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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-K

OR

Commission File No. 0-795

Registrant ’s telephone number, including area code: (715) 582-4551

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Without Nominal or Par Value

Indicate by checkmark 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 |X|     No ___

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K.    [_]

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act)      Yes ___     No |X|

As of June 30, 2003 the aggregate market value of the common stock (based upon the closing sale price of the common stock as reported on the Nasdaq SmallCap Market) held by non-affiliates was approximately $11,142,533. Determination of stock ownership by non-affiliates was made solely for the purpose of responding to this requirement, and registrant is not bound by this determination for any other purpose.

As of December 31, 2003, 2,039,155 shares of common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The Company’s Proxy Statement for its 2004 Annual Meeting of Shareholders to be filed with the Commission under Regulation 14A is incorporated by reference into Part III of this Form 10-K to the extent indicated in Part III hereof.

Statement Regarding Forward-Looking Information

This Annual Report Form 10-K, each of Badger Paper Mills, Inc. ‘s (the “Company”) annual reports to shareholders, Forms 8-K and 10-Q, definitive proxy statements, and any other written or oral statement made by or on behalf of the Company subsequent to the filing of this Annual Report on Form 10-K may include one or more “forward-looking statements” that may state the Company’s or management’s intentions, hopes, beliefs, expectations or predictions for the future. In the following discussion and elsewhere in this Annual Report on Form 10-K, statements containing words such as “expect,” “anticipate,” “believe,” “estimate,” “goal,” “objective” or similar words are intended to identify forward-looking statements. In making such forward-looking statements, the Company undertakes no obligation to publicly update or revise any such statements.

Forward-looking statements of the Company are based on information available to the Company as of the date of such statements and reflect the Company’s expectations as of such date, but are subject to risks and uncertainties that may cause actual results to differ materially from those projected, expressed or implied by such forward-looking statements. In addition to specific factors, which may be described in connection with any of the Company’s forward-looking statements, factors that could cause actual results to differ materially include:

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Five-Year Comparison of Selected Financial Data

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PART I

Item 1. Business

        Badger Paper Mills, Inc. (“Badger” or the “Company”) has been producing paper and paper products in Wisconsin since it was incorporated under the laws of the State of Wisconsin in 1929.

        The Company has two operating facilities. In Peshtigo, Wisconsin and adjacent to the Company’s principal executive offices, the Company manufactures paper on two paper machines (a “Yankee” paper machine and a “Fourdrinier” paper machine). The Company also performs certain converting operations in Peshtigo. The Company’s physical facilities in Peshtigo are sometimes collectively referred to in this Annual Report as the “Peshtigo Facilities.”

        The Company also has production facilities in Oconto Falls, Wisconsin (approximately 30 miles from Peshtigo, Wisconsin), which consist of a Company-owned manufacturing facility and certain leased warehouse space. The Company’s owned and leased facilities in Oconto Falls are sometimes collectively referred to in this Annual Report as the “Oconto Falls Facilities.”

Products and Distribution

        At the Peshtigo Facilities, the Company manufactures paper on its Yankee paper machine and it’s Fourdrinier paper machine, and converts paper in accordance with customer specifications. Converting operations include punching, sheeting, trimming, sealing, perforating, rewinding, waxing and drilling of paper for uses in several applications.

        Products produced on the Yankee paper machine include converted printed and unprinted waxed papers for quick service restaurants, grades used in laminating applications, colored papers, specialty-coated papers and papers used in applications where twisting is required to seal product. The Company’s sales personnel and commissioned brokers sell these products to manufacturers and converters.

        The Fourdrinier paper machine produces fine paper grades utilizing fiber purchased on the open market, including pre- and post-consumer recycled fibers. Papers produced on the Fourdrinier paper machine are used in several applications including business papers, printing, high quality writing papers, book publishing stock, reply card, watermarked, industrial and consumer papers that require water-oil-grease resistant attributes, copier papers and specialty papers. The Company offers a wide range of colored papers and specializes in color matching. A portion of the products produced by the Company are sold under certain trademarks and trade names, including Ta-Non-Ka®, Copyrite®, ENVIROGRAPHIC®, Northern Brights®, Artopaque®, Marks of Distinction® and DuraEdge®. Other products are sold through paper merchants, brokers and value-added converters who, in turn, sell to other value-adding entities or direct to the consumer.

        The Company’s two paper machines produce papers that have different features. Paper produced on the Yankee paper machine has a very smooth surface on one side of the paper, which is referred to as machine glazed (“MG”). The smooth finish on MG paper allows the paper to work well in certain coating and printing applications.

        Paper produced on the Fourdrinier paper machine does not have a glazed finish, rather it is machine finished (“MF”). MF paper works well in a broad range of applications including publishing, writing paper and certain printing applications.

        Products produced at the Oconto Falls manufacturing facility complement the Company’s overall product offerings by adding value to certain paper grades through printing and converting of paper and plastic substrates. At this facility, the Company produces a variety of printed products on paper and plastic substrates and manufactures polyethylene bags.

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        Badger sells its products produced at each facility to a wide range of converting companies throughout the United States. These sales are conducted through the Company’s sales personnel. The largest concentration of the Company’s customers can be found in the Midwestern states including Wisconsin, Illinois, Michigan and Ohio. However, as a result of expanded national sales efforts, the Company has made significant progress toward expanding its customer base into other regions of the United States.

        The Company’s foreign net sales are immaterial to its operations.

