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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-Q



QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934



|                       |  |                     
|---------------------- |  | --------------------
|For the Quarter Ended: |  | Commission File No.:
|January 31, 2004       |  | 0-24338             



VARIFLEX, INC.

(Exact name of Registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 95-3164466                          
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification Number)



5152 North Commerce
Avenue

Moorpark, California 93021

(Address of principal executive offices)



Registrants telephone number, including area code:

(805) 523-0322



---



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. Yes X
    No



Indicate by check mark whether the Registrant is an accelerated filer (as defined under Rule 12b-2 of the Exchange Act. Yes 
NoX



As of March 3,
2004, there were 4,603,771 shares of Common Stock, $.001 par value, outstanding.



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VARIFLEX, INC.

INDEX



|                                 |  |                                                                                                                 |  |         
|-------------------------------- |  | --------------------------------------------------------------------------------------------------------------- |  | --------
|                                 |  |                                                                                                                 |  | Page No.
|                                 | 
|Part I    Financial Information |  |                                                                                                                
|                                 |  |                                                                                                                
|Item 1.                          |  | Financial Statements                                                                                            |  |         
|                                 |  |                                                                                                                
|                                 |  | Consolidated Balance Sheets at January 31, 2004 and July 31, 2003                                               |  | 3       
|                                 |  |                                                                                                                
|                                 |  | Consolidated Statements of Operations for the Three Month and Six Month Periods Ended January 31, 2004 and 2003 |  | 4       
|                                 |  |                                                                                                                
|                                 |  | Consolidated Statements of Cash Flows for the Six Months Ended January 31, 2004 and 2003                        |  | 5       
|                                 |  |                                                                                                                
|                                 |  | Notes to Consolidated Financial Statements                                                                      |  | 6       
|                                 |  |                                                                                                                
|Item 2.                          |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                           |  | 8       
|                                 |  |                                                                                                                
|Item 4.                          |  | Controls and Procedures                                                                                         |  | 14      
|                                 | 
|Part II    Other Information    |  |                                                                                                                
|                                 |  |                                                                                                                
|Item 1.                          |  | Legal Proceedings                                                                                               |  | 15      
|                                 |  |                                                                                                                
|Item 4.                          |  | Submission of Matters to a vote of Security Holders                                                             |  | 15      
|                                 |  |                                                                                                                
|Item 6.                          |  | Exhibits and Reports on Form 8-K                                                                                |  | 16      



2



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##### Table of Contents

PART 1

FINANCIAL INFORMATION

Item 1.    Financial Statements

VARIFLEX, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)



|                                                                                                                       |  |             |        |   |          |   |        |  
|---------------------------------------------------------------------------------------------------------------------- |  | ----------- | ------ | - | -------- | - | ------ | -
|                                                                                                                       |  | January 31, |        |   | July 31, |  
|                                                                                                                       |  | 2004        |        |   | 2003     |  
|                                                                                                                       |  | (Unaudited) |        |   |          |  
|Assets                                                                                                                 |  |             |        |   |          |   |        |  
|Current assets:                                                                                                        |  |             |        |   |          |   |        |  
|Cash and cash equivalents                                                                                              |  | $           | 17,007 |   |          | $ | 17,582 |  
|Trade accounts receivable, less allowances of $453 and$449 as of January 31, 2004 and July 31, 2003, respectively      |  |             | 7,571  |   |          |   | 10,719 |  
|Inventory (finished goods)                                                                                             |  |             | 7,327  |   |          |   | 5,285  |  
|Inventory (raw materials and work-in-process)                                                                          |  |             | 544    |   |          |   | 417    |  
|Deferred income taxes                                                                                                  |  |             | 1,043  |   |          |   | 1,043  |  
|Prepaid expenses and other current assets                                                                              |  |             | 1,292  |   |          |   | 1,915  |  
|                                                                                                                       |  |             |        |   |          |   |        |  
|Total current assets                                                                                                   |  |             | 34,784 |   |          |   | 36,961 |  
|Property and equipment, net                                                                                            |  |             | 432    |   |          |   | 425    |  
|Intangible assets                                                                                                      |  |             | 1,653  |   |          |   | 1,892  |  
|Other assets                                                                                                           |  |             | 576    |   |          |   | 306    |  
|                                                                                                                       |  |             |        |   |          |   |        |  
|Total assets                                                                                                           |  | $           | 37,445 |   |          | $ | 39,584 |  
|                                                                                                                       |  |             |        |   |          |   |        |  
|                                                                                                                       |  |            
|Liabilities and stockholders equity                                                                                   |  |             |        |   |          |   |        |  
|Current liabilities:                                                                                                   |  |             |        |   |          |   |        |  
|Trade acceptances payable                                                                                              |  | $           |       |   |          | $ | 177    |  
|Accounts payable                                                                                                       |  |             | 1,677  |   |          |   | 1,155  |  
|Accrued warranty                                                                                                       |  |             | 852    |   |          |   | 1,130  |  
|Accrued salaries and related liabilities                                                                               |  |             | 319    |   |          |   | 888    |  
|Accrued co-op advertising                                                                                              |  |             | 1,347  |   |          |   | 1,236  |  
|Accrued returns and allowances                                                                                         |  |             | 1,272  |   |          |   | 1,332  |  
|Other accrued expenses                                                                                                 |  |             | 735    |   |          |   | 953    |  
|Current maturities of note payable                                                                                     |  |             | 200    |   |          |   | 200    |  
|                                                                                                                       |  |             |        |   |          |   |        |  
|Total current liabilities                                                                                              |  |             | 6,402  |   |          |   | 7,071  |  
|                                                                                                                       |  |            
|Note payable, less current maturities                                                                                  |  |             | 454    |   |          |   | 620    |  
|                                                                                                                       |  |            
|Commitments and contingencies                                                                                          |  |             |        |   |          |   |        |  
|                                                                                                                       |  |            
|Stockholders equity:                                                                                                  |  |             |        |   |          |   |        |  
|Preferred stock, $.001 par value, 5,000,000 shares Authorized, none issued and outstanding                             |  |             |       |   |          |   |       |  
|Common stock, $.001 par value, 40,000,000 shares Authorized, 6,044,736 issued as of January 31, 2004 and July 31, 2003 |  |             | 9      |   |          |   | 9      |  
|Common stock warrants                                                                                                  |  |             | 702    |   |          |   | 702    |  
|Additional paid-in capital                                                                                             |  |             | 21,023 |   |          |   | 21,023 |  
|Retained earnings                                                                                                      |  |             | 17,570 |   |          |   | 18,874 |  
|Treasury stock, at cost, 1,440,965 shares as of January 31, 2004 and July 31, 2003                                     |  |             | (8,715 | ) |          |   | (8,715 | )
|                                                                                                                       |  |             |        |   |          |   |        |  
|Total stockholders equity                                                                                             |  |             | 30,589 |   |          |   | 31,893 |  
|                                                                                                                       |  |             |        |   |          |   |        |  
|Total liabilities and stockholders equity                                                                             |  | $           | 37,445 |   |          | $ | 39,584 |  
|                                                                                                                       |  |             |        |   |          |   |        |  
|                                                                                                                       |  |            
|See accompanying notes.                                                                                                |  |             |        |   |          |   |        |  



