UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

þ		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2006

o		Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                     to                    

MOD-PAC CORP.

(Exact name of registrant as specified in its charter)

New York State		16-0957153
(State or other jurisdiction of incorporation or organization)		(IRS employer identification no.)
1801 Elmwood Avenue, Buffalo, New York		14207
(Address of principal executive offices)		(Zip code)

Telephone number including area code: (716) 873-0640

Former name, former address and former fiscal year, if changed since last report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months or for such shorter period that the registrant was required to file such reports, and (2) has been subject to such filing requirements for the past 90 days.

Yes þ       No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one):

Large accelerated filer o       Accelerated filer o       Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o       No þ

The number of shares outstanding of each class of common stock as of October 30, 2006 were:

Common Stock, $0.01 par value		2,749,375 shares
Class B Common Stock, $0.01 par value		699,546 shares

 

 

MOD-PAC CORP.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

						Page
PART I.				FINANCIAL INFORMATION
		Item 1.		Consolidated Balance Sheets September 30, 2006 and December 31, 2005			3
				Consolidated Statements of Operations Three and Nine Months Ended September 30, 2006 and October 1, 2005			4
				Consolidated Statements of Cash Flows Nine Months Ended September 30, 2006 and October 1, 2005			5
				Notes to Consolidated Financial Statements			6-10
		Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operation			11-14
		Item 3.		Quantitative and Qualitative Disclosures about Market Risk			14
		Item 4.		Controls and Procedures			14
PART II.				OTHER INFORMATION
		Item 1.		Legal Proceedings			14
		Item 1A.		Risk Factors			14
		Item 2.		Unregistered Sales of Equity Securities			15
		Item 3.		Defaults Upon Senior Securities			15
		Item 4.		Submission of Matters to a Vote of Securities Holders			15
		Item 5.		Other Information			15
		Item 6.		Exhibits			15
SIGNATURES
							16
EX-31.1
EX-31.2
EX-32

PART I — FINANCIAL INFORMATION

Part 1. Financial Information
Item 1. Financial Statements

MOD-PAC CORP.

		(Dollars in Thousands)
		September 30, 2006				December 31,
		(Unaudited)				2005
Current assets:
Cash and cash equivalents		$	1,471			$	1,178
Temporary investments			1,000				2,700
Trade accounts receivable:
Customers			4,890				4,425
Allowance for doubtful accounts			(156	)			(42	)
Inventories			3,112				2,888
Refundable income taxes			575				1,199
Prepaid expenses			412				423
Total current assets			11,304				12,771
Property, plant and equipment, at cost			64,888				64,363
Less accumulated depreciation and amortization			(38,443	)			(34,678	)
Net property, plant and equipment			26,445				29,685
Other assets			1,284				1,268
Totals assets		$	39,033			$	43,724
Current liabilities:
Current maturities of long-term debt		$	55			$	87
Accounts payable			3,439				3,489
Accrued expenses			887				1,696
Total current liabilities			4,381				5,272
Long-term debt			1,936				1,969
Other liabilities			31				428
Deferred income taxes			2,594				3,457
Total liabilities		$	8,942			$	11,126
Shareholders’ equity:
Common stock, $.01 par value Authorized 20,000,000 shares, issued 3,367,996 in 2006, 3,340,577 in 2005			34				33
Class B common stock, $.01 par value Authorized 5,000,000 shares, issued 700,251 in 2006, 717,968 in 2005			7				7
Additional paid-in capital			1,757				1,395
Retained earnings			34,358				37,228
			36,156				38,663
Less treasury shares, at cost 625,698 in 2006 and 2005			(6,065	)			(6,065	)
Total shareholders’ equity			30,091				32,598
Total liabilities and shareholders’ equity		$	39,033			$	43,724

See notes to financial statements

MOD-PAC CORP.

