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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended July 2, 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)
  þ o
 o þ




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Page No.Part I. Financial Information:Item 1. Financial StatementsConsolidated Balance Sheets  July 2, 2005 and April 2, 2005
    
    3-4Consolidated Statements of Operations and Deficit  Three Months Ended July 2, 2005 and July 3, 2004
    
    5Consolidated Statements of Cash Flows  Three Months Ended July 2, 2005 and July 3, 2004
    
    6Notes to Consolidated Financial Statements
    
    7-9Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    10-12Item 4. Controls and Procedures
    
    13Part II. Other InformationItem 3. Default Upon Senior Securities
    
    14Item 6. Exhibits
    
    14Signatures
    
    15Exhibits
    
    16-19EX-31.1EX-31.2EX-32.1EX-32.2
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Part I  FINANCIAL INFORMATION
 
   
  July 2,
    
    April 2,2005
    
    2005(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    1,099
    
    
    $
    1,099Accounts receivable:Trade, less allowance for doubtful accounts:$585,887 on July 2, 2005 and $608,060 on April 2, 2005
    
    
    541,948
    
    
    
    1,206,143Inventories:Finished products
    
    
    930,236
    
    
    
    811,215Raw materials and work in process
    
    
    1,158,909
    
    
    
    1,223,402Total inventories
    
    
    2,089,145
    
    
    
    2,034,617Prepaid expenses
    
    
    297,754
    
    
    
    112,754Total current assets
    
    
    2,929,946
    
    
    
    3,354,613Properties:Land, building and improvements
    
    
    3,157,054
    
    
    
    3,157,054Machinery, equipment and tooling
    
    
    6,894,871
    
    
    
    6,885,915Total cost
    
    
    10,051,925
    
    
    
    10,042,969Less, accumulated depreciation and amortization
    
    
    7,566,796
    
    
    
    7,526,435Net properties
    
    
    2,485,129
    
    
    
    2,516,534Long-term portion of accounts receivable
trade, less allowance for doubtful accounts:$14,234 on July 2, 2005 and $265,688 on April 2, 2005
    
    
    59,409
    
    
    
    1,068,050Other assets
    
    
    2,253
    
    
    
    2,253Total assets
    
    $
    5,476,737
    
    
    $
    6,941,450
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July 2,
    
    April 2,2005
    
    2005(Unaudited)LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,358,819
    
    
    $
    2,052,134Revolving line of credit
    
    
    250,592
    
    
    
    577,727Current portion of long-term debt
    
    
    1,902,558
    
    
    
    1,926,915Customer advances
    
    
    77,252
    
    
    
    79,547Accrued liabilities:Compensation, employee benefits and payroll taxes
    
    
    213,798
    
    
    
    318,075Sales taxes payable
    
    
    49,883
    
    
    
    59,685Accrued recourse liability
    
    
    241,481
    
    
    
    266,768Accrued expenses
    
    
    256,085
    
    
    
    232,758Other
    
    
    54,118
    
    
    
    73,349Total current liabilities
    
    
    4,404,586
    
    
    
    5,586,958Long-term debt, less current portion
    
    
    
    
    
    
    Total liabilities
    
    
    4,404,586
    
    
    
    5,586,958Shareholders 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
    
    
    (1,734,331
    )
    
    
    (1,451,990
    )Total shareholders equity
    
    
    1,072,151
    
    
    
    1,354,492Total liabilities and shareholders equity
    
    $
    5,476,737
    
    
    $
    6,941,450
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Three Months EndedJuly 2,
    
    July 3,2005
    
    2004(Unaudited)
    
    (Unaudited)Net sales
    
    $
    2,603,012
    
    
    $
    2,787,436Cost of products sold
    
    
    1,267,582
    
    
    
    1,395,440Gross margin
    
    
    1,335,430
    
    
    
    1,391,996Selling expenses
    
    
    1,172,696
    
    
    
    1,384,268Administrative expenses
    
    
    407,256
    
    
    
    455,978Total operating expenses
    
    
    1,579,952
    
    
    
    1,840,246Loss before other income
and expense
    
    
    (244,522
    )
    
    
    (448,250
    )Interest income
    
    
    153
    
    
    
    44,538Interest expense
    
    
    (38,378
    )
    
