##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended January 1, 2005 or o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from  to
 Commission File Number 0-9318 SHOPSMITH,
INC.   Ohio
    
    31-0811466(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)6530 Poe Avenue, Dayton, Ohio
    
    45414(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (937) 898-6070 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. þ Yes o No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
o Yes þ No Indicate the number of shares outstanding of each of the issuers classes of common stock as of the
latest practicable date. Common shares, without par value: 2,605,233 shares as of January 25, 2005.    Page 1




---



SHOPSMITH, INC. AND SUBSIDIARIES INDEX Page No.Part I. Financial Information:Item 1. Financial StatementsConsolidated Balance Sheets -
January 1, 2005 and April 3, 2004
    
    
    3 - 4Consolidated Statements of Operations and Deficit - Three Months and Nine Months Ended
January 1, 2005 and January 3, 2004
    
    
    5Consolidated Statements of Cash Flows - Nine Months Ended
January 1, 2005 and January 3, 2004
    
    
    6Notes to Consolidated Financial Statements
    
    
    7 - 9Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    10 - 13Item 4. Controls and Procedures
    
    
    14Part II. Other InformationItem 3. Default Upon Senior Securities
    
    
    15Item 5. Other Information
    
    
    15Item 6. Exhibits
    
    
    15Signatures
    
    
    16Exhibits
    
    
    17 - 20Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  Page 2




---



##### Table of Contents



Part I  FINANCIAL INFORMATION 
 Item 1. Financial Statements SHOPSMITH, INC. AND SUBSIDIARIES 
  January 1,
    
    
    April 3,2005
    
    
    2004(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    700
    
    
    $
    800Accounts receivable:Trade, less allowance for doubtful accounts:$485,741 on January 1, 2005 and $391,871 on April 3, 2004
    
    
    1,104,661
    
    
    
    1,144,245Inventories:Finished products
    
    
    988,241
    
    
    
    912,318Raw materials and work in process
    
    
    1,305,694
    
    
    
    1,210,122Total inventories
    
    
    2,293,935
    
    
    
    2,122,440Prepaid expenses
    
    
    174,693
    
    
    
    143,569Total current assets
    
    
    3,573,989
    
    
    
    3,411,054Properties:Land, building and improvements
    
    
    3,157,054
    
    
    
    3,157,054Machinery, equipment and tooling
    
    
    6,866,162
    
    
    
    6,806,070Total cost
    
    
    10,023,216
    
    
    
    9,963,124Less, accumulated depreciation and amortization
    
    
    7,487,060
    
    
    
    7,370,470Net properties
    
    
    2,536,156
    
    
    
    2,592,654Long-term portion of accounts receivable
trade, less allowance for doubtful accounts:$345,102 on January 1, 2005 and $278,120 on April 3, 2004
    
    
    882,046
    
    
    
    698,087Other assets
    
    
    2,253
    
    
    
    3,128Total assets
    
    $
    6,994,444
    
    
    $
    6,704,923
 Continued Page 3




---



##### Table of Contents



SHOPSMITH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS January 1,
    
    
    April 3,2005
    
    
    2004(Unaudited)LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,962,039
    
    
    $
    1,049,694Revolving line of credit
    
    
    476,832
    
    
    
    Current portion of long-term debt
    
    
    1,951,272
    
    
    
    107,555Customer advances
    
    
    65,374
    
    
    
    74,031Accrued liabilities:Compensation, employee benefits and payroll taxes
    
    
    254,346
    
    
    
    410,603Sales taxes payable
    
    
    58,350
    
    
    
    55,696Accrued recourse liability
    
    
    266,768
    
    
    
    311,768Accrued expenses
    
    
    254,906
    
    
    
    249,482Other
    
    
    77,566
    
    
    
    54,118Total current liabilities
    
    
    5,367,453
    
    
    
    2,312,947Long-term debt, less current portion
    
    
    
    
    
