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SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2004 Commission file number 0-21630 ACTION PERFORMANCE COMPANIES, INC. (Exact Name of Registrant as Specified in Its Charter)
 ARIZONA
    
    86-0704792(State of Incorporation)
    
    (I.R.S. Employer Identification No.)
 1480 South Hohokam Drive    (602) 337-3700   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 o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes x No o Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date. CLASS
    
    OUTSTANDING AT July 23, 2004Common Stock, $0.01 Par Value
    
    18,359,596 Shares




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TABLE OF CONTENTS  PART I- FINANCIAL INFORMATIONITEM 1. Financial StatementsUnaudited Condensed Consolidated Balance SheetsUnaudited Condensed Consolidated Statements of Operations and Comprehensive IncomeUnaudited Condensed Consolidated Statements of Cash FlowsNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 4. CONTROLS AND PROCEDURESPART II  OTHER INFORMATIONITEM 1. Legal ProceedingsITEM 2. Changes in Securities and Use of ProceedsITEM 3. Defaults Upon Senior SecuritiesITEM 4. Submissions of Matters to a Vote of Security HoldersITEM 5. Other InformationITEM 6. Exhibits and Reports on Form 8-KSIGNATURESEXHIBIT INDEXExhibit 10.73Exhibit 10.74Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2    Table of Contents  
 PART I- FINANCIAL INFORMATION 
 ITEM 1. Financial Statements 2




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ACTION PERFORMANCE COMPANIES, INC.
Unaudited Condensed Consolidated Balance Sheets
June 30, 2004 and September 30, 2003
(in thousands, except per share data) June 30,
    
    September 30,2004
    
    2003ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    53,501
    
    
    $
    49,462Accounts receivable, net
    
    
    49,624
    
    
    
    69,890Inventories
    
    
    60,078
    
    
    
    43,232Prepaid royalties
    
    
    6,830
    
    
    
    6,540Taxes receivable
    
    
    969
    
    
    
    Deferred income taxes
    
    
    5,312
    
    
    
    5,291Prepaid expenses and other
    
    
    5,547
    
    
    
    3,161Total current assets
    
    
    181,861
    
    
    
    177,576Long-Term AssetsProperty and equipment, net
    
    
    63,649
    
    
    
    62,951Goodwill
    
    
    88,278
    
    
    
    87,448Licenses and other intangibles, net
    
    
    51,324
    
    
    
    44,426Other
    
    
    3,389
    
    
    
    2,357Total long-term assets
    
    
    206,640
    
    
    
    197,182$
    388,501
    
    
    $
    374,758LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    31,716
    
    
    $
    36,734Accrued royalties
    
    
    12,950
    
    
    
    11,762Accrued expenses
    
    
    7,563
    
    
    
    11,764Taxes payable
    
    
    690
    
    
    
    3,156Current portion of long-term debt
    
    
    33,613
    
    
    
    567Total current liabilities
    
    
    86,532
    
    
    
    63,983Long-Term Liabilities:Long-term debt
    
    
    12,809
    
    
    
    34,425Deferred income taxes and other
    
    
    22,832
    
    
    
    11,816Total long-term liabilities
    
    
    35,641
    
    
    
    46,241Commitments and ContingenciesMinority Interests
    
    
    2,482
    
    
    
    2,941Shareholders Equity:Common stock, $.01 par value, 62,500 shares authorized,
18,549 and 18,464 shares issued
    
    
    185
    
    
    
    185Additional paid-in capital
    
    
    158,268
    
    
    
    157,301Treasury stock, at cost, 190 and 190 shares
    
    
    (3,999
    )
    
    
    (3,999
    )Accumulated other comprehensive loss
    
    
    (1,870
    )
    
    
    (2,488
    )Retained earnings
    
    
    111,262
    
    
    
    110,594Total shareholders equity
    
    
    263,846
    
    
    
    261,593$
    388,501
    
    
    $
    374,758
 The accompanying notes are an integral part of these consolidated financial statements. 3




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ACTION PERFORMANCE COMPANIES, INC.
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income
Three and Nine Months Ended June 30, 2004 and 2003
(in thousands, except per share data) Three Months Ended
    
    Nine Months Ended2004
    
    2003
    
    2004
    
    2003Net sales
    
    $
    92,150
    
    
    $
    87,497
    
    
    $
    246,953
    
    
    $
    263,615Cost of sales
    
    
    62,579
    
    
    
    56,558
    
    
    
    176,264
    
    
    
    170,840Gross profit
    
    
    29,571
    
    
    
    30,939
    
    
    
    70,689
    
    
    
    92,775Operating expenses:Selling, general and administrative
    
    
    21,683
    
    
    
    20,282
    
    
    
    61,966
    
    
    
    56,706Amortization of licenses and other intangibles
    
    
    990
    
    
    
    840
    
    
    
    2,874
    
    
    
    2,575Total operating expenses
    
    
    22,673
    
    
    
    21,122
    
    
    
    64,840
    
    
    
    59,281Income from operations
    
    
    6,898
    
    
    
    9,817
    
    
    
    5,849
    
    
    
    33,494Interest expense
    
    
    (468
    )
    
    
    (539
    )
    
    
    (1,370
    )
    
    
    (1,728
    )Foreign currency gains (losses)
    
    
    (196
    )
    
    
    820
    
    
    
    377
    
    
    
    3,107Earnings from joint venture
    
    
    204
    
    
    
    
    
    
    
    966
    
    
    
    Other income
    
    
    47
    
    
    
    289
    
    
    
    695
    
    
    
    514Other expense
    
    
    (252
    )
    
    
    (305
    )
    
    
    (954
    )
    
    
    (992
    )Income before income taxes
    
    
    6,233
    
    
    
    10,082
    
    
    
    5,563
    
    
    
    34,395Income taxes
    
    
    2,400
    
    
    
    3,771
    
    
    
    2,147
    
    
    
    12,864Net income
    
    
    3,833
    
    
    
    6,311
    
    
    
    3,416
    
    
    
    21,531Other comprehensive income (loss)
    
    
    (196
    )
    
    
    1,047
    
    
    
    618
    
    
    
    2,021Comprehensive income
    
    $
    3,637
    
    
    $
    7,358
    
    
    $
    4,034
    
    
    $
    23,552Earnings Per Common Share:Basic
    
    $
    0.21
    
    
    $
    0.35
    
    
    $
    0.19
    
    
    $
    1.21Diluted
    
    $
    0.21
    
    
    $
    0.35
    
    
    $
    0.18
    
    
    $
    1.18
 The accompanying notes are an integral part of these consolidated financial statements. 4




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ACTION PERFORMANCE COMPANIES, INC.
Unaudited Condensed Consolidated Statements of Cash Flows
Nine Months Ended June 30, 2004 and 2003
(in thousands) Nine Months Ended June 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    3,416
    
    
    $
    21,531Adjustments to reconcile net income to cash provided by
operations-Depreciation and amortization
    
    
    22,055
    
    
    
    19,593Stock option tax benefits
    
    
    125
    
    
    
    594Undistributed earnings from joint venture
    
    
    (943
    )
    
    
    Other
    
    
    1,617
    
    
    
    2,951Changes in assets and liabilities, net of businesses acquired -Accounts receivable, net
    
    
    20,504
    
    
    
    11,696Accounts payable and accrued expenses
    
    
    (4,403
    )
    
    
    (13,230
    )Income taxes receivable and payable
    
    
    (3,502
    )
    
    
    620Inventories
    
    
    (15,849
    )
    
    
    (4,443
    )Prepaid royalties and accrued royalties
    
    
    805
    
    
    
    (5,397
    )Other
    
    
    (4,463
    )
    
