##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q  þ
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2005 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
Tempe, AZ 85281 
  (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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). Yes þ 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 APRIL 22, 2005Common Stock, $0.01 Par Value
    
    18,573,805 Shares




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TABLE OF CONTENTS  PART I- FINANCIAL INFORMATIONITEM 1. 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. Unregistered Sales of Equity Securities and Use of ProceedsITEM 3. Defaults Upon Senior SecuritiesITEM 4. Submissions of Matters to a Vote of Security HoldersITEM 5. Other InformationITEM 6. ExhibitsSIGNATURESEXHIBIT 10.78EXHIBIT 10.79EXHIBIT 10.80EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2EXHIBIT 99.1    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
March 31, 2005 and September 30, 2004
(in thousands, except per share data) March 31,
    
    
    September 30,2005
    
    
    2004ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    6,414
    
    
    $
    12,580Accounts receivable, net
    
    
    39,444
    
    
    
    51,769Inventories
    
    
    56,095
    
    
    
    56,947Prepaid royalties
    
    
    6,126
    
    
    
    2,834Taxes receivable
    
    
    3,908
    
    
    
    2,126Deferred income taxes
    
    
    8,772
    
    
    
    8,766Prepaid expenses and other
    
    
    4,159
    
    
    
    5,920Total current assets
    
    
    124,918
    
    
    
    140,942Long-Term Assets:Property and equipment, net
    
    
    63,072
    
    
    
    64,878Goodwill
    
    
    89,399
    
    
    
    88,653Licenses and other intangibles, net
    
    
    58,549
    
    
    
    56,614Other
    
    
    2,885
    
    
    
    3,196Total long-term assets
    
    
    213,905
    
    
    
    213,341$
    338,823
    
    
    $
    354,283LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    17,455
    
    
    $
    28,778Accrued royalties
    
    
    9,981
    
    
    
    10,702Accrued expenses
    
    
    6,476
    
    
    
    8,757Taxes payable
    
    
    2,277
    
    
    
    1,742Line-of-credit and term loans
    
    
    13,343
    
    
    
    Current portion of long-term debt
    
    
    395
    
    
    
    4,009Total current liabilities
    
    
    49,927
    
    
    
    53,988Long-Term Liabilities:Long-term debt
    
    
    4,279
    
    
    
    11,882Deferred income taxes
    
    
    26,402
    
    
    
    24,979Other
    
    
    260
    
    
    
    298Total long-term liabilities
    
    
    30,941
    
    
    
    37,159Commitments and ContingenciesMinority Interests
    
    
    2,301
    
    
    
    2,509Shareholders Equity:Common stock, $.01 par value, 62,500 shares authorized,
18,764 and 18,560 shares issued
    
    
    188
    
    
    
    186Additional paid-in capital
    
    
    160,000
    
    
    
    158,429Treasury stock, at cost, 190 and 190 shares
    
    
    (3,999
    )
    
    
    (3,999
    )Accumulated other comprehensive loss
    
    
    (625
    )
    
    
    (1,456
    )Retained earnings
    
    
    100,090
    
    
    
    107,467Total shareholders equity
    
    
    255,654
    
    
    
    260,627$
    338,823
    
    
    $
    354,283
 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 Six Months Ended March 31, 2005 and 2004
(in thousands, except per share data) Three Months Ended
    
    
    Six Months Ended2005
    
    
    2004
    
    
    2005
    
    
    2004Net sales
    
    $
    75,326
    
    
    $
    83,596
    
    
    $
    151,380
    
    
    $
    154,803Cost of sales
    
    
    55,098
    
    
    
    59,434
    
    
    
    114,700
    
    
    
    113,685Gross profit
    
    
    20,228
    
    
    
    24,162
    
    
    
    36,680
    
    
    
    41,118Operating expenses:Selling, general, and administrative
    
    
    20,652
    
    
    
    20,377
    
    
    
    43,553
    
    
    
    40,283Amortization of licenses and other intangibles
    
    
    879
    
    
    
    943
    
    
    
    1,757
    
    
    
    1,884Total operating expenses
    
    
    21,531
    
    
    
    21,320
    
    
    
    45,310
    
    
    
    42,167Income (loss) from operations
    
    
    (1,303
    )
    
    
    2,842
    
    
    