Competition

        Badger’s products are sensitive to competition from numerous sources, including other paper products and products of other composition. Product quality, price, volume and service are all competitive factors. Badger’s paper production represents less than 1% of the production capacity in the United States for these products. Competition for all grades of paper manufactured by the Company includes International Paper Company, Georgia-Pacific Corporation, Domtar, Inc., Wausau-Mosinee Paper Corporation and smaller, non-integrated paper companies. Many of the Company’s larger competitors have greater financial, technical, marketing and public relation resources, larger client bases and greater brand or name recognition than Badger.

Raw Materials; Inventory

        The principal raw material used by the Company is pulp. Badger utilizes a variety of fibers to meet the formulation requirements of the papers it produces. Northern and southern softwood and hardwood pulps, pre-consumer and post-consumer recycled pulps, and hard white rolls make up the total fiber requirements. Badger purchases all its fiber requirements on the open market. Other raw materials used in the manufacturing process include inks and polyethylene substrates. Other raw materials are purchased directly from manufacturers and distributors.

        Badger has at least two sources of supply for major items. Shortages of pulp or certain chemicals (including petrochemicals) could have an adverse effect on Badger’s ability to manufacture its products, and could adversely affect product mix. Although Badger does not anticipate shortages of raw materials, it is anticipated that there will be near-term increases in pulp prices and the cost of polyethylene.

Energy

        Badger is a large consumer of energy, including electricity and natural gas. In 2003, 9.7% of Badger’s cost of sales represented energy costs compared to 7.8% of Badger’s cost of sales in 2002. Badger purchases electricity from local public utilities, and it purchases natural gas from various sources in the United States and Canada. Two dual-fueled boilers capable of burning natural gas or fuel oil and one natural gas boiler supply the Peshtigo Facilities’ heating and manufacturing requirements. During 2002, the Company removed its fuel oil storage tanks at its Peshtigo Facilities. As a result, the Company will not have the flexibility to switch between natural gas and fuel oil as a source of fuel.

        Although Badger experienced temporary interruptions of electrical service in the summer of 2002 due to regional shortages of electricity during peak demand periods, the Company believes that current sources of electricity and natural gas are adequate to meet its needs. Such interruptions caused the Company to temporarily stop the manufacture of paper. There is no damage to equipment during these temporary power interruptions. Badger could experience similar interruptions in the future.

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        The market price for natural gas stabilized at historically high levels during the second half of 2003. In order to reduce the risk of fluctuating market prices for natural gas, the Company has purchased a significant portion of its natural gas requirements for the first half of 2004 at a fixed price.

Patents

        The Company possesses certain patents and licenses used in connection with its business, none of which individually, or in the aggregate, are material.

Research and Development

        The Company maintains a dedicated technical staff of employees charged with the responsibility of researching and developing new products. The Company also relies on outside consultants from time to time for special research and development projects. The Company’s technical staff also refines and improves existing products in response to customer requirements and market demands. The Company spent $673,000 in 2003, $769,000 in 2002 and $469,000 in 2001 on product research and development activities.

        A significant percentage of the Company’s research and development costs are spent working on concepts and designs for new and/or improved paper products for customers. Since many of the Company’s customers for paper products are converters, these customers need trial production runs of paper products to evaluate how the Company’s new or modified paper products perform in actual use on the customers’ paper converting machinery and equipment. If such trial production runs are unsuccessful, the Company charges the associated costs to research and development. If such trial production runs are successful, the Company sells the product to the customers. Revenues from successful trial production runs are included in sales and the associated costs are accounted for in cost of sales.

Backlog

        As of December 31, 2003, the value of the Company’s order backlog was approximately $2,221,000 as compared to $1,270,000 and $2,837,000 at December 31, 2002 and 2001, respectively.

Customers

        In 2003, 2002 and 2001, no customer represented over 10% of Badger’s net sales.

Environmental Matters

        In 2000, the Company received final regulatory approval from the Wisconsin Department of Natural Resources (“WDNR”) of its Title V air operating permit for its Peshtigo Facilities. The permit does not require the Company to install new or additional pollution control equipment, and as such, the Company is responsible for the costs associated with routine monitoring, record keeping and reporting requirements. These costs are minimal.

        Prior to January 30, 2002, effluent flow from Badger’s Peshtigo Facilities was directed into a joint municipal wastewater treatment plant, which Badger operated under contract with the City of Peshtigo, Wisconsin. Effective January 30, 2002, Badger sold this wastewater treatment plant to the City of Peshtigo for approximately $1,250,000; however, Badger continues to operate this wastewater treatment plant under contract with the City of Peshtigo. Management believes that this wastewater treatment plant continues to meet or exceed all currently applicable environmental requirements and that Badger’s use of the treatment plant is in compliance with all regulatory requirements. In 2000, Badger renewed its wastewater discharge permit for this wastewater treatment plant.

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        In January 2000, the WDNR approved a final closure report filed by the Company with respect to its former Harbor Road Landfill. The WDNR will continue to review the effectiveness of this closure. If the WDNR subsequently determines that the closure was ineffective, then the WDNR may require the Company to undertake further remedial actions. Based on the Company’s consultant’s report (dated April 1999), the Company estimated that the potential future cost of such future environmental remedial efforts (assuming that the WDNR determines that the closure was ineffective) was approximately $300,000. The Company has not subsequently updated this consultant’s report. Management believes that the Company is in compliance with all WDNR Net Worth Financial Responsibility Tests as of December 31, 2003.