    
    (5,932
    )Net cash provided by operating activities
    
    
    19,362
    
    
    
    27,983CASH FLOWS FROM INVESTING ACTIVITIES:Capital expenditures, net
    
    
    (20,208
    )
    
    
    (26,854
    )Acquisition of businesses and intangibles, net of costs
    
    
    (2,890
    )
    
    
    (688
    )Other
    
    
    265
    
    
    
    Net cash used in investing activities
    
    
    (22,833
    )
    
    
    (27,542
    )CASH FLOWS FROM FINANCING ACTIVITIES:Long-term debt borrowings
    
    
    11,700
    
    
    
    3,001Long-term debt repayments
    
    
    (478
    )
    
    
    (9,355
    )Common stock purchases for treasury
    
    
    
    
    
    
    (2,024
    )Dividends paid  common shareholders
    
    
    (2,746
    )
    
    
    (1,605
    )Dividends paid  minority interest shareholders
    
    
    (1,414
    )
    
    
    (878
    )Stock option and other exercise proceeds
    
    
    270
    
    
    
    665Net cash provided by (used in) financing activities
    
    
    7,332
    
    
    
    (10,196
    )Effect of exchange rates on cash and cash equivalents
    
    
    178
    
    
    
    729Net change in cash and cash equivalents
    
    
    4,039
    
    
    
    (9,026
    )Cash and cash equivalents, beginning of period
    
    
    49,462
    
    
    
    69,585Cash and cash equivalents, end of period
    
    $
    53,501
    
    
    $
    60,559Supplemental Disclosures:Interest paid
    
    $
    1,632
    
    
    $
    2,089Income taxes paid, net
    
    
    4,571
    
    
    
    9,405
 The accompanying notes are an integral part of these consolidated financial statements. 5




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ACTION PERFORMANCE COMPANIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004 INTERIM FINANCIAL REPORTING The accompanying interim condensed consolidated financial statements for Action
Performance Companies, Inc. and subsidiaries have been prepared without audit
by independent auditors pursuant to the rules and regulations of the Securities
and Exchange Commission. In our opinion, all normal and recurring adjustments
necessary for a fair statement of financial position and results of operations
for the interim periods included herein have been made. Certain information
and note disclosures normally included in the financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted from these statements pursuant to such rules and
regulations. Accordingly, these financial statements should be read in
conjunction with our Form 10-K for the fiscal year ended September 30, 2003.
The results of operations for the interim periods are not necessarily
indicative of the operating results that may be expected for the fiscal year
ending September 30, 2004. Certain prior period amounts have been reclassified to conform to the current
year presentation. SHAREHOLDERS EQUITY We account for stock-based compensation plans under APB No. 25, Accounting for
Stock Issued to Employees and related interpretations, under which no
compensation expense has been recognized, as all options have been granted with
an exercise price equal to or exceeding the fair value of the common stock on
the date of grant. Options generally vest ratably over three years. Options
granted to independent directors generally vest immediately upon grant. Had compensation costs been determined consistent with SFAS No. 123, Accounting
for Stock-Based Compensation (SFAS 123), utilizing the assumptions detailed
below and amortizing the resulting fair value of stock options granted over the
respective vesting period of the options, the net income and per share amounts
would have been the following pro forma amounts for the periods ended June 30
(in thousands, except per share data): Three Months Ended
    
    Nine Months Ended2004
    
    2003
    
    2004
    
    2003Net income, as reported
    
    $
    3,833
    
    
    $
    6,311
    
    
    $
    3,416
    
    
    $
    21,531Total stock-based employee
compensation expense
determined under fair
value method for all
awards, net of related tax
effects
    
    
    (1,015
    )
    
    
    (936
    )
    
    
    (3,043
    )
    
    
    (2,764
    )Pro forma net income
    
    $
    2,818
    
    
    $
    5,375
    
    
    $
    373
    
    
    $
    18,767Basic earnings per share:As reported
    
    $
    0.21
    
    
    $
    0.35
    
    
    $
    0.19
    
    
    $
    1.21Pro forma
    
    $
    0.15
    
    
    $
    0.30
    
    
    $
    0.02
    
    
    $
    1.05Diluted earnings per share:As reported
    
    $
    0.21
    
    
    $
    0.35
    
    
    $
    0.18
    
    
    $
    1.18Pro forma
    
    $
    0.15
    
    
    $
    0.30
    
    
    $
    0.02
    
    
    $
    1.03
 6




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For SFAS 123, we estimated the fair value of each option grant as of the date
of grant using the Black-Scholes option pricing method with the following
assumptions for the periods ended June 30: Three Months Ended
    
    Nine Months Ended2004
    
    2003
    
    2004
    
    2003Volatility
    
    
    65.1
    %
    
    
    42.4
    %
    
    
    65.2
    %
    
    
    55.9
    %Risk-free interest rate
    
    
    3.2
    %
    
    
    2.1
    %
    
    
    2.7
    %
    
    
    2.1
    %Dividend rate
    
    
    1.0
    %
    
    
    1.0
    %
    
    
    1.0
    %
    
    
    0.7
    %Expected life of options
    
    3years
    
    3years
    
    3years
    
    3years
 RECENT ACCOUNTING PRONOUNCEMENTS In January 2003, FASB issued Interpretation No. 46, Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51 (FIN 46). In December
2003, FASB issued a revised interpretation of FIN 46 (FIN 46-R), which
supercedes FIN 46 and clarifies and expands current accounting guidance for
variable interest entities (VIEs). Adoption of FIN 46 and FIN 46-R had no
effect on our financial position, results of operations, or cash flows. We
have interests in an unconsolidated partnership, which remain unconsolidated
under FIN No. 46. SEGMENT INFORMATION Reportable segments are based on divisions operating geographically, domestic
and abroad, and specializing in either die-cast or apparel and memorabilia.
The domestic die-cast operations are based in the Phoenix, Arizona and Los
Angeles, California areas. The domestic apparel and memorabilia operation is
based in Charlotte, North Carolina with a mass-market retail distribution
center in Atlanta, Georgia and warehouse and distribution facilities in
Charlotte, North Carolina, Baraboo, Wisconsin, and Los Angeles, California.
Trackside operations are included in the domestic apparel and memorabilia
segment. The foreign die-cast operation is based in Aachen, Germany. We evaluate performance and allocate resources based on segment operating
income (loss). The accounting policies of the reportable segments are the same
as those used in the consolidated financial statements. Domestic licensing
costs and certain management costs are not allocated to the domestic operating
segments and are included in corporate and other. Intangible licenses are
included in corporate and other assets. Each domestic segment is allocated
royalty expense based on the incremental royalty due on that segments net
sales. Domestic royalty guarantees advanced and unearned are allocated as an
expense of the domestic segments. Financial information for the reportable
segments follows (in thousands): Three Months Ended June 30,Inter-
    
    Depreciation
    
    OperatingExternal
    
    segment
    
    and
    
    IncomeRevenues
    
    Revenues
    
    Amortization
    
    (Loss)2004:Domestic die-cast
    
    $
    40,797
    
    
    $
    2,869
    
    
    $
    3,317
    
    
    $
    7,473Domestic apparel and memorabilia
    
    
    41,905
    
    
    
    82
    
    
    
    674
    
    
    
    4,905Foreign die-cast
    
    
    8,698
    
    
    
    
    
    
    
    2,222
    
    
    
    1,117Corporate and other
    
    
    750
    
    
    
    236
    
    
    
    1,129
    
    
    
    (6,399
    )Eliminations
    
    
    
    
    
    
    (3,187
    )
    
    
    
    
    
    
    (198
    )Total per consolidated
financial statements
    
    $
    92,150
    
    
    $
    
    
    