Consolidated Statements of Operations

		(Dollars in Thousands)
		(Unaudited)
		Nine Months Ended								Three Months Ended
		September 30,				October 1,				September 30,				October 1,
		2006				2005				2006				2005
Revenue:
Net sales		$	33,559			$	40,894			$	11,326			$	12,278
Amortization of buy-out fee			—				5,500				—				1,834
Rental income			416				341				143				122
Total revenue			33,975				46,735				11,469				14,234
Costs and Expenses:
Cost of products sold			31,088				33,161				10,183				10,208
Selling, general and administrative expenses			7,221				8,098				2,317				2,694
Interest Expense			89				15				54				52
Other income			(58	)			(9	)			(10	)			(12	)
Total costs and expenses			38,340				41,265				12,544				12,942
(Loss) Income before taxes			(4,365	)			5,470				(1,075	)			1,292
Income taxes (benefit) provision			(1,495	)			2,474				(358	)			475
Net (loss) income		$	(2,870	)		$	2,996			$	(717	)		$	817
Retained earnings:
January 1			37,228				26,200
September 30			34,358				29,196
(Loss) earnings per share:
Basic		$	(.83	)		$	.82			$	(.21	)		$	.23
Diluted		$	(.83	)		$	.79			$	(.21	)		$	.22

See notes to financial statements

MOD-PAC CORP.

		(Dollars in Thousands)
		(Unaudited)
		Nine Months Ended
		September 30,				October 1,
		2006				2005
Cash flows from operating activities:
Net (loss) income		$	(2,870	)		$	2,996
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization			3,792				4,369
Provision for doubtful accounts			114				3
Stock option compensation expense			319				—
Deferred income — advanced payment from VistaPrint			—				(5,500	)
Deferred income taxes			(863	)			2,043
Other liabilities			(397	)			36
Cash flows from changes in operating assets and liabilities
Accounts receivable			(465	)			650
Inventories			(224	)			(21	)
Prepaid expenses			10				(279	)
Accounts payable			(50	)			960
Refundable or payable income taxes			624				(7,609	)
Accrued expenses			(809	)			(311	)
Net cash used in operating activities			(819	)			(2,663	)
Cash flows from investing activities:
Sale of temporary investments			1,700				8,558
Change in other assets			(44	)			42
Capital expenditures			(525	)			(3,507	)
Net cash provided by investing activities			1,131				5,093
Cash flows from financing activities
Principal payments on long-term debt and capital lease			(65	)			(63	)
Proceeds from issuance of stock			46				504
Purchase of treasury stock			—				(3,522	)
Net cash used in financing activities			(19	)			(3,081	)
Net increase (decrease) in cash and cash equivalents			293				(651	)
Cash and cash equivalents at beginning of year			1,178				2,584
Cash and cash equivalents at end of period		$	1,471			$	1,933

See notes to financial statements.

MOD-PAC CORP.

Notes to Consolidated Financial Statements

Nine and Three Months Ended September 30, 2006

1) Basis of Presentation

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal recurring nature. The results of operations for any interim period are not necessarily indicative of results for the full year. Operating results for the nine-month and three-month period ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted U.S. accounting principles for complete financial statements.

For further information, refer to the financial statements and footnotes thereto included in the Company’s 2005 annual report on Form 10-K.

Revenue is recognized on the accrual basis, which is at the time of shipment of goods, except for the advance payment received from VistaPrint, which was originally estimated to be amortized on a straight-line basis over 36 months from September 2004 through August 2007. During the fourth quarter of 2005, given the final conclusion that the company would likely no longer have sales to VistaPrint, the remaining $14.1 million unamortized portion of the contract buy-out fee was recognized as revenue.

2) Stock-Based Compensation

MOD-PAC CORP. established a Stock Option Plan that authorized the issuance of 800,000 shares of Common Stock for the purpose of attracting and retaining executive officers and key employees, and to align management’s interests with those of the shareholders of MOD-PAC CORP. The options must be exercised no more than ten years from the grant date and vest over up to a five-year period. The exercise price for the options is equal to the fair market value of the common stock as of the date immediately preceding the date of grant.

MOD-PAC CORP. established the Director’s Stock Option Plan that authorized the issuance of 200,000 shares of Common Stock for the purpose of attracting and retaining the services of experienced and knowledgeable outside directors, and to align their interest with those of its shareholders. The options must be exercised no more than ten years from the grant date and vest after six months. The exercise price for the options is equal to the fair market value at the date of grant.

