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. 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, we opened our office in Shanghai, China in 2007 to better serve our Asian customers.

Our current plans for growth include continued funding for research and development 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
six-month periods ended June 30, 2009 and 2008:



                                       Three Months Ended         Six Months Ended
                                            June 30,                  June 30,
                                       2009         2008         2009         2008
 Sales                                   100.0        100.0        100.0        100.0
 Cost of sales                            43.5         40.4         42.7         41.3
 Gross profit                             56.5         59.6         57.3         58.7
 Selling, general and
 administrative expenses                  38.8         33.1         40.3         33.8
 Research and development
 expenses                                  7.2          6.5          7.7          6.9
 Operating income                         10.5         20.0          9.3         18.0
 Other income                              1.8          2.1          1.9          1.9
 Income before income taxes               12.3         22.1         11.2         19.9
 Income taxes                              4.3          7.9          3.9          6.8
 Net income                                8.0         14.2          7.3         13.1

Comparison of Financial Results for the Three- and Six-Month Periods Ended June 30, 2009 and 2008

Sales

Sales for the three-month period ended June 30, 2009 were $6,421,000, down 13% compared to $7,379,000for the same period in 2008. The effects of the global economic recession contributed to a decrease in sales across most major product lines and market regions. On a geographical basis, sales decreased 20% and 7% in our domestic and foreign markets, respectively. Domestic and foreign sales accounted for 43% and 57%, respectively, of our consolidated second quarter sales in 2009, and 47% and 53% of our consolidated sales, respectively, for the same period in 2008.

Sales for the six-month period ended June 30, 2009 were $12,593,000, down 15% compared to $14,841,000for the same period in 2008. Sales in the prior period benefited from a weaker U.S. dollar which made our products and services more attractive in the European market. On a geographical basis, sales decreased 19% and 12% in our domestic and foreign markets, respectively. Domestic and foreign sales accounted for 45% and 55%, respectively, of our consolidated sales for the first six months of 2009, and 47% and 53% for the same period in 2008.

The following table summarizes total sales by product line for the three- and six-month periods ended June 30, 2009 and 2008:

                                        Three Months Ended              Six Months Ended
                                             June 30,                       June 30,
                                       2009           2008            2009            2008
Permeation products and services    $ 3,619,027    $ 4,302,125    $  7,211,652    $  8,236,178
Gas, headspace, and other
analyzer products and services        2,381,052      2,751,485       4,747,048       5,780,563
Other instruments and services          421,257        325,112         634,395         824,415
                                    $ 6,421,336    $ 7,378,722    $ 12,593,095    $ 14,841,156

The following table sets forth the relationship between various components of domestic and foreign sales for the three- and six-month periods ended June 30, 2009 and 2008:

                                Three Months Ended            Six Months Ended
                                     June 30,                     June 30,
                                2009          2008           2009           2008
       Domestic sales        $ 2,773,904   $ 3,456,007   $  5,663,336   $  6,948,938
       Foreign sales:
       Europe                  1,769,388     1,790,772      3,363,147      3,773,673
       Asia                    1,371,598     1,491,505      2,543,181      2,924,700
       Other                     506,446       640,438      1,023,431      1,193,845
       Total foreign sales     3,647,432     3,922,715      6,929,759      7,892,218
                             $ 6,421,336   $ 7,378,722   $ 12,593,095   $ 14,841,156

Permeation Products and Services - Sales of our permeation products and services, which accounted for 56% and 58% of our consolidated second quarter sales in 2009 and 2008, respectively, decreased 16% during the second quarter 2009 compared to the same period in 2008. This decrease, in both our domestic and foreign markets, was due primarily to decreased demand for our core permeation instruments, as orders for capital equipment have weakened. International sales of permeation products and services accounted for 68% of the total sales of this product group in the second quarter 2009.

Sales of our permeation products and services, which accounted for approximately 57% and 55% of our consolidated sales during the first six months in 2009 and 2008, respectively, decreased 12% during the first six months of 2009 compared to the same period in 2008. The decrease was evident in both our domestic and foreign markets.

Gas, Headspace, and Other Analyzer Products and Services - Sales of our gas, headspace, and other analyzer products and services, which accounted for 37% of our consolidated second quarter sales in both 2009 and 2008, decreased 13% during the second quarter 2009 compared to the same period in 2008. Within this group, sales of our packaging products, which includes headspace analyzers and leak detection equipment, increased 27% during the second quarter 2009 compared to the same period in 2008 primarily due to continued growth of the PAC CHECK® series of headspace analyzers including the new Model 450 EC benchtop unit, and the Lippke® Model 4500 package test system. However, sales of our gas analyzer products through our Baseline subsidiary decreased 36% due primarily to reduced demand for gas chromatograph instruments and piD-TECH® sensors. Sales of our total hydrocarbon analyzer instruments were consistent between periods.