3



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VARIFLEX, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)



|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|------------------------------------ |  | ---------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ----- | - |  | - | ----- | -
|                                     |  | Six months ended January 31, |        |   | Three months ended January 31, |  
|                                     |  | 2004                         |        |   | 2003                           |   |        | 2004 |  |   | 2003  |  
|Net sales                            |  | $                            | 20,606 |   |                                | $ | 22,482 |      |  | $ | 8,525 |   |  | $ | 9,880 |  
|Cost of goods sold                   |  |                              | 18,214 |   |                                |   | 19,452 |      |  |   | 7,509 |   |  |   | 8,740 |  
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Gross profit                         |  |                              | 2,392  |   |                                |   | 3,030  |      |  |   | 1,016 |   |  |   | 1,140 |  
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|                                     |  |                              |        |  
|Operating expenses:                  |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Selling and marketing                |  |                              | 1,033  |   |                                |   | 1,058  |      |  |   | 513   |   |  |   | 454   |  
|General and administrative           |  |                              | 2,728  |   |                                |   | 2,701  |      |  |   | 1,363 |   |  |   | 1,392 |  
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Total operating expenses             |  |                              | 3,761  |   |                                |   | 3,759  |      |  |   | 1,876 |   |  |   | 1,846 |  
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Loss from operations                 |  |                              | (1,369 | ) |                                |   | (729   | )    |  |   | (860  | ) |  |   | (706  | )
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|                                     |  |                              |        |  
|Other income (expense):              |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Interest expense                     |  |                              | (34    | ) |                                |   | (40    | )    |  |   | (17   | ) |  |   | (20   | )
|Interest income and other            |  |                              | 99     |   |                                |   | 110    |      |  |   | 51    |   |  |   | 56    |  
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Total other income (expense)         |  |                              | 65     |   |                                |   | 70     |      |  |   | 34    |   |  |   | 36    |  
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|                                     |  |                              |        |  
|Loss before income taxes             |  |                              | (1,304 | ) |                                |   | (659   | )    |  |   | (826  | ) |  |   | (670  | )
|Provision for income taxes           |  |                              |       |   |                                |   |       |      |  |   |      |   |  |   |      |  
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Net loss                             |  | $                            | (1,304 | ) |                                | $ | (659   | )    |  | $ | (826  | ) |  | $ | (670  | )
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|                                     |  |                              |        |  
|Net loss per share of common stock:  |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Basic                                |  | $                            | (0.28  | ) |                                | $ | (0.14  | )    |  | $ | (0.18 | ) |  | $ | (0.15 | )
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Diluted                              |  | $                            | (0.28  | ) |                                | $ | (0.14  | )    |  | $ | (0.18 | ) |  | $ | (0.15 | )
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Weighted average shares outstanding: |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Basic                                |  |                              | 4,604  |   |                                |   | 4,604  |      |  |   | 4,604 |   |  |   | 4,604 |  
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|Diluted                              |  |                              | 4,604  |   |                                |   | 4,604  |      |  |   | 4,604 |   |  |   | 4,604 |  
|                                     |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  
|                                     |  |                              |        |  
|See accompanying notes.              |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |       |  