During the first quarter of 2006, the Company adopted SFAS 123(R),“Share-Based Payment,” applying the modified prospective method. This statement requires all equity-based payments to employees, including grants of employee stock options, to be recognized in the statement of earnings based on the grant date fair value of the award. Under the modified prospective method, the Company is required to record equity-based compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards outstanding as of the date of adoption. The Company uses a straight-line method of attributing the value of stock-based compensation expense, subject to minimum levels of expense, based on vesting. Stock compensation expense recognized during the period is based on the value of the portion of shared-based payment awards that is ultimately expected to vest during the period.

The fair value of stock options granted was estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average fair value of the options was $5.75 for options granted during the nine months ended September 30, 2006 and was $6.24 for options granted during the nine months ended October 1, 2005. The following table provides the range of assumptions used to value stock options granted during the nine months ended September 30, 2006 and October 1, 2005.

		Nine Months Ended
		September 30,				October 1,
		2006				2005
Expected volatility			41	%			36	%
Risk-free rate			4.8	%			4.0%-5.0	%
Expected dividends			0	%			0	%
Expected term (in years)			6.5				7.0

To determine expected volatility, the Company uses historical volatility based on weekly closing prices of its Common Stock since the Company’s spin-off from Astronics Corporation in March 2003. The risk-free rate is based on the United States Treasury yield curve at the time of grant for the appropriate term of the options granted. Expected dividends are based on the Company’s history and expectation of dividend payouts. The expected term of stock options is based on vesting schedules, expected exercise patterns and contractual terms.

The table below reflects net (loss) earnings and net (loss) earnings per share for the nine and three months ended September 30, 2006 compared with the pro forma information for the nine and three months ended October 1, 2005.

		Nine Months Ended								Three Months Ended
		September 30,				October 1,				September 30,				October 1,
		2006				2005				2006				2005
Net earnings, as reported for the prior period (1)			N/A			$	2,996				N/A			$	817
Stock compensation expense		$	319				460			$	35				59
Tax benefit			(73	)			(124	)			0				(7	)
Stock compensation expense, net of tax (2)			246				336				35				52
Net (loss) earnings, including the effect of stock compensation expense (3)		$	(2,870	)		$	2,660			$	(717	)		$	765
Net (loss) earnings per share:
Basic, as reported for the prior period (1)			N/A				.82				N/A			$	.23
Basic, including the effect of stock compensation expense (3)		$	(.83	)			.73			$	(.21	)		$	.21
Diluted, as reported for the prior period (1)			N/A				.79				N/A			$	.22
Diluted, including the effect of stock compensation expense (3)		$	(.83	)			.70			$	(.21	)		$	.21

Stock compensation expense is included in selling, general, and administrative expense. A summary of the Company’s stock option activity and related information for the nine months ended September 30, 2006 is as follows:

						Weighted Average
		Number of				Exercise Price per				Aggregate
($ in thousands, except for per option data)		Options				Option				Intrinsic Value
Outstanding at January 1, 2006			315,939			$	10.49			$	562
Options Granted			15,000				—				—
Options Exercised			(9,704	)			6.27				(70	)
Outstanding at September 30, 2006			321,235				9.38			$	725
Exercisable at September 30, 2006			245,912			$	9.32			$	574

The aggregate intrinsic value in the proceeding table represents the total pretax option holder’s intrinsic value, based on the Company’s closing stock price of Common Stock of $11.20 as of September 30, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. The aggregate intrinsic value of the options exercised is based on the Company’s closing stock price of common stock as of the date the option is exercised. The Company’s current policy is to issue additional new shares upon exercise of stock options.

The fair value of options vested since December 31, 2005 is $0.5 million. At September 30, 2006, total compensation costs related to non-vested awards not yet recognized was $0.3 million which will be recognized over a weighted average period of 1.74 years.