    $
    7,342
    
    
    $
    6,898
 7




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Three Months Ended June 30,Inter-
    
    Depreciation
    
    OperatingExternal
    
    segment
    
    and
    
    IncomeRevenues
    
    Revenues
    
    Amortization
    
    (Loss)2003:Domestic die-cast
    
    $
    40,252
    
    
    $
    1,600
    
    
    $
    2,846
    
    
    $
    10,558Domestic apparel and memorabilia
    
    
    38,494
    
    
    
    171
    
    
    
    796
    
    
    
    4,885Foreign die-cast
    
    
    8,208
    
    
    
    
    
    
    
    1,718
    
    
    
    1,355Corporate and other
    
    
    543
    
    
    
    542
    
    
    
    1,291
    
    
    
    (7,274
    )Eliminations
    
    
    
    
    
    
    (2,313
    )
    
    
    
    
    
    
    293Total per consolidated
financial statements
    
    $
    87,497
    
    
    $
    
    
    
    $
    6,651
    
    
    $
    9,817
 Nine Months Ended June 30,Inter-
    
    Depreciation
    
    OperatingExternal
    
    segment
    
    and
    
    IncomeRevenues
    
    Revenues
    
    Amortization
    
    (Loss)2004:Domestic die-cast
    
    $
    104,270
    
    
    $
    5,925
    
    
    $
    10,123
    
    
    $
    14,010Domestic apparel and memorabilia
    
    
    113,227
    
    
    
    697
    
    
    
    2,194
    
    
    
    7,540Foreign die-cast
    
    
    27,135
    
    
    
    
    
    
    
    6,264
    
    
    
    3,819Corporate and other
    
    
    2,321
    
    
    
    1,024
    
    
    
    3,474
    
    
    
    (18,881
    )Eliminations
    
    
    
    
    
    
    (7,646
    )
    
    
    
    
    
    
    (639
    )Total per consolidated
financial statements
    
    $
    246,953
    
    
    $
    
    
    
    $
    22,055
    
    
    $
    5,8492003:Domestic die-cast
    
    $
    115,160
    
    
    $
    6,309
    
    
    $
    8,134
    
    
    $
    32,560Domestic apparel and memorabilia
    
    
    120,832
    
    
    
    353
    
    
    
    2,486
    
    
    
    16,678Foreign die-cast
    
    
    25,509
    
    
    
    
    
    
    
    4,840
    
    
    
    4,525Corporate and other
    
    
    2,114
    
    
    
    1,594
    
    
    
    4,133
    
    
    
    (19,843
    )Eliminations
    
    
    
    
    
    
    (8,256
    )
    
    
    
    
    
    
    (426
    )Total per consolidated
financial statements
    
    $
    263,615
    
    
    $
    
    
    
    $
    19,593
    
    
    $
    33,494
 Identifiable Assets
    
    Goodwill and TrademarksJune 30,
    
    Sept. 30,
    
    June 30,
    
    Sept. 30,2004
    
    2003
    
    2004
    
    2003Domestic die-cast (a)
    
    $
    114,716
    
    
    $
    98,847
    
    
    $
    44,529
    
    
    $
    33,953Domestic apparel and memorabilia (b)
    
    
    124,623
    
    
    
    131,845
    
    
    
    61,840
    
    
    
    62,840Foreign die-cast
    
    
    59,876
    
    
    
    58,619
    
    
    
    19,062
    
    
    
    18,232Corporate and other (c)
    
    
    99,199
    
    
    
    93,387
    
    
    
    
    
    
    
    Eliminations
    
    
    (9,913
    )
    
    
    (7,940
    )
    
    
    
    
    
    
    Total per consolidated
financial statements
    
    $
    388,501
    
    
    $
    374,758
    
    
    $
    125,431
    
    
    $
    115,025
  (a)
    
    Domestic die-cast identifiable assets include the Winners Circle
trademark, purchased from Hasbro in May 2001. As additional
consideration for the trademark purchase, we pay 1.5% or 3% of certain
Winners Circle product net sales to Hasbro, quarterly, through May
2006. The additional consideration is added to the cost of the
trademark quarterly. Domestic die-cast identifiable assets also
include Funline trademarks. 8




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In 2004, we made an election for federal income tax purposes, which
resulted in a revision of the Funline preliminary purchase price
allocation to establish deferred tax liabilities of $11.0 million. Also
during 2004, we accrued $1.7 million as additional consideration payable
under the earn-out provisions of the Funline acquisition agreement and
reduced liabilities established in the preliminary purchase price
allocation by $3.6 million. The additional consideration and preliminary
purchase price allocation revisions were allocated to the Funline
trademarks.  (b)
    
    During the second quarter of fiscal 2004, the Jeff Hamilton
trademark was decreased by $1.0 million when an accrual for expected
contingent consideration was reversed.(c)
    
    Corporate and other identifiable assets includes $49.1 million in
cash and cash equivalents at June 30, 2004, and $45.4 million in cash
and cash equivalents at September 30, 2003. EARNINGS PER COMMON SHARE (EPS) Reconciliations of the numerators and denominators in the EPS computations for
net income for the periods ended June 30 follows (in thousands): Three Months Ended
    
    Nine Months Ended2004
    
    2003
    
    2004
    
    2003NUMERATOR:Basic and diluted  net income

    
    $
    3,833
    
    
    $
    6,311
    
    
    $
    3,416
    
    
    $
    21,531DENOMINATOR:Basic  weighted average shares
    
    
    18,336
    
    
    
    17,868
    
    
    
    18,315
    
    
    
    17,835Effect of dilutive stock options and warrants
    
    
    270
    
    
    
    423
    
    
    
    304
    
    
    
    393Diluted  adjusted weighted average shares
    
    
    18,606
    
    
    
    18,291
    
    
    
    18,619
    
    
    
    18,228
 The impact of options and warrants outstanding for the purchase of 2.0 million
and 1.2 million shares of common stock, at an average price of $25.83 and
$30.36, were not included in the calculation of diluted EPS for the three
months ended June 30, 2004 and 2003, because to do so would be antidilutive.
The impact of options and warrants outstanding for the purchase of 1.9 million
and 1.2 million shares of common stock, at an average price of $25.97 and
$30.16 were not included in the calculation of diluted EPS for the nine months
ended June 30, 2004 and 2003, because to do so would be antidilutive. The
options and warrants had exercise prices greater than the average market price
of the common stock for the three and nine months ended June 30, 2004 and 2003,
but could potentially dilute EPS in the future. The impacts of
outstanding 43⁄4%
convertible subordinated notes were not included in the calculation of diluted
EPS for the three and nine months ended June 30, 2004 because to do so also
would be antidilutive. The notes could potentially dilute EPS in the future. OFF-BALANCE SHEET ARRANGEMENTS We are not currently a party to any off-balance sheet arrangements and do not
anticipate being a party to any off-balance sheet arrangements in the future. JOINT VENTURE We have an investment in a joint venture, Action-McFarlane LLC. The joint
venture distributes action figurines based on NASCAR driver likenesses. All of
the figurines are manufactured by third parties. Our investment in the LLC,
included in other long-term assets, was $0.5 million at June 30, 2004, and
earnings on the investment in the LLC, included in other income, were $0.2
million for the three months ended June 30, 2004, and $1.0 million for the nine
months ended June 30, 2004. 9