    (8,630
    )
    
    
    (1,049
    )Interest expense
    
    
    (396
    )
    
    
    (471
    )
    
    
    (697
    )
    
    
    (902
    )Foreign exchange gains (losses)
    
    
    (871
    )
    
    
    (256
    )
    
    
    908
    
    
    
    1,153Earnings from joint venture
    
    
    109
    
    
    
    198
    
    
    
    402
    
    
    
    762Other income
    
    
    56
    
    
    
    46
    
    
    
    81
    
    
    
    112Other expense
    
    
    (456
    )
    
    
    (288
    )
    
    
    (725
    )
    
    
    (746
    )Total other income (expense)
    
    
    (1,558
    )
    
    
    (771
    )
    
    
    (31
    )
    
    
    379Income (loss) before income taxes
    
    
    (2,861
    )
    
    
    2,071
    
    
    
    (8,661
    )
    
    
    (670
    )Income taxes
    
    
    54
    
    
    
    783
    
    
    
    (2,208
    )
    
    
    (253
    )Net income (loss)
    
    
    (2,915
    )
    
    
    1,288
    
    
    
    (6,453
    )
    
    
    (417
    )Other comprehensive income (loss)
    
    
    (1,587
    )
    
    
    (591
    )
    
    
    831
    
    
    
    814Comprehensive income (loss)
    
    $
    (4,502
    )
    
    $
    697
    
    
    $
    (5,622
    )
    
    $
    397Earnings (Loss) Per Common Share:Basic
    
    $
    (0.16
    )
    
    $
    0.07
    
    
    $
    (0.35
    )
    
    $
    (0.02
    )Diluted
    
    $
    (0.16
    )
    
    $
    0.07
    
    
    $
    (0.35
    )
    
    $
    (0.02
    )Cash dividends declared, per common share
    
    $
    
    
    
    $
    0.05
    
    
    $
    0.05
    
    
    $
    0.10
 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
Six Months Ended March 31, 2005 and 2004
(in thousands) Six Months Ended March 31,2005
    
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (6,453
    )
    
    $
    (417
    )Adjustments to reconcile net loss to cash provided by
operating activities-Depreciation and amortization
    
    
    16,258
    
    
    
    14,713Provision for doubtful accounts
    
    
    2,897
    
    
    
    572Other
    
    
    457
    
    
    
    40Changes in assets and liabilities, net of businesses acquired and disposed-Accounts receivable
    
    
    9,518
    
    
    
    16,779Accounts payable and accrued expenses
    
    
    (9,525
    )
    
    
    (6,276
    )Taxes payable and receivable, net
    
    
    (1,306
    )
    
    
    (4,934
    )Inventories
    
    
    1,003
    
    
    
    (12,144
    )Prepaid royalties and accrued royalties
    
    
    (4,029
    )
    
    
    (3,320
    )Other
    
    
    1,140
    
    
    
    (2,080
    )Net cash provided by operating activities
    
    
    9,960
    
    
    
    2,933CASH FLOWS FROM INVESTING ACTIVITIES:Capital expenditures, net
    
    
    (14,698
    )
    
    
    (13,443
    )Acquisition of businesses and intangibles, net of costs
    
    
    (2,051
    )
    
    
    (2,439
    )Other
    
    
    450
    
    
    
    503Net cash used in investing activities
    
    
    (16,299
    )
    
    
    (15,379
    )CASH FLOWS FROM FINANCING ACTIVITIES:Net borrowings (repayments) under line-of-credit

    
    
    4,091
    
    
    
    Long-term debt repayments
    
    
    (2,287
    )
    
    
    (403
    )Dividends paid  common shareholders
    
    
    (1,842
    )
    
    
    (1,829
    )Dividends paid  minority interest shareholders
    
    
    (847
    )
    
    
    (1,149
    )Stock option and other exercise proceeds
    
    
    918
    
    
    
    145Net cash provided by (used in) financing activities
    
    
    33
    
    
    
    (3,236
    )Effect of exchange rates on cash and cash equivalents
    
    
    140
    
    
    
    180Net change in cash and cash equivalents
    
    
    (6,166
    )
    
    
    (15,502
    )Cash and cash equivalents, beginning of period
    
    
    12,580
    
    
    