    
    (53,698
    )Other income, net
    
    
    406
    
    
    
    895Loss before income taxes
    
    
    (282,341
    )
    
    
    (456,515
    )Income tax expense
    
    
    
    
    
    
    Net loss
    
    
    (282,341
    )
    
    
    (456,515
    )Deficit:Beginning
    
    
    (1,451,990
    )
    
    
    (681,171
    )Ending
    
    $
    (1,734,331
    )
    
    $
    (1,137,686
    )Net loss per common share (Note 3)Basic
    
    $
    (0.11
    )
    
    $
    (0.18
    )Diluted
    
    $
    (0.11
    )
    
    $
    (0.18
    )
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Three Months EndedJuly 2,
    
    July 3,2005
    
    2004(Unaudited)
    
    (Unaudited)Cash flows from operating activities:Net loss
    
    $
    (282,341
    )
    
    $
    (456,515
    )Adjustments to reconcile net loss to
cash (used in) operating activitiesDepreciation and amortization
    
    
    40,361
    
    
    
    38,433Provision for doubtful accounts
    
    
    26,102
    
    
    
    47,887Proceeds from sale of consumer revolving credit receivables
    
    
    1,138,721
    
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    508,013
    
    
    
    344,757Inventories
    
    
    (54,528
    )
    
    
    (16,818
    )Prepaid expenses and other
    
    
    (185,000
    )
    
    
    (102,696
    )Accounts payable and customer advances
    
    
    (695,610
    )
    
    
    49,461Other current liabilities
    
    
    (135,270
    )
    
    
    (122,747
    )Cash (used in) operating activities
    
    
    360,448
    
    
    
    (218,238
    )Cash flows from investing activities:Property additions
    
    
    (8,956
    )
    
    
    (22,692
    )Cash (used in) investing activities
    
    
    (8,956
    )
    
    
    (22,692
    )Cash flows from financing activities:Net borrowings (repayments) on revolving line of credit
    
    
    (327,135
    )
    
    
    614,754Payments on long-term debt
    
    
    (24,357
    )
    
    
    (373,824
    )Cash provided from financing activities
    
    
    (351,492
    )
    
    
    240,930Net decrease in cash
    
    
    
    
    
    
    Cash and cash equivalents:At beginning of period
    
    
    1,099
    
    
    
    800At end of period
    
    $
    1,099
    
    
    $
    800
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1.
    
    In the opinion of management, all adjustments (consisting of only normal and recurring
adjustments) have been made as of July 2, 2005 and July 3, 2004 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 2, 2005.2.
    
    There was no tax benefit during the three-month periods ended July 2, 2005 and July 3, 2004,
as the tax benefits were offset by changes in a valuation allowance.3.
    
    Basic loss per share is computed by dividing net loss by the weighted average number of
common shares outstanding during the period. Diluted 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 EndedJuly 2,
    
    July 3,2005
    
    2004Net loss
    
    $
    (282,341
    )
    
    $
    (456,515
    )Weighted average shares
    
    
    2,605,233
    
    
    
    2,605,233Additional dilutive shares
    
    
    
    
    
    
    Total dilutive shares
    
    
    2,605,233
    
    
    
    2,605,233Basic loss per share
    
    $
    (0.11
    )
    
    $
    (0.18
    )Diluted loss per share
    
    $
    (0.11
    )
    
    $
    (0.18
    )
 There were no additional dilutive shares included in the computation for the three-month periods
ended July 2, 2005 and July 3, 2004 because the effect of stock options were anti-dilutive.4.
    
