UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q R QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ______________ Commission File No. 0-795 BADGER PAPER MILLS, INC. (Exact name of registrant as specified in its charter) Wisconsin 39-0143840 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 200 West Front Street Peshtigo, Wisconsin 54157 (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code: (715) 582-4551 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 report(s), and (2) has been subject to such filing requirements for the past 90 days. |X| Yes. |_| No. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). |_| Yes. |X| No. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practicable date: 2,033,797 as of June 30, 2003. 1 BADGER PAPER MILLS, INC. & SUBSIDIARY INDEX Page No. -------- PART I-FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Interim Statements of Operations Three Months and Six Months Ended June 30, 2003 and 2002 3 Consolidated Balance Sheets June 30, 2003 and December 31, 2002 4 Consolidated Interim Statements of Cash Flow Six Months Ended June 30, 2003 and 2002 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 Item 3. Quantitative and Qualitative Disclosures About Market Risk 10 Item 4. Controls and Procedures 11 PART II-OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 11 Item 6. Exhibits and Reports on Form 8-K 11 SIGNATURES EXHIBIT INDEX 2 PART I-FINANCIAL INFORMATION Item 1. Financial Statements BADGER PAPER MILLS, INC. & SUBSIDIARY CONSOLIDATED INTERIM STATEMENTS OF OPERATIONS (Unaudited) For Three Months Ended For Six Months Ended (Dollars in thousands, except per share data) June 30 June 30 ----------------------------------------------------------------- 2003 2002 2003 2002 ---- ---- ---- ---- Net Sales $18,636 $19,570 $38,305 $37,820 Cost of Sales 17,993 17,222 37,656 33,398 -------------- --------------------------------- ---------------- Gross Profit 643 2,348 649 4,422 Selling and Administrative Expenses 1,380 1,544 2,841 2,891 -------------- --------------------------------- ---------------- Operating Income (Loss) (737) 804 (2,192) 1,531 Interest Expense (112) (100) (209) (204) Interest Income 1 12 3 15 Gain on Sale of Non-Core Assets 0 0 0 1,131 Other Income, Net 4 15 7 32 -------------- --------------------------------- ---------------- Income Before Income Taxes (844) 731 (2,391) 2,505 Income Tax (Benefit) Expense (287) 249 (813) 852 -------------- --------------------------------- ---------------- Net Income (Loss) $ (557) $ 482 $(1,578) $ 1,653 ============== ================================= ================ Net Earnings (Loss) Per Share - Basic $ (0.27) $ 0.24 $ (0.78) $ 0.82 Average Shares Outstanding - Basic 2,032,165 2,025,458 2,032,909 2,025,458 Net Earnings (loss) Per Share - Diluted $ (0.27) $ 0.23 $ (0.78) $ 0.80 Average Shares Outstanding - Diluted 2,032,165 2,071,244 2,032,909 2,071,244 See Notes to Consolidated Financial Statements 3 BADGER PAPER MILLS, INC. & SUBSIDIARY CONSOLIDATED BALANCE SHEETS (Dollars in thousands) June 30, 2003 December 31, (Unaudited) 2002 ---------------------- ---------------------- ASSETS: Current Assets: Cash & Cash Equivalents $ 549 $ 1,102 Accounts Receivable - Net 5,978 5,080 Inventories 6,723 6,615 Refundable Income Taxes 300 469 Deferred Income Taxes 1,957 1,367 Prepaid Expenses and Other 797 599 ---------------------- ---------------------- Total Current Assets 16,304 15,232 PROPERTY, PLANT AND EQUIPMENT, NET 26,278 26,105 OTHER ASSETS 485 471 ---------------------- ---------------------- TOTAL ASSETS $43,067 $41,808 ====================== ====================== LIABILITIES AND SHAREHOLDERS' EQUITY: Current Liabilities: Current Portion of Long-Term Debt $ 727 $ 590 Accounts Payable 4,082 4,156 Accrued Liabilities 4,341 4,029 ---------------------- ---------------------- Total Current Liabilities 9,150 8,775 LONG-TERM DEBT 9,818 7,377 DEFERRED INCOME TAXES 2,471 2,471 OTHER LONG-TERM LIABILITIES 791 793 COMMITMENTS AND CONTINGENCIES - - SHAREHOLDERS' EQUITY Common Stock, No Par Value; 4,000,000 Shares Authorized 2,160,000 Shares Issued 2,700 2,700 Additional Paid-In Capital 59 59 Retained Earnings 19,533 21,112 Treasury Stock, At Cost, 126,203 and 129,815 Shares in 2003 and 2002, Respectively (1,455) (1,479) ---------------------- ---------------------- Total Shareholders' Equity 20,837 22,392 ---------------------- ---------------------- Total Liabilities and Shareholders' Equity $43,067 $41,808 ====================== ====================== See Notes to Consolidated Financial Statements 4 BADGER PAPER MILLS, INC. & SUBSIDIARY CONSOLIDATED INTERIM STATEMENTS OF CASH FLOW (Unaudited) (Dollars in thousands) For Six Months Ended June 30 ---------------------------- 2003 2002 ---------------- ---------------- Cash Flow from Operating Activities: Net Income ($1,578) $ 1,653 Adjustments to Reconcile to Net Cash Provided By (Used in) Operating Activities: Depreciation 1,280 1,219 Directors' Fees Paid in Stock 24 24 Gain on Sale of Non-Core Assets - (1,131) Deferred Income Taxes (590) - Changes in Assets and Liabilities: Increase