    49,462Cash and cash equivalents, end of period
    
    $
    6,414
    
    
    $
    33,960Supplemental Disclosures:Interest paid
    
    $
    517
    
    
    $
    861Income taxes paid (refunded), net
    
    
    (1,425
    )
    
    
    4,225
 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
MARCH 31, 2005 INTERIM FINANCIAL REPORTING The accompanying interim condensed consolidated financial statements for Action Performance
Companies, Inc. and subsidiaries have been prepared by management without audit by an independent
registered public accounting firm 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, 2004. 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, 2005. Certain prior period amounts have been reclassified to conform to the current year presentation. RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R),
Share-Based Payment. SFAS No. 123(R) revises FASB Statement No. 123, Accounting for Stock-Based
Compensation (SFAS 123) and requires companies to expense the fair value of employee stock options
and other forms of stock-based compensation. We will adopt SFAS 123(R) effective October 1, 2005.
We have selected the modified prospective method of adoption, under which unvested awards as of
October 1, 2005 will be charged to expense over the remaining vesting period of the awards. We are
currently evaluating the impact of SFAS 123(R) on our financial position, results of operations,
and cash flows. The American Jobs Creation Act of 2004 (the Act) creates a temporary incentive for U.S.
corporations to repatriate accumulated income earned abroad. Beginning in May 2002, U.S. federal
income taxes have been provided on undistributed earnings of our German subsidiaries. Accordingly,
the Act has no impact on our financial statements. STOCK-BASED COMPENSATION We currently 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. Pursuant to SFAS 123, we estimated the fair value
of each option grant as of the date of grant using the Black-Scholes option pricing method using
the following assumptions for the periods ended March 31: Three Months Ended
    
    
    Six Months Ended2005
    
    
    2004
    
    
    2005
    
    
    2004Volatility
    
    
    62.6
    %
    
    
    40.2
    %
    
    
    60.5
    %
    
    
    40.2
    %Risk-free interest rate
    
    
    3.7
    %
    
    
    2.7
    %
    
    
    3.4
    %
    
    
    2.7
    %Dividend rate
    
    
    0.5
    %
    
    
    1.0
    %
    
    
    0.7
    %
    
    
    1.0
    %Expected life of options
    
    3 years
    
    3 years
    
    3 years
    
    3 years
 Options granted to employees generally vest ratably over three years or after one and a half years.
Options granted to independent directors generally vest immediately upon grant. Had compensation
costs been determined consistent with SFAS 123, utilizing the assumptions detailed above and
amortizing the resulting fair value of stock options granted over the respective vesting period of
the options, the net income (loss) and per share amounts would have been the following pro forma
amounts for the periods ended March 31 (in thousands, except per share data): 6




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Three Months Ended
    
    
    Six Months Ended2005
    
    
    2004
    
    
    2005
    
    
    2004Net income (loss) as reported
    
    $
    (2,915
    )
    
    $
    1,288
    
    
    $
    (6,453
    )
    
    $
    (417
    )Total stock-based employee
compensation expense determined
under fair value method for all
awards, net of related tax
effects
    
    
    (698
    )
    
    
    (1,030
    )
    
    
    (1,485
    )
    
    
    (1,943
    )Pro forma net income (loss)
    
    $
    (3,613
    )
    
    $
    258
    
    
    $
    (7,938
    )
    
    $
    (2,360
    )Basic earnings (loss) per share:As reported
    
    $
    (0.16
    )
    
    $
    0.07
    
    
    $
    (0.35
    )
    
    $
    (0.02
    )Pro forma
    
    $
    (0.20
    )
    
    $
    0.01
    
    
    $
    (0.43
    )
    
    $
    (0.11
    )Diluted earnings (loss) per share:As reported
    
    $
    (0.16
    )
    
    $
    0.07
    
    
    $
    (0.35
    )
    
    $
    (0.02
    )Pro forma
    
    $
    (0.20
    )
    
    $
    0.01
    
    
    $
    (0.43
    )
    
