This Management's Discussion and Analysis provides material historical and prospective disclosures intended to enable investors and other users to assess our financial condition and results of operations. Statements that are not historical are forward-looking and involve risks and uncertainties discussed below under the caption "Forward-Looking Statements." The following discussion of the results of operations and financial condition of MOCON should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this report.

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. 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.

We have three primary operating locations in the United States - Minnesota, Colorado and Texas - and foreign offices in Germany and China. We use a direct sales force and independent sales representatives to market our products and services in the United States, Canada, Germany and China and use a network of independent sales representatives to market and service our products and services in other foreign countries.

Historically, a significant portion of our revenues have come from international customers. In this regard, we acquired our subsidiary in Germany in 2004 to solidify our presence and opportunities in Europe. Similarly, in 2007, we opened our office in Shanghai, China, to better serve our Asian customers.

Our current plans for growth include continued funding for research and development at levels consistent with amounts spent on these activities in recent periods to foster new product development, together with strategic acquisitions where appropriate.

Results of Operations


The following table sets forth the relationship between various components of
our results of operations, stated as a percent of sales, for the three- and
nine-month periods ended September 30, 2008 and 2007:



                                 Three Months Ended           Nine Months Ended
                                   September 30,                September 30,
                                2008           2007          2008           2007
Sales                              100.0          100.0         100.0          100.0
Cost of sales                       38.6           42.5          40.4           42.6
Gross profit                        61.4           57.5          59.6           57.4
Selling, general and
administrative expenses             34.8           31.0          34.2           31.6
Research and development
expenses                             5.8            6.9           6.5            7.1
Operating income                    20.8           19.6          18.9           18.7
Other income                         1.8            2.1           1.9            2.0
Income before income taxes          22.6           21.7          20.8           20.7
Income taxes                         8.0            7.7           7.2            7.3
Net income                          14.6           14.0          13.6           13.4

Comparison of Financial Results for the Three- and Nine-Month Periods Ended September 30, 2008 and 2007

Sales

Sales for the three-month period ended September 30, 2008 were $7,429,238, up 9% compared to $6,820,000for the same period in 2007. On a product line basis, this increase was primarily the result of increased sales of our gas analyzer and packaging products, primarily into our foreign markets. This increase was partially offset by a decline in sales of permeation equipment and services which was a result of slower domestic demand. We also benefitted from a weaker U.S. dollar in the three-month period ended September 30, 2008 compared to the same period in 2007, which made our products and services more attractive in the European market. On a geographical basis, total sales increased 24% in our foreign markets and decreased 9% domestically.

Sales for the nine-month period ended September 30, 2008 were $22,270,394, up 9% compared to $20,354,435 for the same period in 2007. On a product line basis, this increase was primarily the result of increased sales of our permeation products and services, packaging products, and gas analyzer instruments and sensors. We also benefitted from a weaker U.S. dollar in the nine-month period ended September 30, 2008 as compared to same period in 2007, which made our products and services more attractive in the European market. On a geographical basis, total sales increased 20% in our foreign markets, partially offset by a 2% decrease in our domestic markets. There were no significant price increases or decreases during either the third quarter or first nine months of 2008, compared to the same periods in 2007.

On a geographical basis, domestic and foreign sales accounted for 38% and 62%, respectively, of our consolidated third quarter sales in 2008, and 45% and 55% of our consolidated sales, respectively, for the same period in 2007. Domestic and foreign sales accounted for 44% and 56% of our consolidated sales for the first nine months of 2008, and 49% and 51% of our consolidated sales, respectively, for the same period in 2007.

The following table summarizes total sales by product line for the three- and nine-month periods ended September 30, 2008 and 2007:

                                 Three Months Ended             Nine Months Ended
                                    September 30,                 September 30,
                                 2008           2007           2008           2007
Permeation products and
services                     $  3,814,399   $  3,946,713   $ 12,050,577   $ 10,793,545
Gas, headspace, and other
analyzer products and
services                        3,395,414      2,614,772      9,175,977      8,595,820
Other instruments and
services                          219,425        258,515      1,043,840        965,070
Total sales                  $  7,429,238   $  6,820,000   $ 22,270,394   $ 20,354,435

The following table sets forth the relationship between various components of domestic and foreign sales for the three- and nine-month periods ended September 30, 2008 and 2007:

                         Three Months Ended            Nine Months Ended
                            September 30,                September 30,
                         2008          2007           2008           2007
Domestic sales        $ 2,812,010   $ 3,081,370   $  9,760,948   $  9,911,946
Foreign sales:
Europe                  1,992,022     1,921,438      5,765,695      4,364,121
Asia                    1,781,861     1,350,393      4,706,561      4,308,634
Other                     843,345       466,799      2,037,190      1,769,734
Total foreign sales     4,617,228     3,738,630     12,509,446     10,442,489
Total sales           $ 7,429,238   $ 6,820,000   $ 22,270,394   $ 20,354,435

Permeation Products and Services - Sales of our permeation products and services, which accounted for approximately 51% and 58% of our consolidated third quarter sales in 2008 and 2007, respectively, decreased 3% during the third quarter 2008 compared to the same period in 2007. This decrease, which was exclusively in our domestic markets, was due primarily to decreased demand for our core permeation instruments. International sales of permeation products and services accounted for 75% of the total sales of this product group in the third quarter 2008.