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VARIFLEX, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                |  |                              |        |   |      |   |        |  
|------------------------------------------------------------------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                |  | Six months ended January 31, |       
|                                                                                |  | 2004                         |        |   | 2003 |  
|Operating activities                                                            |  |                              |        |   |      |   |        |  
|Net loss                                                                        |  | $                            | (1,304 | ) |      | $ | (659   | )
|Adjustments to reconcile net loss to net cash provided by operating activities: |  |                              |        |   |      |   |        |  
|Depreciation and amortization                                                   |  |                              | 65     |   |      |   | 51     |  
|Amortization of intangibles                                                     |  |                              | 239    |   |      |   | 239    |  
|Non-cash interest charge                                                        |  |                              | 34     |   |      |   | 40     |  
|Deferred income taxes                                                           |  |                              |       |   |      |   | (107   | )
|Changes in operating assets and liabilities:                                    |  |                              |        |   |      |   |        |  
|Trade accounts receivable                                                       |  |                              | 3,148  |   |      |   | 4,878  |  
|Inventory                                                                       |  |                              | (2,168 | ) |      |   | (2,031 | )
|Prepaid expenses and other assets                                               |  |                              | 352    |   |      |   | 312    |  
|Trade acceptances payable                                                       |  |                              | (177   | ) |      |   | 281    |  
|Accounts payable                                                                |  |                              | 522    |   |      |   | (346   | )
|Other current liabilities                                                       |  |                              | (1,015 | ) |      |   | (425   | )
|                                                                                |  |                              |        |   |      |   |        |  
|Net cash provided by (used in) operating activities                             |  |                              | (304   | ) |      |   | 2,233  |  
|                                                                                |  |                              |        |   |      |   |        |  
|                                                                                |  |                             
|Investing activities                                                            |  |                              |        |   |      |   |        |  
|Purchases of property and equipment                                             |  |                              | (71    | ) |      |   | (95    | )
|                                                                                |  |                              |        |   |      |   |        |  
|Net cash used in investing activities                                           |  |                              | (71    | ) |      |   | (95    | )
|                                                                                |  |                              |        |   |      |   |        |  
|                                                                                |  |                             
|Financing activities                                                            |  |                              |        |   |      |   |        |  
|Principal payment on note payable                                               |  |                              | (200   | ) |      |   | (200   | )
|                                                                                |  |                              |        |   |      |   |        |  
|Net cash used in financing activities                                           |  |                              | (200   | ) |      |   | (200   | )
|                                                                                |  |                              |        |   |      |   |        |  
|                                                                                |  |                             
|Net increase (decrease) in cash                                                 |  |                              | (575   | ) |      |   | 1,938  |  
|Cash and cash equivalents at beginning of period                                |  |                              | 17,582 |   |      |   | 12,169 |  
|                                                                                |  |                              |        |   |      |   |        |  
|Cash and cash equivalents at end of period                                      |  | $                            | 17,007 |   |      | $ | 14,107 |  
|                                                                                |  |                              |        |   |      |   |        |  
|                                                                                |  |                             
|See accompanying notes.                                                         |  |                              |        |   |      |   |        |  



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VARIFLEX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



Note 1.    Basis of Presentation



The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.
Operating results for the three and six month periods ended January 31, 2004 are not necessarily indicative of the results that may be expected for the full fiscal year. For further information, refer to the financial statements and footnotes
thereto included in the Companys annual report on Form 10-K for the fiscal year ended July 31, 2003.



Stock Based Compensation



Employee stock options are accounted for under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, as amended and interpreted, which requires recognition of expense when the option price is less
that the fair value of the stock at the date of grant. The Company generally awards options for a fixed number of shares at an option price equal to the fair value of the stock at the date of the grant. The Company has adopted the disclosure-only
provisions of the Financial Accounting Standards Boards Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation (SFAS 123), as amended by (SFAS) No. 148, Accounting for Stock-based
Compensation  Transitional Disclosure.



If the Company
recognized employee stock option related compensation expense in accordance with SFAS 123 and used the Black-Scholes model for determining the weighted average fair value of options granted, the Companys net income and earnings per share would
have been reduced to the pro forma amounts indicated below:



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|                                                                     |  |                              |        |   |                                |   |      |      |  |   |      |   |  |   |      |  
|-------------------------------------------------------------------- |  | ---------------------------- | ------ | - | ------------------------------ | - | ---- | ---- |  | - | ---- | - |  | - | ---- | -
|                                                                     |  | Six months ended January 31, |        |   | Three months ended January 31, |  
|                                                                     |  | 2004                         |        |   | 2003                           |   |      | 2004 |  |   | 2003 |  
|Net loss as reported                                                 |  | $                            | (1,304 | ) |                                | $ | (659 | )    |  | $ | (826 | ) |  | $ | (670 | )
|Stock-based employee compensation cost included in reported net loss |  |                              |       |   |                                |   |     |      |  |   |     |   |  |   |     |  
|Pro forma stock-based employee compensation cost under SFAS 123      |  |                              | (109   | ) |                                |   | (105 | )    |  |   | (54  | ) |  |   | (53  | )
|                                                                     |  |                              |        |   |                                |   |      |      |  |   |      |   |  |   |      |  
|Pro forma net loss                                                   |  | $                            | (1,413 | ) |                                | $ | (764 | )    |  | $ | (880 | ) |  | $ | (723 | )
|                                                                     |  |                              |        |   |                                |   |      |      |  |   |      |   |  |   |      |  



