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MOCON, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q
For the Quarter Ended September 30, 2004

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

MOCON, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to condensed consolidated financial statements.

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MOCON, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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MOCON, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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MOCON, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 — Condensed Consolidated Financial Statements

The condensed consolidated balance sheet as of September 30, 2004, the condensed consolidated statements of income for the three- and nine-month periods ended September 30, 2004 and 2003, and the condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2004 and 2003 have been prepared by us, without audit. However, all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows at September 30, 2004, and for all periods presented, have been made. The results of operations for the period ended September 30, 2004 are not necessarily indicative of operating results for the full year.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, previously filed with the Securities and Exchange Commission.

We operate in a single industry segment: the development, 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 barrier packaging, food, pharmaceutical, and other industries throughout the world.

Principles of Consolidation

The consolidated financial statements include the accounts of MOCON, Inc. and its subsidiaries after elimination of inter-company transactions and accounts.

Foreign Currency Translation

The financial statements for operations outside the United States are maintained in their local currency. All assets and liabilities of our foreign subsidiary are translated to United States dollars at period-end exchange rates, while revenue and expense accounts are translated at the average exchange rates during the period transactions occurred. Translation adjustments arising from the use of differing exchange rates are included in accumulated other comprehensive income or loss in stockholders’ equity. Gains and losses on foreign currency transactions are included in other income or loss.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such

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estimates and assumptions include the carrying amount of property, plant and equipment, intangibles and goodwill; and valuation of allowances for receivables, inventory, warranty and deferred income taxes. Actual results could differ from those estimates.

Stock-Based Compensation

We use the intrinsic-value method for employee stock-based compensation pursuant to Accounting Principles Board Opinion No. 25 (Opinion 25), Accounting for Stock Issued to Employees. Under the guidelines of Opinion 25, compensation cost for stock-based employee compensation plans is recognized based on the difference, if any, between the quoted market price of the stock on the date of grant and the amount an employee must pay to acquire the stock.

We have adopted the disclosure-only provisions for employee stock-based compensation and the fair-value method for nonemployee stock-based compensation of Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for Stock-Based Compensation. These provisions require us to show, on a pro forma basis, our net income and income per common share if we had recorded an expense for our stock options at the time of grant. Other than disclosure in this footnote, we do not use these pro forma results for any purpose. No stock options were granted during the three-month period ended September 30, 2004.

Had we recorded compensation cost based on the estimated fair value on the date of grant, as defined by SFAS No. 123, our net income and net income per common share would have been reduced to the pro forma amounts indicated below:

Note 2 — Inventories

Inventories consist of the following:

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Note 3 — Net Income Per Common Share

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

The following table presents a reconciliation of the denominators used in the computation of net income per common share — basic and net income per common share — diluted for the three- and nine-month periods ended September 30, 2004, and 2003:

Note 4 — Goodwill and Intangible Assets

As of September 30, 2004, unamortized goodwill amounted to $1,868,556, which includes the current year addition of $521,761 related to the acquisition of Paul Lippke Handels-GmbH. Other identifiable intangible assets are as follows:

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Total amortization expense for the three and nine months ended September 30, 2004 was $112,743 and $350,388, respectively, and $44,949 and $135,498, respectively, for the three and nine months ended September 30, 2003. Estimated amortization expense for each of the five succeeding fiscal years based on the intangible assets as of September 30, 2004 is as follows:

Note 5 — Marketable Securities

Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses on available-for-sale securities are excluded from income and are reported as a separate component of stockholders’ equity until realized. A decline in the market value of any available-for-sale security below cost that is deemed other than temporary is charged to income resulting in the establishment of a new cost basis for the security. At September 30, 2004, and September 30, 2003, this resulted in a net unrealized (loss) gain of ($1,297) and $5,553, respectively, within stockholders’ equity.

Note 6 — Comprehensive Income

Other comprehensive income pertains to net unrealized gains and losses on marketable securities and foreign currency translation adjustments that are not included in net income but rather are recorded directly in stockholders’ equity.