The following is a summary of weighted average exercise prices and contractual lives for outstanding and exercisable stock options as of September 30, 2006:

		Outstanding												Exercisable
						Weighted												Weighted
						Average				Weighted								Average				Weighted
						Remaining				Average								Remaining				Average
Exercise Price						Life				Exercise								Life in				Exercise
Range		Shares				in Years				Price				Shares				Years				Price
$5.21-$8.44			170,581				5.9			$	6.95				137,700				5.7			$	7.04
$10.34- $15.54			150,654				8.1			$	12.14				108,212				7.9			$	12.22
			321,235				6.9			$	9.38				245,912				6.6			$	9.32

3) Inventories

Inventories are stated at the lower of cost or market, cost being determined in accordance with the first-in, first-out method. Inventories are as follows:

		(Dollars in Thousands)
		September 30, 2006				December 31, 2005
		(Unaudited)
Finished Goods		$	1,686			$	1,583
Work in Progress			218				104
Raw Material			1,208				1,201
		$	3,112			$	2,888

4) Product Line Net Sales

Product line net sales are as follows:

		(Dollars in Thousands)
		Nine months ended								Three months ended
		September 30,				October 1,				September 30,				October 1,
		2006				2005				2006				2005
Custom Folding Cartons		$	21,877			$	17,584			$	7,260			$	5,996
Commercial Print			967				14,265				430				3,115
Stock Box			6,954				6,444				2,449				2,281
Personalized Print			3,761				2,601				1,187				886
		$	33,559			$	40,894			$	11,326			$	12,278

5) VistaPrint Limited

During 2005, the Company performed printing and order fulfillment services for VistaPrint Limited, which resulted in revenue of $12.0 million for the nine months ended October 1, 2005. In addition, the Company recognized $5.5 million of amortization revenue during the first nine months of 2005, which was related to the $22 million contract buy-out fee received on September 1, 2004 from VistaPrint in connection with a new supply agreement effective as of July 2004. The buy-out fee was negotiated between the two companies and provided MOD-PAC with cost recovery and profit on the production resources developed or acquired to fulfill the original contract with VistaPrint that terminated in 2011. Robert S. Keane is a shareholder in and Chief Executive Officer of VistaPrint Limited and is the son of Kevin T. Keane, the Chairman of the Board of Directors of MOD-PAC.

The new agreement, entered into during July of 2004 provided for MOD-PAC to be VistaPrint’s exclusive North American supplier of printed products through August 30, 2005. The agreement also set prices on a per unit basis and provided a framework for pricing products covered by any renewals or extensions through August of 2007.

During the third quarter of 2005, VistaPrint informed MOD-PAC that they were able to fulfill all of their print needs in-house, and therefore, no further orders were expected to be given to MOD-PAC. The Company has performed no services for VistaPrint during the first nine months of fiscal year 2006. In addition, due to the fact that the Company did not anticipate any future sales to VistaPrint, the remaining $14.1 million of the unamortized portion of the contract buy-out fee was recognized as income during the fourth quarter of 2005. As a result, there was no related amortization during the first nine months of 2006.

6) (Loss) Earnings Per Share.

The following table sets forth the computation of (loss) earnings per share:

		(in thousands, except for per share data)
		Nine months ended								Three months ended
		September 30,				October 1,				September 30,				October 1,
		2006				2005				2006				2005
Net (loss) income as reported		$	(2,870	)		$	2,996			$	(717	)		$	817
Basic (loss) earnings per share weighted average shares			3,441				3,646				3,443				3,626
Net effect of dilutive stock options			—				132				—				100
Diluted (loss) earnings per share weighted average shares			3,441				3,778				3,443				3,726
Basic (loss) earnings per share		$	(.83	)		$	.82			$	(.21	)		$	.23
Diluted (loss) earnings per share		$	(.83	)		$	.79			$	(.21	)		$	.22

The effect of dilutive stock options has not been included for the nine months and three months ended September 30, 2006, since this would be anti-dilutive as a result of the Company’s net loss.

7) Income Taxes.

The Company’s effective tax rate for the first nine months of 2006 was 34.2%, which approximates the Company’s expectations. The effective tax rate of 45.2% in the first nine months of 2005 that was higher than would be customary was due to increasing the valuation allowance for deferred tax assets related to New York State credits. New York State enacted tax legislation resulting in a change to the New York State apportionment methodology. The enacted legislation will result in a lower apportionment of the Company’s taxable income to New York State, resulting in lower New York State income taxes. Accordingly, the Company’s ability to use or realize New York State tax credits was expected to be reduced. As a result, the Company increased its valuation allowance resulting in an increase to income tax expense of approximately $600,000 in the second quarter of 2005.

8) Capital structure.