    On June 3, 2005, the Company executed a Loan Agreement (the Revolving Credit Agreement)
with National City Bank. Under the loan documents, the Company may borrow the lesser of (i)
$600,000 or (ii) the sum of 80% of accounts receivable due from Lowes Companies. 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 August 15, 2005. All loans under the Revolving
Credit Agreement are at the discretion of National City Bank. At July 2, 2005, $250,592 was
outstanding under the Revolving Credit Agreement.The Revolving Credit Agreement contains the following financial covenants:
   As of July 2, 2005, the Company was not in compliance with the above two financial covenants,
having a tangible net worth of $1,072,151 and a year-to-date net loss of $282,341. The Company
has notified the lender of such noncompliance, but no waiver has been obtained. Failure to
obtain a 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 (National City Bank is successor
to Provident Bank) a Continuing Unconditional Guaranty pursuant to which Mr. Folkerth guaranteed
repayment of $200,000 of the indebtedness then or thereafter owing
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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 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 July 2, 2005, there was $1,902,558 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 has been classified as a current liability in the accompanying consolidated
balance sheets due to the Companys noncompliance with the financial covenants of its Revolving
Credit Agreement. The Company has requested a forbearance agreement from National City Bank
(successor to Provident Bank) concerning the mortgage loan, but no such agreement is yet in
place.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 35% and 44% of net sales for the quarters ended July 2,
2005 and July 3, 2004, respectively. This retailer also represented 44% and 31% of trade
accounts receivable at July 2, 2005 and April 2, 2005, 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 loss and net loss per share if compensation
expense was measured using the fair value recognition provisions of SFAS No. 123.
 Three Months EndedJuly 2,
    
    July 3,2005
    
    2004Net loss  as reported
    
    $
    (282,341
    )
    
    $
    (456,515
    )Net loss  pro forma
    
    $
    (282,341
    )
    
    $
    (456,515
    )Diluted loss per share  as reported
    
    $
    (0.11
    )
    
    $
    (0.18
    )Diluted loss per share  pro forma
    
    $
    (0.11
    )
    
    $
    (0.18
    )
 7.
    
    Uncertainties. The accompanying consolidated financial statements have been prepared assuming
that the Company will continue to operate as a going concern. As discussed below, the Company
has incurred recurring losses and is in default of its debt obligations, which taken as a
whole, raise substantial doubt about its ability to continue as a going concern. The
accompanying consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty. At July 2, 2005, the Company had a deficiency of
working capital of $1,474,640, a net loss of $282,341 for the quarter ended July 2, 2005, and
was not in compliance with various debt covenants (see Note 4).The future of the Company as an
operating entity will depend on managements plans and ability to (a) maintain or replace
existing financing arrangements, (b) obtain financing to meet its cash requirements and (c)
operate profitably in the future.To improve profitability, the Company needs to reduce costs and increase per event sales. One
effort to reduce costs in fiscal 2006 is a reduction in the number of Mark V sales demonstration
events. Demonstration sales are focused on the most promising locations for the events. The
Company is also continuing its prospect generation advertising efforts to increase the number of
prospects invited to each sales event.In April 2005, the Company has implemented a employee salary reduction plan. As part of this
plan, fiscal 2006 pre-tax income above $100,000 will be used to return the amount of the
reduction. The effect of this plan on the first quarter was to reduce expenses by $40,000.
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To improve liquidity, the Company completed a sale of substantially all of its consumer
receivables to Citizens Finance Company in April 2005. During fiscal 2006, the Company also
plans efforts to increase liquidity through better inventory management.
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MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 GENERAL
  CRITICAL ACCOUNTING POLICIES AND ESTIMATES
  Allowance For Doubtful Accounts
   Accrued Recourse Liability
  Deferred Tax Valuation Allowance
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Results of Operations
     Liquidity and Financial Position
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Contractual Obligations
  Scheduled payments due by periodLess than
    
    
    
    
    
    
    
    
    
    More thanContractual Obligations
    
    Total
    
    1 Year
    
    1-3 Years
    
    3-5 Years
    
    5 YearsRevolving Line of Credit
    
    $
    250,592
    
    
    $
    250,592
    
    
    $
    
    
    
    $
    
    
    
    $
    Long-Term Debt
    
    
    1,902,558
    
    
    
    101,652
    
    
    
    216,708
    
    
    
    1,584,198
    
    
    
    Operating Leases
    
    
    223,378
    
    
    
    73,385
    
    
    
    120,770
    
    
    
    29,223
    
    
    
    Total
    
    $
    2,376,528
    
    
    $
    425,629
    
    
    $
    337,478
    
    
    $
    1,613,421
    
    
    $
    
 Forward Looking Statements
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PART II. OTHER INFORMATION
 
   
  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.
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SIGNATURES
  SHOPSMITH, INC.By:
    /s/ Mark A. MayMark A. May

Vice President of Finance (Principal Financial
and Accounting Officer)  Page 15