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Note 7 — Warranty Guarantees

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

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

Warranty provisions and claims for the nine-month periods ended September 30, 2004 and 2003 were as follows:

Note 8 — Acquisition

Effective January 1, 2004, we acquired Paul Lippke Handels-GmbH Prozess- und Laborsysteme (Lippke) which is located in Germany. Lippke had been the primary distributor of our products in Europe for approximately thirty years, and also served in the capacity of distributor or agent for several companies in addition to MOCON. The acquisition of Lippke provides us with a direct presence in Europe, which we plan to leverage to benefit all of our product and service offerings. 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”payments to Lippke’s former parent company based on the net profits of Lippke in each of the years 2004, 2005, and 2006, with a minimum payment amount of 100,000 euros per year which is included in the financial statements.

The purchase price of the acquisition was:

Purchase Price Allocation

The purchase price was allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as of the acquisition date:

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

The results of Lippke have been included in the consolidated financial statements since the date of acquisition of January 1, 2004.  Unaudited pro forma results of operations for the three- and nine-month periods ended September 30, 2003 are included below.  Such pro forma information assumes that the above acquisition had occurred as of January 1, 2003.  This summary is not necessarily indicative of what our results of operations would have been had we been a combined entity during the period ended September 30, 2003, nor does it purport to represent results of operations for any future periods. Pro forma adjustments consist primarily of amortization of intangible assets.

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MOCON, INC.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Form 10-Q includes certain statements that are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, included in this Form 10-Q that address activities, events, or developments that we expect, believe, or anticipate will or may occur in the future, are forward-looking statements. The forward-looking statements in this filing are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that any such statements are not guarantees of future performance and that actual results or developments may differ materially from those projected in the forward-looking statements because these statements are subject to a number of risks and uncertainties including, but not limited to, expected orders, expected revenues, expected profitability and financial performance for the fourth quarter of 2004, as well as, the risk factors described in our annual report on Form 10-K for the year ended December 31, 2003, and the factors included in this report in the section entitled "Risk Factors." Persons reading this Form 10-Q should carefully review the discussion of all of the risk factors described in this report and in our other filings made from time to time with the Securities and Exchange Commission. We undertake no duty to update any of the forward-looking statements after the date of this report.

Overall Summary of Financial Results for Third Quarter and First Nine Months of 2004

Sales for the third quarter of 2004 were $6,411,073, an increase of 34% compared to $4,778,161 for 2003. The increase is primarily due to the acquisition of Paul Lippke Handels-GmbH Prozess- und Laborsysteme (Lippke) as explained below in the Company Overview section. Net income was $728,369, a 36% increase compared to $534,316 in the third quarter of 2003. Net income per share was 13 cents (diluted) in the third quarter of 2004, a 30% increase compared to 10 cents (diluted) for the same period in 2003. Nine-month sales increased 22% to $18,287,249 compared to $14,939,584 for the first nine months of 2003. Net income and net income per share were $1,694,362 and 31 cents (diluted), respectively, for the first nine months of 2004, both down 3% compared to $1,750,253 and 32 cents (diluted) during the same period in 2003.

Company Overview

MOCON, Inc. designs, manufactures, markets, and services products and provides consulting services primarily in the measurement and analytical instrument and services markets. Our products include instruments that detect, measure and monitor gases and chemical compounds as well as products that prepare samples of various substances for laboratory analysis. Although some of the markets for our products are maturing, we continually seek growth opportunities through technological and product improvement, by acquiring and developing new products, and by acquiring new companies.

Effective January 1, 2004, we acquired Lippke which is located in Germany. Lippke had been the primary distributor of our products in Europe for approximately thirty years, and also served in the capacity of distributor or agent for several companies in addition to MOCON. The acquisition of Lippke provides us with a direct presence in Europe, which we plan to leverage to benefit many of our product and service offerings. 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” payments to Lippke’s former parent company based on the net profits of Lippke in each of the years 2004, 2005, and 2006, with a minimum payment amount of 100,000 euros per year.