        Soil contamination was identified at the Company’s French Street location in Peshtigo during the removal of four above ground storage tanks. The Company performed site investigation work and in October 2003, requested that the case be transferred from the WDNR to the Wisconsin Department of Commerce (“Commerce”) for case closure with a soil Geographic Information System Registry and a Wisconsin Administrative Code Chapter NR 140 Preventative Action Limit exemption. Commerce requested additional information in February 2004. The requested documents and information were provided to Commerce. As of the filing of this Annual Report on Form 10-K, the Company has not received a response regarding closure from Commerce. It is not possible to determine the costs, if any, that may be incurred in completing any additional investigation or required remediation.

        The Company’s Peshtigo Facilities are located near the Lower Fox River/Green Bay Area of Concern (“AOC”). Pursuant to the Great Lakes Water Quality Agreement, 43 AOC’s have been identified and re-located throughout the Great Lakes Basin. The Company has not been identified by WDNR or the United States Environmental Protection Agency (“EPA”) as responsible for the environmental problems within the Lower Fox/Green Bay AOC.

        The Company does not anticipate any material capital expenditures for pollution control equipment during the next two fiscal years.

        The Company holds an air-operating permit by the WDNR for its Oconto Falls Facilities. The permit expires on January 29, 2006. The permit limits emissions so that the facility is considered a “synthetic minor” under the EPA’s Title V air permit program. The permit authorizes the operation of the flexographic printing process at the Oconto Falls Facilities.

        Badger believes it has in force all of the necessary environmental permits from Federal, state and local authorities to continue production of current business activities. The Company began production on new foil laminating equipment in late 2003, which requires a permit for additional volatile organic compounds emissions. The Company is currently operating its laminating equipment under the construction permit it received in 2003. The construction permit will expire in January 2005.

Employees

        As of December 31, 2003, the Company had 292 employees, including 183 employees at the Peshtigo Facilities covered by three-year collective bargaining agreements running through May 2005. The Company has begun a process to redesign workflow in order to reduce the number employees necessary to produce its products. Teams comprised of management and union employees are working to redesign workflow with the objective of improving efficiency and quality. Another result will be fewer employees required to meet manufacturing requirements. It is anticipated that workforce reductions will begin during the second quarter of 2004.

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Available Information

        The Company maintains a website with the address www.badgerpaper.com. Additional information regarding the Company can be found on this website. The Company is not including the information contained in the Company’s website as a part of, or incorporating it by reference into, this Form 10-K.

Item 2. Properties*

Item 3. Legal Proceedings

        The Company does not have any material legal proceedings pending, and does not have any litigation or governmental proceedings with respect to environmental matters pending (except to the extent identified under the “Environmental Matters” caption in Item 1 of Part I of this Annual Report on Form 10-K).

Item 4. Submission of Matters to a Vote of Shareholders

        No matters were submitted to a vote of the Company’s shareholders in the fourth quarter of 2003.

Executive Officers of the Registrant

        The following table sets forth certain information as of December 31, 2003 concerning the Company’s executive officers.

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        Officers are elected to hold office until the next annual meeting of the Board of Directors following the annual meeting of shareholders or until their successors are elected and qualified. There is no arrangement or understanding among any of the above officers or any other person pursuant to which such officer was selected for the office held. No family relationship of any kind exists between the officers.

PART II

Item 5. Market For the Registrant’s Common Stock and Related Shareholder Matters

        The Company’s Common Stock trades on the Nasdaq SmallCap Market under the symbol “BPMI.” As of December 31, 2003, the Company had 307 shareholders of record. Information about the trading prices for shares of the Company’s Common Stock and dividends on the Common Stock is included in this Annual Report on Form 10-K under the caption “Stock Price and Dividend Information.” Information about equity compensation plans is included in this Annual Report on Form 10-K under Item 12.

Item 6. Selected Financial Data

        Selected Company financial data is presented in this Annual Report on Form 10-K under the caption “Five-Year Comparison of Selected Financial Data.”

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

Executive Overview

        The Company saw a decline in net sales during 2003 as a result of decreased shipment volume. Reduced shipment volume can be attributed to declining market demand for certain products manufactured by the Company. The Company also realized increases in costs for pulp and natural gas in 2003 as compared to 2002.

        The combination of reduced shipment volume and higher manufacturing costs resulted in a decrease in gross profit. In 2003, gross profit was $1,219,000 and 1.7% of net sales, compared to $7,829,000 and 10.6% in 2002. As a result of lower gross profit, the Company generated a net loss for 2003 of $3,091,000 as compared to net earnings of $1,899,000 in the previous year. The results for 2002 include a pretax gain of $1,125,000 (after tax gain of $747,000) from the sale of non-core assets. The Company did not have a similar gain in 2003.

        The increases in the cost of pulp and natural gas are driven by market conditions outside of the Company’s control. In order to reduce internal costs, the Company has begun a process to redesign workflow. Teams comprised of management and union employees are redesigning workflow with the objective of improving efficiency and quality. Another result will be fewer employees required to meet manufacturing requirements. The teams began meeting in the first quarter of 2004. It is anticipated that workforce reductions will begin during the second quarter of 2004.

2003 versus 2002

Net Sales

        Net sales in 2003 were $71,691,000 compared to $73,772,000 in 2002, a decrease of $2,081,000 and 2.8%. The reduction in net sales can be attributed to decreased shipment volume of paper products combined with increased sales of printed products. The shipment volume of paper products in 2003 as compared to 2002 declined by 5.3% while the average price for paper products increased 0.8%. The Company realized an increase in the sales of printed and converted products of $1,487,000 in 2003 as compared to 2002.