|                      |  |   |       |   |  |   |       |   |  |   |       |   |  |   |       |  
|--------------------- |  | - | ----- | - |  | - | ----- | - |  | - | ----- | - |  | - | ----- | -
|Loss per share:       |  |   |       |   |  |   |       |   |  |   |       |   |  |   |       |  
|Basic  as reported   |  | $ | (0.28 | ) |  | $ | (0.14 | ) |  | $ | (0.18 | ) |  | $ | (0.15 | )
|Basic  pro forma     |  | $ | (0.31 | ) |  | $ | (0.17 | ) |  | $ | (0.19 | ) |  | $ | (0.16 | )
|Diluted  as reported |  | $ | (0.28 | ) |  | $ | (0.14 | ) |  | $ | (0.18 | ) |  | $ | (0.15 | )
|Diluted  pro forma   |  | $ | (0.31 | ) |  | $ | (0.17 | ) |  | $ | (0.19 | ) |  | $ | (0.16 | )



Note
2.    Reclassification



Certain reclassifications have been
made to the fiscal 2003 financial statements to conform with fiscal 2004 presentation.



Note 3.    Earnings per Share



Basic earnings per
share exclude any dilutive effects of options, warrants and convertible securities. Diluted earnings per share include the dilutive effects of stock options and warrants. For the three and six month periods ended January 31, 2004 and 2003, diluted
earnings per share excluded the effect of all options and warrants as their effect would have been antidilutive. Total options and warrants outstanding as of January 31, 2004 and 2003 were 1,177,000 and 1,228,000, respectively.



Note 4.    Segment Information



Pursuant to Statement of Financial Accounting Standards No. 131 (SFAS
No. 131), Disclosures about Segments of an Enterprise and Related Information, the Company has determined, based on its internal system of management reporting and its assessment of performance as a single operating unit, that
during the three and six months ended January 31, 2004 and 2003, it operated in only one segment. The Company classifies its products into similar product groupings. The action sport products primarily include in-line skates and skateboards. The
outdoor products primarily include portable instant canopies and springless trampolines. The protective products include recreational protective equipment, such as wrist guards, elbow pads, knee pads, and helmets.



7



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Sales of similar products within the segment are as follows:



|                        |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |        |  
|----------------------- |  | ---------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ----- | - |  | - | ------ | -
|                        |  | Six months ended January 31, |        |   | Three months ended January 31, |  
|                        |  | 2004                         |        |   | 2003                           |   |        | 2004 |  |   | 2003  |  
|Action sport products   |  | $                            | 9,896  |   |                                | $ | 13,618 |      |  | $ | 4,164 |   |  | $ | 5,586  |  
|Outdoor products        |  |                              | 10,773 |   |                                |   | 8,739  |      |  |   | 4,081 |   |  |   | 4,192  |  
|Protective products     |  |                              | 1,180  |   |                                |   | 1,300  |      |  |   | 748   |   |  |   | 643    |  
|Other products          |  |                              | 164    |   |                                |   | 233    |      |  |   | 66    |   |  |   | 122    |  
|                        |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |        |  
|Total gross sales       |  |                              | 22,013 |   |                                |   | 23,890 |      |  |   | 9,059 |   |  |   | 10,543 |  
|Returns and allowances  |  |                              | (1,040 | ) |                                |   | (895   | )    |  |   | (412  | ) |  |   | (392   | )
|Cooperative advertising |  |                              | (367   | ) |                                |   | (513   | )    |  |   | (122  | ) |  |   | (271   | )
|                        |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |        |  
|Total net sales         |  | $                            | 20,606 |   |                                | $ | 22,482 |      |  | $ | 8,525 |   |  | $ | 9,880  |  
|                        |  |                              |        |   |                                |   |        |      |  |   |       |   |  |   |        |  



Note 5. Legal Proceedings



From time to time, the Company is involved in claims involving product
liability arising in the ordinary course of its business. The Company carries product liability insurance coverage with self-insured retention deductible claims. A prior year insurance carrier has declared bankruptcy and as such, coverage for one
claim has the potential of not being covered by insurance. At January 31, 2004 the Company has a reserve against all insured and uninsured claims. In the opinion of management, any additional liability to the Company arising under any pending
product liability claims would not materially affect its financial condition, results of operations or cash flows.



|
|

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



Overview



The Company is a leading distributor and wholesaler in the United States of in-line skates, skateboards, recreational protective equipment (such as wrist
guards, elbow pads and knee pads used by skaters and skateboarders) helmets, canopies, trampolines and bike accessories. The Company designs and develops these products, which are then manufactured to the Companys detailed specifications by
independent contractors. The Company distributes its products throughout the United States and, to a lesser extent, in foreign countries.



Net sales consist of invoiced sales less agreed upon programs, (primarily returns and allowances, and cooperative advertising expenses). The Company sells
its products primarily to mass merchandise, major sporting goods and major home improvement retailers. The Company uses a combination of internal sales personnel and independent sales representatives to provide sales support. Sales are subject to
trends that frequently change and affect the demand for certain products. Accordingly, the Companys future sales will fluctuate based on the Companys ability to identify and create products that meet such changes in demand. Outdoor
products typically have higher sales in the spring and early summer months. As outdoor products have become a larger part of the business, the Company has experienced increased levels of seasonality with higher sales in the third and fourth fiscal
quarters.