    $
    (0.11
    )
 In the six months ended March 31, 2005, we issued options to purchase 432 thousand shares of common
stock, at an average price of $12.45. DEBT AND FINANCING In May 2005, we refinanced the $9.3 million outstanding balance of the term loans with the
revolving credit facility and amended the agreement to consist of only the $63.3 million revolving
credit facility. Consequently we have reflected the balance of the term loans at March 31, 2005,
as current line-of-credit borrowings in the accompanying balance sheet. We did not meet the agreements required minimum fixed charge coverage ratio of 0.80 for the three
months ended March 31, 2005, however, the bank waived non-compliance. We amended the agreement in
May 2005. Under the amended agreement, we will be required to meet a minimum fixed charge coverage
ratio of 0.81 to 1.0 for the six months ended June 30, 2005, and 1.35 to 1.0 for the nine months
ended September 30, 2005, and 1.0 to 1.0 for each quarter thereafter. Based on current
projections, we expect to be in compliance with our covenants through March 31, 2006, however, we
expect our actual fixed charge coverage ratio to be close to the requirement throughout that
period and we are close to the minimum tangible net worth that we must
maintain. If we do not maintain compliance with these covenants, our business or profitability
deteriorates or we incur unexpected expenses or asset impairments, it could have a material adverse
effect on our liquidity and financial resources, including an inability to utilize our revolving
credit facility and an acceleration of the indebtedness outstanding thereunder. If we are unable
to utilize our revolving credit facility, we may be required to refinance all or part of our
existing debt, sell assets, borrow more money, or obtain other additional financing. 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 Phoenix, Arizona and Los Angeles, California areas. The domestic apparel and memorabilia
operation is based in Charlotte, North Carolina with a mass-merchant retail distribution center in
Atlanta, Georgia and warehouse and distribution facilities in Charlotte, North Carolina and
Baraboo, Wisconsin. 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 sales. Domestic royalty 7




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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 March 31,Inter-
    
    
    Depreciation
    
    
    OperatingExternal
    
    
    segment
    
    
    and
    
    
    IncomeRevenues
    
    
    Revenues
    
    
    Amortization
    
    
    (Loss)2005:Domestic die-cast
    
    $
    23,773
    
    
    $
    1,152
    
    
    $
    3,887
    
    
    $
    165Domestic apparel and memorabilia
    
    
    40,822
    
    
    
    484
    
    
    
    768
    
    
    
    3,822Foreign die-cast
    
    
    9,767
    
    
    
    
    
    
    
    2,319
    
    
    
    1,455Corporate and other
    
    
    964
    
    
    
    595
    
    
    
    1,594
    
    
    
    (6,393
    )Eliminations
    
    
    
    
    
    
    (2,231
    )
    
    
    
    
    
    
    (352
    )Total per consolidated
financial statements
    
    $
    75,326
    
    
    $
    
    
    
    $
    8,568
    
    
    $
    (1,303
    )2004 (c):Domestic die-cast
    
    $
    29,902
    
    
    $
    1,909
    
    
    $
    3,129
    
    
    $
    3,083Domestic apparel and memorabilia
    
    
    43,683
    
    
    
    153
    
    
    
    751
    
    
    
    4,199Foreign die-cast
    
    
    9,000
    
    
    
    
    
    
    
    2,122
    
    
    
    1,203Corporate and other
    
    
    1,011
    
    
    
    468
    
    
    
    1,145
    
    
    
    (5,476
    )Eliminations
    
    
    
    
    
    
    (2,530
    )
    
    
    
    
    
    
    (167
    )Total per consolidated
financial statements
    
    $
    83,596
    
    
    $
    
    
    
    $
    7,147
    
    
    $
    2,842
 Six Months Ended March 31,Inter-
    
    
    Depreciation
    
    
    OperatingExternal
    
    
    segment
    
    
    and
    
    
    IncomeRevenues
    
    
    Revenues
    
    
    Amortization
    
    
    (Loss)2005:Domestic die-cast
    
    $
    57,390
    
    
    $
    1,922
    
    
    $
    7,699
    
    
    $
    (966
    )Domestic apparel and memorabilia
    
    
    72,132
    
    
    

    502
    
    
    
    1,462
    
    
    
    3,040Foreign die-cast
    
    
    20,100
    
    
    
    
    
    
    
    4,408
    
    
    
    3,118Corporate and other
    
    
    1,758
    
    
    
    839
    
    
    
    2,689
    
    
    
    (13,883
    )Eliminations
    
    
    
    
    
    
    (3,263
    )
    