        The decrease in shipment volume in 2003 as compared to 2002 can be directly related to the Company’s decline in sales of fine paper products. Net sales in 2003 of fine paper products declined 19.6% when measured in sales dollars, and declined 22.0% when measured in tons shipped when compared to 2002. The reduction in fine paper volume resulted in increased downtime on the Fourdrinier paper machine in 2003 as compared to 2002. The decline in fine paper business can be attributed to difficult market conditions resulting in lower pricing in the market.

Cost of Sales

        Cost of sales in 2003 was $70,472,000 and 98.3% of net sales compared to $65,943,000 and 89.4% of net sales in 2002. During 2003 the market price for pulp increased resulting in higher pulp costs for the Company. The Company also incurred significantly higher costs for natural gas in 2003 as compared to 2002. The increases in the cost of pulp and natural gas combined with the inability to increase prices due to difficult market conditions resulted in higher cost of sales when measured as a percentage of sales.

        The Company’s overall cost for pulp increased $594,000 and 2.7% in 2003 as compared to 2002 on 6.7% lower production volume. The disproportionate increase in pulp costs is a result of higher market prices for pulp.

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        The Company anticipates that the market price of pulp will continue to increase into 2004. The Company has entered into contracts with pulp suppliers to purchase a portion of its pulp requirements at a fixed price. The Company anticipates that approximately half of its pulp requirements in 2004 will be purchased under these agreements.

        During the first quarter of 2003, the market price for natural gas increased significantly. The market price for natural gas stabilized at historically high levels during the second half of 2003. Because of the increases in the market price of natural gas, the Company’s cost for natural gas in 2003 increased $1,649,000 and 57.3% from 2002. In order to reduce the risk of fluctuating market prices for natural gas, the Company has purchased a significant portion of its natural gas requirements for the first half of 2004 at a fixed price.

Gross Profit

        Gross profit in 2003 was $1,219,000 and 1.7% of net sales compared to $7,829,000 and 10.6% of net sales in 2002. The decrease in gross profit is the result of higher costs for pulp and natural gas combined with the Company’s inability to increase pricing on fine paper products due to difficult market conditions.

Selling &Administrative Expense

        Selling and administrative expenses in 2003 were $5,097,000 and 7.1% of net sales compared to $5,779,000 and 7.8% in 2002. The reduction in selling and administrative expenses is the result of lower employment related costs and reduced spending on outside professional services.

Income Tax

        In 2003, the Company had an income tax benefit of $1,203,000 and 28% of the loss before income taxes compared to income tax expense of $925,000 and 32.8% of income before taxes in 2002. The differences between statutory rates and the Company’s effective rate are a largely the result of increases in the valuation allowance.

Other Income & Expense

        During 2003 other income and expense was a $416,000 expense compared to a $774,000 net income in 2002. In 2002, the Company recognized a gain on the sale of a wastewater treatment facility of $1,125,000. The Company did not have a similar gain in 2003.

2002 versus 2001

Net Sales

        Net sales in 2002 were $73,772,000 compared to $76,305,000 in 2001, a decrease of $2,533,000 and 3.3%. The reduction in net sales can be attributed to volume and pricing. The sale of paper in 2002 as compared to 2001 increased by 4.5% while average pricing decreased by 3.7%. The Company also realized a decrease of $3,050,000 in the shipment of printed products in 2002 versus 2001.

        Net sales volume as measured in weight increased on each paper machine, while total average pricing decreased. The decrease in average pricing was driven entirely by pricing on machine finished (MF) paper grades. The average selling price of machine glazed (MG) products increased an average of 1.7%. The increase in the average price of MG products is a result of shifting the product offering to specialty markets.

        The decrease in net sales of printed products is a result of losing business from a number of customers through competitive bidding processes.

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Cost of Sales

        The cost of sales for 2002 was $65,943,000 and 89.4% of net sales compared to $66,463,000 and 87.1% in 2001. During 2002, the production volume of printed products declined when compared to the previous year. This decline in business resulted in a portion of the decline in the cost of sales as measured in dollars. The increase in cost of sales relative to sales is driven primarily by the decrease in the average selling prices while, at the same time, maintaining a relatively flat cost for pulp.

        During 2002, production activity on the Company’s two paper machines increased 4.2% compared to 2001. Total cost for pulp in 2002 increased 5.1% when compared to 2001. The disproportionate increase in pulp cost when compared to production activity is the combined effect of the average cost for fiber and the utilization efficiency.

Gross Profit

        Gross profit during 2002 was $7,829,000 and 10.6% of net sales compared to $9,842,000 and 12.9% of net sales in 2001. The decrease in gross profit is the combined result of the decrease in net sales as it relates to pricing, while at the same time holding certain production costs consistent with the previous year. The overall average selling price during 2002 decreased 3.7% when compared to 2001. The reduction in average pricing is the result of pricing pressure on certain commodity grades still manufactured by the Company.

Selling &Administrative Expense

        In 2002, selling and administrative expenses were $5,779,000 and 7.8% of net sales compared to $5,559,000 and 7.3% in 2001. The increase in selling and administrative expenses is a result of cost associated with additional resources necessary to develop and market products for specialty markets that are consistent with the Company’s strategy to move from commodity grades to specialty paper markets. During 2002, the Company incurred $252,000 associated with management restructuring costs. Had the Company not incurred management restructuring costs, selling and administrative expenses would have been $5,527,000 in 2002 compared to $5,559,000 the previous year.