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Prior to 1998, we expanded our business primarily through internally developing new products and technologies, acquiring product lines and technology, and licensing products and technology. In 1998, 2001, 2003, and 2004, we supplemented our internal growth through a total of five acquisitions that have provided us with additional technologies, products and product development expertise. We have three primary operating locations in the United States and one in Germany.

Critical Accounting Policies

Our estimates related to certain assets and liabilities are an integral part of our consolidated financial statements. These estimates are considered critical to our consolidated financial statements because they require us to make subjective and complex judgments.

Allowance for doubtful accounts — This reserve is for accounts receivable balances that are potentially uncollectible. The reserve is based on (1) an analysis of customer accounts and (2) our historical experience with accounts receivable write-offs. The analysis includes the age of the receivable, the financial condition of a customer or industry, and general economic conditions. We believe the results could be materially different if historical trends do not reflect actual results or if economic conditions worsened for our customers.

Inventory obsolescence analysis — We perform an analysis to identify inventory shrinkage, slow moving, and obsolete inventory. We record a charge to cost of sales for amounts identified. Our analysis includes inventory levels, physical inventory counts, cycle count adjustments, the nature of the finished product and its inherent risk of obsolescence, the gross margin of the product, and the on-hand quantities relative to the sales history of that finished product. We believe that the results could be materially different if historical trends do not reflect actual results or if demand for our products decreased because of economic or competitive conditions or otherwise.

Recoverability of long-lived assets — We assess the recoverability of goodwill and other long-lived assets annually or whenever events or changes in circumstances indicate that expected future undiscounted cash flows might not be sufficient to support the carrying amount of an asset. We deem an asset to be impaired if a forecast of undiscounted future operating cash flows is less than an asset’s carrying amount. If an asset is determined to be impaired, the loss is measured as the amount by which the carrying value of the asset exceeds its fair value. Changes in our business strategies and/or changes in the economic environment in which we operate may result in future impairment charges.

Results of Operations

The following table sets forth the relationship between various components of operations, stated as a percent of sales, for the three- and nine-month periods ended September 30, 2004, and 2003.

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The following table sets forth the relationship between various components of domestic and foreign sales, stated as a percent of total sales, for the three- and nine-month periods ended September 30, 2004 and 2003.

Net Sales

Sales for the third quarter of 2004 were $6,411,073, up 34% compared to $4,778,161 for the same period in 2003. This increase was primarily the result of the Lippke acquisition, which provided $964,329 in net incremental sales. On a product basis, this increase was primarily due to increased foreign sales of our permeation products (including $426,451 in net additional foreign permeation sales from Lippke), foreign sales of our leak detection products (including $197,423 in net additional foreign leak detection sales from Lippke), domestic and foreign sales of our headspace analyzer products, and foreign sales of our weighing products, offset somewhat by decreases in domestic sales of our weighing products. The impact of price increases was not significant.

Sales for the nine months ended September 30, 2004, were $18,287,249, up 22% compared to $14,939,584 for the nine months ended September 30, 2003. This increase was primarily the result of the addition of Lippke, which provided $2,737,074 in net incremental sales. On a product basis, this increase was primarily due to increased foreign sales of our permeation products (including $1,473,786 in net additional foreign permeation sales from Lippke), foreign sales of our leak detection products (including $456,698 in net additional foreign leak detection

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sales from Lippke), foreign sales of our headspace analyzer products (including $281,045 in net additional foreign headspace sales from Lippke), foreign sales of our weighing products, and domestic sales of our sample preparation products, offset somewhat by decreases in domestic sales of our permeation and weighing products and domestic sales of our consulting and analytical services. The impact of price increases was not significant.

In addition to a direct presence in Europe provided by the acquisition of Lippke, we use a network of independent representatives to market and service our products in foreign countries, and expect that international sales will continue to account for a significant portion of our revenues for the foreseeable future.

