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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934  or [  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  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. [X] Yes [  ] No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [  ] Yes
    
    [X] 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 July 21, 2004. Page 1




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SHOPSMITH, INC. AND SUBSIDIARIES INDEX Page No.Part I. Financial Information:Item 1. Financial StatementsConsolidated Balance Sheets -
July 3, 2004 and April 3, 2004
    
    
    3 - 4Consolidated Statements of Operations and Deficit - Three Months Ended
July 3, 2004 and July 5, 2003
    
    
    5Consolidated Statements of Cash Flows - Three Months Ended
July 3, 2004 and July 5, 2003
    
    
    6Notes to Consolidated Financial Statements
    
    
    7 - 8Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    9 - 11Item 4. Controls and Procedures
    
    
    12Part II. Other InformationItem 2. Changes in Securities and Use of Proceeds
    
    
    13Item 6. Exhibits and Reports on Form 8-K
    
    
    13Signatures
    
    
    13Exhibits
    
    
    14 - 52Exhibit 4.16Exhibit 4.17EX-4.18EX-4.19Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  Page 2




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Part I  FINANCIAL INFORMATION 
 Item 1. Financial Statements SHOPSMITH, INC. AND SUBSIDIARIES 
  July 3,
    
    April 3,2004
    
    2004(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    800
    
    
    $
    800Accounts receivable:Trade, less allowance for doubtful accounts:
$408,134
on July 3, 2004 and $391,871 on April 3, 2004
    
    
    788,105
    
    
    
    1,144,245Inventories:Finished products
    
    
    1,122,707
    
    
    
    912,318Raw materials and work in process
    
    
    1,016,551
    
    
    
    1,210,122Total inventories
    
    
    2,139,258
    
    
    
    2,122,440Prepaid expenses
    
    
    246,265
    
    
    
    143,569Total current assets
    
    
    3,174,428
    
    
    
    3,411,054Properties:Land, building and improvements
    
    
    3,157,054
    
    
    
    3,157,054Machinery, equipment and tooling
    
    
    6,828,762
    
    
    
    6,806,070Total cost
    
    
    9,985,816
    
    
    
    9,963,124Less, accumulated depreciation and amortization
    
    
    7,408,903
    
    
    
    7,370,470Net properties
    
    
    2,576,913
    
    
    
    2,592,654Long-term portion of accounts receivable
trade, less allowance for doubtful accounts: $279,567
on July 3, 2004 and $278,120 on April 3, 2004
    
    
    661,583
    
    
    
    698,087Other assets
    
    
    3,128
    
    
    
    3,128Total assets
    
    $
    6,416,052
    
    
    $
    6,704,923
 Continued Page 3




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SHOPSMITH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS July 3,
    
    April 3,2004
    
    2004(Unaudited)LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,108,905
    
    
    $
    1,049,694Revolving line of credit
    
    
    614,754
    
    
    
    Current portion of long-term debt and capital lease obligation
    
    
    97,824
    
    
    
    107,555Customer advances
    
    
    64,281
    
    
    
    74,031Accrued liabilities:Compensation, employee benefits and payroll taxes
    
    
    288,979
    
    
    
    410,603Sales taxes payable
    
    
    48,121
    
    
    
    55,696Accrued recourse liability
    
    
    311,768
    
    
    
    311,768Accrued expenses
    
    
    255,934
    
    
    
    249,482Other
    
    
    54,118
    
    
    
    54,118Total current liabilities
    
    
    2,844,684
    
    
    
    2,312,947Long-term debt and capital lease obligation, less current portion
    
    
    1,902,572
    
    
    
    2,266,665Total liabilities
    
    
    4,747,256
    
    
    
    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
    
    
    (1,137,686
    )
    
    
    (681,171
    )Total shareholders equity
    
    
    1,668,796
    
    
    
    2,125,311Total liabilities and shareholders equity
    
    $
    6,416,052
    
    
    $
    6,704,923
 See notes to consolidated financial statements. Page 4




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SHOPSMITH, INC. AND SUBSIDIARIES 
  Three Months EndedJuly 3,
    