    
    2,266,665Total liabilities
    
    
    5,367,453
    
    
    
    4,579,612Shareholders equity:Preferred shares- without par value;
authorized 500,000; none issuedCommon shares- without par value;
authorized 5,000,000; issued and outstanding 2,605,233
    
    
    2,806,482
    
    
    
    2,806,482Deficit
    
    
    (1,179,491
    )
    
    
    (681,171
    )Total shareholders equity
    
    
    1,626,991
    
    
    
    2,125,311Total liabilities and shareholders equity
    
    $
    6,994,444
    
    
    $
    6,704,923
 See notes to consolidated financial statements. Page 4




---



##### Table of Contents



SHOPSMITH, INC. AND SUBSIDIARIES 
  Three Months Ended
    
    
    Nine Months EndedJanuary 1,
    
    
    January 3,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2004
    
    
    2005
    
    
    2004(Unaudited)
    
    
    (Unaudited)
    
    
    (Unaudited)
    
    
    (Unaudited)Net sales
    
    $
    3,680,844
    
    
    $
    3,645,732
    
    
    $
    9,494,010
    
    
    $
    9,932,570Cost of products sold
    
    
    1,844,579
    
    
    
    1,795,158
    
    
    
    4,632,689
    
    
    
    4,890,152Gross margin
    
    
    1,836,265
    
    
    
    1,850,574
    
    
    
    4,861,321
    
    
    
    5,042,418Selling expenses
    
    
    1,526,292
    
    
    
    1,410,002
    
    
    
    4,194,472
    
    
    
    3,695,276Administrative expenses
    
    
    355,470
    
    
    
    418,114
    
    
    
    1,186,211
    
    
    
    1,282,344Total operating expenses
    
    
    1,881,762
    
    
    
    1,828,116
    
    
    
    5,380,683
    
    
    
    4,977,620Income (loss) before
other income and expense
    
    
    (45,497
    )
    
    
    22,458
    
    
    
    (519,362
    )
    
    
    64,798Interest income
    
    
    54,559
    
    
    
    53,081
    
    
    
    142,620
    
    
    
    140,242Interest expense
    
    
    (36,411
    )
    
    
    (53,145
    )
    
    
    (123,766
    )
    
    
    (186,164
    )Other income, net
    
    
    406
    
    
    
    1,557
    
    
    
    2,188
    
    
    
    4,386Income (loss) before income taxes
    
    
    (26,943
    )
    
    
    23,951
    
    
    
    (498,320
    )
    
    
    23,262Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,881Net income (loss)
    
    
    (26,943
    )
    
    
    23,951
    
    
    
    (498,320
    )
    
    
    18,381Deficit:Beginning
    
    
    (1,152,548
    )
    
    
    (816,341
    )
    
    
    (681,171
    )
    
    
    (810,771
    )Ending
    
    $
    (1,179,491
    )
    
    $
    (792,390
    )
    
    $
    (1,179,491
    )
    
    $
    (792,390
    )Net income (loss) per common share
(Note 3)Basic
    
    $
    (0.01
    )
    
    $
    0.01
    
    
    $
    (0.19
    )
    
    $
    0.01Diluted
    
    $
    (0.01
    )
    
    $
    0.01
    
    
    $
    (0.19
    )
    
    $
    0.01
 See notes to consolidated financial statements. Page 5




---



##### Table of Contents



SHOPSMITH, INC. AND SUBSIDIARIES 
  Nine Months EndedJanuary 1,
    
    
    January 3,2005
    
    
    2004(Unaudited)
    
    
    (Unaudited)Cash flows from operating activities:Net income (loss)
    
    $
    (498,320
    )
    
    $
    18,381Adjustments to reconcile net income (loss) to
cash provided from operating activitiesDepreciation and amortization
    
    
    116,590
    
    
    
    117,201Provision for doubtful accounts
    
    
    171,316

    
    
    
    212,815Changes in operating assets and liabilities:Accounts receivable
    
    
    (315,691
    )
    