Income Tax

        Income taxes in 2002 were $925,000 and 32.8% of income before taxes and reflect the statutory tax rates.

        Income taxes in 2001 were $1,374,000 and 26.3% of income before taxes. The difference between statutory tax rates and the Company’s effective tax rate is the realization of the benefits related to the Federal net operating loss carryforward utilized in 2001.

Other Income & Expense

        During 2002, the Company realized a gain of $1,125,000 on the sale of a wastewater treatment facility. The Company continues to manage the facility under an operating agreement with the City of Peshtigo.

        During 2001, the Company realized $1,627,000 in gains from the sale of timberland that was not used in the day-to-day operations of the business since the Company closed its pulp mill several years ago.

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Liquidity and Capital Resources

Capital Expenditures

        Capital expenditures in 2003 were $1,880,000 ($1,150,000 of which were financed through a capital lease) compared to $3,165,000 in 2002. The largest project in 2003 was the purchase of foil laminating equipment. The total cost of the project was $1,257,000. In 2002, the Company purchased waxer / winder equipment with a total estimated cost of $2,822,000. As of December 31, 2003, the Company had invested $2,319,000 into this equipment. The Company will continue to purchase interchangeable components as necessary to keep the equipment operating on a continuous basis.

The Company anticipates that total capital expenditures in 2004 will not exceed $2,000,000.

Capital Resources

        In November 2001, the Company obtained a revolving credit agreement with a commercial bank providing for asset-based financing which was scheduled to expire in November 2004. In November 2003, the Company received a two-year extension of the revolving credit agreement. The financing is now scheduled to expire in November 2006. The line of credit provides for maximum borrowings of $15,000,000, limited to certain percentages of receivables and inventory, and reduced by outstanding letters of credit. The line of credit bears interest at a variable rate based on alternative interest rate bases at the Company’s option (4.50% at December 31, 2003). A facility fee of 0.25% is payable for unused amounts. The line of credit is collateralized by accounts receivable and inventory.

        As of December 31, 2003, the Company’s capital resources included $656,000 in cash and the Company’s $15,000,000 revolving credit facility. Borrowings under this facility totaled $2,756,000 as of December 31, 2003. Based on the balances in inventory and accounts receivable, the Company had $4,555,000 of availability under the revolving credit facility at December 31, 2004.

        At December 31, 2003, the revolving line of credit required, among other items, the Company to maintain $3,500,000 in unused availability and a minimum tangible net worth. Capital expenditures are limited to $3,000,000 in 2003 and each subsequent year while the revolving line of credit is in effect.

        The Company obtained a variable rate term loan in November 2001. The agreement provides for monthly payments of principal and interest, with interest at prime plus 0.25%. Borrowings are collateralized by certain property, plant and equipment.

        The Urban Development Action Grant debt, including additional funding obtained in November 2001, is due in monthly installments of $17,931, including interest at 5.0%, through maturity in November 2011. This loan is collateralized by certain property.

        The Company obtained a variable rate loan in September 2002 to finance capital expenditures. This agreement provides for up to $2,000,000 in borrowings and was due in January 2004. In May 2003, the Company refinanced this loan with variable rate term debt. The long-term debt agreement provides for monthly payments of $17,336, including interest at 4.25% through maturity in November 2015.

        During 2003, the Company violated the fixed charge coverage ratio covenant contained in the credit facility and the debt service coverage ratio included in the Company’s long-term debt agreement. As of December 31, 2003, the Company has obtained waivers for these violations. The Company has also received waiver for the possible violation of the fixed charge coverage ratio and the minimum tangible net worth covenants contained in its credit facility for the first quarter of 2004. The Company believes that cash provided by operations and its revolving credit facility are sufficient to meet its current and anticipated working capital needs as well as to fund its planned capital expenditures.

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        In November 2003, the Company entered into a lease purchase agreement for $1,150,000 to finance the purchase of certain converting equipment. The monthly lease payments are $14,913, including interest at an effective rate of 5.9% with a purchase option in December 2010.

Cash Flows

        Net cash required to support operations in 2003 was $2,110,000 compared to cash generated by operations of $4,306,000 in 2002. The reduction of cash flow during 2003 relative to 2002 is the result of reduced profitability and reductions in accounts payable and accrued liabilities.

        Net cash used in investing activities in 2003 was $730,000 compared to $1,627,000 in 2002. During 2002, the Company realized proceeds from the sale of non-core assets of $1,374,000, which it used to pay down debt. The Company did not have a similar gain in 2003. The Company invested $730,000 in fixed assets in 2003 compared to $3,165,000 in 2002.

        Cash flow generated from financing activities in 2003 was $2,394,000 compared to using $2,241,000 for financing activities in 2002. The increase in cash provided by financing activities is the combined result of reduced cash flow from operations and investments in property, plant and equipment.

        In November of 2003 the Company borrowed $1,150,000 under the terms of a lease purchase agreement to finance the purchase of foil laminating equipment.

        During the first quarter of 2002, the Company sold its wastewater treatment facility. Proceeds from the sale were used to reduce the outstanding advances under its revolving credit facility.

        The Company believes that its cash flow from operations, together with available borrowings, will be sufficient to allow the Company to meet its obligations in 2004.

