UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

~~[X]~~þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~July~~January 31, ~~2004~~2005

~~[ ]~~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.

(Exact name of registrant as specified in its charter)

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)

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]~~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

[ ] 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~~January 2125, ~~2004~~2005.

Page 1

SHOPSMITH, INC. AND SUBSIDIARIES

INDEX

	Page No.
Part I. Financial Information:
Item 1. Financial Statements
Consolidated Balance Sheets - July 3, 2004 and April 3, 2004		3 - 4
Consolidated Balance Sheets - January 1, 2005 and April 3, 2004		3 - 4
Consolidated Statements of Operations and Deficit - Three Months Ended July 3, 2004 and July 5, 2003		5
Consolidated Statements of Operations and Deficit - Three Months and Nine Months Ended January 1, 2005 and January 3, 2004		5
Consolidated Statements of Cash Flows - Three Months Ended July 3, 2004 and July 5, 2003		6
Consolidated Statements of Cash Flows - Nine Months Ended January 1, 2005 and January 3, 2004		6
Notes to Consolidated Financial Statements		7 - 89
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		910 - 1113
Item 4. Controls and Procedures		1214
Part II. Other Information
Item 2. Changes in Securities and Use of Proceeds		13
Item 3. Default Upon Senior Securities		15
Item 6. Exhibits and Reports on Form 8-K		13
Item 5. Other Information		15
Signatures		13
Item 6. Exhibits		15
Exhibits		14 - 52
Signatures		16
Exhibit 4.16
Exhibits		17 - 20
Exhibit 4.17
EX-4.18
EX-4.19
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Page 2

Part I – FINANCIAL INFORMATION

Item 1. Financial Statements

SHOPSMITH, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	July 3,		April 3,
	January 1,		April 3,
	2004		2004
	2005		2004
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	~~800~~700	$	800
Accounts receivable:
Trade, less allowance for doubtful accounts: $408,134 on July 3, 2004 and $391,871 on April 3, 2004		788,105		1,144,245
Trade, less allowance for doubtful accounts:
$485,741 on January 1, 2005 and $391,871 on April 3, 2004		1,104,661		1,144,245
Inventories:
Finished products		1988,~~122,707~~241		912,318
Raw materials and work in process		1,~~016~~305,~~551~~694		1,210,122
Total inventories		2,~~139~~293,~~258~~935		2,122,440
Prepaid expenses		~~246~~174,~~265~~693		143,569
Total current assets		3,~~174~~573,~~428~~989		3,411,054
Properties:
Land, building and improvements		3,157,054		3,157,054
Machinery, equipment and tooling		6,~~828~~866,~~762~~162		6,806,070
Total cost		910,~~985~~023,~~816~~216		9,963,124
Less, accumulated depreciation and amortization		7,~~408~~487,~~903~~060		7,370,470
Net properties		2,~~576~~536,~~913~~156		2,592,654
Long-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		698,087
Long-term portion of accounts receivable trade, less allowance for doubtful accounts:
Other assets		3,128		3,128
$345,102 on January 1, 2005 and $278,120 on April 3, 2004		882,046		698,087
Total assets	$	6,416,052	$	6,704,923
Other assets		2,253		3,128
Total assets	$	6,994,444	$	6,704,923