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##### Table of Contents



DEBT AND FINANCING On June 30, 2004, we entered into an amended loan and security agreement with
our bank. The amended agreement increased available borrowings from $35.0
million to $75.0 million. The agreement is comprised of a $63.3 million,
four-year revolving credit facility, which is subject to a borrowing base
calculation, a four-year term loan of $1.7 million (Term Loan A) and a
three-year term loan of $10.0 million (Term Loan B). We received $11.7 million
of cash upon issuance of the term loans on June 30, 2004. As the term loans
are repaid, the available revolving credit facility will increase by an
equivalent amount, subject to the borrowing base calculation. The agreement
provides for issuance of up to $30.0 million of letters of credit, to the
extent not utilized for borrowings. Repayment of borrowings under this
facility is secured by a first lien on substantially all of our assets. We are
required to meet certain financial tests related to minimum tangible net worth
and minimum fixed charge coverage ratio. We were in compliance with those
covenants at June 30, 2004. The revolving credit facility bears interest at LIBOR plus 1.75%-2.50% or prime
plus 0.00% - 0.25%, and the term loans bear interest at LIBOR plus 2.00% -
3.50% or prime plus 0.00% - 1.25%, depending on our fixed coverage ratio, as
defined. We pay a commitment fee of 0.375% of the average unused revolving
credit facility and a fee of 1.0% of the average undrawn letters of credit. As
of June 30, 2004, 43⁄4% convertible subordinated notes with a face value
of $29.9 million remained outstanding. On August 2, 2004, we redeemed the
notes at a price of 100.68%. The notes were classified as current maturities
of long-term debt at June 30, 2004. We funded the redemption with cash on
hand, revolving credit facility borrowings and the term loans under the loan
and security agreement. The subordinated notes were convertible, at the option
of the holders, into shares of common stock at the initial conversion price of
$48.20 per share, subject to adjustments in certain events and would have
matured on April 1, 2005. The
aggregate future maturities of the 43⁄4% convertible subordinated notes,
term loans under the loan and security agreement and other long-term debt at
June 30, 2004, follow (in thousands): Long-termPeriod
    
    DebtJuly-Sept 2004
    
    $
    30,6262005
    
    
    4,0022006
    
    
    4,0272007
    
    
    3,4962008
    
    
    1,0272009
    
    
    248Thereafter
    
    
    2,996Total
    
    $
    46,422
 The schedule above reflects the commitment at June 30, 2004, to redeem the
subordinated notes on August 2, 2004. Term Loan B under the loan and security
agreement is subject to annual mandatory prepayments of 50% of excess cash
flows as defined by the agreement. Only scheduled payments for this three-year
loan are reflected above. COMMITMENTS AND CONTINGENCIES In the ordinary course of business, we are subject to certain lawsuits and
asserted and unasserted claims. We believe that the resolution of any such
matters will not have a material adverse effect on financial position, results
of operations, or cash flows. 10




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##### Table of Contents



In April 2004, we filed a complaint for declaratory judgment in the state of
North Carolina, county of Cabarrus against New Hampshire Speedway, Inc. (NHS)
to settle a dispute regarding trackside payments between the parties, and
requested that the court rule as a matter of law that NHS be precluded from
asserting any claims against us. Subsequently, in May 2004, Action was served
with a lawsuit filed by NHS in the U.S. District Court for the District of New
Hampshire claiming we underpaid certain trackside expenses. We intend to seek
a stay or dismissal on the New Hampshire action and resolve whatever dispute
may still exist in the North Carolina case. We do not believe that the
resolution of this matter will have a material adverse effect on our
consolidated financial position or results of operations. In December 2003, we settled a lawsuit, with Dover International Speedway,
filed in October 2003 against us in the U.S. District Court for the District of
Delaware for $0.9 million. 
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS Overview We are the leading designer and marketer of licensed motorsports products
related to NASCAR, including die-cast scaled replicas of motorsports vehicles,
apparel, and memorabilia. We currently have exclusive license agreements with
many of the most recognized names in NASCAR. We also design and sell products
relating to other motorsports, including racing sanctioned by the NHRA, Formula
One, the IRL, IROC, and the World of Outlaws. In Germany, we merchandise
Formula One and high-end auto manufacturer die-cast replica vehicles. We work
closely with drivers, team owners, track operators, and sponsors to design and
merchandise our products. Third parties manufacture all of the replica
motorsports vehicles and most apparel and memorabilia, generally utilizing our
designs, tools, and dies. We retain ownership and control over designs and
tooling and have close working relationships with our third-party manufacturers
to help assure product quality. We have structured our operations to enable us to service higher levels of
sales with limited increases in operating expenses and capital investments.
The principal elements of this operating structure include the following:  
    
    Our exclusive licenses allow us to exert a high degree of control over product pricing.
    
    Manufacturing costs are largely fixed due to outsourcing under fixed-price contracts.
    
    Royalties are paid generally as a percentage of net sales.
    
    Due to our agreements with distributors and QVC, incremental volume
does not proportionately increase our operating expenses.
    
    Research and development is limited to basic design and engineering.
    
    Capital expenditures are principally limited to tooling for die-cast.
    
    Functions, such as manufacturing and others outside of our core skills, are generally outsourced. Revenue We derive revenue primarily from the sale of our licensed motorsports products.
The popularity and performance of drivers and teams under license, the
popularity of motorsports in general and NASCAR in particular, the general
demand for licensed sports merchandise, and our ability to design, produce, and
distribute our products in a timely manner influence the level of our net
sales. We distribute our products through a broad range of channels, including a
network of wholesale distributors, leading mass-market retailers, mobile
trackside stores, QVC, and our collectors club catalog. We recognize revenue
when persuasive evidence of an arrangement exists, title passes to the
customer, the fee is fixed or determinable, and 11




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##### Table of Contents



collection is probable. Most distributor sales are recognized when product is
shipped to a distributor because title to the product passes to the
distributors at shipment. Sales to mass-market retailers are recognized when
title to product passes to the retailer, either at time of shipment to the
retailer or receipt by the retailer. Under terms of our consignment agreement
with QVC, collectors club catalog sales are recognized when title passes to
QVC, which occurs when QVC ships product to the consumer. We recognize
trackside sales when the consumer purchases product at the point of sale. A
portion of the product sold through television programming is consignment
product, for which sales are recognized when title passes to QVC, which occurs
when QVC ships the product to the consumer. Internet and other sales are
generally recognized when delivered to the consumer. Net sales include sales net of estimated sales returns, discounts, advertising
and other allowances. Advertising allowances are amounts paid
primarily to mass merchant retailers in connection with promoting and
selling our product. These amounts are recorded as a reduction from
sales when revenue is recognized. Cost of Sales Cost of sales includes product cost, shipping and freight forwarding costs paid
to third parties, depreciation of tooling and dies, royalties to third party
licensors, product testing and sample expense, and fees paid to QVC for
shipping and handling. We incur costs to screen-print or embroider certain
inventory, which are also included in cost of sales, although most of our
product is procured in its finished state. Substantial portions of our
die-cast products are manufactured under an exclusive agreement with Early
Light, a third-party manufacturer in China. We obtain substantially all of our
apparel and memorabilia products on a purchase order basis from several
third-party manufacturers and suppliers. Most of the components of our cost of sales are variable in nature. However,
certain factors do affect our gross margin, including the following:  
    
    product mix,
    
    our ability to price our product appropriately,
    
    the effect of amortizing the fixed cost components of cost of
sales, primarily depreciation of tooling and dies, over varying levels
of net sales,
    
    the type of freight charges, and
    
    additional charges related to lower than minimum order quantities
and cancellation of specific purchase orders. Gross Margin Our gross margins may not be comparable to those of other entities, since some
entities include all handling and warehousing costs in cost of sales and others
exclude a portion of them from gross margin, including them instead in line
items such as selling, general, and administrative expenses. Selling, General, and Administrative Expenses Selling, general, and administrative expenses include salaries and benefits,
use and occupancy expenses, creative services costs, advertising and promotion
costs, sponsorship costs, and other general and administrative expenses.
Included are the salaries, benefits and other costs of our procurement,
receiving, and warehouse personnel. Selling, general, and administrative
expenses include internal handling costs, incurred to store, move, and prepare
the products for shipment, of approximately $1.6 million and $1.3 million in
the three months ended June 30, 2004 and 2003, and $4.5 million and $4.0
million in the nine months ended June 30, 2004 and 2003. The majority of these
costs are fixed and, as a result, incremental sales volume generally results in
a decline in selling, general, and administrative expenses as a percentage of
net sales. 12