         Permeation Products

Sales of our permeation products accounted for approximately 55% and 57% of our consolidated third quarter sales in 2004 and 2003, respectively. Sales of permeation products for the nine months ended September 30, 2004, and 2003, were approximately 59% and 60%, respectively.

         Gas Analyzer Products

Sales of our gas analysis and monitoring instrumentation products through our Baseline-MOCON, Inc. subsidiary were approximately 13% and 18% of our consolidated third quarter sales in 2004 and 2003, respectively, and approximately 14% and 17%, of consolidated sales for the nine months ended September 30, 2004, and 2003, respectively. In order to reduce operating costs and increase operating efficiencies, we moved a portion of Baseline’s production to our Minneapolis, Minnesota, facility during the first quarter of 2004.

         Headspace Analyzer Products

Sales of our headspace analyzer products were approximately 8% and 6% of our consolidated third quarter sales in 2004 and 2003, respectively. Sales of headspace analyzer products for the nine months ended September 30, 2004, and 2003, were consistent at approximately 7% of consolidated sales for those periods.

         Weighing Products

Sales of our weighing products accounted for approximately 8% of our consolidated third quarter sales in both 2004 and 2003, and approximately 5% of our consolidated sales for both the nine months ended September 30, 2004, and 2003.

         Leak Detection Products

Sales of our leak detection products were approximately 5% and 1% of our consolidated third quarter sales in 2004 and 2003, respectively. Sales of leak detection products accounted for approximately 5% and 2% of our consolidated sales for the nine months ended September 30, 2004, and 2003, respectively. These increases were primarily due to net additional foreign leak detection sales associated with Lippke.

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         Gas Chromatography Analyzer Products

Sales of our gas chromatography analyzer products through our Microanalytics Instrumentation Corp. subsidiary located in Round Rock, Texas, accounted for approximately 3% of our consolidated sales for the three and nine months ended September 30, 2004 and 2003.

         Consulting and Analytical Services

Consulting and analytical services sales were approximately 2% and 5%, respectively, of our consolidated third quarter sales in 2004 and 2003, respectively. Consulting and analytical services sales were approximately 3% and 4% of our consolidated sales for the nine months ended September 30, 2004, and 2003, respectively.

         Sample Preparation Products

Sales of our sample preparation products through our Lab Connections, Inc. (Lab Connections) subsidiary accounted for approximately 1% and 2% of our consolidated third quarter sales in 2004 and 2003, respectively. Sales of sample preparation products accounted for approximately 2% of consolidated sales for both the nine months ended September 30, 2004, and 2003. During the first quarter of 2004, we moved our Lab Connections operations into our Round Rock, Texas, location and closed the Boston location. The total costs incurred in the first quarter of 2004 associated with this relocation were $78,900. As anticipated, the closing of the Boston location has resulted in a reduction in certain operating costs. Overall Lab Connections results, however, have continued to be below expectations. While we anticipate improvement in revenue and operating results for Lab Connections in the fourth quarter, should these improvements fail to materialize, we may incur a charge in the fourth quarter for the impairment of technology rights associated with Lab Connections. The total remaining net balance of technology rights associated with Lab Connections as of September 30, 2004 is $255,000.

Gross Profit

Our gross profit margin was 53.4% and 54.6% for the three months ended September 30, 2004 and 2003, respectively. The gross profit margin as a percentage of sales was lower for the three months ended September 30, 2004 compared to the same period in 2003 due mostly to increases in our inventory reserve for obsolescence and additional costs associated with moving a portion of our Baseline subsidiary’s manufacturing to Minneapolis, Minnesota. We believe this manufacturing consolidation will positively impact future operating income as reduced costs and increased operating efficiencies are realized.

Our gross profit margin for the nine months ended September 30, 2004 and 2003, respectively, was 53.3% and 55.3%. The gross profit margin as a percentage of sales was lower for the nine months ended September 30, 2004 compared to the same period in 2003 due mostly to costs related to the acquisition of Lippke including the increased cost of sales assigned to finished goods inventory under purchase accounting rules of $161,000, costs associated with the relocation of our Lab Connections subsidiary to Round Rock, Texas, and additional costs associated with moving a portion of our Baseline subsidiary’s manufacturing to Minneapolis, Minnesota. We believe both of these manufacturing consolidations will positively impact future operating income as reduced costs and increased operating efficiencies are realized.