Continued

Page 3

SHOPSMITH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

	July 3,			April 3,
	January 1,			April 3,
	2004			2004
	2005			2004
	(Unaudited)
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,~~108~~962,~~905~~039		$	1,049,694
Revolving line of credit		~~614~~476,~~754~~832			—
Current portion of long-term debt and capital lease obligation		97,824			107,555
Current portion of long-term debt		1,951,272			107,555
Customer advances		6465,~~281~~374			74,031
Accrued liabilities:
Compensation, employee benefits and payroll taxes		~~288~~254,~~979~~346			410,603
Sales taxes payable		4858,~~121~~350			55,696
Accrued recourse liability		~~311~~266,768			311,768
Accrued expenses		~~255~~254,~~934~~906			249,482
Other		5477,~~118~~566			54,118
Total current liabilities		25,~~844~~367,~~684~~453			2,312,947
Long-term debt and capital lease obligation, less current portion		1,902,572			2,266,665
Long-term debt, less current portion		—			2,266,665
Total liabilities		45,~~747~~367,~~256~~453			4,579,612
Shareholders’ equity:
Preferred shares- without par value; authorized 500,000; none issued
Common shares- without par value; authorized 5,000,000; issued and outstanding 2,605,233		2,806,482			2,806,482
Deficit		(1,~~137~~179,~~686~~491	)		(681,171	)
Total shareholders’ equity		1,~~668~~626,~~796~~991			2,125,311
Total liabilities and shareholders’ equity	$	6,~~416~~994,~~052~~444		$	6,704,923

See notes to consolidated financial statements.

Page 4

SHOPSMITH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT

	Three Months Ended						Nine Months Ended
	July 3,			July 5,
	January 1,			January 3,			January 1,			January 3,
	2004			2003
	2005			2004			2005			2004
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net sales	$	23,~~787~~680,~~436~~844		$	3,~~112~~645,~~504~~732		$	9,494,010		$	9,932,570
Cost of products sold		1,~~395~~844,~~440~~579			1,~~581~~795,~~909~~158			4,632,689			4,890,152
Gross margin		1,~~391~~836,~~996~~265			1,~~530~~850,~~595~~574			4,861,321			5,042,418
Selling expenses		1,~~384~~526,~~268~~292			1,~~187~~410,~~327~~002			4,194,472			3,695,276
Administrative expenses		~~455~~355,~~978~~470			~~444~~418,~~406~~114			1,186,211			1,282,344
Total operating expenses		1,~~840~~881,~~246~~762			1,~~631~~828,~~733~~116			5,380,683			4,977,620
Loss before other income and expense		(448,250	)		(101,138	)
Income (loss) before other income and expense		(45,497	)		22,458			(519,362	)		64,798
Interest income		4454,~~538~~559			4353,~~643~~081			142,620			140,242
Interest expense		(5336,~~698~~411	)		(6853,~~106~~145	)		(123,766	)		(186,164	)
Other income, net		~~895~~406			1,~~524~~557			2,188			4,386
Loss before income taxes		(456,515	)		(124,077	)
Income (loss) before income taxes		(26,943	)		23,951			(498,320	)		23,262
Income tax expense		—			—			—			4,881
Net loss		(456,515	)		(124,077	)
Net income (loss)		(26,943	)		23,951			(498,320	)		18,381
Deficit:
Beginning		(~~681~~1,~~171~~152,548	)		(~~810~~816,~~771~~341	)		(681,171	)		(810,771	)
Ending	$	(1,~~137~~179,~~686~~491	)	$	(~~934~~792,~~848~~390	)	$	(1,179,491	)	$	(792,390	)
Net loss per common share (Note 3)
Net income (loss) per common share (Note 3)
Basic	$	(0.1801	)	$	(0.0501	)	$	(0.19	)	$	0.01
Diluted	$	(0.1801	)	$	(0.0501	)	$	(0.19	)	$	0.01

See notes to consolidated financial statements.