Sales of our gas, headspace, and other analyzer products and services, which accounted for 38% and 39% of our consolidated sales during the first six months in 2009 and 2008, respectively, decreased 18% during the first six months of 2009 compared to the same period in 2008. Within this group, sales of our packaging products, which includes headspace analyzers and leak detection equipment, increased 4% during the first six months of 2009 compared to the same period in 2008. However, sales of our gas analyzer products through our Baseline subsidiary decreased 26% due primarily to reduced demand for gas chromatograph and total hydrocarbon analyzer instruments, as well as piD-TECH sensors, partially offset by an increase in sales of detectors to the OEM market.

Other Instruments and Services - Sales in our other instruments and services category, which accounted for 7% and 5% of our consolidated second quarter sales in 2009 and 2008, respectively, increased 30% in the second quarter 2009, compared to the same period in 2008. This increase was due primarily to increased demand for our aroma and off-odor compound analysis instruments and an increase in contract manufacturing of sample preparation products.

Sales in our other instruments and services category, which accounted for 5% and 6% of our consolidated sales during the first six months in 2009 and 2008, respectively, decreased 23% during the first six months of 2009, compared to the same period in 2008. This decrease was due primarily to a reduction in contract manufacturing of sample preparation products and reduced sales of non-MOCON products by our German subsidiary.

Gross Profit

The gross profit margins for our product sales were 57.2% and 60.5% for the three-month periods ended June 30, 2009 and 2008, respectively. This decrease was primarily due to the lower percentage of permeation equipment sold, which generally carries a higher gross margin, as well as the lower volume over which to allocate fixed costs. The gross profit margins for our consulting services were 48.4% and 46.4%, respectively, for the three-month periods ended June 30, 2009 and 2008. This increase was primarily due to the increase in sales and also the varying margins between consulting service projects.

For the six months ended June 30, 2009 and 2008, the gross profit margins for our products were 58.4% and 59.7%, respectively. This decrease was primarily due to sales mix as sales of higher margin permeation equipment were lower in the current period, as well as the lower volume over which to allocate fixed costs. For the six months ended June 30, 2009 and 2008, the gross profit margins for our consulting services were consistent at 41.8% and 41.3%, respectively.

Selling, General and Administrative Expenses

Selling, general and administrative (SG&A) expenses were $2,491,000 in the three-month period ended June 30, 2009, consistent with $2,441,000 in the same period of 2008. As a percentage, SG&A expenses were 38.8% and 33.1% of consolidated sales in the second quarters of 2009 and 2008, respectively, due to the lower sales level in 2009. Higher wages and benefits and increased marketing expenses were offset by lower professional fees and stock option expense in the second quarter 2009 compared to the same period in 2008.

SG&A expenses were $5,072,000 in the six-month period ended June 30, 2009, consistent with $5,024,000 in the same period of 2008. As a percentage, SG&A expenses were 40.3% and 33.8% of consolidated sales in the first six months of 2009 and 2008, respectively, due to the lower sales level in 2009. Higher wages and benefits and increased marketing expenses were offset by lower incentive compensation, stock option expense and professional fees in the first six months of 2009 compared to the same period in the prior year.

Research and Development Expenses

Research and development (R&D) expenses were $462,000, or 7.2% of sales in the second quarter 2009, compared to $483,000, or 6.5% of sales, in the same period of 2008. R&D expenses were $970,000, or 7.7% of sales in the first six months of 2009, compared to $1,027,000, or 6.9% of sales, in the same period of 2008. Our intent is to spend between 6% and 8% of consolidated sales on R&D on an on-going basis.

Other Income


Other income for the three- and six-month periods ended June 30, 2009 and 2008
was as follows:



                                         Three Months Ended       Six Months Ended
                                              June 30,                June 30,
                                          2009        2008        2009        2008
      Interest income                  $  103,154   $ 141,169   $ 220,916   $ 280,278
      Foreign currency exchange gain       12,611      12,378       4,593       5,793
      Other                                 3,507       3,374       3,070       2,543
                                       $  119,272   $ 156,921   $ 228,579   $ 288,614

Interest income decreased for both the second quarter and six months ended June 30, 2009, compared to the same periods in 2008, due to lower average yields on lower average interest bearing investments.