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Selling, General and Administrative Expenses

Selling, general and administrative (SG&A) expenses in the third quarter of 2004 were $2,068,871, or 32.2% of sales, compared to $1,498,595, or 31.4% of sales in the third quarter of 2003. The increase in SG&A expenses was primarily due to costs associated with the increase in sales, including Lippke sales, and costs associated with the acquisition of Lippke, including ongoing amortization related to various purchased intangibles of $44,000.

SG&A expenses for the first nine months of 2004 were $6,297,024, or 34.4% of sales, compared to $4,650,221, or 31.2% of sales, for the first nine months of 2003. The increase in SG&A expenses was primarily due to costs associated with the increase in sales, including Lippke sales, and costs associated with the acquisition of Lippke, including amortization of $85,000 related to purchased backlog and ongoing amortization related to various other purchased intangibles of $133,000.

Research and Development Expenses

Research and development (R&D) expenses were $294,840, or approximately 4.6% of sales, in the third quarter of 2004, compared to $314,790, or approximately 6.6% of sales, in the third quarter of 2003. For the nine months ended September 30, 2004, R&D expenses were $1,004,547, or approximately 5.5% of sales, compared to $1,005,992, or approximately 6.7% of sales, for the same period in 2003. Continued R&D expenditures are necessary as we develop new products to expand in our niche markets. For the foreseeable future, we expect to allocate on an annual basis approximately 5% to 8% of sales to research and development.

Other Income

Other income for the nine months ended September 30, 2004 consisted of interest income of $97,107 and gain on foreign currency exchange of $13,943. Interest income increased slightly from $91,610 for the nine months ended September 30, 2003.

Income Tax Expense

Our provision for income taxes was 33.8% of income before income taxes for the three and nine months ended September 30, 2004, compared to 35% of income before income taxes for the three and nine months ended September 30, 2003. Based on current operating conditions and income tax laws, we expect the tax rate for all of 2004 to be in the range of 33% to 36%.

Net Income

Net income was $728,369 in the third quarter of 2004, compared to $534,316 in the third quarter of 2003. Diluted net income per share was 13 cents per share in the third quarter of 2004 compared to 10 cents per share in the third quarter of 2003. For the nine months ended September 30, 2004, net income was $1,694,362 compared to $1,750,253 for the nine months ended September 30, 2003. Diluted net income per share was 31 cents and 32 cents for the nine months ended September 30, 2004 and 2003, respectively.

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Liquidity and Capital Resources

Operating Activities

Cash flow from operations has historically been sufficient to meet our liquidity requirements, capital expenditures and research and development costs. Cash flow from operations for the first nine months of 2004 and 2003 totaled $3,215,370 and $2,231,733, respectively.

The accounts receivable balance at September 30, 2004 increased $222,915 compared to December 31, 2003, mostly due to the increase in sales, offset in part by improved collections. Total inventory increased $106,258 at September 30, 2004, compared to December 31, 2003, primarily due to the acquisition of Lippke. The $817,601 increase in accounts payable at September 30, 2004 compared to December 31, 2003 was also due primarily to the acquisition of Lippke and, to a lesser extent, to increases in commissions payable and customer advance payments.

Investing Activities

Cash flow used in investing activities totaled $73,701 in the first nine months of 2004. Proceeds from sales or maturities of marketable securities, net of purchases, were $705,564. Purchases of property and equipment totaled $276,003, primarily for additions of manufacturing and laboratory equipment.

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” payments to Lippke’s former parent company based on the net profits of Lippke in each of the years 2004, 2005, and 2006, with a minimum payment amount of 100,000 euros per year.

Financing Activities

During the first nine months of 2004, we made final dividend payments of $449,087 to Lippke’s former parent company and dividend payments of $1,048,132 to our shareholders, for total year-to-date dividend payments of $1,497,219.