    
    78,943Inventories
    
    
    (171,495
    )
    
    
    (225,858
    )Prepaid expenses and other
    
    
    (30,249
    )
    
    
    (31,188
    )Accounts payable and customer advances
    
    
    903,688
    
    
    
    295,801Other current liabilities
    
    
    (169,731
    )
    
    
    (180,916
    )Cash provided from operating activities
    
    
    6,108
    
    
    
    285,179Cash flows from investing activities:Property additions
    
    
    (60,092
    )
    
    
    (55,449
    )Cash flows from financing activities:Payments on note payable
    
    
    
    
    
    
    (400,000
    )Net borrowings on revolving line of credit
    
    
    476,832
    
    
    
    Payments on long-term debt
    
    
    (422,948
    )
    
    
    (79,246
    )Cash provided from (used in) financing activities
    
    
    53,884
    
    
    
    (479,246
    )Net decrease in cash
    
    
    (100
    )
    
    
    (249,516
    )Cash and cash equivalents:At beginning of period
    
    
    800
    
    
    
    250,316At end of period
    
    $
    700
    
    
    $
    800
 See notes to consolidated financial statements. Page 6




---



##### Table of Contents



SHOPSMITH, INC. AND SUBSIDIARIES 
   1.
    In the opinion of management, all adjustments (consisting of only normal and recurring
adjustments) have been made as of January 1, 2005 and January 3, 2004 to present the financial
statements fairly. However, the results of operations for the nine months then ended are not
necessarily indicative of results for the full fiscal year. The financial statements and
notes are presented as permitted by Form 10-Q, and do not contain certain information included
in the annual financial statements. The financial statements accompanying this report should
be read in conjunction with the financial statements and notes thereto included in the Annual
Report to Shareholders for the year ended April 3, 2004.  2.
    There was no tax benefit during the three and nine-month periods ended January 1, 2005, as
the tax benefits were offset by changes in a valuation allowance.  3.
    Basic income (loss) per share is computed by dividing net income (loss) by the weighted
average number of common shares outstanding during the period. Diluted income (loss) per share
reflects per share amounts that would have resulted if dilutive stock options had been
converted into common stock. The following reconciles amounts reported in the financial
statements: Three Months Ended
    
    
    Nine Months EndedJanuary 1,
    
    
    January 3,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income (loss)
    
    $
    (26,943
    )
    
    $
    23,951
    
    
    $
    (498,320
    )
    
    $
    18,381Weighted average shares
    
    
    2,605,233
    
    
    
    2,605,233
    
    
    
    2,605,233
    
    
    
    2,605,233Additional dilutive shares
    
    
    
    
    
    
    22,500
    
    
    
    
    
    
    
    3,762Total dilutive shares
    
    
    2,605,233
    
    
    
    2,627,733
    
    
    
    2,605,233
    
    
    
    2,608,995Basic income (loss) per share
    
    $
    (0.01
    )
    
    $
    0.01
    
    
    $
    (0.19
    )
    
    $
    0.01Diluted income (loss) per share
    
    $
    (0.01
    )
    
    $
    0.01
    
    
    $
    (0.19
    )
    