in Accounts Receivable, Net (898) (1,471) (Increase) Decrease in Inventories (108) (540) Increase (Decrease) in Accounts Payable (74) 1,200 Increase in Accrued Liabilities 312 76 (Increase) Decrease in Income Taxes Refundable 169 (145) Increase in Other (262) (150) ---------------- ---------------- Net Cash (Used in) Provided by Operating Activities (1,725) 735 ---------------- ---------------- Cash Flow From Investing Activities: Additions to Property, Plant and Equipment, Net (1,405) (1,625) Proceeds From Sale of Non-Core Assets - 1,371 ---------------- ---------------- Net Cash (Used in) Provided by Investing Activities (1,405) (254) ---------------- ---------------- Cash Flow from Financing Activities: Increase to (Payments on) Long-Term Debt 2,577 (616) ---------------- ---------------- Net Cash (Used in) Provided by Financing Activities 2,577 (616) ---------------- ---------------- Net Increase in Cash and Cash Equivalents (553) (135) Cash and Cash Equivalents: Beginning of Period 1,102 664 ---------------- ---------------- End of Period $ 549 $ 529 ================ ================ See Notes to Consolidated Financial Statements 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1. Basis of Presentation The accompanying consolidated financial statements, in the opinion of management, include all adjustments, which are normal and recurring in nature and are necessary for a fair statement of results for each period shown. Some adjustments involve estimates, which may require revision in subsequent interim periods or at year-end. In all regards, the financial statements have been presented in accordance with generally accepted accounting principles. Refer to the Notes to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2002, for the accounting policies that are pertinent to these statements. Note 2. Income Taxes The benefit or provision for income tax expense has been computed by applying an estimated annual effective tax rate. This rate was 34% for the three-month and six-month periods ended June 30, 2003 and 2002. Note 3. Earnings Per Share Net earnings per share are computed based on the weighted average number of shares of common stock outstanding during the quarter: 2003 2002 ---- ---- Basic 2,032,165 2,025,458 Diluted 2,032,165 2,071,244 Basic earnings (loss) per share excludes any dilutive effects of stock options. Diluted earnings (loss) per share includes the dilutive effects of stock options. The effect of 64,000 options in 2003 and 25,000 options in 2002 have not been included in diluted earnings (loss) per share as their effect would have been anti-dilutive. Note 4. Stock Option Plan Badger Paper Mills, Inc. has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations in accounting for its employee stock option plan. Under APB 25, because the exercise price of the employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recorded. Badger Paper is subject to the disclosure rules of SFAS 123, Accounting for Stock Based Compensation. Management has determined that the impact of SFAS 123 on net income and shareholders' equity was not material as of and for the quarter ended June 30, 2003. Note 5. Inventories The major components of inventories were as follows: (In thousands of dollars) June 30, 2003 December 31, 2002 ------------------------- ------------- ----------------- Raw Materials $2,274 $2,684 Finished Goods and Work in Process 8,418 8,109 ------------- ----------------- 10,692 10,793 Less: LIFO Reserve (3,969) (4,178) ------------- ----------------- Total Inventories $6,723 $6,615 ============= ================= 6 Note 6. Contingencies The Company operates in an industry that is subject to laws and regulations at both federal and state levels relating to the protection of the environment. The Company undergoes continued environmental testing and analysis, and the precise cost of compliance with environmental requirements has not been determined. Please refer to the more complete discussion of legal matters in the Company's Form 10-K for the year ended December 31, 2002. The Company has entered into purchase commitments related to pulp and energy. These commitments are expected to be fulfilled with no adverse consequences material to the Company's operations or financial condition. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Statement Regarding Forward-Looking Information This Form 10-Q may include one or more "forward-looking statements" within the meaning of Sections 27A of the Securities Act of 1933 and 21E of the Securities Exchange Act of 1934 as enacted in the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). In making forward-looking statements within the meaning of the Reform Act, the Company undertakes no obligation to publicly update or revise any such statement. 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 vary materially. 