Page 5

SHOPSMITH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Three Months Ended
	Nine Months Ended
	July 3,			July 5,
	January 1,			January 3,
	2004			2003
	2005			2004
	(Unaudited)			(Unaudited)
Cash flows from operating activities:
Net loss	$	(456,515	)	$	(124,077	)
Net income (loss)	$	(498,320	)	$	18,381
Adjustments to reconcile net loss to cash (used in) operating activities
Adjustments to reconcile net income (loss) to cash provided from operating activities
Depreciation and amortization		38116,~~433~~590			39117,~~685~~201
Provision for doubtful accounts		47171,~~887~~316			76212,~~972~~815
Changes in operating assets and liabilities:
Accounts receivable		~~344~~(315,~~757~~691	)		~~(81~~78,~~404~~943	)
Inventories		(16171,~~818~~495	)		(~~219~~225,~~688~~858	)
Prepaid expenses		(102,696	)		(84,486	)
Prepaid expenses and other		(30,249	)		(31,188	)
Accounts payable and customer advances		49903,~~461~~688			~~187~~295,~~192~~801
Other current liabilities		(~~122~~169,~~747~~731	)		(~~154~~180,~~589~~916	)
Cash (used in) operating activities		(218,238	)		(360,395	)
Cash provided from operating activities		6,108			285,179
Cash flows from investing activities:
Property additions		(2260,~~692~~092	)		(1355,~~156~~449	)
Cash (used in) investing activities		(22,692	)		(13,156	)
Cash flows from financing activities:
Payments on note payable		—			(~~100~~400,000	)
Net borrowings on revolving line of credit		~~614~~476,~~754~~832			~~251,595~~—
Payments on long-term debt and capital lease obligation		(373,824	)		(27,535	)
Payments on long-term debt		(422,948	)		(79,246	)
Cash provided from financing activities		240,930			124,060
Cash provided from (used in) financing activities		53,884			(479,246	)
Net decrease in cash		—(100	)		(249,~~491~~516	)
Cash and cash equivalents:
At beginning of period		800			250,316
At end of period	$	~~800~~700		$	~~825~~800

See notes to consolidated financial statements.

Page 6

SHOPSMITH, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. In the opinion of management, all adjustments (consisting of only normal and recurring adjustments) have been made as of ~~July~~January 31, ~~2004~~2005 and ~~July~~January 53, ~~2003~~2004 to present the financial statements fairly. However, the results of operations for the ~~three~~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 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 Ended
	July 3,			July 5,
	2004			2003
Net loss	$	(456,515	)	$	(124,077	)
Weighted average shares		2,605,233			2,605,233
Additional dilutive shares		—			—
Total dilutive shares		2,605,233			2,605,233
Basic loss per share	$	(0.18	)	$	(0.05	)
Diluted loss per share	$	(0.18	)	$	(0.05	)

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.

~~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.Basic Onincome ~~December~~(loss) ~~31,~~per ~~2002,~~share ~~Shopsmith~~is ~~entered~~computed ~~into~~by adividing ~~line~~net ofincome ~~credit~~(loss) ~~agreement~~by ~~with Provident Bank which allows~~ the ~~Company~~weighted toaverage ~~borrow~~number ~~up to the lesser~~ of ~~$750,000~~common orshares ~~80%~~outstanding ofduring ~~eligible~~the ~~receivables due from Lowes Companies, Inc~~period., ~~with~~Diluted ~~interest~~income ~~charged~~(loss) atper ~~one~~share ~~and~~reflects ~~one-half~~per ~~percent~~share ~~over~~amounts ~~the~~that ~~bank’s~~would ~~prime~~have ~~rate.~~resulted Onif ~~June~~dilutive ~~29,~~stock ~~2004,~~options ~~this~~had ~~agreement~~been ~~was~~converted ~~amended~~into tocommon ~~allow~~stock. ~~borrowings~~The upfollowing toreconciles ~~$1,000,000,~~amounts ~~down~~reported ~~from~~in ~~$1,400,000 available from~~ the ~~previous~~financial ~~amendment.~~statements:

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.