    $
    0.01
 There were no additional dilutive shares included in the computation for the three and
nine-month periods ended January 1, 2005 because the effect of stock options were anti-dilutive.  4.
    On December 31, 2002, the Company entered into a Loan Agreement (the Revolving Credit
Agreement) with Provident Bank. The Revolving Credit Agreement was amended by amendments
dated July 17, 2003 and September 24, 2004. The Promissory Note issued pursuant to the
Revolving Credit Agreement was amended by an amendment dated June 29, 2004. Under the loan
documents as amended, the Company may borrow the lesser of (i) $1,000,000 or (ii) the sum of
(x) 80% of accounts receivable due from Lowes Companies, plus (y) 50% of other trade accounts
receivable (with the maximum amount being advanced in respect of such other trade accounts
receivable being $250,000), plus (z) 50% of finished goods inventory (with the maximum amount
being advanced in respect of such inventory being $500,000). Interest on the Revolving Credit
Agreement is charged at one and one-half percent over the Banks prime rate. The maturity
date on the agreement is June 30, 2005. All loans under the Revolving Credit Agreement are at
the discretion of Provident Bank. At January 1, 2005, $477,000 was outstanding under the
Revolving Credit Agreement. By Second Amendment dated September 24, 2004, the financial covenants under the Revolving Credit
Agreement were amended as follows: (a) Debt Service Coverage Ratio. Beginning with the Companys third fiscal quarter,
ending January 1, 2005, the Company must maintain a Debt Service Coverage ratio of 1:10 to
1:00, tested quarterly. Debt Service Coverage is defined as (i) EBITDA minus cash taxes and
dividends, divided by (ii) cash interest expense plus quarterly current maturities of
long-term debt. (b) Consolidated Tangible Net Worth. From July 1, 2004 through March 31, 2005, the
Company must maintain consolidated tangible net worth in excess of $1,450,000. From and
after April 1, 2005, consolidated tangible net worth must be in excess of $1,800,000. Page 7




---



##### Table of Contents



(c) Limitation on Capital Expenditures. The Company may not make capital expenditures
in excess of $50,000 during any fiscal year without Bank approval. As of January 1, 2005, the Company had a debt service coverage ratio of 0.82 to 1.00 , which is
not in compliance with the 1.10 to 1.00 ratio required. The Company has notified the lender of
such noncompliance and has requested a waiver from Provident Bank. Failure to obtain the waiver
could materially affect the Companys financial position, liquidity, and operations. In connection with the Revolving Credit Agreement, Mr. John R. Folkerth, Chairman and Chief
Executive Officer of the Company, delivered to Provident Bank a Continuing Unconditional
Guaranty pursuant to which Mr. Folkerth guaranteed repayment of $200,000 of the indebtedness
then or thereafter owing by the Company to the Bank. In consideration of that Guaranty, the
Company has agreed to pay to Mr. Folkerth an annual fee of $3,000 (being 1.5% of the guaranteed
amount). On June 29, 2004, the Company refinanced a mortgage note on its building with a balance of
$2,356,000 with a mortgage note from Provident Bank in the amount of $2,000,000 with interest at
one-quarter percent over the banks prime rate. The note requires monthly payments of interest
and from $8,000 to $10,000 of the principal. In August 2009, the remaining balance on the note
of approximately $1,477,000 will become due. At January 1, 2005, there was $1,951,000
outstanding under the building mortgage agreement. Under the terms of the mortgage loan, default by the Company under the Revolving Credit
Agreement can trigger default under the mortgage loan. In the event of default, Provident Bank
may declare the mortgage loan immediately due and payable. The outstanding balance of the
mortgage note at January 1, 2005 has been classified as a current liability in the accompanying
consolidated balance sheet due to the Companys noncompliance with the debt service coverage
ratio covenant of its amended Revolving Credit Agreement. The mortgage loan and the revolving credit loans are collateralized by a mortgage on, or
security interest in, substantially all assets of the Company. The Company is dependent upon the Revolving Credit Agreement to fund operations during periods
of negative cash flow. Termination of the Revolving Credit Agreement, without the establishment
of a substitute credit facility, would create significant liquidity issues for the Company.  5.
    A major retailer (Lowes) represented 47% and 40% of net sales for the quarters ended January
1, 2005 and January 3, 2004, respectively. This retailer also represented 41% of trade
accounts receivable at January 1, 2005 and April 3, 2004, respectively.  6.
    The Company has adopted the disclosure only provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation, as amended by SFAS No.
148, Accounting for Stock-Based Compensation - Transition and Disclosure, and, accordingly,
accounts for its stock option plans using the intrinsic value method of Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees. The following table illustrates the effect on net income (loss) and net earnings (loss) per
share if compensation expense was measured using the fair value recognition provisions of SFAS
No. 123. Three Months Ended
    