The Company’s Class B stock is fully convertible into Common stock on a one-for-one basis at no cost. During the first nine months of 2006, 17,717 shares of Class B stock were converted to Common stock.

9) New Accounting Pronouncements

In June 2006, the FASB issued interpretation (“FIN”) No.48, ”Accounting for Uncertainty in Income Taxes – an Interpretation of SFAS No. 109.” FIN No.48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” The pronouncement prescribes a recognition threshold and measurement attributable to financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the effect the adoption of FIN No. 48 will have on its financial position or results of operations.

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

REVENUE

For the third quarter of 2006 revenue was $11.5 million compared with $14.2 million in 2005, a decrease of 19.4%. This decrease of $2.7 million was primarily due to a $3.0 million decrease in net sales for the commercial print product line related to VistaPrint, our former customer, who in the third quarter of 2005 decided to fulfill their print needs in-house. In addition, in the third quarter of 2005, $1.8 million of revenue was recognized related to the amortization of the $22.0 million contract buy-out fee from VistaPrint. During the fourth quarter of 2005, given the conclusion that the Company does not anticipate any future sales to VistaPrint, the remaining $14.1 million of the unamortized portion of the contract buy-out fee was recognized as income. As a result, the Company did not realize any revenue related to the contract buy-out fee in the third quarter of 2006. These decreases were partially offset by a $1.3 million increase in custom folding carton revenue, a $0.3 million increase in personalized print revenue, and a $0.2 million increase in stock box revenue in the third quarter of 2006 compared with the same period in 2005.

For the first nine months of 2006, revenue was $34.0 million compared with $46.7 million in 2005, a decrease of 27.3%. This decrease of $12.7 million was primarily due to a $13.3 million decrease in net sales (including royalty payments received from VistaPrint) for the commercial print product line related to VistaPrint, our former customer, who in the third quarter of 2005 decided to fulfill their print needs in-house. In addition, in the first nine months of 2005, $5.5 million of revenue was recognized related to the amortization of the $22.0 million contract buy-out fee from VistaPrint. These decreases were partially offset by a $4.3 million increase in custom folding carton revenue, a $1.2 million increase in personalized print revenue, and a $0.5 million increase in stock box revenue in the first nine months of 2006 compared with the same period in 2005.

EXPENSES AND MARGINS

Gross margin for the third quarter of 2006 decreased to 11.2% from 28.3% during the same period last year. Excluding the amortization of the buy-out fee, gross margin for the third quarter of 2005 was 17.7%. This decrease in gross margin in 2006 was the result of underutilization of the factory due to the loss of volume from VistaPrint and product mix.

Gross margin for the first nine months of 2006 decreased to 8.5% from 29.0% during the same period last year. Excluding the amortization of the buy-out fee, gross margin for the first nine months of 2005 was 19.6%. This decrease in gross margin in 2006 was the result of underutilization of the factory due to the loss of volume from VistaPrint, product mix, and increased cost for paperboard purchases.

Selling, general, and administrative costs decreased to $2.3 million in the third quarter of 2006 from $2.7 million during the same period in the prior year. This decrease was primarily due to reduced website advertising in the third quarter of this year.

Selling, general, and administrative costs decreased to $7.2 million in the first nine months of 2006 from $8.1 million during the same period in the prior year. This decrease was due to reduced website advertising and severance expense related to the resignation of the former Chief Financial Officer in May 2005. These decreases were partially offset by stock compensation expense recorded in 2006.

Net interest expense for the third quarter of 2006 was $54,000 compared with net interest expense of $52,000 in the third quarter of 2005.

Net interest expense for the first nine months of 2006 was $89,000 compared with net interest expense of $15,000 in the first nine months of 2005. This fluctuation was attributable to the reduced temporary investments in the first nine months of 2006 compared with the first nine months of 2005.

TAXES

The Company’s effective tax rate for the first nine months of 2006 was 34.2%, which approximates the Company’s expectations. The effective tax rate of 45.2% in the first nine months of 2005 that was higher than would be customary was due to increasing the valuation allowance for deferred tax assets related to New York State credits. New York State enacted tax legislation resulting in a change to the New York State apportionment methodology. The enacted legislation will result in a lower apportionment of the Company’s taxable income to New York State, resulting in lower New York State income taxes. Accordingly, the Company’s ability to use or realize New York State tax credits was expected to be reduced. As a result, the Company increased its valuation allowance resulting in an increase to income tax expense of approximately $600,000 in the second quarter of 2005.