    July 5,2004
    
    2003(Unaudited)
    
    (Unaudited)Net sales
    
    $
    2,787,436
    
    
    $
    3,112,504Cost of products sold
    
    
    1,395,440
    
    
    
    1,581,909Gross margin
    
    
    1,391,996
    
    
    
    1,530,595Selling expenses
    
    
    1,384,268
    
    
    
    1,187,327Administrative expenses
    
    
    455,978
    
    
    
    444,406Total operating expenses
    
    
    1,840,246
    
    
    
    1,631,733Loss before other income
and expense
    
    
    (448,250
    )
    
    
    (101,138
    )Interest income
    
    
    44,538
    
    
    
    43,643Interest expense
    
    
    (53,698
    )
    
    
    (68,106
    )Other income, net
    
    
    895
    
    
    
    1,524Loss before income taxes
    
    
    (456,515
    )
    
    
    (124,077
    )Income tax expense
    
    
    
    
    
    
    Net loss
    
    
    (456,515
    )
    
    
    (124,077
    )Deficit:Beginning
    
    
    (681,171
    )
    
    
    (810,771
    )Ending
    
    $
    (1,137,686
    )
    
    $
    (934,848
    )Net loss per common share
(Note 3)Basic
    
    $
    (0.18
    )
    
    $
    (0.05
    )Diluted
    
    $
    (0.18
    )
    
    $
    (0.05
    )
 See notes to consolidated financial statements. Page 5




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SHOPSMITH, INC. AND SUBSIDIARIES 
  Three Months EndedJuly 3,
    
    July 5,2004
    
    2003(Unaudited)
    
    (Unaudited)Cash flows from operating activities:Net loss
    
    $
    (456,515
    )
    
    $
    (124,077
    )Adjustments to reconcile net loss to
cash (used in) operating activitiesDepreciation and amortization
    
    
    38,433
    
    
    
    39,685Provision for doubtful accounts
    
    
    47,887
    
    
    
    76,972Changes in operating assets and liabilities:Accounts receivable
    
    
    344,757
    
    
    
    (81,404
    )Inventories
    
    
    (16,818
    )
    
    
    (219,688
    )Prepaid expenses
    
    
    (102,696
    )
    
    
    (84,486
    )Accounts payable and customer advances
    
    
    49,461
    
    
    
    187,192Other current liabilities
    
    
    (122,747
    )
    
    
    (154,589
    )Cash (used in) operating activities
    
    
    (218,238
    )
    
    
    (360,395
    )Cash flows from investing activities:Property additions
    
    
    (22,692
    )
    
    
    (13,156
    )Cash (used in) investing activities
    
    
    (22,692
    )
    
    
    (13,156
    )Cash flows from financing activities:Payments on note payable
    
    
    
    
    
    
    (100,000
    )Net borrowings on revolving line of credit
    
    
    614,754
    
    
    
    251,595Payments on long-term debt and capital lease obligation
    
    
    (373,824
    )
    
    
    (27,535
    )Cash provided from financing activities
    
    
    240,930
    
    
    
    124,060Net decrease in cash
    
    
    
    
    
    
    (249,491
    )Cash and cash equivalents:At beginning of period
    
    
    800
    
    
    
    250,316At end of period
    
    $
    800
    
    
    $
    825
 See notes to consolidated financial statements. Page 6




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SHOPSMITH, INC. AND SUBSIDIARIES 
   1.
    
    In the opinion of management, all adjustments (consisting of only normal
and recurring adjustments) have been made as of July 3, 2004 and July 5,
2003 to present the financial statements fairly. However, the results of
operations for the three 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 in the quarters ended July 3, 2004 and July 5,
2003, as it was offset by a change in valuation allowance.3.
    