    
    Nine Months EndedJanuary 1,
    
    
    January 3,
    
    
    January 1,
    
    
    January 3,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income
(loss) - as reported
    
    $
    (26,943
    )
    
    $
    23,951
    
    
    $
    (498,320
    )
    
    $
    18,381Net income
(loss) - pro forma
    
    $
    (26,943
    )
    
    $
    23,951
    
    
    $
    (511,864
    )
    
    $
    17,721Diluted
earnings (loss) per share - as reported
    
    $
    (0.01
    )
    
    $
    0.01
    
    
    $
    (0.19
    )
    
    $
    0.01Diluted
earnings (loss) per share - pro forma
    
    $
    (0.01
    )
    
    $
    0.01
    
    
    $
    (0.19
    )
    
    $
    0.01
 Page 8




---



##### Table of Contents



7.
    New Accounting Pronouncements. On December 16, 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised
2004), Share-Based Payment(SFAS 123R). SFAS 123R requires all public companies to record
compensation cost for stock options provided to employees in return for employee service. The
cost is measured at the fair value of the options when granted, and this cost is expensed over
the employee service period, which is normally the vesting period of the options. SFAS 123R will
apply prospectively to awards granted or modified after the beginning of the first interim or
annual reporting period that begins after June 15, 2005. Compensation cost will also be
prospectively recorded for prior option grants that vest after the date of adoption. The effects
on results of operations will depend on the level of future option grants and the calculation of
the fair value of the options granted at such future date, as well as the vesting periods
provided and so cannot currently be predicted. Existing options that will vest after adoption
date are expected to result in additional compensation expense of approximately $6,000 during
fiscal 2006. There will be no significant effect on financial position as total shareholders
equity will not change. Page 9




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Shopsmith manufactures and sells woodworking products. Our core product, the Mark V, is sold
directly to consumers through demonstration sales events and indirectly to consumers through
distributors (primarily Lowes where Shopsmith also conducts sales demonstrations) along with
smaller amounts through other efforts. Mark V sales demonstrations are performed at state fairs, at
home shows, and in shopping malls. Other woodworking products and accessories are sold through mail
and internet channels. Shopsmith recognizes revenue for these orders at the time of product
shipment. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The financial condition and results of operations for Shopsmith presented in the Consolidated
Financial Statements, accompanying notes , and managements discussion and analysis are dependent
upon the Companys accounting policies. The selection and application of these accounting policies
involve judgments, estimates, and uncertainties that are susceptible to change. The Companys
significant accounting policies are discussed in Note 2 of the notes to the Consolidated Financial
Statements included in the Companys annual report to shareholders for the year ended April 3,
2004. In managements opinion, the Companys critical accounting policies include the allowance for
doubtful accounts, accrued recourse liability and deferred tax valuation allowance. Allowance For Doubtful Accounts The Company maintains an allowance for doubtful accounts for estimated losses resulting from the
inability of our customers to make required payments. Customer accounts are stratified by type of
account, original credit rating, and recent payment history. Estimated loss rates are then applied
to these groups. Deterioration of our customers ability to make payments could require additions
to the allowance. Accounts repurchased under the recourse provision, discussed below, are carried in trade accounts
receivable, net of an allowance for doubtful accounts, while the Company attempts to collect them. Accrued Recourse Liability Certain retail installment contracts sold to financial institutions through the fiscal year ended
March 31, 2001 included a recourse provision. Under this recourse provision, Shopsmith is obligated
to purchase the installment contract if the customer defaults on their obligation to the financial
institution. The Companys liability for future recourse obligations has been estimated using
factors based on the value and rate of change of the value of the outstanding accounts, the rate
and changes in the rate of repurchases required under the recourse provision, as well as estimates
of amounts collectable after the accounts are repurchased. If these factors would deteriorate,
additional accruals would be necessary and would affect future operating results. The Company will
be required to adopt Statement of Position 03-03 in April 2005. At that time, purchases of loans
under a recourse provision will be recorded at fair value at repurchase date, instead of gross less
an allowance for doubtful accounts. Deferred Tax Valuation Allowance The Company has recorded a full valuation allowance against its net deferred tax assets based on
its evaluation of the realizability of the future tax benefits of deferred tax assets. The effect
of the allowance is to reduce to zero the carrying value of the potential tax benefit arising from
the possibility of offsetting the Companys cumulative operating losses against future taxable
income. Page 10