Contractual Obligations

        The following table of certain material contractual obligations at December 31, 2003 summarizes the effect that these obligations are expected to have on the Company’s cash flow in future periods set forth below:

Application of Critical Accounting Policies and Estimates

        The discussion and analysis of the Company’s financial condition and results of operations are based on 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 financial statements requires Management to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

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        Critical accounting policies are defined as those that involve significant judgments and uncertainties and potentially result in materially different results under different assumptions and conditions. Application of these policies is particularly important to the portrayal of our financial condition and results of operations. Management believes the accounting policies described below meet these characteristics.

Revenue Recognition

        Revenue is recognized when goods are shipped. Terms of sale are generally free on board destination. Estimated rates of return are fairly consistent and the Company has recorded a reserve to account for such anticipated returns.

Research and Product Development Costs

        The Company’s strategy is to expand its product offering into specialty and niche markets. The costs associated with the development of new products are expensed when incurred. To the extent that new product trials are successful, customers will pay for the product and the products will be included in sales for the period.

Bad Debt

Each accounting period, the Company determines an amount to be set aside to cover potentially uncollectible accounts. The Company’s determination is based upon an evaluation of accounts receivable for risk associated with a client’s ability to make payments. These determinations require considerable judgment in assessing the ultimate potential for realization of these receivables, including reviewing the financial stability of the customer and gauging current market conditions. If the Company’s evaluation of a client’s ability to pay is incorrect, future charges may be incurred.

Benefit Accruals

        Each accounting period, the Company estimates the amount to be accrued for medical costs incurred but not yet reported under its self-funded employee medical insurance plans. The Company’s determination is based on an evaluation of past rates of claim payouts and trends in the amount of payouts. This determination requires significant judgment and is dependent upon the likelihood that past trends are representative of future payment patterns. A significant shift in usage and payment patterns within the Company’s medical plans could necessitate significant adjustments to these accruals in future accounting periods.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

        The Company is exposed to market risk from changes in interest on its debt. The revolving credit facility provides for borrowings up to $15,000,000 (subject to a collateral formula) and extends to November 2006. An annual commitment fee of 0.25% is payable for unused amounts. The Company’s interest rate floats, based on the lender’s prime rate. As of December 31, 2003, the Company was paying 4.5% annual rate on amounts borrowed against this revolving credit facility.

        A majority of the Company’s debt is at variable interest rates, and a hypothetical 1.0% (100 basis point) change in interest rates would cause an estimated increase in annual interest expense of $115,000.

        The Company does not use financial instruments for trading purposes and is not a party to any leveraged derivatives.

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Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors and Shareholders
Badger Paper Mills, Inc. and Subsidiary

We have audited the accompanying consolidated balance sheets of Badger Paper Mills, Inc. and Subsidiary as of December 31, 2003 and 2002 and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above, present fairly, in all material respects, the consolidated financial position of Badger Paper Mills, Inc. and Subsidiary as of December 31, 2003 and 2002 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

/s/  Grant Thornton LLP
Appleton, Wisconsin
February 2, 2004 (except for Note F, as to which the date is March 1, 2004)

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Badger Paper Mills, Inc. and Subsidiary

CONSOLIDATED BALANCE SHEETS
December 31
(dollars in thousands)

The accompanying notes are an integral part of these statements.

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Badger Paper Mills, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
(dollars in thousands, except for per share data)

The accompanying notes are an integral part of these statements.

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Badger Paper Mills, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Years ended December 31,
(dollars in thousands)

The accompanying notes are an integral part of these statements.

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Badger Paper Mills, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
(dollars in thousands)

The accompanying notes are an integral part of these statements.

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE A — SUMMARY OF ACCOUNTING POLICIES

        Badger Paper Mills, Inc. (“the Company”) manufactures paper and paper products and provides printing and converting services to customers throughout North America, with concentrations in the Midwestern States of Wisconsin, Illinois, Michigan and Ohio. The Company’s wholly owned subsidiary, Peshtigo Power, LLC (“Peshtigo”) produces steam for the Company.

        A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows.

1. Consolidation Principles

The consolidated financial statements include the accounts of Badger Paper Mills, Inc. and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.

2. Operating Segments

The Company previously operated in the paper products segment and flexible packaging segment. During the third quarter of 2002, the Company reorganized its operations into a single business segment. Financial statements have been revised for the change in reportable segments.

3. Concentrations

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents and trade accounts receivable. The Company places its cash and cash equivalents with high quality financial institutions. The Company provides credit in the normal course of business to its customers. These customers are located throughout North America. No single customer accounted for more than 10% of sales in 2003, 2002 or 2001. The Company performs ongoing credit evaluations of its customers and maintains allowances for potential credit losses and generally does not require collateral to support the accounts receivable balances.

4. Financial Instruments

For cash and cash equivalents, the carrying amount approximates fair value because of the short maturity of these instruments. For long-term debt, the carrying amount approximates fair value based on comparison with current rates offered to the Company for debt with similar remaining maturities.

5. Estimates

Preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE A — SUMMARY OF ACCOUNTING POLICIES — Continued

6. Cash Equivalents

The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.

7. Receivables

Accounts receivable are stated net of an allowance for sales returns, cash discounts and doubtful accounts. Credit is extended based on prior experience with the customer and evaluation of the customer’s current financial condition. Accounts receivable are generally due within 30 to 45 days. The Company estimates an allowance based on actual payment history of each individual customer, adverse situations that may affect the customer’s ability to pay and prevailing economic conditions. Consequently, an adverse change in the financial condition of a particular customer could affect the Company’s estimate of its allowance. Accounts past due more than 120 days are generally written off, with subsequent payments on previously written off accounts credited to miscellaneous income.