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Seasonality Because the auto-racing season is concentrated between the months of February
and November, the second and third calendar quarters of each year (our third
and fourth fiscal quarters) are historically characterized by higher sales. Application of Critical Accounting Policies Our discussion and analysis of financial condition and results of operations
are based upon our financial statements, which have been prepared in accordance
with generally accepted accounting principles in the United States. During
preparation of these financial statements, we are required to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenue
and expenses, and related disclosure of contingent assets and liabilities. On
an on-going basis, we evaluate our estimates, including those related to bad
debts, inventories, fixed assets, goodwill and other intangible assets, income
taxes, royalties, contingencies, and litigation. We base our estimates on
historical experience and various other assumptions that we believe are
reasonable under the circumstances. The results form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. The following critical accounting policies require us to make significant
judgments and estimates used in the preparation of our financial statements. Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. We determine
the adequacy of this allowance by regularly evaluating individual customer
receivables and considering a customers financial condition, credit history,
and current economic conditions. If the financial condition of our customers
were to deteriorate, additional allowances may be required. Our accounts
receivable are written off against the allowance once the account is deemed to
be uncollectible. This typically occurs once we have exhausted all efforts to
collect the account, which includes collection attempts by company employees
and outside collection agencies. Inventory We write down our inventory for estimated obsolescence or unmarketable
inventory in an amount equal to the difference between the cost of inventory
and the estimated market value based upon assumptions about future demand and
market conditions. If actual market conditions are less favorable than those
projected, additional inventory write-downs may be required. Royalties Our license agreements generally require payments of royalties to drivers,
sponsors, teams, and other parties. Contracts generally provide for royalties
to be calculated as a specified percentage of sales. Some contracts, however,
provide for guaranteed minimum royalty payments. Royalties payable calculated
using the contract percentage rates are recognized as cost of sales when the
related sales are recognized. To the extent we project that royalties payable
under a contract, calculated using the contract percentage rate, will be lower
than guaranteed minimums during the guarantee period, we recognize additional
cost of sales over the guarantee period, generally a calendar year. Guarantees
advanced under the license agreements are carried as prepaid royalties until
earned by the third party, or considered to be unrecoverable. We evaluate
prepaid royalties regularly and expense prepaid royalties to cost of sales to
the extent projected to be unrecoverable through sales. Goodwill and Other Intangibles We evaluate goodwill and other intangibles for impairment annually, and when
impairment indicators arise, in accordance with SFAS 142, Goodwill and Other
Intangible Assets. For goodwill, we first compare the fair value of a
reporting unit with its carrying amount, including goodwill. If the carrying
amount of a reporting unit exceeds the fair value of a reporting unit,
additional tests would be used to measure the amount of impairment loss, if
any. We 13




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##### Table of Contents



use a present value technique to measure reporting unit fair value. If the
carrying amount of any other intangible asset exceeds its fair value, we would
recognize an impairment loss for the difference between fair value and the
carrying amount. We have not recognized any impairment losses to date. If
events occur and circumstances change, causing the fair value of a reporting
unit to fall below its carrying amount, impairment losses may be recognized in
the future. Deferred Tax Assets We estimate our actual current tax exposure together with the temporary
differences that have resulted from the differing treatment of items dictated
by generally accepted accounting principles versus U.S. and German tax laws.
These temporary differences result in deferred tax assets and liabilities. On
an on-going basis, we assess the likelihood that our deferred tax assets will
be recovered from future taxable income. If we were to believe the recovery
was less than likely, we would establish a valuation allowance against the
deferred tax asset and charge the amount as an income tax expense in the period
in which such a determination was made. Stock-Based Compensation We account for employee stock-based compensation in accordance with Accounting
Principles Board Opinion 25, Accounting for Stock Issued to Employees and
related interpretations (APB No. 25). Common stock options issued under our
plans generally do not result in compensation expense because the exercise
price of the stock options equals the market price of the underlying stock on
the date of grant. Were we required to record compensation expense for these
options, the charge to earnings might be significant (See Shareholders Equity
Note). Results of Operations The following table sets forth the percentage of total revenue represented by
certain expense and revenue items for the periods ended June 30: Three Months Ended
    
    Nine Months Ended2004
    
    2003
    
    2004
    
    2003Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    67.9
    
    
    
    64.6
    
    
    
    71.4
    
    
    
    64.8Gross profit
    
    
    32.1
    
    
    
    35.4
    
    
    
    28.6
    
    
    
    35.2Selling, general and administrative
    
    
    (23.5
    )
    
    
    (23.2
    )
    
    
    (25.1
    )
    
    
    (21.5
    )Amortization of licenses and other
intangibles
    
    
    (1.1
    )
    
    
    (1.0
    )
    
    
    (1.2
    )
    
    
    (1.0
    )Income from operations
    
    
    7.5
    
    
    
    11.2
    
    
    
    2.3
    
    
    
    12.7Interest expense
    
    
    (0.5
    )
    
    
    (0.6
    )
    
    
    (0.5
    )
    
    
    (0.7
    )Foreign currency gains (losses)
    
    
    (0.2
    )
    
    
    1.0
    
    
    
    0.2
    
    
    
    1.2Earnings from joint venture
    
    
    0.2
    
    
    
    
    
    
    
    0.4
    
    
    
    Other income
    
    
    
    
    
    
    0.3
    
    
    
    0.3
    
    
    
    0.2Other expense
    
    
    (0.2
    )
    
    
    (0.4
    )
    
    
    (0.4
    )
    
    
    (0.4
    )Income before income taxes
    
    
    6.8
    
    
    
    11.5
    
    
    
    2.3
    
    
    
    13.0Income taxes
    
    
    2.6
    
    
    
    4.3
    
    
    
    0.9
    
    
    
    4.8Net income
    
    
    4.2
    
    
    
    7.2
    
    
    
    1.4
    
    
    
    8.2
 14




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##### Table of Contents



The following table sets forth net sales by channel of distribution and net
sales from the operations of acquired businesses for the periods ended June 30
(in thousands): Three Months Ended
    
    Nine Months Ended2004
    
    2003
    
    2004
    
    2003Domestic Die-cast:Wholesale distribution and promotion
    
    $
    25,707
    
    
    $
    31,332
    
    
    $
    49,636
    
    
    $
    76,509Wholesale to mass-merchant retailers
    
    
    9,389
    
    
    
    643
    
    
    
    40,884
    
    
    
    19,790Retail through collectors catalog club
    
    
    5,701
    
    
    
    8,277
    
    
    
    13,750
    
    
    
    18,861Foreign
Die-cast - wholesale distribution and
promotion
    
    
    8,698
    
    
    
    8,208
    
    
    
    27,135
    
    
    
    25,509Total die-cast
    
    
    49,495
    
    
    
    48,460
    
    
    
    131,405
    
    
    
    140,669Domestic Apparel and Memorabilia:Wholesale distribution and promotion
    
    
    18,465
    
    
    
    19,892
    
    
    
    53,148
    
    
    
    58,344Wholesale to mass-merchant retailers
    
    
    6,745
    
    
    
    4,046
    
    
    
    26,462
    
    
    