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Costs of goods sold consist of product costs, freight distribution, (as well as warehouse costs), payroll
expenses, facility costs, and other product related costs such as warranty expenses and royalty fees. The Company does not own or operate any manufacturing facilities and sources its products through independent contract manufacturers. A recent
trend affecting the Company is the increases in direct shipments to its customers directly from its vendors in Asia. The effects on the Company include, lower selling prices, an increased ability to lower our warehousing space
requirements and decreased exposure to inventory risk.



Operating expenses consist of selling and marketing costs and general and administrative costs. Selling and marketing costs consist of payroll expenses, sales commissions and other promotional items. General and administrative costs consist
of payroll, legal, accounting, information systems, product development, intangible amortization and other overhead expenses.



Other income and expenses consists of interest income, interest expense and other non-operating items.



Results of Operations



Net Sales.    Net sales for the
second quarter of fiscal 2004 (the quarter ended January 31, 2004) totaled $8,525,000 compared to $9,880,000 for the second quarter of fiscal 2003, representing a decrease of $1,355,000 or 14%. For the six months ended January 31, 2004, net sales
totaled $20,606,000 compared to $22,482,000 for the corresponding period of the prior year, representing a decrease of $1,876,000 or 8%.



Gross sales of action sport products decreased $1,422,000, or 25% and $3,722,000, or 27% for the quarter ended and six month period ended January 31,
2004, respectively. These decreases were primarily the result of lower sales of both in-line skates and skateboards. Gross sales of outdoor products decreased $111,000, or 3% for the quarter ended January 31, 2004. The slight decline in outdoor
products during the quarter was a result of lower canopy sales partially offset by higher trampoline sales. Although lower during the second quarter, canopy sales for the six months ended January 31, 2003 were up significantly along with an increase
in trampoline sales for the same period, which were the factors that drove outdoor products sales to increase during the six month period by $2,034,000 or 23%. Gross sales of protective products increased $105,000 or 16% during the quarter as a
result of higher protective pad sales, partially offset by lower helmet sales. For the six months ended January 31, 2004, protective product sales decreased $120,000 or 9% due to lower helmet sales partially offset by higher protective pad sales.



The following table shows the Companys major product
categories as a percentage of total gross sales for the second quarter and first six months of fiscal 2004 compared to the second quarter and first six months of fiscal 2003. Action sport products include in-line skates, skateboards, scooters and
bike accessories. Outdoor products include portable instant canopies and springless trampolines. Protective products include recreational protective equipment, such as wrist guards, elbow pads, knee pads and helmets.



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|                      |  |                             |   |  |                          |   |  |      |   |  |      |  
|--------------------- |  | --------------------------- | - |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                      |  | Six months endedJanuary 31, |   |  | Quarter endedJanuary 31, |  
|                      |  | 2004                        |   |  | 2003                     |   |  | 2004 |   |  | 2003 |  
|Action sport products |  | 45                          | % |  | 57                       | % |  | 46   | % |  | 53   | %
|Outdoor products      |  | 49                          | % |  | 37                       | % |  | 45   | % |  | 40   | %
|Protective products   |  | 5                           | % |  | 5                        | % |  | 8    | % |  | 6    | %
|Other products        |  | 1                           | % |  | 1                        | % |  | 1    | % |  | 1    | %
|                      |  |                             |   |  |                          |   |  |      |   |  |      |  
|Total                 |  | 100                         | % |  | 100                      | % |  | 100  | % |  | 100  | %
|                      |  |                             |   |  |                          |   |  |      |   |  |      |  



Gross
Profit.    Gross profit for the second quarter of fiscal 2004 totaled $1,016,000 compared to $1,140,000 for the second quarter of fiscal 2003, a decrease of $124,000 or 10.9%. The Companys gross margin was 11.9%
of net sales for the quarter ended January 31, 2004, compared to 11.5% for the quarter ended January 31, 2003. The slight increase in gross margin percentage despite lower sales was primarily the result of fewer closeout sales in the quarter versus
the prior year, partially offset by lower gross profit margins on increased direct (direct shipments to the customer from Asia) product sales. Gross profit for the six months ended January 31, 2004 totaled $2,392,000 compared to
$3,030,000 in fiscal 2003, a decrease of $638,000 or 21.1%. Gross margin was 11.6% for the six months ended January 31, 2004, compared to 13.5% for the six months ended January 31, 2003. The decrease in gross margin was primarily due to lower gross
profit margins on increased direct shipments and a portion of labor and overhead costs being fixed in nature, therefore not decreasing with lower sales volumes.



Operating Expenses.    The Companys selling and marketing expenses totaled
$513,000, for the second quarter of fiscal 2004, compared to $454,000 in the second quarter of 2003, an increase of $59,000 or 13.0%. Selling and marketing expenses for the second quarter of fiscal 2004 amounted to 6.0% of net sales, compared to
4.6% during the second quarter of fiscal 2003. The increase in selling and marketing expense during the quarter was attributable to the addition of a sales office in Illinois used primarily for the distribution of bike accessories. For the six
months ended January 31, 2004, selling and marketing expenses totaled $1,033,000 compared to $1,058,000 for the corresponding period of the prior year, representing a decrease of $25,000 or 2.4%. Selling and marketing expenses for the first six
months of fiscal 2004 amounted to 5.0% of net sales, compared to 4.7% during the first six months of fiscal 2003. Selling and marketing expense for the six month period were relatively flat with the prior period.