NET (LOSS) INCOME AND (LOSS) EARNINGS PER SHARE

The net loss for the third quarter of 2006 was $0.7 million, a decrease of $1.5 million from the third quarter of 2005. This decrease was due to the fluctuations discussed above. Diluted (loss) earnings per share was $(0.21) in the third quarter of 2006 and $0.22 in the third quarter of 2005.

The net loss for the first nine months of 2006 was $2.9 million, a decrease of $5.9 million from the first nine months of 2005. This decrease was due to the fluctuations discussed above. Diluted (loss) earnings per share was $(0.83) in the first nine months of 2006 and $0.79 in the first nine months of 2005.

LIQUIDITY

Cash used in operating activities during the first nine months of 2006 amounted to $0.8 million compared with cash used by operating activities during the first nine months of 2005 of $2.7 million. The $0.8 million of cash used in the first nine months of 2006 was primarily due to changes in working capital components. The $2.7 million of cash used in the first nine months of 2005 was primarily due to tax payments associated with the $22.0 million contract buy-out fee.

The Company’s capital expenditures of $0.5 million for the first nine months of 2006 were down by $3.0 million from the 2005 level. The Company expects capital expenditures to be approximately $1.0 million in 2006.

The Company has an outstanding authorization from its Board to repurchase up to 100,885 shares at September 30, 2006. The closing price of the Company’s common stock as of September 30, 2006 was $11.20. At this price, the repurchase of 100,885 shares would require $1,129,912.

We have a $6 million dollar line of credit facility available to us at the discretion of the lender. At September 30, 2006 there were no borrowings on this line of credit, but there are two letters of credit outstanding that total $297,000. Interest on the line of credit is either 1.0% over LIBOR or the prime rate, at the Company’s option.

We believe that cash on hand of $1.5 million and temporary investments of $1.0 million at September 30, 2006 are sufficient to meet our cash requirements for operations, capital expenditures, and debt service for the balance of 2006.

COMMITMENTS

The Company has commitments for items that it purchases in the normal on-going affairs of the business. The Company is not aware of any obligations in excess of normal market conditions, or of any long-term commitments that would have a material adverse affect on its financial condition.

MARKET RISK

There has been no significant change in market risks since December 31, 2005.

As a result of short cycle times, the Company does not have any long-term commitments to purchase production raw materials or sell products that would present significant risks due to price fluctuations. Raw paper stock is available to us from multiple domestic sources; as a result, we believe the risk of supply interruptions due to such things as strikes at the source of supply or to logistics systems are limited.

Risks due to fluctuation in interest rates are not material to the Company at September 30, 2006 because of no exposure to floating rate debt and limited market risk on its $1.0 million of temporary investments, because interest is reset to market rates every 7 days.

Since May of 2003, over 90% of the Company’s power needs are met through natural gas. The Company has investigated supply contracts of various length and currently it has supply arrangements for fixed prices on approximately 95% of its estimated usage from October 1, 2006 through March 31, 2007, and approximately 50% of its estimated usage from April 1, 2007 through September 30, 2009. Historically, the price of natural gas has fluctuated widely. Although the Company is concerned about cost, its main concern is availability. The Company monitors the availability of natural gas, considering such factors as amount in storage, gas production data and transportation data, so that it can take appropriate action if concerns about availability occur. The Company has investigated and tested a back-up power source in the form of a rented transportable diesel powered generator. Although such generators are generally available, the Company cannot be assured that a generator adequate to meet the Company’s needs will be available if and when such need should arise.

We have no foreign operations, nor do we transact any business in foreign currencies. Accordingly, we have no foreign currency market risks.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with generally accepted accounting policies requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. In developing such estimates, management evaluates the facts known to it at the time and applies such facts within the framework of certain critical accounting policies that govern valuation allowances of the Company’s assets. These policies include determining the need for a valuation allowance with respect to doubtful accounts receivable, lower of cost or market reserves related to the Company’s inventories, depreciation allowances and impairment reserves with respect to the Company’s long-lived assets and valuation allowances with respect to the realizability of deferred tax assets. Often, management must make certain assumptions about the future when applying these policies. Management uses experience in developing such assumptions about the future. Actual experience will be different than the assumptions made and differences could result in material adjustments to management’s estimates.