    Basic income per share is computed by dividing net income by the weighted
average number of common shares outstanding during the period. Diluted
income 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 EndedJuly 3,
    
    July 5,2004
    
    2003Net loss
    
    $
    (456,515
    )
    
    $
    (124,077
    )Weighted average shares
    
    
    2,605,233
    
    
    
    2,605,233Additional dilutive shares
    
    
    
    
    
    
    Total dilutive shares
    
    
    2,605,233
    
    
    
    2,605,233Basic loss per share
    
    $
    (0.18
    )
    
    $
    (0.05
    )Diluted loss per share
    
    $
    (0.18
    )
    
    $
    (0.05
    )
  There were no additional dilutive shares included in the computation for the
periods ended July 3, 2004 and July 5, 2003 because the stock options were
anti-dilutive.4.
    
    On December 31, 2002, Shopsmith entered into a line of credit agreement
with Provident Bank which allows the Company to borrow up to the lesser of
$750,000 or 80% of eligible receivables due from Lowes Companies, Inc.,
with interest charged at one and one-half percent over the banks prime
rate. On June 29, 2004, this agreement was amended to allow borrowings up
to $1,000,000, down from $1,400,000 available from the previous amendment.  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 of
approximately $1,477,000 will become due.  Both agreements require compliance with certain net income, net worth, and
miscellaneous covenants. Substantially all personal property is pledged as
collateral. As of July 3, 2004, the Company was not in compliance with the
net worth and fixed charge coverage covenants of these agreements. The
Company has reached agreement with the Provident Bank to waive the covenant
violations and to amend the covenants going forward. The Company expects
to remain in compliance with its amended covenants through the remainder of
fiscal 2005 as well as through June 2005.  At July 3, 2004, there was $2,000,000 and $614,754 outstanding under the
building mortgage agreement and line of credit agreement, respectively.5.
    
    A major retailer represented 44% and 43% of net sales for the quarters
ended July 3, 2004 and July 5, 2003, respectively. This retailer also
represented 32% and 41% of trade accounts receivable at July 3, 2004 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. Page 7




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The following table illustrates the effect on net loss and net loss per share
if compensation expense was measured using the fair value recognition
provisions of SFAS No. 123. Three Months EndedJuly 3,
    
    July 5,2004
    
    2003Net loss - as reported
    
    $
    (456,515
    )
    
    $
    (124,077
    )Net loss - pro forma
    
    $
    (456,515
    )
    
    $
    (124,077
    )Diluted loss per share - as reported
    
    $
    (0.18
    )
    
    $
    (0.05
    )Diluted loss per share - pro forma
    
    $
    (0.18
    )
    
    $
    (0.05
    )
 Page 8




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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 in shopping malls, at home
shows, and at state fairs. 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 2006.
At that time, purchase 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 9




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Results of Operations Fiscal 2005 first quarter sales decreased to $2,787,000, or 10.5%, from
$3,113,000 during the same period a year ago. This decrease in the first
quarter occurred primarily in our demonstration event Mark V sales. Gross margin rates for the fiscal 2005 first quarter increased by 0.75
percentage points compared to the same period last year. Operating expenses
increased by $208,000 to $1,840,000 in the fiscal 2005 first quarter from
$1,632,000 in last years first quarter. The most significant reason for the
increase in operating expenses was an increased expenditure on sales
representative training costs. Training was done to both increase the number
of Mark V sales representatives, as well as to increase the effectiveness of
existing sales representatives. Provisions for recoverable federal income taxes are based on estimated annual
effective rates, less a valuation allowance. No tax benefit is reported for the
quarters ended July 3, 2004 and July 5, 2003, as it was offset by a change in
valuation allowance. With the reduction in sales and increased operating expenses, the Company
recorded a net loss of $457,000, or $.18 per diluted share, in the quarter
ended July 3, 2004, compared to a net loss of $124,000, or $.05 per diluted
share, for the same period of last year. Liquidity and Financial Position Cash used in operations totaled $218,000 for the quarter ended July 3, 2004,
compared with $360,000 for the same period of the preceding year. 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. $615,000 was also borrowed on the Companys revolving line of
credit during the first quarter of fiscal 2005, of which $356,000 was used to
reduce the above note prior to refinancing. Interest on this new mortgage note
is at one-quarter percent over the banks prime rate. The note requires monthly
payment of interest and from $8,000 to $10,000 of principal. In August 2009,
the remaining balance of approximately $1,477,000 will become due. On December 31, 2002, Shopsmith entered into a line of credit agreement with
Provident Bank. On June 29, 2004, this agreement was amended to allow
borrowings up to $1,000,000, down from $1,400,000 available from the previous
amendment. The agreement requires compliance with certain net income, net worth, and miscellaneous covenants. Substantially all personal
property is pledged as collateral. At July 3, 2004, $615,000 was outstanding
under this agreement. Both the mortgage agreement and the Companys line of credit agreement with
Provident Bank require compliance with certain net income, net worth, and
miscellaneous covenants. As of July 3, 2004, the Company was not in compliance
with the net worth and fixed charge covenants of these agreements. The
covenants required a consolidated tangible net worth of not less than
$1,800,000 and a fixed charge coverage ratio at all times greater than 1.2:1 on
a rolling twelve month basis. At July 3, 2004, the Company has a consolidated
tangible net worth of $1,668,796 and a fixed charge coverage ratio of 0.6:1.
The Company has reached agreement with Provident Bank to waive the violation of
the covenants and to amend the covenants going forward. The amended covenants
require a consolidated tangible net worth of not less than $1,450,000 and a
fixed charge coverage ratio of 1.1:1 on a quarterly basis. The Company expects
to remain in compliance with its amended covenants through the remainder of
fiscal 2005 as well as through June 2005. The current ratio was 1.16 to 1 at July 3, 2004 and 1.47 to 1 at April 3, 2004.
The debt to equity ratio increased to 2.84 to 1 from 2.15 to 1 at April 3,
2004. The Company believes that profitability is critical to ensuring adequate
liquidity in both the current and future fiscal years. Page 10