General and administrative expenses totaled $1,363,000 in the second quarter
of 2004, compared to $1,392,000 in the second quarter of 2003, a decrease of $29,000 or 2.1%. General and administrative expenses for the second quarter of fiscal 2004 amounted to 16.0% of net sales, compared to 14.1% during the second quarter of
2003. For the six months ended January 31, 2004, general and administrative expenses totaled $2,728,000 compared to $2,701,000 for the corresponding period of the prior year, relatively flat with the prior period. General and administrative expenses
for the first six months of fiscal 2004 amounted to 13.2% of net sales, compared to 12.0% during the first six months of fiscal 2003. The slight changes in general and administrative costs in both periods can be attributed to increases in product
development expenses and lower general and administrative expenses.



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Other Income (Expense).    Other income totaled $34,000 in the
second quarter of 2004, compared to $36,000 in the second quarter of 2003, a decrease of $2,000 or 6%. For the six months ended January 31, 2004, other income totaled $65,000 compared to $70,000 for the corresponding period of the prior year, a
decrease of $5,000 or 7%. The decrease for the second quarter and first six months was primarily due to decreased interest rates available on the Companys cash and cash equivalents.



Provision for Income Taxes.    The income tax provision for the second quarter and
first six months of fiscal 2004 and 2003 was zero. Tax benefits primarily created through operating losses are being fully reserved for through increases in the valuation allowance, due to the realization of the related deferred tax asset not being
considered more likely than not at this point. The effective rate differs from the federal statutory rate due to offsetting increases in the valuation allowance, certain expenses not deductible for tax purposes and state taxes. At January 31, 2004,
the Company had a valuation allowance of approximately $2.6 million against a portion of its net deferred tax assets. To the extent that the Company generates sufficient taxable ordinary income in the future, the valuation allowance may be reduced.
Should the Company not generate sufficient taxable income in the future, the valuation may need to be increased. Approximately $1.3 million of the valuation allowance would only be reversed and reflected as a reduction of income tax expense if the
Company generates qualifying capital gain income, which we do not expect to occur in the foreseeable future.



Liquidity and Capital Resources



The Company funds its activities principally from cash flow generated from operations and a credit facility with a major bank. Cash and cash equivalents
totaled $17,007,000 as of January 31, 2004, compared to $17,582,000 as of July 31, 2003. The cash equivalents are invested in money market funds which consist of investment-grade short-term instruments. The Company currently plans to continue
investing cash in this manner. Net working capital as of January 31, 2004 was $28,382,000 compared to $29,890,000 as of July 31, 2003.



The Company has a credit agreement with a major bank providing a $9,000,000 revolving line of credit with separate sub-limits of $9,000,000 for the
issuance of commercial letters of credit and $2,000,000 for actual cash borrowing. The agreement is secured by substantially all the assets of the Company and carries an interest rate equal to the banks reference rate which is
equivalent to prime and offers certain LIBOR based interest options. The Company is in compliance with all monthly financial covenants called for in the credit agreement. Borrowings for letters of credit have varied, historically
reaching the highest levels in the pre-Christmas months. However, in recent years and expected to continue into the future, is the surge of Outdoor products in the spring and summer months, which has changed this borrowing pattern and accordingly
the Company expects its highest periods of borrowings to be at the beginning of the calendar year. The outstanding balance on letters of credit on January 31, 2004 was $2,275,000 leaving approximately $6,725,000 available for issuance of letters of
credit, inclusive of a separate sub limit of $2,000,000 available for cash borrowings. Since the Company expects to finance its 2004 operations from operating cash flow and existing cash reserves, the Company does not currently anticipate borrowing
cash available under the line during this fiscal year. To the extent that terms and conditions are favorable, the Company intends to renegotiate its credit agreement with the bank for an extended period on or before expiration of the current
agreement on May 1, 2005.



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The Company had long-term debt of $454,000 as of January 31, 2004 compared to $620,000 as of July 31,
2003, with the decrease due to a $200,000 principal payment made in the first quarter, offset by accrued interest for the period. The long term debt arose as a result of the purchase of a patent in April 2000 involving a collapsible canopy with a
telescoping roof support structure and is payable in installments of $200,000 each year, to be paid over an eight-year period with a final payment on August 1, 2007.



Future Liquidity and Financial Position



The Company intends to continue to focus upon building and maintaining its existing product lines. The Company also plans to
continue to devote resources toward the pursuit and development of new products. In addition, management continues to explore the possibility of making selected acquisitions of other companies or products that would offer a strategic fit with the
Companys existing products and its sourcing and distribution channels in the mass market.



Management believes that its current cash position, funds available under existing banking arrangements, and cash generated from operations will be
sufficient to meet the Companys presently projected cash and working capital requirements for the next fiscal year assuming continued financial performance at present levels.