Our Board of Directors has authorized, depending upon market conditions and other factors, the repurchase of up to a total of $3,200,000 of our common stock at prices not exceeding prevailing market prices at the time of purchase. There were no repurchases of our common stock during the third quarter of 2004, however, the year-to-date repurchases total $900,360. As of September 30, 2004, $1,672,034 was remaining in this authorization.

We continue to maintain a strong financial position. Total cash, temporary cash investments and marketable securities increased $135,231 during the first nine months of 2004 to $6,926,881, compared to $6,791,650 at December 31, 2003. Our working capital as of September 30, 2004 increased $341,514 to $11,243,640, compared to $10,902,126 at December 31, 2003.

We had no material commitments for capital expenditures as of September 30, 2004. We do not believe that any major property, plant and equipment expenditures are required to accommodate our current level of operations. We anticipate that a combination of our existing cash, temporary cash investments and marketable securities, plus an expected continuation of cash flow from operations, will continue to be adequate to fund operations, capital expenditures and dividend payments in the foreseeable future.

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Contractual Obligations

We refer you to our Annual Report on Form 10-K for the year ended December 31, 2003 for a summary of our contractual obligations. Except for the earnout payments expected to be paid in connection with the Lippke acquisition, there has been no material change in this information.

Off-Balance Sheet Arrangements

Except for operating leases entered in the ordinary course of business and customary indemnification obligations under certain of our agreements entered in the ordinary course of business, we do not have any material off-balance sheet arrangements.

Risk Factors

Our business faces significant risks. The risks below are not the only risks we face. Additional risks and uncertainties not presently known to us, or that we currently believe are immaterial, may also impair our business operations. If any of the events or circumstances described in the following risks occurs, our business, operating results or financial condition could be materially adversely affected. The following risk factors should be read in conjunction with the other information and risks set forth in this report.

In the past, the overall cost of the materials that we purchase has not risen much more than the rate of inflation, although the price of some of the components that we purchase has increased in the past several years due in part to our purchasing less of such components. Certain other material and labor costs have increased, but we believe that such increases are approximately consistent with overall inflation rates. We believe that the price of our products and the prices of our competitors’ products is a significant factor affecting our customers’ buying decisions and consequently, we may not be able to pass along any cost increases in the form of price increases or sustain profit margins that we have achieved in prior years.

The analytical and measurement instrument markets in which we operate have not shown significant growth in recent years. Although we have identified a number of strategies that we believe will allow us to grow our business and increase our sales, including developing new products and technologies, developing new applications for our technologies, acquiring complementary businesses and product lines, and strengthening our sales force, we can not assure you that we will be able to successfully implement these strategies, or that these strategies will result in the growth of our business or an increase in sales.

One of our growth strategies is to supplement our internal growth with the acquisition of businesses and technologies that complement or augment our existing products. Some of the businesses that we previously acquired have produced net operating losses or low levels of profitability. Businesses that we may acquire in the future may be marginally profitable or unprofitable. We will likely have to successfully change the operations of any companies that we acquire in the future and improve the market penetration of such companies in order to achieve the level of profitability that we desire. In addition, acquisitions that we believe will be beneficial to our business and financial results are difficult to identify and complete for a number of reasons, including the competition among prospective buyers. We may not be able to complete

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acquisitions in the future and any acquisitions that we do complete may have an adverse effect on our financial performance and liquidity. It may be necessary for us to raise additional funds either through public or private financing in order to finance any future acquisitions. Any equity or debt financing, if available at all, may be on terms that are not favorable to us and may dilute the ownership of our existing shareholders.

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

Our customers include pharmaceutical, food, medical, and chemical companies, laboratories, government agencies, and public and private research institutions. The capital spending of these entities can have a significant effect on the demand for our products. Any decrease in capital spending by any of these customer groups could have a material adverse effect on our business and results of operations.