8. Inventories

Substantially all inventories are valued at the lower of cost or market with cost being determined on the last-in, first-out (“LIFO”) basis.

9. Property Held for Resale

Property held for resale at December 31, 2001 consisted of a sewage treatment plant. On January 2, 2002, the Company sold this plant to the City of Peshtigo for cash proceeds of $1,125,000.

10. Property, Plant and Equipment

Property, plant and equipment are stated at cost. Spare parts are stated at cost, subject to net realizable value. If the parts are utilized in a project that either extends the lives or increases the capacity of the equipment, they are capitalized. If the parts are utilized in ordinary repairs or maintenance, they are charged to operating expense. Depreciation of plant and equipment is provided on the straight-line basis over the estimated useful lives of the assets. Land improvements useful lives are 15 years. Buildings useful lives range from 30 to 33 years and machinery and equipment from 3 to 17 years. Leased property under the capital lease is amortized over the life of the respective asset. Accelerated depreciation is used for income tax purposes.

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amounts of the assets exceed their respective fair values. Assets held for sale are recorded at the lower of their fair value less costs to sell or the carrying amount of the asset.

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE A — SUMMARY OF ACCOUNTING POLICIES – Continued

11. Environmental Expenditures

Accruals for remediation costs are recorded when it is probable that a liability has been incurred and the amount of the costs can be reasonably estimated.

12. Income Taxes

Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets and liabilities to the amount expected to be realized.

13. Stock Options

The Company uses the intrinsic value method to account for its stock options. Therefore, if the exercise price of the stock options is equal to or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recorded. The Company discloses the impact if the shares were accounted for under the fair value method (see Note K).

        The following table illustrates the effect on net income (loss) and income (loss) per share if the Company had applied the fair value method to stock-based employee compensation:

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE A — SUMMARY OF ACCOUNTING POLICIES – Continued

14. Revenue Recognition

Revenue is recognized when goods are shipped. Estimated rates of return are fairly consistent and the Company has recorded a reserve to account for such anticipated returns.

15. Shipping and Handling Costs

The Company records shipping and handling costs in cost of sales on the statement of operations. Shipping and handling costs amounted to $4,751,000, $5,133,000 and $4,562,000 for the years ended December 31, 2003, 2002 and 2001.

16. Research and Product Development Costs

Research and product development costs related to potential new products and applications are expensed when incurred. These costs, after consideration of customer reimbursements, amounted to $673,000, $769,000 and $469,000 for 2003, 2002 and 2001. Customer reimbursements amounted to $944,000, $2,467,000 and $1,921,000 for 2003, 2002 and 2001.

17. Net Earnings (Loss) Per Share

Net earnings (loss) per share are computed based on the weighted average number of shares of common stock outstanding during the year:

Stock options to purchase 66,000 common shares in 2003 and 7,000 common shares in 2002 and 25,000 common shares in 2001 were not dilutive and, therefore, have not been included in the computations of diluted per common share amounts.

18. Prospective Accounting Pronouncements

The Financial Accounting Standards Board (FASB) issued Interpretation 46, Consolidation of Variable Interest Entities (FIN 46) in January 2003. In December 2003, the FASB revised the effective date for entities other than special-purpose entities to financial statements for periods after March 15, 2004. The Company is studying the application of the new rules, and anticipates that this new accounting pronouncement will not have a significant impact on its results of operations or financial position.

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE B — RECEIVABLE ALLOWANCES

The receivable allowances at December 31, 2003 and 2002 are as follows (in thousands):

NOTE C — INVENTORIES

The major classes of inventories, valued on the LIFO cost method, at December 31, 2003 and 2002 are as follows (in thousands):

It is not practical to separate finished stock and work-in-process inventories. The first-in, first-out (“FIFO”) cost of raw materials, work-in-process and finished stock inventories approximated $10,233,000 and $10,844,000 at December 31, 2003 and 2002.

NOTE D — PROPERTY, PLANT AND EQUIPMENT

The major classes of property, plant and equipment at December 31, 2003 and 2002 are as follows (in thousands):

        At December 31, 2003, $28,684,000 of fully depreciated assets were still in use.

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE E — ACCRUED LIABILITIES

Accrued liabilities at December 31, 2003 and 2002 are as follows (in thousands):

NOTE F — LONG-TERM DEBT

Long-term debt at December 31, 2003 and 2002 consists of the following (in thousands):

In November 2001, the Company obtained a revolving credit agreement, as most recently amended November 2003, with a commercial bank expiring in November 2006. The revolving credit agreement provides for maximum borrowings of $15,000,000, limited to certain percentages of receivables and inventory, and reduced by outstanding letters of credit. The revolving credit agreement bears interest at a variable rate based on alternative interest rate bases plus the applicable margin, as defined in the agreement, at the Company’s option (4.50% at December 31, 2003). A facility fee of 0.25% is payable for unused amounts. At December 31, 2003, the revolving credit agreement required, among other items, the Company to maintain a minimum tangible net worth, as outlined in the agreement, undrawn availability of not less than $3,500,000 and a limitation on capital expenditures. The Company is in compliance with these covenants at December 31, 2003.

The Company obtained a term note in November 2001 with a commercial bank. The agreement provides for monthly payments of principal and interest of $49,102, with interest at prime plus 0.25% (effectively 4.25% at December 31, 2003). The final payment on this loan is due in November 2011. At December 31, 2003, the term note required, among other things, the Company to maintain a minimum debt service ratio and restrict indebtedness of the Company. At December 31, 2003, the Company was not in compliance with these covenants. A waiver of these violations was obtained on March 1, 2004.