Sales of our permeation products and services, which accounted for approximately 54% and 53% of our consolidated sales during the first nine months in 2008 and 2007, respectively, increased 12% during the first nine months of 2008 compared to the same period in 2007. This increase, which was exclusively in our foreign markets, was due primarily to increased demand for instruments and testing services. International sales of permeation products and services accounted for 69% of the total sales of this product group in the first nine months of 2008.

Gas, Headspace, and Other Analyzer Products and Services - Sales of our gas, headspace, and other analyzer products and services, which accounted for 46% and 38% of our consolidated third quarter sales in 2008 and 2007, respectively, increased 30% during the third quarter 2008 compared to the same period in 2007. Within this group, sales of our gas analyzer products through our Baseline subsidiary increased 49% due primarily to sales of Model 8900 gas chromatographs to the environmental monitoring and oil and gas drilling markets.

Sales of our packaging products, which includes headspace analyzers and leak detection equipment, increased 17% during the third quarter 2008 compared to the same period in 2007. We experienced an increase in foreign orders for leak detection equipment (primarily in Europe) due to continued acceptance of the new Lippke 4000 product line introduced mid-2007. This was offset by a slight reduction in domestic orders for leak detection equipment while sales of headspace analyzers increased domestically, more than offsetting a slight decline in the international markets.

Sales of our gas, headspace, and other analyzer products, which accounted for 41% and 42% of our consolidated sales during the first nine months in 2008 and 2007, respectively, increased 7% during the first nine months of 2008 compared to the same period in 2007. Within this group, sales of our gas analyzer products through our Baseline subsidiary increased 6% due primarily to greater total hydrocarbon analyzer and sensor shipments.

Sales of our packaging products increased 9% during the first nine months of 2008 compared to the same period in 2007. This increase was due primarily to continued market acceptance of our PAC CHECKŪ series of analyzers and growth in shipments of our Lippke 4000 leak detection instruments.

Other Instruments and Services - Sales in our other instruments and services category, which accounted for 3% and 4% of our consolidated third quarter sales in 2008 and 2007, respectively, decreased 15% in the third quarter 2008, compared to the same period in 2007. This decrease was due primarily to a reduction in contract manufacturing of sample preparation products, reduced sales of non-MOCON products by our German subsidiary and decreased demand for our gas chromatography analyzer products and consulting services.

For both the nine months ended September 30, 2008 and 2007, sales of other instruments and services accounted for 5% of our consolidated sales, increasing 8% in the first nine months of 2008 as compared to the same period in 2007. The increase was primarily due to higher sales of sample preparation products which we manufacture under an exclusive contract and also the sales of non-MOCON products by our German subsidiary, partially offset by decreased sales of our consulting services.

Gross Profit

The gross profit margins for our product sales were 62.7% and 58.4% for the three-month periods ended September 30, 2008 and 2007, respectively. This increase was primarily due to the mix of products shipped, a price increase on gas chromatographs, and efficiencies gained by longer production runs of our gas analyzer instruments.

The gross profit margins for our consulting services were 40.5% and 45.1%, respectively, for the three-month periods ended September 30, 2008 and 2007. This decrease was primarily due to the varying margins between consulting service projects.

For the nine months ended September 30, 2008 and 2007, the gross profit margins for our products were 60.7% and 58.3%, respectively. The higher margin for the first nine months of 2008 was due primarily to the increased percentage of permeation and leak detection equipment sold, which generally carry a higher gross margin, as well as a shift in product mix in our gas analyzer line to higher margin items.

For the nine months ended September 30, 2008 and 2007, the gross profit margins for our consulting services were 41.0% and 44.8%, respectively. This decrease was primarily due to decreased demand for our consulting and analytical testing services which reduced the ability to fully absorb the related fixed overhead costs, and also the varying margins between consulting service projects.

Selling, General and Administrative Expenses

Selling, general and administrative (SG&A) expenses in the three-month period ended September 30, 2008 were $2,586,565, or 34.8% of sales, compared to $2,117,652, or 31.0% of sales in the third quarter 2007. The $468,913 increase in SG&A expenses was primarily the result of higher professional fees, increased personnel costs, relocation costs of our German office, and higher travel and marketing expenses.