---



##### Table of Contents



Results of Operations Fiscal 2005 third quarter sales increased to $3,681,000, or 1.0%, from $3,646,000 during the same
period a year ago. Increases in sales through demonstrations within Lowes stores were nearly
offset by decreases in catalog and traveling academy sales. Fiscal 2005 year-to-date sales
decreased to $9,494,000, or 4.4%, from $9,933,000 last year. The decline in year-to-date sales was
primarily in the Companys Catalog and Internet sales channels. Gross margin rates for the fiscal 2005 third quarter decreased by 0.9 percentage points compared to
the same period last year. On a year-to-date basis, gross margin rates increased by 0.4 percentage
points. Operating expenses increased by $54,000 to $1,882,000 in the fiscal 2005 third quarter from
$1,828,000 in last years third quarter. For fiscal 2005 year-to-date, operating expenses increased
by $403,000 to $5,381,000 from $4,978,000 in the prior year. The most significant factors in the
increase in operating expenses were an increase in the number of Mark V sales demonstration events,
primarily within Lowes stores, as well as expenditures on sales representative training costs. Provisions for recoverable federal income taxes are based on estimated annual effective rates, less
a valuation allowance. No tax benefit or expense is reported for the periods ended January 1, 2005,
as they were offset by changes in the valuation allowance. With the increased operating expenses, the Company recorded a net loss of $27,000, or $.01 per
diluted share, in the quarter ended January 1, 2005, compared to net income of $24,000, or $.01 per
diluted share, for the same period of last year. For fiscal 2005 year-to-date, a net loss of
$498,000, or $.19 per diluted share, was incurred, compared to net income of $18,000, or $.01 per
diluted share, for the same period last year. Liquidity and Financial Position Cash provided from operations totaled $6,000 for the nine months ended January 1, 2005, compared
with $285,000 provided from operations for the same period of the preceding year. During the
period, cash was used for an increase in accounts receivable, as well as for the periods net loss.
Cash was provided from an increase in accounts payable of $904,000, which occurred both due to
seasonal volume, as well as an extension of payment terms beyond the Companys customary practice. On December 31, 2002, the Company entered into a Loan Agreement (the Revolving Credit Agreement)
with Provident Bank. The Revolving Credit Agreement was amended by amendments dated July 17, 2003
and September 24, 2004. The Promissory Note issued pursuant to the Revolving Credit Agreement was
amended by an amendment dated June 29, 2004. Under the loan documents as amended, the Company may
borrow the lesser of (i) $1,000,000 or (ii) the sum of (x) 80% of accounts receivable due from
Lowes Companies, plus (y) 50% of other trade accounts receivable (with the maximum amount being
advanced in respect of such other trade accounts receivable being $250,000), plus (z) 50% of
finished goods inventory (with the maximum amount being advanced in respect of such inventory being
$500,000). Interest on the Revolving Credit Agreement is charged at one and one-half percent over
the Banks prime rate. The maturity date on the agreement is June 30, 2005. All loans under the
Revolving Credit Agreement are at the discretion of Provident Bank. At January 1, 2005, $477,000
was outstanding under the Revolving Credit Agreement. The maximum amount available under the
credit line at January 1, 2005 was $882,000. By Second Amendment dated September 24, 2004, the financial covenants under the Revolving Credit
Agreement were amended as follows: (a) Debt Service Coverage Ratio. Beginning with the Companys third fiscal quarter,
ending January 1, 2005, the Company must maintain a Debt Service Coverage ratio of 1:10 to
1:00, tested quarterly. Debt Service Coverage is defined as (i) EBITDA minus cash taxes and
dividends, divided by (ii) cash interest expense plus quarterly current maturities of
long-term debt. (b) Consolidated Tangible Net Worth. From July 1, 2004 through March 31, 2005, the
Company must maintain consolidated tangible net worth in excess of $1,450,000. From and
after April 1, 2005, consolidated tangible net worth must be in excess of $1,800,000. (c) Limitation on Capital Expenditures. The Company may not make capital expenditures
in excess of $50,000 during any fiscal year without Bank approval. Page 11




