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 including those discussed under the heading "Item 1A. Risk Factors" and elsewhere in this report. For more information, see "Part I Item 1 Business-Forward-Looking Statements" of this report. The following discussion of the results of the 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. 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 sales 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, we opened our office in Shanghai, China in 2007 to better serve our Asian customers.

Our current plans for growth include substantial funding for research and development to foster new product development together with strategic acquisitions where appropriate. In February 2006, we sold the capital stock of our Lab Connections, Inc. subsidiary in exchange for $517,296 in cash, subject to a purchase price adjustment based on the amount of Lab Connections' net tangible assets as of the closing date. As a result of the sale, we recognized an after-tax gain of $92,345 in the first quarter 2006. See Note 16 to our consolidated financial statements.

Significant Transactions and Financial Trends

Throughout these financial sections, you will read about significant transactions or events that materially contribute to, or reduce our earnings, and materially affect our financial results and financial position. Significant transactions and events that affected our 2008 financial results and position included the moving of our German office to a new facility. Significant transactions, such as the sale of our Lab Connections subsidiary in 2006, result from unique facts and circumstances and, given their nature, some of these items will likely not recur with similar materiality or impact on our continuing operations.

Our international sales have historically accounted for a significant portion of our revenues, and we expect our international sales, as a percentage of total sales, to continue to increase for the foreseeable future.

Our research and development costs were approximately 7% of our consolidated sales for the years 2008, 2007 and 2006. On an annual basis, we intend to spend approximately 6% to 8% of our sales on research and development in the future.

Critical Accounting Policies

Our significant accounting policies are described in Note 1 to our consolidated financial statements included in Item 8 of this report. This Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Securities and Exchange Commission has defined a company's most critical accounting policies as those that are most important to the portrayal of its financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the following critical accounting policies. Although we believe that our estimates and assumptions are reasonable, they are based upon information available when they are made. Actual results may differ significantly from these estimates under different assumptions or conditions.

Revenue Recognition

We recognize revenue when it is realized or realizable and earned. In accordance with the Securities and Exchange Commission Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition, we consider revenue realized or realizable when persuasive evidence of an arrangement exists, the product has been shipped or the services have been provided to the customer, title and risk of loss of products has passed to the customer, the sales price is fixed or determinable, and collectability is reasonably assured. Our terms are F.O.B. shipping point with no right of return, and customer acceptance of its products is not required. The revenue recognition policy does not differ among the various product lines, the marketing venues, or various geographic destinations. We do not have distributors who stock our equipment. We do not offer rebates, price protection, or other similar incentives, and discounts when offered are recorded as a reduction in revenue.

Revenue for preventive maintenance agreements is recognized on a per visit basis and extended warranties on a straight-line basis over the life of the contracts, in accordance with FASB Technical Bulletin No. 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts.

Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, provides revenue recognition guidance for arrangements with multiple deliverables, and the criteria to determine if items in a multiple deliverable agreement should be accounted for separately. If products or services are sold on a standalone basis, revenue is recognized as the products or services are delivered. When products or services are sold as part of a multiple element arrangement, the Company allocates revenue on a relative fair value basis.

Allowance for Doubtful Accounts and Sales Returns

Our allowance for doubtful accounts and sales returns is for accounts receivable balances that are estimated to be uncollectible as well as anticipated sales returns. The reserve is based on a number of factors, including: (1) an analysis of customer accounts and (2) our historical experience with accounts receivable write-offs and sales returns. The analysis includes the age of the receivable, the financial

condition of a customer or industry and general economic conditions. We believe our financial results could be materially different if historical trends do not reflect actual results or if economic conditions worsened for our customers. In the event we determined that a smaller or larger allowance for doubtful accounts is appropriate, we would record a credit or charge to selling, general and administrative expense in the period that we made such a determination. As of December 31, 2008 and 2007, we had $137,182 and $125,797, respectively, reserved against our accounts receivable for doubtful accounts and sales returns.

Accrual for Excess and Obsolete Inventories

We perform an analysis to identify excess and obsolete inventory. We record a charge to cost of sales for amounts identified. Our analysis includes inventory levels, the nature of the finished product and its inherent risk of obsolescence and the on-hand quantities relative to the sales history of that finished product. We believe that our financial 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. As of December 31, 2008 and 2007, we had $303,823 and $335,344, respectively, accrued for excess and obsolete inventories.

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, changes in the economic environment in which we operate, competitive conditions, and other factors could result in future impairment charges. We did not record any long-lived asset impairment charges in 2008, 2007 or 2006.