    27,505Total apparel and memorabilia
    
    
    25,210
    
    
    
    23,938
    
    
    
    79,610
    
    
    
    85,849Retail at Trackside
    
    
    16,695
    
    
    
    14,556
    
    
    
    33,617
    
    
    
    34,983Royalties and Other
    
    
    750
    
    
    
    543
    
    
    
    2,321
    
    
    
    2,114Net Sales
    
    $
    92,150
    
    
    $
    87,497
    
    
    $
    246,953
    
    
    $
    263,615Net Sales from Businesses Acquired in Fiscal 2003
    
    $
    6,468
    
    
    $
    
    
    
    $
    30,140
    
    
    $
    
 Three Months Ended June 30, 2004, Compared with Three Months Ended June 30,
2003 Net sales increased to $92.2 million in the quarter ended June 30, 2004, from
$87.5 million in the prior year quarter. Excluding $6.5 million in revenues
from Funline operations, acquired in September 2003, net sales declined $1.8
million, or 2.1%, from the prior year quarter. Domestic die-cast sales,
excluding the $6.5 million Funline revenues, decreased $5.9 million, or 14.7%,
from the prior year quarter. The decrease in domestic die-cast sales resulted,
in part, from timing issues surrounding the finalization of promotion
approvals, which led to reduced die-cast order quantities for individual
programs and delayed our ability to produce and ship motorsports die-cast, and
cautious orders by both wholesale distributors and mass retailers for
motorsports die-cast. Foreign die-cast sales increased $0.5 million, or 6.0%,
from the prior quarter. Domestic apparel and memorabilia segment sales,
exclusive of trackside, increased $1.3 million, or 5.3%, from the prior year
quarter. Trackside sales increased $2.1 million in the third quarter compared
to the prior year quarter, to $16.7 million, primarily because the Texas race
($3.0 million revenue) occurred in our third quarter in 2004 rather than our
second quarter as in 2003. Revenues are expected to increase in the fourth
quarter of 2004 over the third quarter of 2004 due in part to seasonal mass
retail shipments. The 3.3% decline in gross profit, to 32.1% of net sales in the third quarter of
2004 from 35.4% in the 2003 third quarter, was impacted by the changes in
segment gross margins as follows: WeightedYear-Over-
    
    Year-Over-Year Gross
    
    Year Gross% of Net
    
    Margin
    
    MarginSales
    
    Decline
    
    DeclineDomestic die-cast
    
    
    49.5
    %
    
    
    (5.1
    )%
    
    
    (2.5
    )%Domestic apparel and memorabilia
    
    
    46.7
    
    
    
    (0.4
    )
    
    
    (0.2
    )Foreign die-cast
    
    
    9.4
    
    
    
    (2.4
    )
    
    
    (0.2
    )Corporate and other
    
    
    (5.6
    )
    
    
    
    
    
    
    (0.4
    )Consolidated Total
    
    
    100.0
    %
    
    
    
    
    
    
    (3.3
    )%
 15




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##### Table of Contents



The domestic die-cast decline in gross margin of 5.1% was comprised of the
following: Impact of revenue mix between higher margin NASCAR die-cast sales
and lower margin Funline stylized die-cast (acquired in September
2003)
    
    
    1.4
    %Impact of NASCAR gross margin changes-Increased royalty rate due to NASCAR product mix
    
    
    3.4Increased estimated royalty reserves
    
    
    0.6Write down of Jeff Hamilton apparel inventory
    
    
    1.6Impact from selling price increases, mix, and other
    
    
    (1.9
    )5.1
    %
 Domestic die-cast gross margins improved in the third quarter, which
improvement is expected to continue as a result of price increases which went
in to effect in the third quarter of 2004 and product cost reductions. The
2.4% decline in foreign die-cast gross margins was the result of higher tooling
charges as a percent of revenue, in part as a result of changes in the
euro-to-dollar exchange rate. Selling, general, and administrative expenses were $21.7 million, or 23.5% of
net sales, in the quarter ended June 30, 2004, compared to $20.3 million, or
23.2% of net sales, in the prior year quarter. Excluding the operating
expenses of Funline, acquired in September 2003, expenses in the 2004 third
quarter were $19.3 million, which was $1.0 million lower than the prior year
period due to decreases in promotion and advertising expenses and legal costs. Interest expense of $0.5 million for the three months ended June 30, 2004, was
$0.1 million lower than the prior year period, primarily as a result of
convertible subordinated note repurchases after March 31, 2003. Foreign currency losses were $0.2 million in the three months ended June 30,
2004, versus a foreign currency gain of $0.8 million in the prior year quarter.
Changes in the euro-to-U.S. dollar exchange rate resulted in $0.4 million in
translation losses in the 2004 third quarter compared to $0.8 million in
translation gains in the prior year quarter. These gains and losses resulted
from translation of German advances payable, which are denominated in U.S.
dollars. In 2004, these translation losses were offset by a gain of $0.2
million on a forward exchange contract. The effective tax rate of 38.5% in the third fiscal quarter reflects current
expectations for the effective tax rate for fiscal 2004 and is approximately
the same effective tax rate for the prior year quarter. Nine Months Ended June 30, 2004, Compared with Nine Months Ended June 30, 2003 Net sales decreased to $247.0 million in the nine months ended June 30, 2004,
from $263.6 million in the prior year period. Excluding $30.1 million in
revenues from Funline operations, acquired in September 2003, net sales in the
nine months declined $46.7 million, or 17.8%, from the prior year period.
Domestic die-cast sales, excluding the $30.1 million Funline revenues,
decreased $41.0 million, or 35.6%, from the prior year period while foreign
die-cast sales increased $1.6 million, or 6.4%, from the prior period. The
decrease in domestic die-cast sales resulted, in part, from timing issues
surrounding the finalization of sponsor relationships and promotion approval,
compounded by cautious orders by both wholesale distributors and mass retailers
for motorsports die-cast. These factors led to reduced die-cast order
quantities for individual programs and delayed our ability to produce and ship
motorsports die-cast. Domestic apparel and memorabilia segment sales,
exclusive of trackside, decreased $6.2 million, or 7.3%, in the nine months
ended June 30, 2004, compared to the prior year period. Apparel and
memorabilia revenues were down due to reduced mass retail apparel orders, and
reduced wholesale apparel and Jeff Hamilton Collection jacket demand.
Trackside sales decreased 3.9% in the first nine months of 2004, compared to
the prior year period, to $33.6 million. 16




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The 6.6% decline in gross profit, to 28.6% of net sales in the first nine
months of 2004 from 35.2% in the prior year period, was impacted by the changes
in segment gross margins as follows: Year-Over-
    
    WeightedYear
    
    Year-Over-Gross
    
    Year Gross% of Net
    
    Margin
    
    MarginSales
    
    Decline
    
    DeclineDomestic die-cast
    
    
    45.4
    %
    
    
    (9.9
    )%
    
    
    (4.5
    )%Domestic apparel and memorabilia
    
    
    46.6
    
    
    
    (2.5
    )
    
    
    (1.2
    )Foreign die-cast
    
    
    11.0
    
    
    
    (2.4
    )
    
    
    (0.3
    )Corporate and other
    
    
    (3.0
    )
    
    
    
    
    
    
    (0.6
    )Consolidated Total
    
    
    100.0
    %
    
    
    
    
    
    
    (6.6
    )%
 The domestic die-cast decline in gross margin of 9.9% was comprised of the
following: Impact of revenue mix between higher margin NASCAR die-cast sales and
lower margin Funline stylized die-cast (acquired in September 2003)
    
    
    1.4
    %Impact of NASCAR gross margin changes-Write-off of Pontiac NASCAR tooling due to the withdrawal of
Pontiac from NASCAR
    
