UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 2, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-9318
SHOPSMITH, INC.
Ohio (State or other jurisdiction of incorporation or organization) |
31-0811466 (I.R.S. Employer Identification No.) |
6530 Poe Avenue, Dayton, Ohio (Address of principal executive offices) |
45414 (Zip Code) |
Registrants 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 issuers classes of common stock as of the latest practicable date.
Common shares, without par value: 2,605,233 shares as of October 25, 2004.
Page 1
SHOPSMITH, INC. AND SUBSIDIARIES
INDEX
Page No. |
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3-4 | ||||||||
5 | ||||||||
6 | ||||||||
7-8 | ||||||||
9-11 | ||||||||
12 | ||||||||
13 | ||||||||
13 | ||||||||
13 | ||||||||
13 | ||||||||
14 | ||||||||
Exhibits |
15-19 | |||||||
Exhibit 4.20 | ||||||||
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
October 2, | April 3, | |||||||
2004 |
2004 |
|||||||
(Unaudited) | ||||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 700 | $ | 800 | ||||
Accounts receivable: |
||||||||
Trade, less allowance for doubtful accounts: |
||||||||
$467,528 on October 2, 2004 and $391,871 on April 3, 2004 |
587,616 | 1,144,245 | ||||||
Inventories: |
||||||||
Finished products |
969,827 | 912,318 | ||||||
Raw materials and work in process |
1,281,563 | 1,210,122 | ||||||
Total inventories |
2,251,390 | 2,122,440 | ||||||
Prepaid expenses |
181,498 | 143,569 | ||||||
Total current assets |
3,021,204 | 3,411,054 | ||||||
Properties: |
||||||||
Land, building and improvements |
3,157,054 | 3,157,054 | ||||||
Machinery, equipment and tooling |
6,847,533 | 6,806,070 | ||||||
Total cost |
10,004,587 | 9,963,124 | ||||||
Less, accumulated depreciation and amortization |
7,446,963 | 7,370,470 | ||||||
Net properties |
2,557,624 | 2,592,654 | ||||||
Long-term portion of accounts receivable
trade, less allowance for doubtful accounts: |
||||||||
$302,515 on October 2, 2004 and $278,120 on April 3, 2004 |
845,258 | 698,087 | ||||||
Other assets |
2,253 | 3,128 | ||||||
Total assets |
$ | 6,426,339 | $ | 6,704,923 | ||||
Continued
Page 3
SHOPSMITH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
October 2, | April 3, | |||||||
2004 |
2004 |
|||||||
(Unaudited) | ||||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 1,179,009 | $ | 1,049,694 | ||||
Revolving line of credit |
609,055 | | ||||||
Current portion of long-term debt and capital lease obligation |
98,484 | 107,555 | ||||||
Customer advances |
66,156 | 74,031 | ||||||
Accrued liabilities: |
||||||||
Compensation, employee benefits and payroll taxes |
304,690 | 410,603 | ||||||
Sales taxes payable |
76,021 | 55,696 | ||||||
Accrued recourse liability |
266,768 | 311,768 | ||||||
Accrued expenses |
235,477 | 249,482 | ||||||
Other |
59,600 | 54,118 | ||||||
Total current liabilities |
2,895,260 | 2,312,947 | ||||||
Long-term debt and capital lease obligation, less current portion |
1,877,145 | 2,266,665 | ||||||
Total liabilities |
4,772,405 | 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 |
(1,152,548 | ) | (681,171 | ) | ||||
Total shareholders equity |
1,653,934 | 2,125,311 | ||||||
Total liabilities and shareholders equity |
$ | 6,426,339 | $ | 6,704,923 | ||||
See notes to consolidated financial statements.
Page 4
SHOPSMITH, INC. AND SUBSIDIARIES
Three Months Ended |
Six Months Ended |
|||||||||||||||
October 2, | October 4, | October 2, | October 4, | |||||||||||||
2004 |
2003 |
2004 |
2003 |
|||||||||||||
(Unaudited) | (Unaudited) | (Unaudited) | (Unaudited) | |||||||||||||
Net sales |
$ | 3,025,730 | $ | 3,174,334 | $ | 5,813,166 | $ | 6,286,838 | ||||||||
Cost of products sold |
1,392,670 | 1,513,085 | 2,788,110 | 3,094,994 | ||||||||||||
Gross margin |
1,633,060 | 1,661,249 | 3,025,056 | 3,191,844 | ||||||||||||
Selling expenses |
1,283,912 | 1,097,947 | 2,668,180 | 2,285,274 | ||||||||||||
Administrative expenses |
374,763 | 419,824 | 830,741 | 864,230 | ||||||||||||
Total operating expenses |
1,658,675 | 1,517,771 | 3,498,921 | 3,149,504 | ||||||||||||
Income (loss) before
other income and expense |
(25,615 | ) | 143,478 | (473,865 | ) | 42,340 | ||||||||||
Interest income |
43,523 | 43,518 | 88,061 | 87,161 | ||||||||||||
Interest expense |
(33,657 | ) | (64,913 | ) | (87,355 | ) | (133,019 | ) | ||||||||
Other income, net |
887 | 1,305 | 1,782 | 2,829 | ||||||||||||
Income (loss) before income taxes |
(14,862 | ) | 123,388 | (471,377 | ) | (689 | ) | |||||||||
Income tax expense |
| 4,881 | | 4,881 | ||||||||||||
Net income (loss) |
(14,862 | ) | 118,507 | (471,377 | ) | (5,570 | ) | |||||||||
Deficit: |
||||||||||||||||
Beginning |
(1,137,686 | ) | (934,848 | ) | (681,171 | ) | (810,771 | ) | ||||||||
Ending |
$ | (1,152,548 | ) | $ | (816,341 | ) | $ | (1,152,548 | ) | $ | (816,341 | ) | ||||
Net income (loss) per common share
(Note 3) |
||||||||||||||||
Basic |
$ | (0.01 | ) | $ | 0.05 | $ | (0.18 | ) | $ | (0.00 | ) | |||||
Diluted |
$ | (0.01 | ) | $ | 0.05 | $ | (0.18 | ) | $ | (0.00 | ) | |||||
See notes to consolidated financial statements.
Page 5
SHOPSMITH, INC. AND SUBSIDIARIES
Six Months Ended |
||||||||
October 2, | October 4, | |||||||
2004 |
2003 |
|||||||
(Unaudited) | (Unaudited) | |||||||
Cash flows from operating activities: |
||||||||
Net loss |
$ | (471,377 | ) | $ | (5,570 | ) | ||
Adjustments to reconcile net loss to
cash provided from (used in) operating activities |
||||||||
Depreciation and amortization |
76,493 | 79,376 | ||||||
Provision for doubtful accounts |
102,311 | 145,929 | ||||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
307,147 | 360,002 | ||||||
Inventories |
(128,950 | ) | (188,996 | ) | ||||
Prepaid expenses |
(37,054 | ) | (37,254 | ) | ||||
Accounts payable and customer advances |
121,440 | 56,771 | ||||||
Other current liabilities |
(139,111 | ) | (172,675 | ) | ||||
Cash provided from (used in) operating activities |
(169,101 | ) | 237,583 | |||||
Cash flows from investing activities: |
||||||||
Property additions |
(41,463 | ) | (33,488 | ) | ||||
Cash flows from financing activities: |
||||||||
Payments on note payable |
| (400,000 | ) | |||||
Net borrowings on revolving line of credit |
609,055 | | ||||||
Payments on long-term debt and capital lease obligation |
(398,591 | ) | (53,611 | ) | ||||
Cash provided from (used in) financing activities |
210,464 | (453,611 | ) | |||||
Net decrease in cash |
(100 | ) | (249,516 | ) | ||||
Cash and cash equivalents: |
||||||||
At beginning of period |
800 | 250,316 | ||||||
At end of period |
$ | 700 | $ | 800 | ||||
See notes to consolidated financial statements.
Page 6
SHOPSMITH, INC. AND SUBSIDIARIES
1. | In the opinion of management, all adjustments (consisting of only normal and recurring adjustments) have been made as of October 2, 2004 and October 4, 2003 to present the financial statements fairly. However, the results of operations for the six 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 six-month periods ended October 2, 2004 or the six months ended October 4, 2003, 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 | Six Months Ended | |||||||||||||||
October 2, | October 4, | October 2, | October 4, | |||||||||||||
2004 |
2003 |
2004 |
2003 |
|||||||||||||
Net income (loss) |
$ | (14,862 | ) | $ | 118,507 | $ | (471,377 | ) | $ | (5,570 | ) | |||||
Weighted average shares |
2,605,233 | 2,605,233 | 2,605,233 | 2,605,233 | ||||||||||||
Additional dilutive shares |
| 375 | | 188 | ||||||||||||
Total dilutive shares |
2,605,233 | 2,605,608 | 2,605,233 | 2,605,421 | ||||||||||||
Basic income (loss) per share |
$ | (0.01 | ) | $ | 0.05 | $ | (0.18 | ) | $ | (0.00 | ) | |||||
Diluted income (loss) per share |
$ | (0.01 | ) | $ | 0.05 | $ | (0.18 | ) | $ | (0.00 | ) | |||||
There were no additional dilutive shares included in the computation for the three and six-month periods ended October 2, 2004 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 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 Lowes 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 Banks prime rate. The maturity date on the agreement is June 30, 2005. All loans under the Revolving Credit Agreement are at the discretion of the Bank. At October 2, 2004, $609,000 was outstanding under the Revolving Credit Agreement. |
At July 3, 2004, the Company was not in compliance with the financial covenants under the Revolving Credit Agreement as then amended. By Second Amendment dated September 24, 2004, the financial covenants were further amended as follows: |
(a) Debt Service Coverage Ratio. Beginning with the Companys third fiscal quarter (which began October 3, 2004 and ends 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.
Page 7
(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.
As of October 2, 2004, the Company was in compliance with the foregoing financial covenants. The Company expects to remain in compliance with its amended covenants through the remainder of fiscal 2005. | ||||
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 banks 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. | ||||
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. | ||||
The new mortgage loan and the revolving credit loans are secured by a mortgage on, or security interest in, substantially all assets of the Company. | ||||
At October 2, 2004, there was $1,975,629 and $609,055 outstanding under the building mortgage agreement and line of credit agreement, respectively. | ||||
5. | A major retailer represented 32% and 24% of net sales for the quarters ended October 2, 2004 and October 4, 2003, respectively. This retailer also represented 18% and 41% of trade accounts receivable at October 2, 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. | |||
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 |
Six Months Ended |
|||||||||||||||
October 2, | October 4, | October 2, | October 4, | |||||||||||||
2004 |
2003 |
2004 |
2003 |
|||||||||||||
Net income (loss) as reported |
$ | (14,862 | ) | $ | 118,507 | $ | (471,377 | ) | $ | (5,570 | ) | |||||
Net income (loss) pro forma |
$ | (28,406 | ) | $ | 117,847 | $ | (484,921 | ) | $ | (6,230 | ) | |||||
Diluted earnings (loss) per share as reported |
$ | (0.01 | ) | $ | 0.05 | $ | (0.18 | ) | $ | (0.00 | ) | |||||
Diluted earnings (loss) per share pro forma |
$ | (0.01 | ) | $ | 0.05 | $ | (0.18 | ) | $ | (0.00 | ) |
Page 8
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENTS 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 Lowes 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 managements discussion and analysis are dependent upon the Companys accounting policies. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change. The Companys significant accounting policies are discussed in Note 2 of the notes to the Consolidated Financial Statements included in the Companys annual report to shareholders for the year ended April 3, 2004. In managements opinion, the Companys 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 Companys 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 Companys cumulative operating losses against future taxable income.
Page 9
Results of Operations
Fiscal 2005 second quarter sales decreased to $3,026,000, or 4.7%, from $3,174,000 during the same period a year ago. The decrease in the second quarter occurred primarily in our mail and internet accessory sales. Fiscal 2005 year-to-date sales decreased to $5,813,000, or 7.5%, from $6,287,000 last year.
Gross margin rates for the fiscal 2005 second quarter increased by 1.6 percentage points compared to the same period last year. On a year-to-date basis, gross margin rates increased by 1.3 percentage points. Operating expenses increased by $141,000 to $1,659,000 in the fiscal 2005 second quarter from $1,518,000 in last years second quarter. For fiscal 2005 year-to-date, operating costs increased by $349,000 to $3,499,000 from $3,150,000 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, 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 is reported for the periods ended October 2, 2004 and October 4, 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 $15,000, or $.01 per diluted share, in the quarter ended October 2, 2004, compared to net income of $119,000, or $.05 per diluted share, for the same period of last year. For fiscal 2005 year-to-date, a net loss of $471,000, or $.18 per diluted share, was incurred, compared to a net loss of $6,000, or $.00 per diluted share, for the same period last year.
Liquidity and Financial Position
Cash used in operations totaled $169,000 for the six months ended October 2, 2004, compared with $238,000 provided from operations for the same period of the preceding year. The Companys net loss of $471,000 was the primary reason for the change from last year.
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 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 Lowes 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 Banks prime rate. The maturity date on the agreement is June 30, 2005. All loans under the Revolving Credit Agreement are at the discretion of the Bank. At October 2, 2004, $609,000 was outstanding under the Revolving Credit Agreement. The maximum amount available under the credit line at October 2, 2004 was $822,000.
At July 3, 2004, the Company was not in compliance with the financial covenants under the Revolving Credit Agreement as then amended. By Second Amendment dated September 24, 2004, the financial covenants were further amended as follows:
(a) Debt Service Coverage Ratio. Beginning with the Companys third fiscal quarter (which began October 3, 2004 and ends 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.
As of October 2, 2004, the Company was in compliance with the foregoing financial covenants.
Page 10
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 Banks 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 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.
The New Mortgage Loan and the revolving credit loans are secured by a mortgage on, or security interest in, substantially all assets of the Company.
Borrowings under the Revolving Credit Agreement totaled $609,000 during the first six months of fiscal 2005. As stated above, $356,000 of such borrowings was used to reduce the balance of the previous mortgage loan prior to the refinancing.
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 Companys current ratio was 1.04 to 1 at October 2, 2004 and 1.47 to 1 at April 3, 2004. The debt to equity ratio increased to 2.89 to 1 at October 2, 2004 from 2.15 to 1 at April 3, 2004. Losses during the six months ended October 2, 2004 have contributed to a tightening of liquidity which in turn has caused the Company to defer payments to vendors beyond the Companys 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 |
$ | 609,055 | $ | 609,055 | $ | | $ | | $ | | ||||||||||
Long-Term Debt |
1,975,629 | 98,484 | 209,958 | 1,667,187 | | |||||||||||||||
Operating Leases |
176,531 | 63,191 | 82,721 | 30,619 | | |||||||||||||||
Total |
$ | 2,761,215 | $ | 770,730 | $ | 292,679 | $ | 1,697,806 | $ | |
Forward Looking Statements
The foregoing discussion and the Companys 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 Lowes of the in-store sales program; (iii) the Company may fail to meet the amended financial covenants contained in 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 Bank may decline to make further advances under the revolving credit facility; (v) the Company may be unable to extend or refinance the revolving credit facility when the revolving credit loans mature on June 30, 2005; and (vi) actual losses related to doubtful accounts and recourse liabilities (discussed under Critical Accounting Policies and Estimates) may exceed current estimates.
Page 11
Item 4. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
The Companys Chairman and Chief Executive Officer, John R. Folkerth, and the Companys Chief Financial Officer, Mark A. May, have evaluated the Companys disclosure controls and procedures within 90 days of the filing of this report. Messrs. Folkerth and May have concluded that the Companys 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 Commissions rules and forms.
(b) Changes in Internal Controls
There were no significant changes in the Companys internal controls over financial reporting that could materially affect these controls subsequent to the date of the above reference evaluation.
Page 12
PART II. OTHER INFORMATION
Item 3. Defaults Upon Senior Securities
As discussed in the Liquidity and Financial Position section of the Managements Discussion and Analysis of Financial Condition and Results of Operations set forth in Item 2 of this report, at July 3, 2004, the Company was not in compliance with the financial covenants (relating to fixed charge coverage and tangible net worth) contained in its Loan Agreement with Provident Bank. Also as discussed in that section, the Bank has waived the covenant violations and the financial covenants have been modified. As of October 2, 2004, the Company was in compliance with the covenants as modified.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Shareholders on July 28, 2004. At the meeting, shareholders (a) elected Messrs. John R. Folkerth, J. Michael Herr, and Edward A. Nicholson as directors of the Company and (b) approved the appointment of Crowe Chizek and Company LLC as independent public accountants for the Company. Votes were tabulated as follows:
Broker | ||||||||||||||||
Issue | For | Against | Withheld | Non votes | ||||||||||||
Election of directors: |
||||||||||||||||
John R. Folkerth |
2,070,481 | 83,646 | | |||||||||||||
J. Michael Herr |
2,070,878 | 83,249 | ||||||||||||||
Edward A. Nicholson |
2,070,878 | 83,249 | | |||||||||||||
Appointment |
||||||||||||||||
Crowe Chizek and Company LLC |
2,082,913 | 11,437 | 59,777 | |
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
4.20 | Second amendment to loan agreement with The Provident Bank dated September 24, 2004. | |||
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
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.
SHOPS | MITH, INC. | |||
By | /s/ Mark A May | |||
Mark A. May | ||||
Vice President of Finance (Principal Financial and Accounting Officer) |
Date: November 15, 2004
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