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Contractual Obligations Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    More thanContractual Obligations
    
    Total
    
    1 Year
    
    1-3 Years
    
    3-5 Years
    
    5 YearsRevolving Line of Credit
    
    $
    614,754
    
    
    $
    614,754
    
    
    $
    
    
    
    $
    
    
    
    $
    Long-Term Debt
    
    
    2,000,000
    
    
    
    97,428
    
    
    
    208,668
    
    
    
    216,483
    
    
    
    1,477,421Capital Lease Obligations
    
    
    396
    
    
    
    396
    
    
    
    
    
    
    
    
    
    
    
    Operating Leases
    
    
    82,279
    
    
    
    45,882
    
    
    
    22,817
    
    
    
    13,580
    
    
    
    Total
    
    
    2,697,429
    
    
    
    758,460
    
    
    
    231,485
    
    
    
    230,063
    
    
    
    1,477,421
 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 meet the amended
financial covenants contained in its Loan Agreements dated December 31, 2002
and June 29, 2004 with Provident Bank, in which event the bank may declare all
amounts owed by the Company to the bank to be immediately due and payable; and
(iv) actual losses related to doubtful accounts and recourse liabilities
(discussed under Critical Accounting Policies and Estimates) may exceed current
estimates. Item 3. Defaults Upon Senior Securities. See Liquidity and Financial Position in Item 2 above for a discussion of
certain violations by the Company under financial covenants contained in the
loan agreements to which the Company is a party. The lender has agreed to
waive the violations. Page 11




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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 12




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PART II. OTHER INFORMATION 
 Item 2. Changes in Securities and Use of Proceeds The Loan Agreement between the Company and Provident Bank prohibits the
payment of dividends. 
 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 4.16
    
    Second amendment to loan agreement, promissory
note, and security agreement with The Provident Bank dated
June 29, 2004.4.17
    
    Promissory note ($2,000,000) and mortgage dated
June 29, 2004 between The Provident Bank and the Company.4.18
    
    Environmental Indemnity Agreement dated June
29, 2004 between The Provident Bank and the Company.4.19
    
    Assignment of Rents and Leases dated June 29,
2004 between The Provident Bank and the Company.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 July 3, 2004, the Company filed the
following report on Form 8-K: A Form 8-K filed on June 21, 2004 included the text of the
Companys press release reporting the results of its operations
for the year ended April 3, 2004. 
 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. May
Vice President of Finance (Principal
Financial and Accounting Officer) Date: August 17, 2004 Page 13