	Three Months Ended					Nine Months Ended
	January 1,			January 3,		January 1,			January 3,
	2005			2004		2005			2004
Net income (loss)	$	(26,943	)	$	23,951	$	(498,320	)	$	18,381


Weighted average shares		2,605,233			2,605,233		2,605,233			2,605,233
Additional dilutive shares		—			22,500		—			3,762

Total dilutive shares		2,605,233			2,627,733		2,605,233			2,608,995


Basic income (loss) per share	$	(0.01	)	$	0.01	$	(0.19	)	$	0.01


Diluted income (loss) per share	$	(0.01	)	$	0.01	$	(0.19	)	$	0.01

~~Both~~There ~~agreements~~were ~~require~~no ~~compliance~~additional ~~with~~dilutive ~~certain~~shares ~~net~~included ~~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~~computation ~~worth~~for ~~and fixed charge coverage covenants of these agreements. The Company has reached agreement with~~ the ~~Provident~~three ~~Bank to waive the covenant violations~~ and nine-month toperiods ~~amend~~ended ~~the~~January 1, ~~covenants~~2005 ~~going~~because ~~forward. The Company expects to remain in compliance with its amended covenants through~~ the ~~remainder~~effect of ~~fiscal~~stock ~~2005~~options aswere ~~well as through June 2005~~anti-dilutive.

		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.”

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

~~The~~ (c) ~~following~~Limitation ~~table illustrates the effect~~ on ~~net~~Capital ~~loss~~Expenditures. ~~and~~The ~~net~~Company ~~loss~~may ~~per~~not ~~share~~make ifcapital ~~compensation~~expenditures in ~~expense~~excess ~~was~~of ~~measured~~$50,000 ~~using~~during ~~the~~any ~~fair~~fiscal ~~value~~year ~~recognition~~without ~~provisions~~Bank ~~of SFAS No~~approval. ~~123.~~

	Three Months Ended
	July 3,			July 5,
	2004			2003
Net 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	)

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).

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.

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 Ended
	January 1,			January 3,		January 1,			January 3,
	2005			2004		2005			2004
Net income (loss) - as reported	$	(26,943	)	$	23,951	$	(498,320	)	$	18,381
Net income (loss) - pro forma	$	(26,943	)	$	23,951	$	(511,864	)	$	17,721

Diluted earnings (loss) per share - as reported	$	(0.01	)	$	0.01	$	(0.19	)	$	0.01
Diluted earnings (loss) per share - pro forma	$	(0.01	)	$	0.01	$	(0.19	)	$	0.01

Page 8

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

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 inat ~~shopping~~state ~~malls~~fairs, at ~~home~~ home shows, and atin ~~state~~shopping ~~fairs~~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~~ 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~~2005. At that time, ~~purchase~~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 910

Results of Operations

Fiscal 2005 ~~first~~third quarter sales ~~decreased~~increased to $23,~~787~~681,000, or 101.50%, from $3,~~113~~646,000 during the same period a year ago. ~~This~~Increases ~~decrease~~in sales through demonstrations within Lowe’s stores were nearly offset by decreases in ~~the~~catalog ~~first~~and traveling academy sales. Fiscal 2005 year-to-date sales ~~quarter~~decreased ~~occurred~~to $9,494,000, or 4.4%, from $9,933,000 last year. The decline in year-to-date sales was primarily in ~~our~~the ~~demonstration~~Company’s ~~event~~Catalog ~~Mark~~and VInternet sales channels.

Gross margin rates for the fiscal 2005 ~~first~~third quarter ~~increased~~decreased by 0.75 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 $~~208~~54,000 to $1,~~840~~882,000 in the fiscal 2005 ~~first~~third quarter from $1,~~632~~828,000 in last year’s ~~first~~third quarter. ~~The~~For ~~most~~fiscal ~~significant~~2005 year-to-date, ~~reason~~operating ~~for~~expenses ~~the~~increased ~~increase~~by in$403,000 ~~operating~~to ~~expenses~~$5,381,000 ~~was~~from an$4,978,000 ~~increased~~in ~~expenditure~~the onprior ~~sales representative~~year. ~~training~~The ~~costs.~~most ~~Training~~significant ~~was~~factors ~~done~~in tothe increase ~~both~~in operating expenses were an increase in the number of Mark V sales ~~representatives~~demonstration events, primarily within Lowe’s stores, as well as toexpenditures ~~increase~~on ~~the~~sales ~~effectiveness~~representative ~~of existing~~training ~~sales representatives~~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 ~~quarters~~ periods ended ~~July~~January 31, ~~2004 and July 5~~2005, ~~2003,~~ as itthey ~~was~~were offset by achanges ~~change~~ in the valuation allowance.