    
    0.6Increased royalty rate due to NASCAR product mix
    
    
    1.8Increased estimated royalty reserves
    
    
    1.8Impact of tooling amortization relatively fixed
    
    
    2.1Write down of Jeff Hamilton apparel inventory
    
    
    0.6Product cost increases, offset by selling price increases in
the third quarter, mix, and other
    
    
    1.69.9
    %
 Domestic die-cast gross margins improved in the third quarter, which
improvement is expected to continue as a result of price increases which went
in to effect in the third quarter of 2004 and product cost reductions. The
decline in domestic apparel and memorabilia gross margins of 2.5% was the
result of higher estimated royalty reserves. The 2.4% decline in foreign
die-cast gross margins was principally the result of higher tooling charges as
a percent of revenue, in part as a result of changes in the euro-to-dollar
exchange rate. Selling, general, and administrative expenses were $62.0 million, or 25.1% of
net sales, in the nine months ended June 30, 2004, compared to $56.7 million,
or 21.5% of net sales, in the prior year period. Selling, general, and
administrative expenses included the $0.9 million settlement of litigation with
Dover International Speedway in the first quarter of 2004. Excluding this
settlement charge and the operating expenses of Funline, acquired in September
2003, expenses in the first nine months of 2004 were $56.1 million, which was
$0.6 million lower than the prior year period due to decreased legal costs. Interest expense of $1.4 million for the nine months ended June 30, 2004, was
$0.4 million lower than the prior year period, primarily as a result of the
convertible subordinated note repurchases after March 31, 2003. Foreign currency gains were $0.4 million in the nine months ended June 30,
2004, versus a foreign currency gain of $3.1 million in the prior year period.
Changes in the euro-to-U.S. dollar exchange rate resulted in translation gains
of $0.5 million in the 2004 nine months and $3.1 million in the 2003 nine
months. These gains resulted from translation of German advances payable,
which are denominated in U.S. dollars. In 2004, these translation gains were
offset by losses of $0.1 million on forward exchange contracts. The effective tax rate of 38.6% in the nine months ended June 30, 2004,
reflects current expectations for the effective tax rate for fiscal 2004 and is
approximately the same effective tax rate for the prior year period. 17




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##### Table of Contents



Liquidity and Capital Resources Working capital decreased $18.3 million to $95.3 million at June 30, 2004, from
$113.6 million at September 30, 2003. Cash increased $4.0 million to $53.5
million at June 30, 2004, from $49.5 million at September 30, 2003. Cash
increased as a result of decreases in accounts receivable ($20.5 million) and
long-term borrowings ($11.7 million). This increase in cash was offset by
reductions in cash for net property and equipment expenditures ($20.2 million),
payments for acquisitions of businesses and intangibles ($2.9 million),
increases in inventory ($15.8 million), dividends to common and minority
interest shareholders ($4.2 million), increases in other current assets, and
decreases in other current liabilities. Days sales outstanding, calculated on quarterly sales, were 49.0 days as of
June 30, 2004, compared to 60.6 days as of September 30, 2003, and 52.1 days at
June 30, 2003. Days sales outstanding improved from June 30, 2003, although
Funlines days sales outstanding was 59.1 days at June 30, 2004. Inventories at June 30, 2004, increased $16.8 million over amounts at September
30, 2003. Of this increase, $6.5 million was attributable to Funline due to
inventory requirements for the mass retailers, $2.6 million was due to
in-transit inventories, and a $2.3 million increase in Jeff Hamilton Collection
jacket inventories. Except for Funline and collectors catalog club die-cast, we generally produce
domestic and foreign die-cast based upon orders received from customers. The
timing of receiving orders is directly related to the timing of the completion
of product program approvals and is not necessarily indicative of product
demand or future sales. We produce Funline die-cast for inventory based on
customer-projected orders. We receive Funline customer orders weekly, which
are fulfilled in the following week. We record as backlog orders received from
customers, which for Funline, is limited to the weekly orders. Apparel and memorabilia product, except Trevco product, is generally ordered
from inventory. Trevco is a seasonal business in which orders are received in
our second and third fiscal quarters and shipped in our third and fourth fiscal
quarters. Domestic and foreign die-cast, including Funline product, backlog was $56
million and $54 million at June 30, 2004 and 2003. Apparel and memorabilia
backlog was $33 million and $26 million at June 30, 2004 and 2003. Backlog on
any date in a given year is not necessarily indicative of future sales. Capital expenditures related principally to ongoing investments in tooling and
building additions in Aachen, Germany, were $20.2 million for the nine months
ended June 30, 2004, and included $6.3 million applicable to foreign operations
and $6.4 million for Funline capital expenditures, which included $1.6 million
of tooling existing at the acquisition date that was acquired from one of
Funlines contract manufacturers. Capital expenditures for 2004 are expected
to total $26 million. During the first quarter of 2004, the results of Funlines operations were
sufficient to meet earn-out targets established in the Funline acquisition
agreement. As a result, we issued 28 thousand shares of our common stock with
a value of $0.5 million in the first quarter of 2004 and paid $1.2 million as
additional consideration in the second quarter. The additional consideration
increased the amount recorded for the Funline trademarks. On June 30, 2004, we entered into an amended loan and security agreement with
our bank. The amended agreement increased available borrowings from $35.0
million to $75.0 million. The agreement is comprised of a $63.3 million,
four-year revolving credit facility, which is subject to a borrowing base
calculation, a four-year term loan of $1.7 million (Term Loan A) and a
three-year term loan of $10.0 million (Term Loan B). We received $11.7 million
of cash upon issuance of the term loans on June 30, 2004. As the term loans
are repaid, the available revolving credit facility will increase by an
equivalent amount, subject to the borrowing base calculation. The agreement
provides for issuance of up to $30.0 million of letters of credit, to the
extent not utilized for borrowings. Repayment of borrowings under this
facility is secured by a first lien on substantially all of our assets. We are
required to meet certain financial tests related to minimum tangible net worth
and minimum fixed charge coverage ratio. We were in compliance with those
covenants at June 30, 2004. Outstanding letters of credit totaled $12.4
million at June 30, 2004. 18




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##### Table of Contents



The revolving credit facility bears interest at LIBOR plus 1.75%-2.50% or prime
plus 0.00% - 0.25%, and the term loans bear interest at LIBOR plus 2.00% -
3.50% or prime plus 0.00% - 1.25%, depending on our fixed coverage ratio, as
defined. We pay a commitment fee of 0.375% of the average unused revolving
credit facility and a fee of 1.0% of the average undrawn letters of credit. As
of June 30, 2004, 43⁄4% convertible subordinated notes with a face value
of $29.9 million remained outstanding. On August 2, 2004, we redeemed the
notes at a price of 100.68%. We funded the redemption with cash on hand,
revolving credit facility borrowings, and the term loans under the loan and
security agreement. The subordinated notes were convertible, at the option of
the holders, into shares of common stock at the initial conversion price of
$48.20 per share, subject to adjustments in certain events and would have
matured on April 1, 2005. Based on our current forecast, and historical results, we believe that we have
adequate credit availability and cash flow from operations to fund our
operating needs, including the requirements of our new Funline subsidiary, for
the foreseeable future. We do not currently anticipate a change in our capital
structure or the use of off-balance sheet financing arrangements. A summary of dividends paid on common stock since September 30, 2003, follows
(in thousands, except per share data): Amount
    