---



##### Table of Contents



As of January 1, 2005, the Company had a debt service coverage ratio of 0.82 to 1.00, which is not
in compliance with the 1.10 to 1.00 ratio required. The Company has notified the lender of such
noncompliance and has requested a waiver. Failure to obtain the waiver could materially affect the
Companys financial position, liquidity, and operations. In connection with the Revolving Credit Agreement, Mr. John R. Folkerth, Chairman and Chief
Executive Officer of the Company, delivered to Provident Bank a Continuing Unconditional Guaranty
pursuant to which Mr. Folkerth guaranteed repayment of $200,000 of the indebtedness then or
thereafter owing by the Company to the Bank. In consideration of that Guaranty, the Company has
agreed to pay to Mr. Folkerth an annual fee of $3,000 (being 1.5% of the guaranteed amount). On June 29, 2004, the Company refinanced a mortgage on its office and manufacturing facility. At
the time of the refinancing, the mortgage balance was $2,356,000. The mortgage was refinanced with
a mortgage loan from Provident Bank in the amount of $2,000,000 (the New Mortgage Loan). In
order to facilitate the New Mortgage Loan, the Company drew $356,000 under the Revolving Credit
Agreement to reduce the prior mortgage balance immediately before the refinancing. Interest on the
New Mortgage Loan is at one-quarter percent over the Banks prime rate. The loan documents require
monthly payment of interest and monthly payments of principal from $8,000 to $10,000. In August
2009, the remaining balance on the note of approximately $1,477,000 will become due. Under the terms of the New Mortgage Loan, default under the Revolving Credit Agreement can trigger
default under the New Mortgage Loan. In the event of default, the Bank may declare the New
Mortgage Loan immediately due and payable. As of January 1, 2005, the Company was not in
compliance with the debt service coverage ratio covenant of the Revolving Credit Agreement. As a
result of this covenant violation, the mortgage debt has been classified as a current liability as
of January 1, 2005. The New Mortgage Loan and the revolving credit loans are collateralized by a mortgage on, or
security interest in, substantially all assets of the Company. The Company is dependent upon the Revolving Credit Agreement to fund operations during periods of
negative cash flow. Termination of the Revolving Credit Agreement, without establishment of a
substitute credit facility, would create significant liquidity issues for the Company. The Companys current ratio was 0.67 to 1 at January 1, 2005 and 1.47 to 1 at April 3, 2004.
Excluding the current liability classification of the Companys mortgage note, the current ratio
would have been 1.02 to 1 at January 1, 2005. The debt to equity ratio increased to 3.30 to 1 at
January 1, 2005 from 2.15 to 1 at April 3, 2004. Losses during the nine months ended January 1,
2005 have contributed to a tightening of liquidity which in turn has caused the Company to defer
payments to vendors beyond the Companys customary payment practice. The Company believes that profitability is critical to ensuring adequate liquidity in both the
current and future fiscal years. Contractual Obligations Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    
    More thanContractual Obligations
    
    Total
    
    
    1 Year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    5 YearsRevolving Line of Credit
    
    $
    476,832
    
    
    $
    476,832
    
    
    $
    
    
    