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, but are not limited to, the following: o Increased competition from either domestic or foreign paper producers or providers of alternatives to the Company's products, including increases in competitive production capacity and/or weakness in demand for paper products. As a paper manufacturer, the Company, if it wants to achieve acceptable production costs, must operate its paper mill at a relatively high percentage of its available production capacity. The Company's competitors face the same or similar situations. Therefore, when the overall market for paper products softens, the Company (and other paper manufacturers) will generally accept lower selling prices for its products in order to maintain acceptable production efficiencies and costs. o Changes in the price of pulp, the Company's main raw material. The Company purchases all of its pulp needs on the open market and price changes for pulp have a significant impact on the Company's costs. Pulp price changes can occur due to changes in worldwide consumption of pulp, pulp capacity additions, expansions or curtailments affecting the supply of pulp, inventory building or depletion at pulp consumer levels which affect short-term demand, and pulp producer cost changes related to wood availability, environmental issues, or other variables. o Interruptions in the supply of, or increases and/or changes in the price of energy (principally electricity and natural gas) that the Company needs in its manufacturing operations. Political uncertainty in the Mideast could result in higher energy costs. Future energy costs are uncertain. 7 o Changes in demand for the Company's products due to overall economic activity affecting the rate of consumption of the Company's paper products, growth rates of the end markets for the Company's products, technological or consumer preference changes or acceptance of the Company's products by the markets it serves. o Unforeseen operational problems at any of the Company's facilities causing significant lost production and/or higher operating costs. o Changes in laws or regulations affecting the Company, particularly environmental laws and regulations affecting air quality and wastewater discharges. o The Company's profitability may be adversely affected by increases in interest rates because a significant portion of the Company's debt bears interest at variable interest rates. Results of Operations Net Sales Net sales for the for the second quarter were $18,636,000 compared to $19,570,000 for the same period last year, a decrease of $934,000 and 4.8%. The decrease in sales is the result of difficult business conditions in fine paper markets, resulting in pricing pressure. After two quarters, net sales were $38,305,000 compared to $37,820,000 for the same period last year. The increase in sales in the first six months of 2003 relative to 2002 is the result of relatively stronger shipment volume in the first quarter of 2003. Gross Profit Gross profit during the second quarter of 2003 was $643,000 and 3.5% of net sales compared to $2,348,000 and 12.0% of net sales during the second quarter of 2002. The most significant cause for the reduction in gross profit in 2003 relative to 2002 is increasing costs associated with pulp and natural gas. In response to increased costs, the Company increased pricing on certain specialty paper grades, but was not able to increase prices of fine paper grades because of difficult market conditions. As a result, the Company was not able to pass the entire cost increase through to its customers and saw gross profit decline in dollars and as a percentage of net sales in 2003 as compared to 2002. After two quarters of 2003, gross profit was $649,000 and 1.7% of net sales compared to $4,422,000 and 11.7% of net sales for the same period of 2002. Rapid increases in the cost of natural gas and pulp during the first quarter of 2003 negatively impacted the Company's gross profits in 2003 as compared to the prior year. During the second quarter of 2003, the Company was able to increase pricing on certain specialty paper grades, but was not able to raise prices on fine paper products. Selling & Administrative Expenses During the second quarter of 2003, selling and administrative expenses were $1,380,000 compared to $1,544,000 during the same period last year, a decrease of $164,000 and 10.6%. After two quarters, selling and administrative expenses were $2,841,000 compared to $2,891,000 for the same period last year a decrease of $50,000 and 1.7%. 8 Other Income and Expense Interest expense during the second quarter of 2003 was consistent with prior year costs at $112,000 compared to $100,000 during the second quarter of the prior year. After two quarters, interest expense was $209,000 in 2003 compared to $204,000 last year. During the first two quarters of 2002, the Company recognized a gain on the sale of non-core assets of $1,131,000. The Company did not have a similar transaction in 2003. Net Income During the second quarter of 2003, the Company incurred a net loss of $557,000 compared to $482,000 of net income during the second quarter of 2002. The reduction in net income is attributable to the increased cost of pulp and natural gas combined with the Company's inability to increase prices on fine paper products. The Company was able to increase prices on