Sales outside the United States accounted for approximately 55% of our revenues for the nine months ended September 30, 2004 and for approximately 40% of our revenues for the same period in 2003. We expect that foreign sales will continue to account for a significant portion of our revenues in the future. Sales to customers in foreign countries are subject to a number of risks, including the following:

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If any of these risks were to materialize, our sales into foreign countries could decline, or our operating costs could increase, which would adversely affect our financial results.

We currently encounter, and expect to continue to encounter, competition in the sale of our products. We believe that the principal competitive factors affecting the market for our products include product quality and performance, price, reliability and customer service.

Our competitors include large multinational corporations. Some of our competitors have substantially greater financial, marketing, and other resources than we do. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the promotion and sale of their products than we can. In addition, competition could increase if new companies enter the market or if existing competitors expand their product lines or intensify efforts within existing product lines. Our current products, products under development and our ability to discover new technologies may be insufficient to enable us to compete effectively with our competitors.

We hold patents relating to various aspects of our products and believe that proprietary technical know-how is critical to many of our products. Proprietary rights relating to our products are protected from unauthorized use by third parties only to the extent that they are covered by valid and enforceable patents or are maintained in confidence as trade secrets. We can not be certain that we will be issued any patents from any pending or future patent applications owned by or licensed to us or that the claims allowed under any issued patents will be sufficiently broad to protect our technology. In the absence of patent protection, we may be vulnerable to competitors who attempt to copy our products or gain access to our trade secrets and know-how. Our competitors may initiate litigation to challenge the validity of our patents, or they may use their resources to design comparable products that do not infringe our patents. We may incur substantial costs if our competitors initiate litigation to challenge the validity of our patents or if we initiate any proceedings to protect our proprietary rights and if the outcome of any such litigation is unfavorable to us, our business and results of operations could be materially adversely affected. There may also be pending or issued patents held by parties not affiliated with us that relate to our products or technologies and we may need to acquire licenses to any such patents to continue selling some or all of our products. If we had to obtain any such license in order to be able to continue to sell some or all of our products, we may not be able to do so on terms that were favorable to us, if at all.

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

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Some companies have begun to account for stock options as compensation expense thus resulting in a reduction of their net income and net income per common share. We currently grant all options at fair market value and do not record compensation expense in connection with the grants. It is possible that future laws, regulations or changes in accounting standards will require us to record the fair market value of all stock options as a compensation expense in our consolidated financial statements. If such a change occurs, our net income and net income per common share will be reduced.

The market price of our common stock has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future. These factors include:

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

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Equity Price and Interest Rate Risk

Substantially all of our marketable securities are at fixed interest rates. However, virtually all of our marketable securities mature within two years, therefore, we believe that the market risk arising from the holding of these financial instruments is minimal.

Foreign Currency Exchange Risk

We are exposed to market risks related to fluctuations in foreign exchange rates because some sales transactions, primarily associated with our foreign subsidiary Lippke, and the assets and liabilities of Lippke, are denominated in foreign currencies, primarily the euro. We are not currently engaging in any hedging activities, but may do so in the future.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) that are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered in this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of such period.

Changes in Internal Controls

There was no change in our internal control over financial reporting that occurred during our quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities

Unregistered Sales of Equity Securities

We did not sell any equity securities of MOCON, Inc. during the three months ended September 30, 2004 that were not registered under the Securities Act of 1933.

Issuer Repurchases of Equity Securities

We did not repurchase any equity securities of MOCON, Inc. during the three months ended September 30, 2004. In November 2002, our Board of Directors authorized the repurchase of up to $2,000,000 of our common stock in the open market at prices not exceeding the market price at the time of purchase. In May 2003, our Board of Directors authorized a $1,200,000 increase in our stock repurchase program, increasing the total to $3,200,000. As of September 30, 2004, we had repurchased 204,000 shares of MOCON common stock under the program at a total cumulative cost of approximately $1,527,966. The repurchase program does not have an expiration date.

Item 6. Exhibits

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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MOCON, INC.
QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2004

EXHIBIT INDEX

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