With the ~~reduction in sales and~~ increased operating expenses, the Company recorded a net loss of $~~457~~27,000, or $.1801 per diluted share, in the quarter ended ~~July~~January 31, ~~2004~~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 $~~124~~498,000, or $.0519 per diluted share, was incurred, compared to net income of $18,000, or $.01 per diluted share, for the same period of last year.

Liquidity and Financial Position

Cash ~~used~~provided infrom operations totaled $~~218~~6,000 for the ~~quarter~~nine months ended ~~July~~January 31, ~~2004~~2005, ~~compared~~ compared with $~~360~~285,000 provided from operations for the same period of the preceding year. OnDuring ~~June 29, 2004,~~the ~~Company refinanced a mortgage note on its building with a balance of~~ $2period,~~356,000~~ ~~with~~cash awas ~~mortgage~~used ~~note~~for ~~from~~an ~~Provident~~increase ~~Bank~~ in ~~the~~accounts ~~amount of $2~~receivable,~~000,000.~~ ~~$615,000~~as ~~was~~well ~~also~~as ~~borrowed~~for on the ~~Company~~period’s ~~revolving~~net ~~line of~~loss. ~~credit~~Cash ~~during~~was ~~the~~provided ~~first~~from ~~quarter~~an ofincrease ~~fiscal~~in ~~2005,~~accounts payable of ~~which~~ $~~356~~904,000, ~~was~~which ~~used~~occurred ~~to reduce~~both ~~the~~due ~~above note prior~~ to seasonal ~~refinancing.~~volume, ~~Interest~~as onwell ~~this~~as ~~new~~an ~~mortgage~~extension ~~note is~~of atpayment ~~one-quarter~~terms ~~percent~~beyond ~~over~~ the ~~bank~~Company’s ~~prime~~customary ~~rate~~practice. ~~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~~the Company entered into a ~~line~~Loan ofAgreement ~~credit~~(the ~~agreement~~“Revolving ~~with~~Credit Agreement”) with Provident Bank. OnThe 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,. ~~this~~Under ~~agreement~~the ~~was~~loan documents as amended, tothe ~~allow~~Company may ~~borrowings~~borrow upthe tolesser of (i) $1,000,000, ~~down~~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 $1250,~~400,~~000), ~~available~~plus ~~from~~(z) 50% of finished goods inventory (with the ~~previous~~maximum amount being advanced in respect of such inventory being ~~amendment~~$500,000). ~~The~~Interest ~~agreement~~on ~~requires~~the ~~compliance~~Revolving ~~with~~Credit ~~certain~~Agreement ~~net~~is ~~income,~~charged ~~net~~at ~~worth,~~one and ~~miscellaneous~~one-half ~~covenants~~percent over the Bank’s prime rate. ~~Substantially~~The ~~all~~maturity ~~personal property~~date on the agreement is ~~pledged~~June 30, as2005. ~~collateral~~All loans under the Revolving Credit Agreement are at the discretion of Provident Bank. At ~~July~~January 31, ~~2004~~2005, $~~615~~477,000 was outstanding under ~~this~~the ~~agreement~~Revolving Credit Agreement. The maximum amount available under the credit line at January 1, 2005 was $882,000.