certain specialty paper grades, however, such price increases were not sufficient to pass the entire cost increase through to customers. As a result, the Company experienced a reduction of net income. After two quarters of 2003, the Company incurred a net loss of $1,578,000 compared to $1,653,000 of net income for the same period in 2002. The reduction in net income in 2003 as compared to 2002 is a result of increased costs for pulp and natural gas and the Company's inability to raise prices sufficiently to cover the increased costs. During the first two quarters of 2002, the Company realized a gain on sale of non-core assets of $1,131,000. The Company did not have a similar gain in 2003. Capital Resources and Liquidity At June 30, 2003 the Company had cash resources of $549,000 and an unused credit availability of $6,299,000 under the Company's revolving credit facility to fund on-going operations. During the first two quarters of 2003, the Company made scheduled debt payments of $285,000. The Company's revolving credit facility contains certain covenants that require the Company, among other things, to maintain a specified fixed charge coverage ratio. As of June 30, 2003, the Company was not in compliance with the required fixed charge coverage ratio covenant but requested and received a waiver of that covenant. While the Company is attempting to reduce its costs and improve its gross profit in order to address this issue, there can be no assurance that the Company will be in compliance with the covenants contained in its revolving credit facility in the future. If the Company fails to comply with any of such covenants and is unable to obtain a waiver of such covenants in the future, then there could be a material adverse effect on the Company's liquidity. Capital Expenditures Capital expenditures during the second quarter of 2003 were $1,064,000 compared to $1,225,000 for the same period last year. After two quarters of 2003, capital expenditures were $1,405,000 as compared to $1,625,000 in 2002. In 2002, the Company committed to purchase equipment to apply waxed coatings to certain specialty paper grades with an anticipated total cost of $2,822,000. As of June 30, 2003, the Company has invested $2,144,000 leaving a remaining balance of $678,000. The remaining cost associated with this investment includes the purchase of additional interchangeable components necessary to keep the 9 equipment operating on a continuous basis in the future. The Company purchases these components on an as needed basis and anticipates completing the project in 2003. At the end of the second quarter of 2003, the Company took delivery of laminating equipment designed to laminate foil and paper products. The total cost of the project is anticipated to be $1,340,000. As of June 30, 2003, the Company has invested $1,040,000 leaving an estimated balance of $300,000, which the Company expects to invest during the remainder of 2003. The Company anticipates financing a portion of the investment in this project through long term debt. The Company anticipates that total capital expenditures in 2003 will not exceed $5,000,000. Cash Flow During the first two quarters of 2003, the Company used $1,725,000 in cash to support operating activities compared to generating cash flow from operations of $735,000 for the same period last year. The primary reason for the change in cash flow is the net loss for the first two quarters in 2003. The decline in profitability is a result of the increased costs related to paper manufacturing. During the first two quarters of 2003, the Company incurred significantly higher costs for pulp and natural gas when compared to the same period last year. Given the Company's current cash resources, the unused available line of credit at June 30, 2003 and the availability of long-term debt to fund a portion of the Company's investment in the laminating equipment, the Company believes that it has adequate liquidity to meet its future financial obligations. Application of Critical Accounting Policies and Estimates In accordance with the rules proposed by the Securities and Exchange Commission in May 2002, we reviewed our critical accounting policies for new critical accounting estimates and other significant changes. We found that the disclosures made in our Annual Report on Form 10-K for the year ended December 31, 2002 are still current and that there have been no significant changes since such Annual Report was filed. Off Balance Sheet Arrangements As of June 30, 2003, the Company does not have any off balance sheet financing arrangements. Item 3. Quantitative and Qualitative Disclosure 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 and extends to November 2004. An annual commitment fee of 1/4% is payable for unused amounts. The Company's interest rate floats, based on the lender's prime rate. As of June 30, 2003, the Company was paying interest at a 4.25% annual rate on amounts borrowed against this line. A majority of the Company's debt is at variable interest rates, and a hypothetical 1% (100 basis point) change in interest rates would cause an estimated increase in annual interest expense of $105,000. The Company does not use financial instruments for trading purposes and is not a party to any leveraged derivatives. 