The following table summarizes the outstanding borrowings and long-term contractual obligations of Variflex, Inc. at January
31, 2004 and the effects such obligations are expected to have on liquidity and cash flow in future periods.



|                                   |       |                                                   |                      |  |                     |       |                   |   |           |  |   |     |  |  
|---------------------------------- | ----- | ------------------------------------------------- | -------------------- |  | ------------------- | ----- | ----------------- | - | --------- |  | - | --- |  | -
|Contractual Obligations            |       | Years (or periods) ending July 31: (In thousands)
|                                   | Total |                                                   | Six Monthsending2004 |  | Threeyearsended2007 |       | TwoYearsended2009 |   | After2009
|Outstanding Letters of Credit      |       | $                                                 | 2,275                |  | $                   | 2,275 |                   |   |           |  |   |     |  |  
|Notes Payable                      |       | $                                                 | 800                  |  |                     |      |                   | $ | 600       |  | $ | 200 |  | 
|Operating Leases                   |       |                                                   | 1,689                |  |                     | 559   |                   |   | 1,130     |  |   |    |  | 
|Minimum Royalty Payments           |       |                                                   | 815                  |  |                     | 210   |                   |   | 605       |  |   |    |  | 
|                                   |       |                                                   |                      |  |                     |       |                   |   |           |  |   |     |  |  
|Total Contractual Cash Obligations |       | $                                                 | 5,579                |  | $                   | 3,044 |                   | $ | 2,335     |  | $ | 200 |  | 
|                                   |       |                                                   |                      |  |                     |       |                   |   |           |  |   |     |  |  



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Sensitivity



The Company does not believe that the fluctuation in the value of the dollar in relation to the currency of its suppliers
has any significant material and adverse impact on the Companys ability to purchase products at agreed upon prices. Typically, the Company and its suppliers negotiate prices in U.S. Dollars and payments to suppliers are also made in U.S.
Dollars. Nonetheless, there can be no assurance that the value of the dollar will not have an impact upon the Company in the future if it fluctuates significantly against foreign currencies.



The Companys exposure to market rate risk for changes in interest rates
relates primarily to the Companys investment in short-term instruments and money market funds. Any decrease or exposure to market risk relating to such instruments or funds would be immaterial to the companys results of operations,
balance sheet and cash flows. The Company also has interest rate sensitivity related to its revolving direct advance line of credit.



Risks Associated With Forward Looking Statements



From time to time, the Company may make certain statements that contain forward-looking information or statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended. Words such as believe, intends, expects, anticipates and similar expressions are intended to identify such forward-looking statements.
Forward-looking statements may be made by management orally or in writing, including, but not limited to, in press releases, as part of the Managements Discussion and Analysis of Financial Condition and Results of Operations
contained in this Report, and in the Companys other filings with the Securities Exchange Commission. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that
such expectations will prove to have been correct. Such forward-looking statements are subject to certain risks, uncertainties and assumptions, including, without limitation those identified below. Should one or more of these risks or uncertainties
materialize, or should any of the underlying assumptions prove incorrect, actual results of current or future operations may vary materially from those anticipated, estimated, or projected. The Company undertakes no obligations to revise or update
any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report.



There are risks and uncertainties that may affect our future operating results, business and financial condition, including, but not limited to the
following risks: (1) the risk of reduction in consumer demand for the product categories in which the Company does business or the Companys products in particular; (2) a slowdown in economic conditions in general and the retail sector in
particular; (3) the risk of loss of one or more of the Companys major customers; (4) the risks inherent in the design, development, and sale of new products and product enhancements, including those associated with patent issues and
marketability; (5) the risk that the Company may not be able to continue to provide its products at prices that are competitive or that it can continue to design and market products that appeal to consumers even if price-competitive; (6)
fluctuations in the companys quarterly operating results may negatively affect the Companys stock price; (7) reliance on foreign suppliers to source the Companys products could make it difficult to enforce our rights abroad and to
quickly find alternative sources of supply if needed; (8) the risks that certain foreign suppliers will not be able to keep up with the volume of demand leaving the Company with unfilled orders; (9) the Companys product mix subjects it to
potentially large product liability claims.



Readers are also
encouraged to refer to the Companys most recent annual report on Form 10-K for a further discussion of the Companys business and the risks and opportunities attendant thereto.



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Critical Accounting Policies



Use of Estimates  Financial statements prepared in accordance with generally accepted accounting
principles require management to make estimates and judgments that affect amounts and disclosures reported in the financial statements. Actual results could differ from those estimates. Significant estimates made in preparing the consolidated
financial statements include allowances made against accounts receivables, reserves taken against inventory, accruals for sales returns and allowances, cooperative advertising, warranty, product liability claims, and other litigation related
matters.



Accounts Receivable  Accounts
receivable consist primarily of amounts due to us from our normal business activities. The Companys ability to collect outstanding receivables from our customers is critical to our operating performance and cash flows. We maintain an allowance
for doubtful accounts to reflect the estimated future uncollectability of accounts receivable based on past collection history and specific risks that have been identified by reviewing current customer information.



Inventory  Inventories consist primarily of finished
products purchased in bulk categories to be sold to our customers. We state our inventories at lower of cost or market. In assessing the ultimate realization of inventories, we are required to make judgments as to the future selling prices and
demand requirements and compare that with the current or committed inventory levels. In addition, an allowance for obsolete inventory is maintained to reflect the expected net realizable value of inventory based on an evaluation of slow-moving
products.