Accrued Product Warranties

Our products are generally covered by a warranty, with warranty periods ranging from ninety days to one year from the date of sale. Estimated warranty costs are accrued in the same period in which the related revenue is recognized, based on anticipated parts and labor costs, utilizing historical experience. Additional warranty reserves are also accrued for major rework campaigns. We periodically assess the adequacy of our warranty reserves based on changes in these factors and record any necessary adjustments if actual claim experience indicates that adjustments are necessary. Although we believe the likelihood to be relatively low, warranty claims experience could be materially different from actual results due to manufacturing changes that could impact product quality, a change in our warranty policy in response to industry trends, as yet unrecognized defects in products sold, or other factors. As of December 31, 2008 and 2007, we had $229,087 and $201,373, respectively, accrued for future estimated warranty claims.

Income Taxes

In the preparation of our consolidated financial statements, management is required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax exposures together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Consolidated Balance Sheets.

Management reviews the deferred tax assets for recoverability on a quarterly basis and assesses the need for valuation allowances. These deferred tax assets are evaluated by considering historical levels of

income, estimates of future taxable income streams and the impact of tax planning strategies. A valuation allowance is recorded to reduce deferred tax assets when it is determined that it is more likely than not that we would not be able to realize all or part of our deferred tax assets. At December 31, 2008 and 2007, we provided a valuation allowance in the amounts of $364,000 and $324,000, respectively, against our net deferred tax assets, related primarily to the long-term capital loss carryforward.

On January 1, 2007, we adopted FIN 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement 109. FIN 48 requires application of a more-likely-than-not threshold to the recognition and derecognition of uncertain tax positions. Under FIN 48, once the more-likely-than-not threshold is met, the amount of benefit to be recognized is the largest amount of tax benefit that is greater than 50% likely of being ultimately realized upon settlement. It further requires that a change in judgment related to the expected ultimate resolution of uncertain tax positions be recognized in earnings in the period of such a change. We have recognized a tax accrual in the amount of $216,000 for estimated exposures associated with uncertain tax positions and periodically adjust this accrual when facts and circumstances change. However, due to the complexity of some of these uncertainties, the ultimate settlement may result in payments that are significantly different from our current estimate of tax liabilities, resulting in the recognition of additional charges or benefits to income tax expense.

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 fiscal years ended December 31, 2008, 2007 and 2006. Our historical financial data were derived from our consolidated financial statements and related notes included in Item 8 of this report.

                                                              Percent of Sales
                                                          2008      2007      2006
      Sales                                                100.0     100.0     100.0
      Cost of sales                                         40.8      41.6      42.4

              Gross profit                                  59.2      58.4      57.6
      Selling, general and administrative expenses          34.2      31.5      29.4
      Research and development expenses                      6.6       7.4       7.4

              Operating income                              18.4      19.5      20.8
      Other income, net                                      2.0       2.1       1.5

              Income before income taxes                    20.4      21.6      22.3
      Income taxes                                           6.7       7.7       7.5

              Income from continuing operations             13.7      13.9      14.8
              Gain from discontinued operations,
                      net of tax                               -         -       0.1

      Net income                                            13.7      13.9      14.9

                                                  Years Ended December 31,
                                             2008           2007           2006
      Permeation products and services   $ 15,850,027   $ 14,428,823   $ 14,604,579
      Gas, headspace and other
      analyzer products
           and services                    12,490,244     11,478,501     10,072,101
      Other instruments and services        1,355,435      1,489,258      1,613,295

      Total sales                        $ 29,695,706   $ 27,396,582   $ 26,289,975

The following table sets forth the relationship between various components of domestic and foreign sales for 2008, 2007 and 2006:

                                            Years Ended December 31,
                                       2008           2007           2006
           Domestic sales          $ 12,960,723   $ 13,160,268   $ 11,924,805
           Foreign Sales:
             Europe                   7,836,335      6,595,075      7,360,019
             Asia                     6,144,822      5,309,901      4,842,523
             Other                    2,753,826      2,331,338      2,162,628

             Total foreign sales     16,734,983     14,236,314     14,365,170

           Total sales             $ 29,695,706   $ 27,396,582   $ 26,289,975

Sales

Sales for 2008 were $29,696,000, an increase of 8% compared to $27,397,000 for 2007. This increase in sales was primarily the result of the increased volume of our permeation products and services, gas analyzer instruments and sensors, and packaging products. These increases were partially offset by decreases in the sale of weighing and pharmaceutical products and gas chromatography instruments and services. Our domestic sales were $12,961,000, or 44% of total sales in 2008, a 2% decrease compared to $13,160,000, or 48% of sales in 2007. Our foreign sales were $16,735,000, or 56% of total sales in 2008, an increase of 18% compared to $14,236,000, or 52% of sales in 2007. The overall sales volume increase in 2008 was driven by an increased demand as a result of enhanced marketing efforts in our foreign markets, which offset a slight decline in sales in our domestic markets. The impact of any price increases was not significant in 2008.