    $
    
    
    
    $
    Long-Term Debt
    
    
    1,951,272
    
    
    
    99,540
    
    
    
    212,208
    
    
    
    1,639,524
    
    
    
    Operating Leases
    
    
    172,597
    
    
    
    61,274
    
    
    
    81,090
    
    
    
    30,233
    
    
    
    Total
    
    $
    2,600,701
    
    
    $
    637,646
    
    
    $
    293,298
    
    
    $
    1,669,757
    
    
    $
    
 As noted in managements discussion of liquidity and financial position, the mortgage debt, shown
here as long-term debt, has been classified as a current obligation on the balance sheet Page 12




---



##### Table of Contents



Forward Looking Statements The foregoing discussion and the Companys consolidated financial statements contain certain
forward-looking statements that involve risks and uncertainties, including but not limited to the
following: (i) the operating cash flows together with currently available working capital may be
inadequate to finance the operating needs of the Company; (ii) cancellation by Lowes of the
in-store sales program; (iii) the Company may fail to obtain a waiver for its failure to meet the
financial covenants contained its Loan Agreement with Provident Bank, in which event the Bank may
declare all amounts owed by the Company to the Bank under the revolving credit and mortgage loan
facilities to be immediately due and payable; (iv) the Companys future results may fail to meet
the financial covenants contained in its Loan Agreement with Provident Bank; (v) the Bank may
decline to make further advances under the revolving credit facility; (vi) the Company may be
unable to extend or refinance the revolving credit facility when the revolving credit loans mature
on June 30, 2005; and (vii) actual losses related to doubtful accounts and recourse liabilities
(discussed under Critical Accounting Policies and Estimates) may exceed current estimates. Page 13




---



##### Table of Contents



Item 4. Controls and Procedures. (a) Evaluation of Disclosure Controls and Procedures The Companys Chairman and Chief Executive Officer, John R. Folkerth, and the Companys
Chief Financial Officer, Mark A. May, have evaluated the Companys disclosure controls and
procedures within 90 days of the filing of this report. Messrs. Folkerth and May have
concluded that the Companys disclosure controls and procedures are functioning effectively
to provide reasonable assurance that the Company can meet its disclosure obligations. The
reporting process is designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits with the Commission is recorded, processed,
summarized and reported within the time periods specified in the Commissions rules and
forms. (b) Changes in Internal Controls There were no significant changes in the Companys internal controls over financial
reporting that could materially affect these controls subsequent to the date of the above
reference evaluation. Page 14




---



##### Table of Contents



PART II. OTHER INFORMATION 
 Item 3. Default Upon Senior Securities As discussed in the Liquidity and Financial Position section of Managements Discussion and
Analysis of Financial Condition and Results of Operations set forth in Item 2 of this report, at
January 1, 2005, the Company was not in compliance with a financial covenant (relating to debt
service coverage ratio) contained in its Revolving Credit Agreement with Provident Bank. 
 Item 5. Other Information  (a)
    The Loan Agreement, dated December 31, 2002 and amended July 17, 2003 and
September 24, 2004, between the Company and Provident Bank prohibits the payment of
dividends by the Company. 
 Item 6. Exhibits And Reports On Form 8-K  (a)
    Exhibits  31.1
    Certification of the Chief Executive Officer pursuant to Securities
Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.31.2
    Certification of the Chief Financial Officer pursuant to Securities
Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.32.1
    Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.32.2
    Certification of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.  (b)
    Reports On Form 8-K During the quarter ended January 1, 2005 the Company filed the following report on Form 8-K: A Form 8-K filed on November 16, 2004 included the text of the Companys press release
reporting the results of its operations for the quarter ended October 2, 2004. Page 15




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned thereunto duly
authorized. SHOPSMITH, INC.By
    
    /s/ Mark A MayMark A. MayVice President of Finance (Principal Financial
and Accounting Officer)
 Date: February 8, 2005 Page 16