RECENT/NEW ACCOUNTING PRONOUNCEMENTS

During the first quarter of 2006, we adopted SFAS 123 ( R ), “Shared-Based Payment,” applying the modified prospective method. This Statement requires all equity-based payments to employees, including grants of employee stock options, to be recognized in the statement of earnings based on the grant date fair value of the award. Under the modified prospective method, we are required to record equity-based compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards outstanding as of the date of adoption. We use a straight-line method of attributing the value of stock-based compensation expense, subject to minimum levels of expense based on vesting. Stock compensation expense was $35,000 in the third quarter of 2006 and $319,000 in first nine months of 2006. No stock compensation expense was recognized prior to 2006.

In June 2006, the FASB issued interpretation (“FIN”) No.48, ”Accounting for Uncertainty in Income Taxes – an Interpretation of SFAS No. 109.” FIN No.48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” The

pronouncement prescribes a recognition threshold and measurement attributable to financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the effect the adoption of FIN No. 48 will have on our financial position or results of operations.

FORWARD-LOOKING STATEMENTS

Certain statements contained in this report are “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. All forward-looking statements involve risks and uncertainties. All statements contained herein that are not clearly historical in nature are forward-looking, and the word “anticipate,” “believe,” “expect,” “estimate,” “project,” and similar expressions are generally intended to identify forward-looking statements. Any forward looking statement contained herein, in press releases, written statements or other documents filed with the Securities and Exchange Commission, or in MOD-PAC’s communications and discussions with investors and analysts in the normal course of business through meetings, webcasts, phone calls and conference calls, regarding expectations with respect to sales, earnings, cash flows, operating efficiencies, product and market channel expansions, capacity utilization and expansion, and repurchase of capital stock, are subject to known and unknown risks, uncertainties and contingencies. Many of these risks, uncertainties, and contingencies are beyond our control, and may cause actual results, performance or achievements to differ materially from anticipated results, performance or achievements. Factors that might affect such forward-looking statements include, among other things:

	•		Overall economic and business conditions;
	•		The demand for MOD-PAC’s goods and services;
	•		Competitive factors in the commercial printing and folding cartons markets;
	•		Changes in tax requirements (including tax rate changes, new tax laws and revised tax law interpretations);
	•		The availability and costs of natural gas supplies in Western New York State;
	•		The internal and external costs of compliance with laws and regulations such as Section 404 of the Sarbanes-Oxley Act of 2002

Item 3. Quantitative and Qualitative Disclosures About Market Risk

See Market Risk in Item 2, above.

Item 4. Controls and Procedures

The company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in Rules 13a — 15(e) and 15(d) — 15(e) of the Securities Exchange Act of 1934, as of September 30, 2006. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2006. There were no changes in the Company’s internal control over financial reporting during the third quarter of 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings.

     None.

Item 1A. Risk Factors.

There has been no significant change to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

(d) Maximum Number (or

Approximate Dollar

(c) Total Number

Value) of Shares (or

of Shares (or

Units)

Units) Purchased

that May Yet Be

(a) Total Number

(b) Average Price

as Part of Publicly

Purchased

of Shares (or

Paid per Share

Announced Plans

Under the Plans or

Period

Units) Purchased

(or Unit)

or Programs

Programs

July 2 -July. 29, 2006

—

—

—

100,885

July 30 - August 26, 2006

—

—

—

100,885

August 27 - Sept. 30, 2006

—

—

—

100,885

Total

—

—

—

Item 3. Defaults Upon Senior Securities.

     None.

Item 4. Submission of Matters to a Vote of Securities Holders.

     None

Item 5. Other Information.

     None.

Item 6. Exhibits

Exhibit 31.1		Section 302 Certification — Chief Executive Officer

Exhibit 31.2		Section 302 Certification – Chief Financial Officer

Exhibit 32.		Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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.

		MOD-PAC CORP.
		(Registrant)
Date: November 13, 2006		By: /s/ David B. Lupp
		David B. Lupp
		Chief Financial Officer