Permeation Products and Services-Sales of our permeation products and services, which accounted for 53% of our consolidated sales in both 2008 and 2007, increased $1,421,000, or 10% in 2008 compared to 2007. This increase in permeation sales was primarily due to a 21% increase in foreign sales. We believe that product introductions in recent years, specifically the PERMATRAN-W Model 1/50 (lower price point product for less sensitivity in water vapor measurement), and growing acceptance of the AQUATRAN (for increased sensitivity in measuring water vapor) were factors in this growth. Domestic sales declined 11% from 2007 to 2008, which we believe is attributable to the slowdown in the U.S. economy in the second half of the year.

Gas, Headspace and Other Analyzer Products and Services-Sales of our gas, headspace, and other analyzer products and services, which accounted for 42% our consolidated sales in both 2008 and 2007, increased $1,012,000, or 9% in 2008 compared to 2007. Within this group, sales of our gas analyzers and sensors through our Baseline subsidiary, which accounted for 23% and 21% of our 2008 and 2007

consolidated sales, respectively, increased $1,016,000, or 18% in 2008 to $6,679,000 compared to $5,663,000 in 2007. This was due primarily to increased shipments of the piD-TECH Plus to the OEM portable sensor market, which increase was offset somewhat by a decrease in the sales of gas chromatographs. Sales of total hydrocarbon analyzer instruments were essentially the same in both years. Baseline's domestic sales increased $820,000, or 24% in 2008 compared to 2007, and foreign sales increased $196,000, or 9% over the same period.

Sales of our packaging products (headspace analyzers and leak detection), which accounted for 16% and 17% of our consolidated sales in 2008 and 2007, respectively, increased $137,000, or 3% in 2008 to $4,822,000 compared to $4,685,000 in 2007. The increase resulted from sales of our Lippke 4000 leak detection instrument primarily in the European markets as well as continued market acceptance of our PAC CHECK series of analyzers generally used for headspace analysis. Our emphasis on the international markets resulted in a 19% increase in sales outside the U.S. of packaging products in 2008 over 2007, and our entry into the medical device market in 2008 contributed to the overall sales increase.

Sales of our weighing and pharmaceutical products, which accounted for 3% and 4% of our consolidated sales in 2008 and 2007, respectively, decreased $141,000, or 12% in 2008 compared to 2007. The decrease resulted from decreased demand in both our domestic and foreign markets. Our weighing and pharmaceutical products group consists of a relatively fewer number of products compared to our other product groups and will typically experience significant fluctuations in demand.

Other Instruments and Services-Sales of our other instruments and services group, which accounted for 5% of our consolidated sales in both 2008 and 2007, decreased $134,000, or 9% in 2008 compared to 2007. This decrease was due primarily to lower sales of our consulting and testing laboratory services.

Sales for 2007 were $27,397,000, an increase of 4% compared to $26,290,000 for 2006. This increase in sales was primarily the result of the increased volume of our gas analyzer and packaging products, together with increased domestic sales volume of our permeation products and services. These increases were partially offset by decreases in the foreign sales volume of our permeation products and services and a decline in the sale of weighing and pharmaceutical products. Our domestic sales were $13,160,000, or 48% of total sales in 2007, an increase of 10% compared to $11,925,000, or 45% of sales in 2006. Our foreign sales were $14,236,000, or 52% of total sales in 2007, a decrease of 1% compared to $14,365,000, or 55% of sales in 2006. The overall sales volume increase in 2007 was generally the result of increased demand primarily in our domestic markets. The impact of any price increases was not significant in 2007.