SG&A expenses were $7,610,490, or 34.2% of sales, during the first nine months of 2008, compared to $6,444,582, or 31.6% of sales, for the same period in 2007. The increase in SG&A expenses was primarily due to increased personnel costs, increased marketing and travel expense, and higher professional fees.

Research and Development Expenses

Research and development (R&D) expenses were $433,630, or 5.8% of sales in the third quarter 2008, compared to $469,132, or 6.9% of sales, in the same period of 2007. This level of expense is slightly below our planned range of R&D expenditures.

R&D expenses were $1,460,594 and $1,439,232, or 6.5% and 7.1% of sales for the nine-month periods ended September 30, 2008 and 2007, respectively. For the foreseeable future, we expect to allocate on an annual basis approximately 6% to 8% of sales to research and development.

Other Income

Other income for the third quarter ended September 30, 2008 of $134,051 consisted of interest income of $149,408, partially offset by a loss of $15,357 on foreign currency exchange. Other income for the third quarter ended September 30, 2007 of $146,406 consisted of interest income of $144,437 and miscellaneous other income of $1,969.

For the nine months ended September 30, 2008, other income of $422,665 consisted of interest income of $429,686 and miscellaneous other income of $2,543, partially offset by a loss of $9,564 on foreign currency exchange. For the nine months ended September 30, 2007, other income of $414,312 consisted of interest income of $418,991 and miscellaneous other income of $1,630, partially offset by a loss of $6,309 on foreign currency exchange. Interest income increased for the third quarter and nine months ended September 30, 2008, compared to the same periods in 2007, due to higher average interest bearing investments, partially offset by lower average yields.

Income Tax Expense

Our provision for income taxes was 35.5% of income before income taxes for the third quarter ended September 30, 2008, compared to 35.6% of income before income taxes for the third quarter ended September 30, 2007. Based on current operating conditions and income tax laws, we expect the tax rate for the remainder of 2008 to be in the range of 31% to 36%. This rate fluctuates over time based on the income tax rates in the various jurisdictions in which we operate, and also the level of profits in those jurisdictions.

For the nine months ended September 30, 2008, our provision for income taxes was 34.7% of income before income taxes compared to 35.5% of income before income taxes for the nine months ended September 30, 2007. The lower effective rate in the current year period was due primarily to the increased amount of tax-exempt interest earned by the Company in 2008 and lower statutory tax rates in Germany.

Net Income

Net income was $1,081,555 in the third quarter 2008, compared to $955,392 in the third quarter 2007. Diluted net income was $0.19 and $0.17 per share in the third quarters of 2008 and 2007, respectively. For the nine months ended September 30, 2008, net income was $3,018,551, or $0.53 per diluted share, compared to net income of $2,720,609, or $0.48 per diluted share in the prior year.

Liquidity and Capital Resources

We have historically financed our operations, capital expenditures and other liquidity needs through our cash flows generated from operations. Total cash, cash equivalents and marketable securities increased $1,175,519 during the first nine months of 2008 to $16,200,400 as of September 30, 2008, compared to $15,024,881 at December 31, 2007. Our working capital as of September 30, 2008 decreased $1,087,354 to $16,269,710, as compared to $17,357,064 at December 31, 2007. This decrease was primarily due to a shift in the investment strategy of some marketable securities to longer than one year maturities. Our investment in marketable securities consists primarily of municipal bonds, certificates of deposits and U.S. treasury obligations. We do not currently have any funds invested in auction rate certificates. We believe that a combination of our existing cash, cash equivalents and marketable securities, plus an expected continuation of cash flow from operations, will continue to be adequate to fund our operations, capital expenditures, dividend payments and authorized stock repurchases for at

least the next twelve months. Purchases of property and equipment were relatively constant between the two periods mentioned above, and we had no material commitments for capital expenditures as of September 30, 2008 except for expected renovation costs for our Colorado building of approximately $350,000 which we expect will be fully incurred by the end of 2008.

One of our strategic objectives is, as market and business conditions warrant, to consider acquisitions of businesses, products or technologies. We may need to fund such activities, should they arise, with a combination of cash on hand and debt and/or equity financing, although no assurance can be given that such debt and/or equity financing will be available at reasonable terms or at all. We currently do not have any committed lines of credit or other credit facilities available for use. If we raise additional funds by issuing debt, we may be subject to restrictive covenants that could limit our operational flexibility and higher interest expense could dilute earnings per share. Any plan to raise additional capital may involve an equity-based or equity-linked financing, which may be dilutive to existing shareholders.

Cash Flow

Cash Flow from Operating Activities

Our primary source of funds is cash provided by operating activities which totaled $2,571,899 and $2,552,527 in the first nine months of 2008 and 2007, respectively. The key components of the cash provided by operating activities in 2008 were the net income and increased accounts payable, primarily offset by increases in inventories, prepaid expenses and accounts receivable.