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE F — LONG-TERM DEBT — Continued

The Company obtained a variable rate loan in September 2003 with a commercial bank. The agreement provides for monthly payments of principal and interest of $17,336, with interest at prime plus 0.25% (effectively 4.25% at December 31, 2003). The final payment on this loan is due in November 2015.

The UDAG debt, including additional funding obtained in November 2001 and March 2002, is due in monthly installments of $2,972 and $17,931, including interest at 4.0% and 5.0%, through maturity in May 2006 and November 2011.

In November 2003, the Company entered into a capital lease agreement for equipment with a financing company. The agreement provides for monthly payments of principal and interest of $14,913, including interest at 5.9%. The final payment is due in November 2010. Gross amount of the asset recorded is $1,257,000 with a net book value of $1,220,000 at December 31, 2003.

Substantially all assets of the Company serve as collateral for the above debt.

Maturities of long-term debt for the years ending after December 31, 2003 are as follows:

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE G — INCOME TAXES

The provision (benefit) for income taxes consists of the following (in thousands):

The significant differences between the effective tax rate and the statutory federal tax rates are as follows:

The components of the deferred tax assets and liabilities are as follows (in thousands):

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE G — INCOME TAXES – Continued

The total deferred tax liabilities (assets) as presented in the accompanying balance sheet are as follows (in thousands):

For Federal income tax purposes, the Company has net operating loss carryforwards, research and development credit carryovers and alternative minimum tax credit carryovers of $1,053,000, $1,099,000 and $1,902,000 respectively. For state income tax purposes, the Company has net operating loss and tax credit carryovers of $9,943,000 and $2,736,000, respectively. Certain carryforwards expire at various times over the next 20 years. For financial reporting purposes, a valuation allowance has been established to the extent that state carryforwards, absent future taxable income, will expire unused. The valuation allowance increased $526,000 in 2003.

NOTE H — EMPLOYEE BENEFITS

The Company has defined contribution plans covering substantially all employees. Contribution expenses associated with these plans were $550,000, $646,000 and $717,000 in 2003, 2002 and 2001.

The Company is self-funded for health costs. The Company has stop-loss coverage for costs in excess of $100,000 per individual per year.

NOTE I — SUPPLEMENTAL CASH FLOW INFORMATION

Cash paid (refunded) for interest and income taxes was as follows (in thousands):

In November 2003, the Company entered into a capital lease arrangement with a financing company. Total amount financed was $1,150,000.

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE J — DIRECTOR STOCK GRANT PLANS

In 2001, 1999 and 1997, in order to attract and retain competent directors to serve as Directors of the Company, the Company established Director Stock Grant Plans. An aggregate of 110,000 shares of Common Stock was reserved for issuance. Each Director of the Company is to receive a grant of Common Stock, at fair market value, in partial payment of his or her director’s fee. During 2003, 2002 and 2001, 8,970, 6,600 and 35,168 shares, were issued from treasury stock, at a value of $48,000, $48,000 and $117,000.

NOTE K — STOCK OPTION PLAN

In May 1998, the Company established an incentive stock option plan (“Plan”) as a mechanism to attract and retain its officers and key employees by providing additional performance incentives and the opportunity to share ownership in the Company. The Plan allows the Company to grant options for 130,000 common shares. Options awarded under the Plan vest over a three or five year period and expire in five to nine years.

In May 2002, the Company established an incentive stock option plan (“2002 Plan”) to encourage and provide for acquisition of an equity interest in the Company by officers and key employees. The 2002 Plan allows the Company to grant options for 150,000 common shares. The terms of any options granted under the 2002 Plan will be determined by the Compensation Committee of the Company.

The following table summarizes the transactions of the Company’s stock option plan for the three-year period ended December 31, 2003:

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE K - STOCK OPTION PLAN - Continued

The Company has determined the pro-forma effect as if the Company had accounted for stock options granted under the plan under the fair value method. The Black-Scholes option-pricing model was used with the following weighted-average assumptions for options issued:

The weighted-average fair value of options granted in 2003 was $5.75 per share and $2.89 per share in 2001. No options were granted in 2002.

NOTE L — COMMITMENTS AND CONTINGENCIES

Rental Agreements

The Company leases warehouse space and certain equipment under various agreements, classified as operating leases, expiring through April 2007. Total rent expense amounted to approximately $736,000, $726,000 and $817,000 for the years ended December 31, 2003, 2002 and 2001, respectively.

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Badger Paper Mills, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

December 31, 2003, 2002 and 2001

NOTE L — COMMITMENTS AND CONTINGENCIES — Continued

Future minimum rental payments are as follows (in thousands):

Environmental Matters

In May 1999, the Company entered into an agreement with the Wisconsin Department of Natural Resources (WDNR) related to the closure of a solid waste landfill. If the WDNR subsequently determines that the closure was ineffective, then the WDNR may require the Company to undertake further remedial actions. In April 1999, a consultant was engaged by the Company to determine the costs associated with potential future remediation actions. These potential future remediation actions were estimated to approximate $300,000. The Company has not subsequently updated this consultant’s report. Management believes any future remediation actions, if any, will not have a material adverse impact on the financial statements.

NOTE M — CONTRACTUAL OBLIGATIONS AND OFF BALANCE SHEET FINANCING

The following table summarizes the Company’s significant contractual obligations at December 31, 2003: