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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549



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Form 10-QSB



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(Mark One)

|x | Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ---------------------------------------------------------------------------------



For the quarter ended September 30, 2004



or



| ̈ | Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------



For the transition period from  to



000-13118

(Commission File No.)



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ACTION PRODUCTS INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|Florida                                                        |  | 59-2095427                       
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification No.)



1101 North Keller
Road, Orlando, Florida 32810

(Address of principal executive offices, Zip Code)



Registrants telephone number, including area code (407) 481-8007



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Check 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.    YES  x    NO ̈



State the number of shares outstanding of each of the issuers classes of common equity, as of last practicable date.



|                               |  |                                
|------------------------------ |  | -------------------------------
|Class                          |  | Outstanding at October 27, 2004
|Common Shares, $.001 par value |  | 4,609,600                      



Transitional Small
Business Disclosure Format (check one):    YES ̈NO  x



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##### Table of Contents

I N D E X



|                                                                                                                             |  |           
|---------------------------------------------------------------------------------------------------------------------------- |  | ----------
|                                                                                                                             |  | PageNumber
|PART I.
FINANCIAL INFORMATION                                                                                                |  |           
|                                                                                                                             | 
|Item 1.     
Financial Statements                                                                                            |  |           
|                                                                                                                             | 
|Condensed Consolidated Balance Sheet at September 30, 2004 (unaudited)                                                       |  | 3         
|                                                                                                                             | 
|Condensed Consolidated Statements of Operations - Three months and Nine months ended September 30, 2004 and 2003 (unaudited) |  | 4         
|                                                                                                                             | 
|Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 2004 and 2003 (unaudited)                  |  | 5         
|                                                                                                                             | 
|Notes to unaudited Condensed Consolidated Financial Statements                                                               |  | 6         
|                                                                                                                             | 
|Item 2.     
Managements Discussion and Analysis of Financial Condition and Results of Operations                           |  | 8         
|                                                                                                                             | 
|Item 3.     
Controls and Procedures                                                                                         |  | 11        
|                                                                                                                             | 
|PART II.
OTHER INFORMATION                                                                                                   |  |           
|                                                                                                                             | 
|Item 2.     
Changes in Securities                                                                                           |  | 12        
|                                                                                                                             | 
|Item 6.     
Exhibits and Reports on Form 8-K                                                                                |  | 12        
|                                                                                                                             | 
|SIGNATURE PAGE                                                                                                               |  | 13        



Page 2 of 17



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##### Table of Contents

PART I. FINANCIAL INFORMATION



ITEM 1. Financial Statements



ACTION PRODUCTS INTERNATIONAL, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)



|                                                                                       |  |                    |            |  
|-------------------------------------------------------------------------------------- |  | ------------------ | ---------- | -
|                                                                                       |  | September 30, 2004 |           
|ASSETS                                                                                 |  |                    |            |  
|CURRENT ASSETS                                                                         |  |                    |            |  
|Cash and cash equivalents                                                              |  | $                  | 541,800    |  
|Investment securities                                                                  |  |                    | 17,500     |  
|Accounts receivable, net of an allowance for doubtful accounts of $94,900              |  |                    | 2,115,100  |  
|Inventories, net                                                                       |  |                    | 1,999,600  |  
|Prepaid expenses and other assets                                                      |  |                    | 287,200    |  
|                                                                                       |  |                    |            |  
|TOTAL CURRENT ASSETS                                                                   |  |                    | 4,961,200  |  
|                                                                                       | 
|PROPERTY, PLANT AND EQUIPMENT                                                          |  |                    | 3,274,600  |  
|Less accumulated depreciation and amortization                                         |  |                    | (1,953,800 | )
|                                                                                       |  |                    |            |  
|NET PROPERTY, PLANT AND EQUIPMENT                                                      |  |                    | 1,320,800  |  
|GOODWILL                                                                               |  |                    | 1,434,000  |  
|OTHER ASSETS                                                                           |  |                    | 148,700    |  
|                                                                                       |  |                    |            |  
|TOTAL ASSETS                                                                           |  | $                  | 7,864,700  |  
|                                                                                       |  |                    |            |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                   |  |                    |            |  
|CURRENT LIABILITIES                                                                    |  |                    |            |  
|Current portion of notes payable and obligation under capital lease                    |  | $                  | 22,500     |  
|Accounts payable                                                                       |  |                    | 97,700     |  
|Accrued expenses, payroll and related expenses                                         |  |                    | 922,600    |  
|Current portion of mortgage payable                                                    |  |                    | 36,700     |  
|Borrowings under line of credit                                                        |  |                    | 1,611,400  |  
|Other current liabilities                                                              |  |                    | 85,300     |  
|                                                                                       |  |                    |            |  
|TOTAL CURRENT LIABILITIES                                                              |  |                    | 2,776,200  |  
|                                                                                       |  |                    |            |  
|MORTGAGE PAYABLE                                                                       |  |                    | 457,400    |  
|DEFERRED REVENUE                                                                       |  |                    | 56,300     |  
|                                                                                       |  |                    |            |  
|TOTAL LIABILITIES                                                                      |  |                    | 3,289,900  |  
|                                                                                       |  |                    |            |  
|SHAREHOLDERS EQUITY                                                                   |  |                    |            |  
|Preferred shares - 10,000,000 shares authorized, zero shares issued and outstanding    |  |                    |            |  
|                                                                                       | 
|Common shares - $.001 par value; 15,000,000 shares authorized; 4,609,600 shares issued |  |                    | 4,600      |  
|Treasury shares - $.001 par value; 178,700 shares                                      |  |                    | (200       | )
|Additional paid-in capital                                                             |  |                    | 6,932,800  |  
|Accumulated deficit                                                                    |  |                    | (2,362,400 | )
|                                                                                       |  |                    |            |  
|TOTAL SHAREHOLDERS EQUITY                                                             |  |                    | 4,574,800  |  
|                                                                                       |  |                    |            |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                             |  | $                  | 7,864,700  |  
|                                                                                       |  |                    |            |  



See Accompanying Notes



Page 3 of 17



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##### Table of Contents

ITEM 1. Financial Statements (cont.)



ACTION PRODUCTS INTERNATIONAL, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)



|                                                      |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|----------------------------------------------------- |  | -------------------------------- | --------- | - | ------------------------------- | - | --------- | ---- |  | - | --------- | - |  | - | --------- | -
|                                                      |  | Three Months EndedSeptember 30th |           |   | Nine Months EndedSeptember 30th |  
|                                                      |  | 2004                             |           |   | 2003                            |   |           | 2004 |  |   | 2003      |  
|NET SALES                                             |  | $                                | 2,392,000 |   |                                 | $ | 2,724,000 |      |  | $ | 6,092,100 |   |  | $ | 6,374,800 |  
|                                                      |  |                                  |           |  
|COST OF SALES                                         |  |                                  | 1,139,600 |   |                                 |   | 1,361,200 |      |  |   | 2,974,600 |   |  |   | 3,115,100 |  
|                                                      |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|GROSS PROFIT                                          |  |                                  | 1,252,400 |   |                                 |   | 1,362,800 |      |  |   | 3,117,500 |   |  |   | 3,259,700 |  
|                                                      |  |                                  |           |  
|OPERATING EXPENSES                                    |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|Selling                                               |  |                                  | 581,700   |   |                                 |   | 619,100   |      |  |   | 1,726,200 |   |  |   | 1,554,500 |  
|General and administrative                            |  |                                  | 603,700   |   |                                 |   | 553,600   |      |  |   | 1,773,500 |   |  |   | 1,565,100 |  
|                                                      |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|TOTAL OPERATING EXPENSES                              |  |                                  | 1,185,400 |   |                                 |   | 1,172,700 |      |  |   | 3,499,700 |   |  |   | 3,119,600 |  
|                                                      |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|INCOME (LOSS) FROM OPERATIONS                         |  |                                  | 67,000    |   |                                 |   | 190,100   |      |  |   | (382,200  | ) |  |   | 140,100   |  
|                                                      |  |                                  |           |  
|OTHER INCOME (EXPENSE)                                |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|Interest expense                                      |  |                                  | (22,600   | ) |                                 |   | (32,200   | )    |  |   | (76,700   | ) |  |   | (87,500   | )
|Other, net                                            |  |                                  | 8,900     |   |                                 |   | 6,900     |      |  |   | 56,300    |   |  |   | 8,300     |  
|                                                      |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|                                                      |  |                                  | (13,700   | ) |                                 |   | (25,300   | )    |  |   | (20,400   | ) |  |   | (79,200   | )
|                                                      |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|INCOME (LOSS) BEFORE BENEFIT FROM INCOME TAXES        |  |                                  | 53,300    |   |                                 |   | 164,800   |      |  |   | (402,600  | ) |  |   | 60,900    |  
|                                                      |  |                                  |           |  
|BENEFIT FROM INCOME TAXES                             |  |                                  |          |   |                                 |   |          |      |  |   | 14,400    |   |  |   |          |  
|                                                      |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|NET INCOME (LOSS)                                     |  | $                                | 53,300    |   |                                 | $ | 164,800   |      |  | $ | (388,200  | ) |  | $ | 60,900    |  
|                                                      |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|INCOME (LOSS) PER SHARE                               |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|Basic                                                 |  | $                                | 0.01      |   |                                 | $ | 0.05      |      |  | $ | (0.10     | ) |  | $ | 0.02      |  
|Diluted                                               |  | $                                | 0.01      |   |                                 | $ | 0.04      |      |  | $ | (0.10     | ) |  | $ | 0.02      |  
|                                                      |  |                                  |           |  
|Weighted average number of common shares outstanding: |  |                                  |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|Basic                                                 |  |                                  | 4,434,500 |   |                                 |   | 3,158,400 |      |  |   | 4,073,300 |   |  |   | 3,137,100 |  
|Diluted                                               |  |                                  | 4,511,400 |   |                                 |   | 4,163,000 |      |  |   | 4,073,300 |   |  |   | 3,140,400 |  



See Accompanying Notes



Page 4 of 17



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##### Table of Contents

ITEM 1. Financial Statements (cont.)



ACTION PRODUCTS INTERNATIONAL INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)



|                                                                           |  |                                  |            |   |      |   |            |  
|-------------------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                           |  | Nine Months Ended September 30th |           
|                                                                           |  | 2004                             |            |   | 2003 |  
|CASH FLOWS FROM OPERATING ACTIVITIES                                       |  |                                  |            |   |      |   |            |  
|Net Loss                                                                   |  | $                                | (388,200   | ) |      | $ | 60,900     |  
|Adjustments to reconcile net loss to net cash used in operating activities |  |                                  |            |   |      |   |            |  
|Depreciation                                                               |  |                                  | 216,800    |   |      |   | 225,200    |  
|Amortization                                                               |  |                                  | 111,600    |   |      |   | 155,000    |  
|Gain on disposal of property plant and equipment                           |  |                                  | 1,000      |   |      |   |           |  
|Warrant issued for services                                                |  |                                  | 50,800     |   |      |   | 16,600     |  
|Provision for bad debts                                                    |  |                                  | (29,900    | ) |      |   | 47,000     |  
|Changes in:                                                                |  |                                  |            |   |      |   |            |  
|Accounts receivable                                                        |  |                                  | (538,500   | ) |      |   | (1,268,800 | )
|Inventories                                                                |  |                                  | (243,800   | ) |      |   | (29,400    | )
|Prepaid expenses                                                           |  |                                  | (92,300    | ) |      |   | (7,900     | )
|Other assets                                                               |  |                                  | (240,700   | ) |      |   | (44,000    | )
|Accounts payable                                                           |  |                                  | 5,400      |   |      |   | 147,600    |  
|Accrued expenses, payroll and related expenses                             |  |                                  | 479,600    |   |      |   | 518,300    |  
|Deferred revenue                                                           |  |                                  | (18,700    | ) |      |   | (18,700    | )
|                                                                           |  |                                  |            |   |      |   |            |  
|NET CASH USED IN OPERATING ACTIVITIES                                      |  |                                  | (686,900   | ) |      |   | (198,200   | )
|                                                                           |  |                                  |            |   |      |   |            |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                       |  |                                  |            |   |      |   |            |  
|Proceeds from the sale of investment securities                            |  |                                  | 72,900     |   |      |   |           |  
|Acquisition of Curiosity Kits                                              |  |                                  | (1,870,900 | ) |      |   |           |  
|Acquisition of property, plant and equipment                               |  |                                  | (95,500    | ) |      |   | (208,100   | )
|                                                                           |  |                                  |            |   |      |   |            |  
|NET CASH USED IN INVESTING ACTIVITIES                                      |  |                                  | (1,893,500 | ) |      |   | (208,100   | )
|                                                                           |  |                                  |            |   |      |   |            |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                       |  |                                  |            |   |      |   |            |  
|Purchase of treasury shares                                                |  |                                  | (12,000    | ) |      |   | (141,300   | )
|Proceeds from notes payable                                                |  |                                  | 645,000    |   |      |   |           |  
|Repayment of mortgage principal                                            |  |                                  | (70,400    | ) |      |   | (17,000    | )
|Proceeds from exercise of common shares options and warrants               |  |                                  | 1,571,000  |   |      |   | 465,600    |  
|Repayment of notes payable and obligation under capital lease              |  |                                  | (712,700   | ) |      |   | (60,000    | )
|Net change in borrowings under line of credit                              |  |                                  | 951,200    |   |      |   | 163,100    |  
|                                                                           |  |                                  |            |   |      |   |            |  
|NET CASH PROVIDED BY FINANCING ACTIVITIES                                  |  |                                  | 2,372,100  |   |      |   | 410,400    |  
|                                                                           |  |                                  |            |   |      |   |            |  
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                       |  |                                  | (208,300   | ) |      |   | 4,100      |  
|                                                                           |  |                                 
|CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                           |  |                                  | 750,100    |   |      |   | 563,400    |  
|                                                                           |  |                                  |            |   |      |   |            |  
|CASH AND CASH EQUIVALENTS AT END OF PERIOD                                 |  | $                                | 541,800    |   |      | $ | 567,500    |  
|                                                                           |  |                                  |            |   |      |   |            |  
|Supplemental disclosures - cash paid for:                                  |  |                                  |            |   |      |   |            |  
|Interest                                                                   |  | $                                | 63,400     |   |      | $ | 87,500     |  
|Income taxes                                                               |  | $                                |           |   |      | $ |           |  



See Accompanying Notes



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##### Table of Contents

ACTION PRODUCTS INTERNATIONAL, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)



|1. | Condensed Consolidated Financial Statements.In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all normal
recurring adjustments necessary to present fairly the financial position of Action Products International, Inc. and its subsidiary, Action Products Canada Ltd. (collectively, the Company), at September 30, 2004 and the results of its (i)
operations for the three month and nine month periods ended September 30, 2004 and 2003 and (ii) cash flows for the nine month periods ended September 30, 2004 and 2003. The financial information included herein is taken from the books and records
of the Company and is unaudited.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Certain
information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These condensed financial statements should be read in conjunction
with the audited financial statements and notes thereto included in the Companys annual report on Form 10-KSB for the year ended December 31, 2003. The results of operations for the nine month period ended September 30, 2004 are not
necessarily indicative of the operating results for the full year. Through September 30, 2004, the Company has been able to meet its obligations as they come due; however, it is at least reasonably possible that if the Company continues to incur
losses and negative cash flows, it will have to obtain additional sources of debt or equity financing to maintain its liquidity. There can be no assurance that such financing will be available or available on terms acceptable to the Company, if
needed.



|2. | Line of Credit.In June 2003, the Company entered into an agreement with a financial institution, to renew an existing revolving line of credit (the
Revolver) for up to $2 million at prime plus 1⁄2%. The borrowings under the Revolver are collateralized by inventory and accounts receivable. The Company utilizes the Revolver to finance accounts receivable, inventory and other
operating and capital requirements. The renewed Revolver matures June 30, 2005 and contains covenants relating to the financial condition of the Company. If the Company fails to maintain compliance with the financial covenants contained in the
Revolver, the maturity date could be accelerated. The Company is currently in compliance with all of the covenants.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. | Mortgage Payable.In November 1998, the Company borrowed $750,000 in the form of a mortgage payable. The mortgage is collateralized by real estate and improvements and
contains certain restrictive covenants, which provide that, among other things, the Company maintain a minimum working capital, net worth, debt service coverage and a maximum debt to net worth ratio. If the Company fails to maintain compliance with
the financial covenants contained in the note, the maturity date could be accelerated. At December 31, 2003, the Company was not in compliance with the debt service coverage covenant. However, the Company has obtained a waiver of non-compliance from
the financial institution for the twelve month period ending December 31, 2004.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. | Earnings per Share. Common share equivalents were not included in the computation of diluted earnings per share for the nine month period ending September 30, 2004, as their
effect would have been anti-dilutive.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. | Common Shares and Equity Securities. On April 24, 2003 the Company announced a Warrant distribution to all shareholders of record as of June 12, 2003. Shareholders were
issued one warrant for each common share owned as of the record date. The warrant entitles the holder to purchase common shares at an exercise price of $2.00 per share with an original expiration date of June 11, 2004. As of June 30, 2003
approximately 3,272,100 warrants had been issued. On June 3, 2004 the Board of Directors elected to extend the life of the warrants. The new expiration date is Friday June 9, 2006 at 5:00 PM E.S.T. There is no other change in the terms of the
warrant. As of September 30, 2004 warrants outstanding totaled 2,044,000.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

Common Shares and Equity Securities (cont.)



In January 2004, the Company issued a warrant for services, which entitles the holder to purchase 50,000 common shares at an exercise price of $4.00 per
share. The Company used the Black-Scholes valuation model to estimate the fair value of these warrants, which resulted in an estimated fair value of $50,800. As of September 30, 2004, no warrants under this agreement had been exercised.



On March 30, 2004, the Company announced that the Board of Directors had
authorized a program for repurchases of up to 150,000 common shares. The repurchased shares will be held in the treasury. The Company has repurchased 5,900 common shares during the first nine months of 2004.



At September 30, 2004, the Company has one stock-based employee compensation
plan. The Company accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees and related Interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under the plan had an exercise price not less than the market value of the underlying common shares on the date of grant. The effect on net income and earnings per share if the Company had applied the fair value
recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation is shown below:



|               |  |                 |  |                                       |        |                                     |   |          |  
|-------------- |  | --------------- |  | ------------------------------------- | ------ | ----------------------------------- | - | -------- | -
|               |  |                 |  | Three Months EndedSeptember 30th 2004 |        | Nine Months EndedSeptember 30th2004 |  
|Net loss       |  | As reported     |  | $                                     | 53,300 |                                     | $ | (388,200 | )
|               |  | Pro forma       |  | $                                     | 53,300 |                                     | $ | (483,000 | )
|Loss per share |  | Basic & Diluted |  |                                       |        |                                     |   |          |  
|               |  | As reported     |  | $                                     | 0.01   |                                     | $ | (0.10    | )
|               |  | Pro forma       |  | $                                     | 0.01   |                                     | $ | (0.12    | )



|6. | Related Party Transactions.In March and April 2004, the Company issued notes payable to Warren Kaplan and Judith Kaplan for a total of $645,000. The notes were for a two
year term and provided for monthly interest payments of 6% annually on the outstanding principal balance and 129,000 warrants to purchase common shares at $4.50 per share. An accrual for loan fees of $178,100 was recorded to reflect the estimated
value of the warrants. The warrants terminate in April 2009. As of May 2004, the Company had paid the $645,000 principal balance in full. In May 2004, as consideration for the accelerated prepayment of the total loan principal, the Kaplans
relinquished the 129,000 warrants issued to them.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|7. | Other Commitments.On March 29, 2004 the Company entered into an operating lease for 19,000 square feet of additional warehouse space. The lease commencing April 1,
2004 is for a one year term, with monthly payments of $8,550.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In April 2004, we entered into an agreement to purchase the assets of Curiosity Kits, Inc. As consideration for these assets, we agreed to pay Curiosity Kits approximately $1.87 million plus the greater of (i) 80% of
Curiosity Kits current accounts receivable we purchased, and (ii) 90% of such accounts receivable that we actually collect up to 180 days following the purchase. As of September 30, 2004 an additional payment of $75,600 will be due.



In September 2004 we exercised our right to extend the Jay
Jay the JetPlane licensing agreement for an
additional one year period expiring on December 31, 2005. Per the terms of the agreement the licensor shall receive a guaranteed minimum payment of $75,000 for the renewal term.



|8. | Reclassifications.Certain amounts from the prior period have been reclassified to conform to the current period presentation.
|-- | -----------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



Forward-looking Statements:



Forward-looking statements in this Form 10-QSB including, without limitation, statements relating to our plans, strategies, objectives, expectations, intentions and
adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements made in this report, other than statements of historical fact, are forward-looking statements. These
forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or
implied by the forward-looking statements. The following factors, among others, could cause actual results to differ materially from those set forth in the forward-looking statements: our ability to successfully develop our brands and proprietary
products through internal development, licensing and/or mergers and acquisitions. Additional factors include, but are not limited to the following: the size and growth of the market for our products, competition, pricing pressures, market acceptance
of our products, the effect of economic conditions, intellectual property rights, the results of financing efforts, risks in product development, other risks identified in this report and our other periodic filings with the Securities and Exchange
Commission.



Results of Operations:



Three Months Ended September 30, 2004 Compared With Three Months Ended September 30,
2003



The following should be read in conjunction with
our consolidated financial statements and the related notes thereto included elsewhere herein. The following table sets forth, as a percentage of net sales, certain items appearing in our consolidated statements of operations.



|                                   |  |                                      |    |  |                                      |   
|---------------------------------- |  | ------------------------------------ | -- |  | ------------------------------------ | --
|                                   |  | Three Months EndedSeptember 30, 2004 |    |  | Three Months EndedSeptember 30, 2003 |   
|Net Sales                          |  | 100                                  | %  |  | 100                                  | % 
|Cost of Sales                      |  | 48                                   | %  |  | 50                                   | % 
|Gross Profit                       |  | 52                                   | %  |  | 50                                   | % 
|Selling Expense                    |  | 24                                   | %  |  | 23                                   | % 
|General and Administrative Expense |  | 25                                   | %  |  | 20                                   | % 
|Total Operating Expense            |  | 49                                   | %  |  | 43                                   | % 
|Income (Loss) from Operations      |  | 3                                    | %  |  | 7                                    | % 
|Other Income (Expense)             |  | (1                                   | )% |  | (1                                   | )%
|Income (Loss) before income taxes  |  | 2                                    | %  |  | 6                                    | % 
|Net Income (Loss)                  |  | 2                                    | %  |  | 6                                    | % 



Net salesfor the three months
ended September 30, 2004 were $2,392,000, compared with net sales of $2,724,000 for the three months ended September 30, 2003. Management attributes the $332,000 or 12% decrease to a decline of approximately $1 million in sales to toy chain stores.
This decline was largely offset by sales of the recently acquired Curiosity Kits products and increased sales to independent toy stores, museums and gift store accounts, resulting from our ongoing efforts to broaden our base of distribution.



Gross profitdecreased by $110,400 to $1,252,400 for the three months
ended September 30, 2004, compared with $1,362,800 for the three months ended September 30, 2003. The gross profit percentage increased to 52% from 50% for the three month periods ended September 30, 2004 and 2003 respectively. The decrease in gross
profit is mainly attributable to the decrease in sales discussed above. The increase in gross profit percentage compared to the same period in 2003, was mainly attributable to lower product costs partially offset by an increase in importation
freight costs.



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##### Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)

ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations (Continued)



Selling, general and administrative (SG&A) expenses increased by $12,700 to
$1,185,400 for the three month period ended September 30, 2004 from $1,172,700 for the three month period ended September 30, 2003. This 1% increase in SG&A expenses is due primarily to increases in:



| |  | Compensation costs of $125,500 due principally to staffing additions in product development, sales, customer service and warehouse operations
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  | Advertising and promotion of $31,300 resulting from increased merchandising promotion and trade show participation
| | - | ------------------------------------------------------------------------------------------------------------------



| |  | Travel expenses of $20,400 related principally to trade show attendance and product sourcing activities
| | - | -------------------------------------------------------------------------------------------------------



| |  | Outbound freight of $13,900 resulting from a lower mix of direct factory shipments
| | - | ----------------------------------------------------------------------------------



The increase in SG&A was partially offset by decreases in:



| |  | Royalty fees of $114,800 due principally to lower sales, to toy chain stores, of our Jay Jay the JetPlane brand
| | - | ----------------------------------------------------------------------------------------------------------------



| |  | Professional services of $32,900 due mainly to reductions in legal and public relations expenses
| | - | ------------------------------------------------------------------------------------------------



| |  | Doubtful accounts expense of $29,300
| | - | ------------------------------------



Interest expense related to current and long-term debt was $22,600 and $32,200 for the three month periods ended September 30, 2004 and 2003, respectively. The
decrease of $9,600 is due to lower average borrowings under our line of credit.



Other income and (expense) during the three month periods ended September 30, 2004 and 2003 was $8,900 and $6,900, respectively. The $2,000 change was mainly attributable to increased gains from investments.



Net income, as a result of the foregoing, was $53,300 and $164,800 respectively for
the three months ended September 30, 2004, and the three months ended September 30, 2003.



Nine Months Ended September 30, 2004 Compared With Nine Months Ended September 30, 2003



The following should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere herein. The
following table sets forth, as a percentage of net sales, certain items appearing in our consolidated statements of operations.



|                                   |  |                                      |    |  |                                      |   
|---------------------------------- |  | ------------------------------------ | -- |  | ------------------------------------ | --
|                                   |  | Nine Months Ended September 30, 2004 |    |  | Nine Months Ended September 30, 2003 |   
|Net Sales                          |  | 100                                  | %  |  | 100                                  | % 
|Cost of Sales                      |  | 49                                   | %  |  | 49                                   | % 
|Gross Profit                       |  | 51                                   | %  |  | 51                                   | % 
|Selling Expense                    |  | 28                                   | %  |  | 24                                   | % 
|General and Administrative Expense |  | 29                                   | %  |  | 25                                   | % 
|Total Operating Expense            |  | 57                                   | %  |  | 49                                   | % 
|Income (Loss) from Operations      |  | (6                                   | )% |  | 2                                    | % 
|Other Income (Expense)             |  | (1                                   | )% |  | (1                                   | )%
|Income (Loss) before income taxes  |  | (7                                   | )% |  | 1                                    | % 
|Benefit from Income Taxes          |  | 1                                    | %  |  |                                     |   
|Net Income (Loss)                  |  | (6                                   | )% |  | 1                                    | % 



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##### Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)



ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations (Continued)



Net salesfor the nine months ended
September 30, 2004 were $6,092,100, compared with net sales of $6,374,800 for the nine months ended September 30, 2003. Management attributes the $282,700 or 4% decrease in net sales to a decline of over $2 million in sales to toy chain stores. This
decrease was partially offset by sales of the recently acquired Curiosity Kits products and increases in sales to independent toy stores, museums, gift stores and selected mass market accounts for the nine months ended September 30, 2004 compared to
the nine month period ended September 30, 2003.



Gross profitdecreased by $142,200 to $3,117,500 for the nine months ended September 30, 2004, compared with $3,259,700 for the nine months ended September 30, 2003. The gross profit percentage remained flat at 51% for the nine month periods ended September
30, 2004 and 2003 respectively. The decrease in gross profit is mainly attributable to the decrease in sales discussed above. The gross profit percentage remained the same compared to the same period in 2003, mainly as a result of lower product
costs offsetting higher importation freight costs.



Selling, general
and administrative (SG&A) expenses increased by $380,100 to $3,499,700 for the nine month period ended September 30, 2004 from $3,119,600 for the nine month period ended September 30, 2003. This 12% increase in SG&A expenses is due
primarily to increases in:



| |  | Compensation costs of $349,100 due principally to staffing additions in marketing, sales, customer service and warehouse operations
| | - | -----------------------------------------------------------------------------------------------------------------------------------



| |  | Advertising and promotion of $146,600 resulting from increased merchandising promotion and trade show participation
| | - | -------------------------------------------------------------------------------------------------------------------



| |  | Outbound freight of $78,700 resulting from a lower mix of direct factory shipments
| | - | ----------------------------------------------------------------------------------



| |  | Travel of $66,000 related principally to trade show attendance and product sourcing activities
| | - | ----------------------------------------------------------------------------------------------



| |  | Commissions of $51,300 resulting from a higher mix of specialty store sales
| | - | ---------------------------------------------------------------------------



| |  | Insurance of $30,000 resulting from higher commercial and product liability premiums
| | - | ------------------------------------------------------------------------------------



This increase in SG&A was partially offset by decreases in:



| |  | Royalty fees of $217,800 resulting from decreased sales, to toy chain stores, of our Jay Jay the JetPlaneTMbrand
| | - | ----------------------------------------------------------------------------------------------------------------



| |  | Doubtful accounts expense of $76,900
| | - | ------------------------------------



| |  | Professional services of $21,900 due mainly to reductions in legal and public relations expenses
| | - | ------------------------------------------------------------------------------------------------



| |  | Lease expense of $11,600 resulting from the relocation of our corporate offices to a new facility at a lower lease rate
| | - | -----------------------------------------------------------------------------------------------------------------------



Interest expense related to current and long-term debt was $76,700 and $87,500 for the
nine month periods ended September 30, 2004 and 2003, respectively. The decrease of $10,800 is due to lower average borrowings under our line of credit partially offset by interest on notes payable related to the Curiosity Kits, Inc. acquisition.



Other income and (expense) during the nine month periods ended
September 30, 2004 and 2003 was $56,300 and $8,300, respectively. The $48,000 change was mainly attributable to a decrease in miscellaneous expense related to the settlement of a legal claim in the first quarter of 2003, an increase in service
charges and gains from investments.



Income (loss) before income
taxes and net income (loss), as a result of the foregoing, were ($402,600) and ($388,200), respectively, for the nine months ended September 30, 2004, compared with $60,900 and $60,900, respectively, for the nine months ended September 30,
2003.



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##### Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)



ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations (Continued)



Financial Condition, Liquidity, and Capital
Resources



As of September 30, 2004, we had cash and cash equivalents of
$541,800 representing a decrease of $208,300 since December 31, 2003.



After
taking account of non-cash items and other adjustments, our cash requirements for operations for the nine months ended September 30, 2004 were $686,900. The principal source of cash from operating activities for the nine months ended September 30,
2004 was an increase in accrued expenses of $479,600 due to a seasonal increase in inventory purchases. Principal uses of cash from operating activities in the first nine months of fiscal 2004 were seasonal increases of:



| |  | $538,500 in accounts receivable
| | - | -------------------------------



| |  | $243,800 in inventories and
| | - | ---------------------------



| |  | $240,700 in other assets
| | - | ------------------------



The principal source of cash from investing activities for the first nine months of 2004 was $72,900 from the sale of investment securities. The principal uses of cash from investing activities for the nine months
ended September 30, 2004 were $1,870,900 for the acquisition of Curiosity Kits and $95,500 for additional computer and production equipment.



To meet a portion of our operating cash requirements, we increased our borrowing under our line of credit by $951,200, increased notes payable by $645,000 and received
net proceeds of $1,571,000 from common share option and warrant exercises. After applying $783,100 to repayment of notes payable, mortgage and capital lease principal, this left net cash from financing activities of $2,372,100.



At September 30, 2004, borrowing under our line of credit was $1,611,400, an increase of
$532,600 from $1,078,800 as of September 30, 2003. Our line of credit provides for borrowings up to $2,000,000 at the prime rate plus 1⁄2 % and matures June 30, 2005 at which time we currently intend to extend the credit arrangement. Under the
line of credit agreement, we are subject to financial covenants relating to certain asset balances and financial ratios. As of September 30, 2004 we were eligible to borrow $2,000,000 under our line of credit and were in compliance with our
financial covenants.



ITEM 3. Controls and Procedures



As of the end of
the period covered by this report, our company conducted an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of our disclosure controls and procedures (as defined in Rules
13a-15(e) of the Exchange Act). Based on this evaluation, our chief executive officer and chief financial officer concluded that our companys disclosure controls and procedures are effective to ensure that information required to be disclosed
by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.



There was no change in our internal controls, which are included within disclosure controls
and procedures, during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (cont.)



PART II. OTHER INFORMATION



ITEM 2. Changes in Securities



Repurchase of
Securities



We repurchased 5,900 of our common shares during the third
quarter of 2004. In early 2004, our Board of Directors had authorized a program for repurchases of up to 150,000 common shares.



Repurchases of Common Shares



|                                       |  |                                       |  |                                   |      |                                                                                      |       |                                                                                                                  |        
|-------------------------------------- |  | ------------------------------------- |  | --------------------------------- | ---- | ------------------------------------------------------------------------------------ | ----- | ---------------------------------------------------------------------------------------------------------------- | -------
|                                       |  | Total number ofcommon sharespurchased |  | Average price paid percommonshare |      | Total number of commonshares purchased as partof publicly announcedplans or programs |       | Maximum number (or approximatedollar value) of common shares thatmay yet be purchased under theplans or
programs
|July 1, 2004  July 31, 2004           |  |                                      |  |                                   |     |                                                                                      |      |                                                                                                                  | 150,000
|August 1, 2004  August 31, 2004       |  | 2,100                                 |  | $                                 | 1.94 |                                                                                      | 2,100 |                                                                                                                  | 147,900
|September 1, 2004  September 30, 2004 |  | 3,800                                 |  | $                                 | 2.09 |                                                                                      | 3,800 |                                                                                                                  | 144,100
|                                       |  |                                       |  |                                   |      |                                                                                      |       |                                                                                                                  |        
|Total                                  |  | 5,900                                 |  | $                                 | 2.03 |                                                                                      | 5,900 |                                                                                                                  |        
|                                       |  |                                       |  |                                   |      |                                                                                      |       |                                                                                                                  |        



ITEM 6. Exhibits and Reports on Form 8-K



|A. | Exhibits
|-- | --------



|            |  |                                                                       
|----------- |  | ----------------------------------------------------------------------
|Exhibit No. |  | Description                                                           
|31.1        |  | Chief Executive Officer - Sarbanes-Oxley Act Section 302 Certification
|            | 
|31.2        |  | Chief Financial Officer - Sarbanes-Oxley Act Section 302 Certification
|            | 
|32.1        |  | Chief Executive Officer - Sarbanes-Oxley Act Section 906 Certification
|            | 
|32.2        |  | Chief Financial Officer - Sarbanes-Oxley Act Section 906 Certification



|B. | Reports on Form 8-K
|-- | -------------------



| |  | Form 8-K dated and filed on October 5, 2004 announcing revenues for the quarter and nine months ended September 30, 2004.
| | - | -------------------------------------------------------------------------------------------------------------------------



| |  | Form 8-K dated and filed on October 22, 2004 setting forth, among other matters, the Companys profitability for the three months ended September 30, 2004.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES



Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



ACTION PRODUCTS INTERNATIONAL, INC.



|                       |  |     |  |                                                       
|---------------------- |  | --- |  | ------------------------------------------------------
|Date: October 29, 2004 |  | By: |  | /s/ RONALD S. KAPLAN                                  
|                       |  |     |  | Ronald S. Kaplan                                      
|                       |  |     |  | Chief Executive Officer (Principal Executive Officer) 
|                       |  |    
|Date: October 29, 2004 |  | By: |  | /s/ ROBERT L. BURROWS                                 
|                       |  |     |  | Robert L. Burrows                                     
|                       |  |     |  | Chief Financial Officer (Principal Accounting Officer)



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