Cash Flow from Investing Activities

Cash used in investing activities totaled $2,663,696 and $529,634 in the first nine months of 2008 and 2007, respectively. The primary reasons for cash usage in 2008 were net purchases of marketable securities of $2,207,530 and purchases of property and equipment. For 2007, the primary reasons for the cash usage were the final earn-out payment of $574,568 made for the Lippke acquisition and purchases of property and equipment, partially offset by the impact of net proceeds from the maturity of marketable securities of $314,171. We presently do not believe that any significant property, plant and equipment expenditures are required to accommodate our current level of operations except for the building renovation at our Colorado facility mentioned above.

Cash Flow from Financing Activities

Cash used in financing activities totaled $846,169 and $834,851 in the first nine months of 2008 and 2007, respectively. During the first nine months of 2008 and 2007, we made dividend payments to our shareholders of $1,359,833 and $1,261,916, respectively. Partially offsetting the impact of these payments were the proceeds from the exercise of stock options in the amounts of $491,062 and $427,065 in the first nine months of 2008 and 2007, respectively.

Our Board of Directors has authorized, depending upon market conditions and other factors, the repurchase of up to a total of $2,000,000 of our common stock. As of September 30, 2008, we had repurchased an aggregate of 41,725 shares of MOCON common stock under the program at a total cumulative cost of $365,094, leaving $1,634,906 remaining in this authorization at that date.

Contractual Obligations

We refer you to our Annual Report on Form 10-K for the year ended December 31, 2007 for a summary of our contractual obligations. There has been no material change in this information.

Off-Balance Sheet Arrangements

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

New Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued the Statement of Financial Accounting Standard (SFAS) No. 157, Fair Value Measurement (SFAS 157). This statement did not require any new fair value measurements, but rather, it provided enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. The changes to current practice resulting from the application of this statement related to the definition of fair value, the methods used to estimate fair value, and the requirement for expanded disclosures about estimates of fair value. This statement became effective for us beginning in 2008. The effective date for this statement for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring bases, has been delayed by one year. We adopted the provisions of SFAS 157 related to financial assets and financial liabilities on January 1, 2008. The partial adoption of this statement did not have an impact on our consolidated financial statements. It is expected that the remaining provisions of this statement will not have a material effect on our consolidated financial statements.

In February 2008, the FASB issued FASB Staff Position (FSP) No. 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Its Related Interpretive Accounting Pronouncements That Address Leasing Transactions, and FSP FAS 157-2, Effective Date of FASB Statement No. 157. FSP FAS 157-1 removes leasing from the scope of SFAS 157, Fair Value Measurements. FSP FAS 157-2 delays the effective date of SFAS 157 from 2008 to 2009 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). See SFAS 157 discussion above. Adoption of FSP FAS 157-1 did not have an effect on our consolidated financial statements.

In October 2008, the FASB issued FSP No. FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Activewhich clarifies the application of SFAS 157 in an inactive market and illustrates how an entity would determine fair value when the market for a financial asset is not active. The Staff Position is effective immediately and applies to prior periods for which financial statements have not been issued, including interim or annual periods ending on or before September 28, 2008. The implementation of FAS 157-3 did not have a material impact on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement 115 (SFAS 159). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 was effective for us beginning in 2008 and was to be applied prospectively. As we did not elect to measure existing assets and liabilities at fair value, the adoption of this statement did not have an effect on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141(R)). SFAS 141(R) retains the fundamental requirements of the original pronouncement requiring that the purchase method be used for all business combinations. SFAS 141(R) defines the acquirer as the entity that obtains control of one or more businesses in the business combination, establishes the acquisition date as the date that the acquirer achieves control and requires the acquirer to recognize the assets acquired, liabilities assumed and any noncontrolling interest at their fair values as of the

acquisition date. SFAS 141(R) also requires that acquisition-related costs be recognized separately from the acquisition. SFAS 141(R) becomes effective for business combinations occurring on or after January 1, 2009, and early adoption is prohibited.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements (SFAS 160). SFAS 160 clarifies that a noncontrolling interest in a subsidiary should be reported as equity in the consolidated financial statements. Consolidated net income should include the net income for both the parent and the noncontrolling interest with disclosure of both amounts on the consolidated statement of income. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. SFAS 160 is effective for us beginning in 2009. We currently do not have any subsidiaries in which we hold a noncontrolling interest and, therefore, we believe this pronouncement will have no impact on our consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161), an amendment of SFAS No. 133. SFAS 161 establishes, among other things, the disclosure requirements for derivative instruments and for hedging activities. The intent is to provide users of financial statements with an enhanced understanding of a) how and why an entity uses derivative instruments, b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and c) how derivative instruments and related hedged items affect an entity's . . .