~~Both~~By ~~the~~Second ~~mortgage~~Amendment ~~agreement~~dated ~~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~~September 324, 2004, the ~~Company~~financial ~~was not in compliance with the net worth and fixed charge~~ covenants ofunder 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~~Revolving ~~has a consolidated~~Credit ~~tangible~~Agreement ~~net~~were 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~~as ~~a consolidated tangible net worth of not less than $1,450,000 and a fixed charge coverage ratio of 1.1~~follows:~~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~~ (a) ~~current~~Debt ~~ratio~~Service ~~was~~Coverage 1Ratio.16 toBeginning 1with atthe ~~July 3,~~Company’s ~~2004~~third ~~and~~fiscal quarter, ending January 1~~.47~~, to2005, 1the atCompany ~~April 3,~~must ~~2004. The~~maintain ~~debt~~a toDebt ~~equity~~Service Coverage ratio ~~increased~~of to1:10 ~~2.84~~ to 1:00, ~~from~~tested 2quarterly.15 toDebt 1Service atCoverage ~~April~~is defined as (i) 3EBITDA minus cash taxes and dividends, divided by (ii) cash interest expense plus quarterly current maturities of ~~2004~~long-term debt.

~~The~~ (b) ~~Company~~Consolidated ~~believes~~Tangible ~~that~~Net ~~profitability~~Worth. isFrom ~~critical~~July 1, to2004 ~~ensuring~~through ~~adequate~~March 31, 2005, the ~~liquidity~~Company must maintain consolidated tangible net worth in ~~both~~excess ~~the~~of ~~current~~$1,450,000. From and after ~~future~~April 1, ~~fiscal~~2005, ~~years~~consolidated tangible net worth must be in excess of $1,800,000.

~~Page~~ (c) 10Limitation on Capital Expenditures. The Company may not make capital expenditures in excess of $50,000 during any fiscal year without Bank approval.

Page 11

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.

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 period
			Less than						More than
Contractual Obligations	Total		1 Year		1-3 Years		3-5 Years		5 Years
Revolving Line of Credit	$	~~614~~476,~~754~~832	$	~~614~~476,~~754~~832	$	—	$	—	$	—
Long-Term Debt		21,~~000~~951,~~000~~272		9799,~~428~~540		~~208~~212,~~668~~208		~~216~~1,~~483~~639,524		~~1,477,421~~—
Capital Lease Obligations		396		396		—		—		—
Operating Leases		172,597		61,274		81,090		30,233		—
Operating Leases		82,279		45,882		22,817		13,580		—
Total	$	2,600,701	$	637,646	$	293,298	$	1,669,757	$	—
Total		2,697,429		758,460		231,485		230,063		1,477,421

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

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~~ inadequate to finance the operating needs of the Company; (ii) cancellation by Lowe’s of ~~the~~ the in-store sales program; (iii) the Company may fail to obtain a waiver for its failure to meet the ~~amended~~ financial covenants contained in its Loan ~~Agreements~~Agreement ~~dated December 31, 2002 and June 29, 2004~~ with Provident Bank, in which event the ~~bank~~Bank may declare all amounts owed by the Company to the ~~bank~~Bank under the revolving credit and mortgage loan facilities to be immediately due and payable; ~~and~~ (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.

~~Item 3.~~Page ~~Defaults Upon Senior Securities.~~13

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

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 1214

PART II. OTHER INFORMATION

Item 23. ~~Changes~~Default inUpon ~~Securities~~Senior ~~and Use of Proceeds~~Securities

~~The~~As ~~Loan~~discussed ~~Agreement~~in ~~between~~ the ~~Company~~“Liquidity and ~~Provident~~Financial ~~Bank~~Position” ~~prohibits~~section ~~the~~of Management’s Discussion and ~~payment~~Analysis of ~~dividends~~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 65. ~~Exhibits~~Other ~~and Reports on Form 8-K~~Information

(a) ~~Exhibits:~~ 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.

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.

Item 6. Exhibits And Reports On Form 8-K

(ba) ~~Reports~~ ~~on Form 8-K:~~ Exhibits

During the quarter ended July 3, 2004, the Company filed the following report on Form 8-K:

	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.

A(b) Reports On 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.~~

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

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 May

				Mark A. May

				Vice President of Finance (Principal Financial and Accounting Officer)

Date: ~~August~~February 178, ~~2004~~2005

Page 1316

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