---------|-----------|--------|
| Present value of  future minimum earnout payments |   | 796,965 |      |
| Costs associated  with the transaction            |   | 184,975 |      |
|                                              |   | $       | 1,784,628 |   |

 

**Purchase PriceAllocation**

Thepurchase price was allocated to the tangible and identifiable intangible assetsacquired and liabilities assumed based on their estimated fair values at theacquisition date. The following table summarizes the estimated fair values ofthe assets acquired and liabilities assumed as of the acquisition date:
| Cash and  marketable securities                                  |   | $          | 518,980   |   |
|------------------------------------------------------------------|--------|------------|-----------|--------|
| Current assets,  principally accounts receivable and inventories |   | 1,088,824  |      |
| Property, plant  and equipment                                   |   | 166,021    |      |
| Identifiable  intangible assets:                                 |   |       |      |
| Domain names                                                     |   | 5,700      |      |
| Trademark and trade name                                         |   | 335,000    |      |
| Commercial agent/subagent network                                |   | 70,000     |      |
| Sales order backlog                                              |   | 84,896     |      |
| Compiled customer list                                           |   | 48,000     |      |
| Manufacturer’s representative contracts                     |   | 225,000    |      |
| Goodwill                                                         |   | 968,979    |      |
| Current  liabilities                                             |   | (1,355,009 | )         |
| Other non-current  liabilities                                   |   | (371,763   | )         |
|                                                             |   | $          | 1,784,628 |   |

 

The allocation of the purchase price was based, inpart, on a third-party valuation of the fair value of identifiable intangibleassets, and certain property, plant and equipment. Other non-currentliabilities includes deferred income taxes of $264,683 and obligations payableto two former employees totaling $107,080. The cost of the identifiableintangible assets will be amortized on a straight-line basis over periods ofless than 1 to 5 years. We expect that substantially all of the amountallocated to goodwill will not be deductible for tax purposes.

F-20

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**MOCON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) December 31, 2004, 2003 and 2002**

Theresults of Lippke have been included in the consolidated financial statementssince the date of acquisition of January 1, 2004. Unaudited pro formaresults of operations for the years ended December 31, 2003 and 2004 areincluded below. Such pro forma information assumes that the above acquisitionhad occurred as of January 1, 2003. This summary is not necessarilyindicative of what our results of operations would have been had we been acombined entity during the period ended December 31, 2003, nor does itpurport to represent results of operations for any future periods. Pro formaadjustments consist primarily of amortization of intangible assets.
| ** **                    | ** ** | **2004**             | ** ** | **2003**     | ** ** |
|-------------------------------|------------|----------------------|------------|--------------|------------|
| ** **                    | ** ** | **As reported** | ** ** | **Proforma** | ** ** | **As reported** | ** ** | **Proforma** | ** ** |
| Net sales                     |       | $                    | 25,108,369 |         | 25,108,369 |   | 19,632,366 |   | 22,710,078 |   |
| Net income                    |       | 2,428,688            |       | 2,428,688    |       | 2,211,305 |   | 2,830,468 |   |
| Net income per common  share: |       |                 |       |         |       |   |   |   |   |
| Basic                         |       | 0.45                 |       | 0.45         |       | 0.41 |   | 0.52 |   |
| Diluted                       |       | 0.44                 |       | 0.44         |       | 0.40 |   | 0.51 |   |
|                               |            |                      |            |              |            |  |  |  |  |  |

 

Effective November 24, 2003, the Company acquiredthe Vaculok® vacuum insulated panel product line from Advantek, Inc. ofMinnetonka, Minnesota (Vaculok). Vacuum insulated panels (VIPs) are deviceswhich utilize unique technologies to excel in packaging applications requiringlengthy temperature protection. The acquisition, valued at $253,514 includingassociated fees and expenses, was recorded using the purchase method ofaccounting and; accordingly, the acquired operations of Vaculok have beenincluded in the results of operations since the date of acquisition. Thepurchase price has been allocated to the net assets acquired based on estimatedfair market values at the date of acquisition. The estimated fair values of theassets acquired in the acquisition included inventory and equipment valued at$43,003 and $210,511, respectively.