10 Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures The Company's management evaluated, with the participation of the Company's President and Chief Executive Officer and Vice President, Chief Financial Officer, Secretary and Treasurer, the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-15 (e) and 15d-15 (e) under the Securities and Exchange Act of 1934) as of the end of the quarter ended June 30, 2003. Based upon their evaluation of these disclosure controls and procedures, the President and Chief Executive Officer and Vice President, Chief Financial Officer, Secretary and Treasurer concluded that the disclosure controls and procedures were effective, as of the end of the quarter ended June 30, 2003, to ensure that material information relating to the Company (including its consolidated subsidiaries) was made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared. Changes in Internal Control There was no change in the Company's internal control over financial reporting that occurred during the quarter ended June 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II-OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders The Company held its annual meeting of shareholders on Tuesday, May 13, 2003, at the Best Western Riverfront Inn, 1821 Riverside Avenue, Marinette, Wisconsin. At such meeting, board nominees L. Harvey Buek, Robert A. Olah and William A. Raaths were elected for terms to expire at the 2006 annual meeting of shareholders and until their successors are duly elected and qualified, pursuant to the following votes: L. Harvey Buek - 1,480,659 voted "for", 465,054 withholding authority and 0 broker nonvotes; Robert A. Olah - 1,418,739 voted "for", 526,974 withholding authority and 0 broker nonvotes; William A. Raaths - 1,481,406 voted "for", 464,307 withholding authority and 0 broker nonvotes. Other members of the Board include Harold J. Bergman and John T. Paprocki, whose terms expire at the 2004 annual meeting, and Mark D. Burish and James L. Kemerling, whose terms expire at the 2005 annual meeting. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 4. Third Amendment to Revolving Credit Facility and Security Agreement, dated August 13, 2003, by and between the Company and PNC Bank, National Association. 11 10. Employment Agreement effective June 30, 2003 between the Company and Robert Spannuth. 31.1 Certification of President and Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act. 31.2 Certification of Vice President, Chief Financial Officer, Secretary and Treasurer pursuant to Section 302 of the Sarbanes-Oxley Act. 32. Written Statement of the President and Chief Executive Officer and Vice President, Chief Financial Officer, Secretary and Treasurer, pursuant to 18 U.S.C. ss.1350. (b) Reports on Form 8-K: On April 22, 2003, the Company filed a Current Report on Form 8-K, dated April 21, 2003, reporting pursuant to Items 7 and 9 a press release announcing a first quarter loss. On April 23, 2003, the Company filed a Current Report on Form 8-K, dated April 23, 2003, reporting pursuant to Items 5 and 7 the appointment of Ronald E. Swanson as President and Chief Executive Officer of the Company, and the resignation of Robert A. Olah as the Company's President and Chief Executive Officer. On June 17, 2003, the Company filed a Current Report on Form 8-K, dated June 16, 2003, reporting pursuant to Items 5 and 7 the appointment of Harold Bergman as Chairman of the Board of Directors and Ronald Swanson as a member of the Board of Directors. On July 21, 2003, the Company filed a Current Report on Form 8-K, dated July 18, 2003, reporting pursuant to Items 7 and 9 a press release announcing a second quarter loss and the appointment of a new Vice President of Operations. 12 SIGNATURE 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. BADGER PAPER MILLS, INC. (Registrant) /s/ Ronald E. Swanson ----------------------------- DATE: August 14, 2003 By: Ronald E. Swanson President and Chief Executive Officer (Principal Executive Officer) /s/ William H.Peters ----------------------------- DATE: August 14, 2003 By: William H. Peters Vice President, Chief Financial Officer, Secretary and Treasurer (Principal Financial Officer) 13 BADGER PAPER MILLS, INC. & Subsidiary EXHIBIT INDEX Number Description - ----- ----------- 4. Third Amendment to Revolving Credit Facility and Security Agreement, dated August 13, 2003, by and between the Company and PNC Bank, National Association. 10. Employment Agreement effective June 30, 2003 between the Company and Robert Spannuth. 31.1 Certification of President and Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act. 31.2 Certification of Vice President, Chief Financial Officer, Secretary and Treasurer pursuant to Section 302 of the Sarbanes-Oxley Act. 32. Written Statement of the President and Chief Executive Officer and Vice President, Chief Financial Officer, Secretary and Treasurer, pursuant to 18 U.S.C. ss.1350. 14