Permeation Products and Services-Sales of our permeation products and services were $14,429,000 and $14,605,000 in 2007 and 2006, respectively, or approximately 53% and 56%, respectively, of our consolidated sales. The 1% decrease in permeation sales in 2007 compared to 2006 was primarily due to an $814,000, or 8% drop in foreign sales. Foreign sales had been favorably impacted in 2006 as a result of a large order from China in the amount of $659,000. By comparison, our domestic sales of permeation equipment and services increased by $638,000, or 14% in 2007 as compared to 2006. We believe that new product introductions, specifically the AQUATRAN (for increased sensitivity in measuring water vapor) and the OX-TRAN Model 2/10 (lower price point product for less sensitivity in oxygen measurement) were factors in this growth.

Gas, Headspace and Other Analyzer Products and Services-Sales of our gas, headspace, and other analyzer products and services, which accounted for 42% and 38% of our consolidated sales in 2007 and 2006, respectively, increased $1,406,000, or 14% in 2007 compared to 2006. Within this group, sales of our gas analyzers and sensors through our Baseline subsidiary, which accounted for 21% and 18% of

our 2007 and 2006 consolidated sales, respectively, increased $925,000, or 20% in 2007 to $5,663,000 compared to $4,738,000 in 2006. This increase was due primarily to shipments of the piD-TECH Plus to the OEM portable sensor market as well as ongoing shipments of our total hydrocarbon analyzers and gas chromatographs. Baseline's domestic sales increased $486,000, or 17% in 2007 compared to 2006, and foreign sales increased $439,000, or 24% over the same period.

Sales of our packaging products (headspace analyzers and leak detection), which accounted for 17% and 15% of our consolidated sales in 2007 and 2006, respectively, increased $804,000, or 21% in 2007 to $4,685,000 compared to $3,881,000 in 2006. The increase resulted primarily from sales of our PAC CHECK series of analyzers and was evident in both our domestic and foreign markets.

Sales of our weighing and pharmaceutical products, which accounted for 4% and 6% of our consolidated sales in 2007 and 2006, respectively, decreased $323,000, or 22% in 2007 compared to 2006. The decrease resulted from decreased demand in both our domestic and foreign markets. Our weighing and pharmaceutical products group consists of a relatively fewer number of products compared to our other product groups and will typically experience significant fluctuations in demand.

Other Instruments and Services-Sales of our other instruments and services group, which accounted for 5% and 6% of our consolidated sales in 2007 and 2006, respectively, decreased $124,000, or 8% in 2007 compared to 2006. This decrease was due both to lower sales of non-MOCON products by our German subsidiary and also a decrease in sales of our consulting and testing laboratory services.

Gross Profit

Our gross profit percentages were 59.2% and 58.4% during 2008 and 2007, respectively. The increase in gross profit percentage resulted primarily from a higher concentration of permeation equipment sales, sales of new products which replaced older, less profitable items, and higher volume in our detector and sensor area which resulted in increased manufacturing efficiencies.

Our gross profit percentages were 58.4% and 57.6% during 2007 and 2006, respectively. One strategic initiative for us in 2007 was to improve our product margins. The increase in gross profit percentage resulted primarily from sales of some of our new products that carried higher margins.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $10,170,000 and $8,644,000, or 34.2% and 31.5% of sales in 2008 and 2007, respectively. The increase of $1,526,000 was due primarily to the following: higher salaries and benefits relating to annual wage increases and a 5% increase in average headcount; increased travel, marketing and promotion expenses related to our increased emphasis in foreign markets; and increased professional fees.

Selling, general and administrative expenses were $8,644,000 and $7,736,000, or 31.5% and 29.4% of sales in 2007 and 2006, respectively. The increase of $908,000 was due primarily to a higher headcount and related hiring expenses, increased stock option expense, increased SOX 404 compliance costs and the expenses related to the opening and ongoing costs associated with the sales and technical support office in China.

Research and development (R&D) expenses were $1,951,000 and $2,030,000 in 2008 and 2007, respectively, or 6.6% and 7.4% of sales, respectively. The relatively consistent spending between years was in line with our 2008 R&D plan. For the foreseeable future, we intend to allocate on an annual basis approximately 6% to 8% of sales to research and development. We believe continued R&D expenditures are necessary as we develop new products to expand revenue opportunities in our niche markets and remain competitive.

Research and development (R&D) expenses were $2,030,000 and $1,943,000 in 2007 and 2006, respectively, or 7.4% of sales in both periods. The increase of $87,000 in 2007 compared to 2006 was in line with our plan to continue to develop products that meet our customers' needs.

Other Income, Net

    Other income, net for 2008, 2007 and 2006 was as follows:

                                                     Years Ended December 31,
                                                   2008        2007        2006
       Interest income on investments            $ 575,094   $ 565,441   $ 412,882
. . .