Thefollowing unaudited pro forma consolidated results of operations have beenprepared as if the acquisition of Vaculok had occurred as of the beginning offiscal 2003 and 2002:
| ** **                    | ** ** | **2003**             | ** ** | **2002**     | ** ** |
|-------------------------------|------------|----------------------|------------|--------------|------------|
| ** **                    | ** ** | **As reported** | ** ** | **Proforma** | ** ** | **As reported** | ** ** | **Proforma** | ** ** |
| Net sales                     |       | $                    | 19,632,366 |         | 19,872,366 |   | 19,931,065 |   | 20,084,065 |   |
| Net income                    |       | 2,211,305            |       | 2,173,113    |       | 2,297,214 |   | 2,178,146 |   |
| Net income per  common share: |       |                 |       |         |       |   |   |   |   |
| Basic                         |       | 0.41                 |       | 0.40         |       | 0.42 |   | 0.40 |   |
| Diluted                       |       | 0.40                 |       | 0.39         |       | 0.41 |   | 0.39 |   |
|                               |            |                      |            |              |            |  |  |  |  |  |

 

F-21

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**MOCON, INC.EXHIBIT INDEX TO ANNUAL REPORT ONFORM 10-KFOR FISCAL YEAR ENDED DECEMBER 31, 2004**
| Item   No. | ** ** | ** **                                                                                                                                                          | ** ** | **Item** | ** ** | **Method of   Filing** | ** ** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|------------------------|------------|
| 3.1        |       | Restated  Articles of Incorporation of the Company                                                                                                                  |       | (1)      |       |
| 3.2        |       | Amendment to Restated Articles of Incorporation of  the Company, effective May 27, 1987                                                                        |       | (2)      |       |
| 3.3        |       | Amendment to Restated Articles of Incorporation of  the Company, effective June 28, 1991                                                                       |       | (3)      |       |
| 3.4        |       | Amendment to Restated Articles of Incorporation of  the Company, effective May 21, 1998                                                                        |       | (11)     |       |
| 3.5        |       | Amendment to Restated Articles of Incorporation of  the Company, effective May 26, 1999                                                                        |       | (13)     |       |
| 3.6        |       | Third Restated Bylaws of the Company                                                                                                                                |       | (4)      |       |
| 10.1       |       | Office/Warehouse Lease, dated July 29, 1994                                                                                                                    |       | (5)      |       |
| 10.2       |       | Office/Warehouse Lease Extension, dated June 6,  1997                                                                                                          |       | (8)      |       |
| 10.3       |       | Office/Warehouse Lease, dated November 17, 1999                                                                                                                |       | (13)     |       |
| 10.4       |       | 1990 Non-Employee Director Stock Option Plan                                                                                                                        |       | (3)      |       |
| 10.5       |       | 1992 Stock Option Plan                                                                                                                                              |       | (6)      |       |
| 10.6       |       | 1998 Stock Option Plan, as amended                                                                                                                                  |       | (9)      |       |
| 10.7       |       | 1999 Compensation Committee resolutions setting  forth the Incentive Compensation Plan                                                                              |       | (12)     |       |
| 10.8       |       | Paired Profit Sharing Plan effective July 1,  1996                                                                                                             |       | (7)      |       |
| 10.9       |       | Agency and Service Agreement, dated January 1,  1987, between the Company and MoCon FSC, Inc.                                                             |       | (4)      |       |
| 10.10      |       | Foreign Sales Corporation Suppliers Agreement, dated  March 28, 1985, between the Company and MoCon FSC, Inc.                                        |       | (4)      |       |
| 10.11      |       | Agreement and Plan of Merger, dated  November 20, 1998, by and among Modern Controls, Inc., MOCON  Acquisition Corporation and Lab Connections, Inc. |       | (10)     |       |
| 10.12      |       | Form of Executive Severance Agreement                                                                                                                          |       | (14)     |       |
| 10.13      |       | Stock Purchase Agreement dated October 24, 2001  by and among MOCON, Inc., Questar InfoComm, Inc. and Questar  Corporation                           |       | (15)     |       |
| 10.14      |       | 2003 Compensation Committee resolution setting forth  the Incentive Compensation Plan                                                                               |       | (15)     |       |
| 10.15      |       | MOCON, Inc. Savings and Retirement Plan                                                                                                                        |       | (16)     |       |