Income Tax Expense

Our provision for income taxes was 35.0% of income before income taxes for the second quarter ended June 30, 2009, compared to 35.6% of income before income taxes for the second quarter ended June 30, 2008. This decrease in the effective tax rate in the second quarter 2009 was primarily due to a one-time charge that occurred in the second quarter 2008.

For the six months ended June 30, 2009, our provision for income taxes was 34.9% of income before income taxes compared to 34.2% of income before income taxes for the similar period in the prior year. The higher rate in the current year was primarily due to the impact of permanent items applied to a lower income base.

Based on current projected annual operating results and current income tax rates, we expect the effective tax rate for the remainder of 2009 to be in the range of 33% 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.

Net Income

Net income was $516,000 in the second quarter 2009, compared to $1,051,000 in the first quarter 2008. Diluted net income per share was $0.09 and $0.18 in the second quarters of 2009 and 2008, respectively. For the six months ended June 30, 2009, net income was $914,000, or $0.16 per diluted share, compared to net income of $1,937,000, or $0.34 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. During the second quarter 2009, we initiated a $1,000,000 revolving line of credit to supplement current working capital requirements. Total cash, cash equivalents and marketable securities decreased $2,173,000 during the first six months of 2009 to $13,936,000 as of June 30, 2009, compared to $16,109,000 at December 31, 2008. The primary reason for this decrease was due to the repurchase of 181,171 shares of our common stock for an aggregate of $1,590,000. Our working capital as of June 30, 2009 increased $655,000 to $18,548,000, as compared to $17,893,000 at December 31, 2008. We invest our excess cash in marketable securities consisting primarily of municipal bonds, certificates of deposits and U.S. treasury obligations. We believe that a combination of our existing cash, cash equivalents and marketable securities, revolving credit line and 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 first six months of 2009 and 2008, and we had no material commitments for capital expenditures as of June 30, 2009.

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. 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 $307,000 and $1,924,000 in the first six months of 2009 and 2008, respectively. The key components of the cash provided by operating activities in 2009 were the income for the period and reduced inventories and accounts receivable. These increases were partially offset by a reduction of accounts payable, a reduction in accrued compensation and vacation, which was primarily due to the March 2009 payment of incentive bonuses related to 2008, and an increase in prepaid income taxes.

Cash Flow from Investing Activities

Cash provided by (used in) investing activities totaled $1,360,000 and ($1,467,000) in the first six months of 2009 and 2008, respectively. The primary reasons for cash provided by investing activities in 2009 were net proceeds from maturities of marketable securities of $1,617,000, offset somewhat by purchases of property and equipment. We presently do not believe that any significant property, plant and equipment expenditures are required to accommodate our current level of operations.

Cash Flow from Financing Activities

Cash used in financing activities totaled $2,189,000 and $478,000 in the first six months of 2009 and 2008, respectively. During the first six months of 2009 and 2008, we made dividend payments to our shareholders of $1,006,000 and $886,000, respectively. During the second quarter of 2009, we borrowed $1,000,000 under our revolving line of credit and repaid $600,000 before June 30, 2009. Also, during the second quarter 2009, we repurchased $1,590,000 of our outstanding common stock. Partially offsetting the impact of the dividend payments in 2008 were the proceeds from the exercise of stock options in the amount of $385,000.

In June 2009, our Board of Directors 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 June 30, 2009, the full amount of this authorization remained in place. During the first six months of 2009 we repurchased 181,171 shares at a total cost of $1,590,000 which completely utilized the prior authorization.

Contractual Obligations

We refer you to our Annual Report on Form 10-K for the year ended December 31, 2008 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.

Recently Issued Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167). SFAS 167 amends certain requirements of FASB Interpretation No.46 (revised December 2003), Consolidation of Variable Interest Entities, to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS 167 becomes effective for us in 2010. We do not expect the adoption of SFAS 167 to have a material effect on our consolidated financial statements.

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles (SFAS 168). SFAS 168 replaces SFAS No. 162 and establishes the FASB Accounting Standards Codification (Codification) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. SFAS 168 becomes effective for us in the third quarter of 2009. We do not expect that the adoption of SFAS 168 will have a material effect on our consolidated financial statements.

Critical Accounting Policies

Our significant accounting policies are described in Note 1 to our consolidated financial statements. 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 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 collectibility is reasonably assured. Our terms are F.O.B. shipping point with no right of return, and customer acceptance of our 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 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts.

Emerging Issues Task Force (EITF) Issue 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, we allocate 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 June 30, 2009, we had $180,000 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 June 30, 2009, we had $308,000 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.

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 . . .