Revenue Recognition  We
recognize revenue when products are shipped, which is at the point in time risk of loss is transferred to the customer. Sales are shown net of estimated allowances for returns, discounts, and cooperative advertising.



Warranties/Returns  The Company records a liability for
the estimated costs of product warranties and returns at the time revenue is recognized. The Companys warranty and returns obligations are affected by product failure rates, material usage, and other factors. The estimate of costs to service
its warranty and returns obligation is based on historical experience and expectation of future conditions. To the extent the Company experiences increased warranty claim and returns activity or increased costs with servicing those claims, its
warranty and returns accrual will increase, resulting in decreased gross profit.



Product Liability  The Company is involved in various claims arising from the sale of products in the normal course of business. The Company carries product liability insurance on its products with
the exception of one outstanding claim, which has the potential of not being covered by insurance as a result of a prior year insurance carrier declaring bankruptcy. Under the insurance policy, any settlements on product liability claims require the
Company to pay a deductible, depending on the type of product.



Deferred Taxes  The Company records a valuation allowance to reduce tax assets to the amount that is more likely than not to be realized. Realization of our deferred tax assets is principally dependent upon our
achievement of projected future taxable income. Our judgment regarding future profitability may change due to future market conditions and other factors. These changes, if any, may require possible material adjustments to these deferred tax asset
balances.



ITEM 4.
CONTROLS AND PROCEDURES



| | (a) | Evaluation of disclosure controls and procedures
| | --- | ------------------------------------------------



The term disclosure controls and procedures refers to the controls and other procedures of a company that are designed to ensure that
information required to be disclosed by a company in the reports that it files under the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed, summarized and reported within required time periods. As of January 31, 2004,
our Chief Executive Officer and our Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of January
31, 2004, such controls and procedures were effective at ensuring that required information will be disclosed on a timely basis in our periodic reports filed under the Exchange Act.



| | (b) | Changes in internal controls over financial reporting
| | --- | -----------------------------------------------------



There have been no changes in our internal control over financial reporting during our last fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.







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##### Table of Contents

PART II

OTHER INFORMATION



Item 1.  Legal Proceedings



See Note 4 to
Notes to Consolidated Financial Statements included in Part I of this Form 10-Q, which is incorporated herein by this reference.



Item 4.   Submissions of Matters to Vote of Security Holders



At the Annual Meeting of Stockholders on December 12, 2003, the following matters were voted on and approved:



| | 1. | Six Directors were elected to the Board of Directors to hold offices for a one-year term or until their successors are elected and qualified. The following persons were elected:
Kenneth N. Berns, Michael T. Carr, Loren Hildebrand, Raymond (Ray) H. Losi, Raymond (Jay) H. Losi II and Mark S. Siegel. A total of 4,580,914 shares voted, representing 99.5% of the Companys total shares outstanding. None of the shares voting
abstained. Following is a summary of the votes for and against each Director:
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                   |  |           |  |  |  |              
|------------------ |  | --------- |  |  |  | -------------
|                   |  | Votes For |  |  |  | Votes Against
|Kenneth N. Berns   |  | 4,271,149 |  |  |  | 309,765      
|Michael T. Carr    |  | 4,271,149 |  |  |  | 309,765      
|Loren Hildebrand   |  | 4,271,149 |  |  |  | 309,765      
|Raymond H. Losi    |  | 4,271,149 |  |  |  | 309,765      
|Raymond H. Losi II |  | 4,271,149 |  |  |  | 309,765      
|Mark S. Siegel     |  | 4,271,149 |  |  |  | 309,765      



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##### Table of Contents

| | 2. | The Amended and Restated 1994 Variflex Stock Plan was approved. 3,528,642 shares of common stock voted in favor of the proposal, 389,614 shares voted against and 1,000 shares
abstained.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. | The Boards selection of Ernst & Young LLP as the Companys independent public accountants for the fiscal year ended July 31, 2004 was ratified. 4,553,549 shares of
common stock voted in favor of the proposal, and 27,365 shares voted against.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Item 6.    Exhibits and Reports on Form 8-K



| | (a) | Exhibits.
| | --- | ---------



31.1    Chief Executive Officers Certification

31.2    Chief Financial Officers Certification

32.1    Section 906 Certification



| | (b) | Reports on Form 8-K.
| | --- | --------------------



No reports on Form 8-K were filed by the Registrant during the quarter to which this Form 10-Q relates.



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SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) 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.





|               |  |  |  |                |                                                                                     |                         |  | 
|-------------- |  |  |  | -------------- | ----------------------------------------------------------------------------------- | ----------------------- |  | 
|               |  |  |  | VARIFLEX, INC.
|               |  |  | 
|March 12, 2004 |  |  |  | By:            |                                                                                     | /s/  Raymond H. Losi II
|               |  |  |  |                |                                                                                    
|               |  |  |  |                | Raymond H. Losi II Chief Executive Officer (Principal Executive Officer)           
|               |  |  | 
|March 12, 2004 |  |  |  | By:            |                                                                                     | /s/  Petar Katurich    
|               |  |  |  |                |                                                                                    
|               |  |  |  |                | Petar Katurich Chief Financial Officer (Principal Financial and Accounting Officer)



17