 

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| 10.16 |   | Share  Purchase Agreement, dated as of December 19, 2003 by and between  Ahlström Capital Oy and MOCON, Inc.        |   | (17) |   |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------|--------|------|--------|
| 10.17 |   | Transfer Deed dated as of January 29, 2004 by  and between Ahlström Capital Oy and MOCON, Inc.                      |   | (17) |   |
| 10.18 |   | Form of Incentive Stock Option Agreement  between MOCON, Inc. and its Executive Officers                                 |   | (18) |   |
| 10.19 |   | Form of Non-Statutory Stock Option Agreement  between MOCON, Inc. and its Non-Employee Directors and Executive  Officers |   | (18) |   |
| 10.20 |   | Description of Non-Employee Director Retirement Plan                                                                               |   | (19) |   |
| 10.21 |   | Description of Non-Employee Director Compensation  arrangements                                                                    |   | (19) |   |
| 10.22 |   | Description of Executive Officer Compensation  Arrangements                                                                        |   | (19) |   |
| 21.1  |   | Subsidiaries of the Company                                                                                                        |   | (19) |   |
| 23.1  |   | Consent of Independent Registered Public Accounting  Firm                                                                          |   | (19) |   |
| 31.1  |   | Principal Executive Officer Certification Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002                          |   | (19) |   |
| 31.2  |   | Principal Financial Officer Certification Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002                          |   | (19) |   |
| 32.1  |   | Certification Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (Chief Executive Officer)                       |   | (19) |   |
| 32.2  |   | Certification  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial  Officer)                      |   | (19) |   |

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(1)          Incorporatedby reference to our Annual Report on Form 10-K for the fiscal yearended January 31, 1984 (File No. 0-9273).

(2)          Incorporated byreference to our Annual Report on Form 10-K for the fiscal yearended December 31, 1987 (File No. 0-9273).

(3)          Incorporated byreference to our Registration Statement on Form S-8 (File No. 33-42255).

(4)          Incorporated byreference to our Annual Report on Form 10-K for the fiscal yearended December 31, 1988 (File No. 0-9273).

(5)          Incorporated byreference to our Annual Report on Form 10-K for the fiscal yearended December 31, 1994 (File No. 0-9273).

(6)          Incorporated byreference to our Registration Statement on Form S-8 (File No. 33-49752).

(7)          Incorporated byreference to our Annual Report on Form 10-K for the fiscal yearended December 31, 1996 (File No. 0-9273).

(8)          Incorporated byreference to our Annual Report on Form 10-K for the fiscal year endedDecember 31, 1997 (File No. 0-9273).

(9)          Incorporated byreference to our Registration Statement on Form S-8 (File No. 33-58789).

(10)   Incorporated by reference toour Report on Form 8-K filed on December 21, 1998 (File No. 0-9273)

 

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(11)   Incorporated by reference toour Annual Report on Form 10-K for the fiscal year ended December 31,1998 (File No. 0-9273).

(12)   Incorporated by reference toour Quarterly Report on Form 10-Q for the quarter ended June 30,1999 (File No. 0-9273).

(13)   Incorporated by reference toour Annual Report on Form 10-K for the fiscal year ended December 31,1999 (File No. 0-9273).

(14)   Incorporated by reference toour Annual Report on Form 10-K for the fiscal year ended December 31,2000 (File No. 0-9273).

(15)   Incorporated by reference toour Report on Form 8-K filed on November 6, 2001 (File No. 0-9273).

(16)   Incorporated by reference toour Annual Report on Form 10-K for the fiscal year ended December 31,2002 (File No. 0-9273).

(17)   Incorporated by reference toour Current Report on Form 8-K filed on January 29, 2004 (File No. 0-9273).

(18)   Incorporated by reference toour Current Report on Form 8-K filed on December 29, 2004 (File No. 0-9273).

(19)   Filed herewith.

 

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