    Rate Per Share
    
    Declaration Date
    
    Record Date
    
    Paid$914
    
    $
    0.05
    
    
    September 22, 2003
    
    September 26, 2003
    
    October 13, 2003$915
    
    $
    0.05
    
    
    December 10, 2003
    
    December 19, 2003
    
    January 12, 2004$917
    
    $
    0.05
    
    
    March 5, 2004
    
    March 19, 2004
    
    April 12, 2004$917
    
    $
    0.05
    
    
    June 9, 2004
    
    June 18, 2004
    
    July 12, 2004
 Contractual Obligations and Commercial Commitments Aggregate future minimum payments due contractually under royalty agreement
guarantees, personal service agreements, long-term debt, noncancellable
operating leases, commercial letters of credit, and other unconditional
purchase obligations are as follows as of June 30, 2004 (in thousands): Uncondi-Royalty
    
    Personal
    
    
    
    
    
    
    
    
    
    
    
    
    
    tionalAgreement
    
    Service
    
    Long-term
    
    Interest
    
    Lease
    
    PurchasePeriod
    
    Guarantees
    
    Agreements
    
    Debt
    
    Payments
    
    Payments
    
    Obligations
    
    TotalJuly-Sept. 2004
    
    $
    5,362
    
    
    $
    439
    
    
    $
    30,626
    
    
    $
    547
    
    
    $
    1,424
    
    
    $
    12,982
    
    
    $
    51,3802005
    
    
    22,180
    
    
    
    1,526
    
    
    
    4,002
    
    
    
    255
    
    
    
    5,479
    
    
    
    
    
    
    
    33,4422006
    
    
    13,506
    
    
    
    868
    
    
    
    4,027
    
    
    
    233
    
    
    
    5,011
    
    
    
    
    
    
    
    23,6452007
    
    
    7,343
    
    
    
    391
    
    
    
    3,496
    
    
    
    210
    
    
    
    4,735
    
    
    
    
    
    
    
    16,1752008
    
    
    4,830
    
    
    
    135
    
    
    
    1,027
    
    
    
    184
    
    
    
    3,911
    
    
    
    
    
    
    
    10,0872009
    
    
    4,445
    
    
    
    135
    
    
    
    248
    
    
    
    160
    
    
    
    3,514
    
    
    
    
    
    
    
    8,502Thereafter
    
    
    20,505
    
    
    
    67
    
    
    
    2,996
    
    
    
    1,064
    
    
    
    9,609
    
    
    
    
    
    
    
    34,241Total
    
    $
    78,171
    
    
    $
    3,561
    
    
    $
    46,422
    
    
    $
    2,653
    
    
    $
    33,683
    
    
    $
    12,982
    
    
    $
    177,472
 In addition to the scheduled interest payments above, we will pay interest on
amounts outstanding under our loan and security agreement. The schedule also
reflects the commitment at June 30, 2004, to redeem the subordinated notes on
August 2, 2004. Unconditional purchase obligations at June 30, 2004, were
approximately $0.6 million for property and equipment and $12.4 million of
outstanding letters of credit. Term Loan B under the loan and security
agreement is subject to annual mandatory prepayments of 50% of excess cash
flows as defined by the agreement. Scheduled payments for this three-year loan
are reflected above. We have also committed to make payments in connection with a license renewal
totaling $10 million, payable $5 million in July 2004 and $5 million in January
2006. 19




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##### Table of Contents



In certain sublease arrangements, we remain the primary obligor under the terms
of the original lease agreements. Commitments under these subleases expire as
follows (in thousands): SubleasePeriod
    
    CommitmentsJuly-Sept 2004
    
    $
    1032005
    
    
    6032006
    
    
    4692007
    
    
    342Thereafter
    
    
    Total
    
    $
    1,517
 Cautionary Statement Regarding Forward-Looking Statements This report contains forward-looking statements, including statements regarding
business strategies, business, and the industry in which we operate. These
forward-looking statements are based primarily on our expectations and are
subject to a number of risks and uncertainties, some of which are beyond our
control. Actual results could differ materially from the forward-looking
statements as a result of numerous factors, including those set forth in our
Form 10-K for the year ended September 30, 2003, as filed with the Securities
and Exchange Commission. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There has been no significant change in our exposure to market risk since
year-end. The risk is limited to interest rate risk associated with our credit
instruments and foreign currency exchange rate risk associated with operations
in Germany. The functional currency for our foreign operation is the euro. As such,
changes in exchange rates between the euro and the U.S. dollar could adversely
affect our future earnings. Given the level of income we currently derive from
our foreign operations, we consider this exposure to be minimal. During part of the year we used a derivative as part of our risk management
strategy related to a portion of our exposure to currency fluctuations on
intercompany advances to our German subsidiary, denominated in dollars, for
which the euro exchange rate gain or loss is included in operations. These
advances totaled $15.0 million at June 30, 2004. We had entered into foreign
currency forward contracts designed to partially offset the effect changes in
the euro exchange rate have on earnings related to these advances. These
forward contracts did not qualify for hedge accounting and were recorded on the
balance sheet at fair value. Changes in fair value were recorded each period
in foreign currency gains (losses). We realized $0.2 million of losses in May
2004 on a contract, which settled at maturity. 
 ITEM 4. CONTROLS AND PROCEDURES We have evaluated, with the participation of our Chief Executive Officer and
Chief Financial Officer, the effectiveness of our disclosure controls and
procedures as of June 30, 2004. Based on this evaluation, our Chief Executive
Officer and Chief Financial Officer have each concluded that our disclosure
controls and procedures are effective to ensure that we record, process,
summarize, and report information required to be disclosed by us in our
quarterly reports filed under the Securities Exchange Act within the time
periods specified by the Securities and Exchange Commissions rules and forms.
During the quarterly period covered by this report, there have not been any
changes in our internal controls over financial reporting that have materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. 20




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##### Table of Contents



PART II - OTHER INFORMATION 
 ITEM 1. Legal Proceedings Not applicable 
 ITEM 2. Changes in Securities and Use of Proceeds Not applicable 
 ITEM 3. Defaults Upon Senior Securities Not applicable 
 ITEM 4. Submissions of Matters to a Vote of Security Holders Not applicable 
 ITEM 5. Other Information Not applicable 
 ITEM 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits  10.73
    
    Amended and Restated Credit Agreement, dated June 30, 2004,
by and among Action Performance Companies, Inc and certain
subsidiaries and affiliates, as guarantors, and Bank One, NA.10.74
    
    Pledge and Security Agreement, dated June 30, 2004, by and
among Action Performance Companies, Inc and certain subsidiaries and
affiliates, as guarantors, and Bank One, NA.31.1
    
    Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended31.2
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended32.1
    
    Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002  (b)
    
    Reports on Form 8-K We filed a current report on Form 8-K, dated May 3, 2004, reporting that
we issued a press release announcing our second quarter ended March 31,
2004, results. 21




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##### Table of Contents



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 PERFORMANCE COMPANIES, INC. 
 Signature
    
    Capacity
    
    Date/s/ Fred W. Wagenhals
    
    Chairman of the Board, President, andChief Executive Officer
    
    August 6, 2004Fred W. Wagenhals
    
    (Principal Executive Officer)/s/ R. David Martin
    
    Chief Financial Officer, Secretary and Treasurer(Principal Financial and Accounting Officer)
    
    August 6, 2004R. David Martin
 22




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##### Table of Contents



EXHIBIT INDEX  10.73
    
    Amended and Restated Credit Agreement, dated June 30, 2004,
by and among Action Performance Companies, Inc and certain
subsidiaries and affiliates, as guarantors, and Bank One, NA.10.74
    
    Pledge and Security Agreement, dated June 30, 2004, by and
among Action Performance Companies, Inc and certain subsidiaries and
affiliates, as guarantors, and Bank One, NA.31.1
    
    Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended31.2
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a), promulgated under the Securities
Exchange Act of 1934, as amended32.1
    
    Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002