    
    
    
    
    
    61Total per consolidated
financial statements
    
    $
    151,380
    
    
    $
    
    
    
    $
    16,258
    
    
    $
    (8,630
    )2004 (c):Domestic die-cast
    
    $
    63,473
    
    
    $
    3,056
    
    
    $
    6,806
    
    
    $
    6,537Domestic apparel and memorabilia
    
    
    71,322
    
    
    
    615
    
    
    
    1,520
    
    
    
    2,635Foreign die-cast
    
    
    18,437
    
    
    
    
    
    
    
    4,042
    
    
    
    2,702Corporate and other
    
    
    1,571
    
    
    
    788
    
    
    
    2,345
    
    
    
    (12,482
    )Eliminations
    
    
    
    
    
    
    (4,459
    )
    
    
    
    
    
    
    (441
    )Total per consolidated
financial statements
    
    $
    154,803
    
    
    $
    
    
    
    $
    14,713
    
    
    $
    (1,049
    )
 8




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Identifiable Assets
    
    
    Goodwill and TrademarksMarch 31,
    
    
    Sept. 30,
    
    
    March 31,
    
    
    Sept. 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Domestic die-cast (a)
    
    $
    102,525
    
    
    $
    114,157
    
    
    $
    49,353
    
    
    $
    45,661Domestic apparel and memorabilia
    
    
    128,634
    
    
    
    125,319
    
    
    
    61,840
    
    
    
    61,840Foreign die-cast
    
    
    61,421
    
    
    
    61,292
    
    
    
    20,183
    
    
    
    19,438Corporate and other (b)
    
    
    55,730
    
    
    
    63,680
    
    
    
    
    
    
    
    Eliminations
    
    
    (9,487
    )
    
    
    (10,165
    )
    
    
    
    
    
    
    Total per consolidated
financial statements
    
    $
    338,823
    
    
    $
    354,283
    
    
    $
    131,376
    
    
    $
    126,939
   (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. During the first
quarter of fiscal 2005, $2.1 million was accrued as additional consideration payable under
the earn-out provisions of the Funline acquisition agreement. The amount recorded for the
Funline trademarks was increased by the amount of the additional consideration.(b)
    
    Corporate and other identifiable assets includes $2.6 million in cash at March 31,
2005, and $8.5 million in cash at September 30, 2004.(c)
    
    Certain prior period amounts have been reclassified to conform to the current year
presentation. EARNINGS PER COMMON SHARE (EPS) Reconciliations of the numerators and denominators in the EPS computations for net income (loss)
for the periods ended March 31 follows (in thousands): Three Months Ended
    
    
    Six Months Ended2005
    
    
    2004
    
    
    2005
    
    
    2004NUMERATOR:Basic and diluted  net income (loss)
    
    $
    (2,915
    )
    
    $
    1,288
    
    
    $
    (6,453
    )
    
    $
    (417
    )DENOMINATOR:Basic  weighted average shares
    
    
    18,568
    
    
    
    18,327
    
    
    
    18,487
    
    
    
    18,304Effect of dilutive stock options and warrants
    
    
    
    
    
    
    275
    
    
    
    
    
    
    
    Diluted  adjusted weighted average shares
    
    
    18,568
    
    
    
    18,602
    
    
    
    18,487
    
    
    
    18,304
 The impact of certain options and warrants outstanding for the purchases of 2.0 million and 2.0
million shares of common stock, at an average price of $22.47 and $25.93, were not included in the
calculation of diluted EPS for the three months ended March 31, 2005 and 2004, because to do so
would be antidilutive. The impact of certain options and warrants outstanding for the purchases of
2.1 million and 1.4 million shares of common stock, at an average price of $22.46 and $29.31 were
not included in the calculation of diluted EPS for the six months ended March 31, 2005 and 2004,
because to do so would be antidilutive. Although the options and warrants had exercise prices
greater than the average market price of the common stock for the three or six months ended March
31, 2005 and 2004, they could potentially dilute EPS in the future. The impact of our outstanding
4 3/4% convertible subordinated notes were not included in the calculation of diluted EPS for the
three and six months ended March 31, 2004 because to do so also would be antidilutive. 9




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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 joint venture, which is included in other long-term assets, was
$0.5 million at March 31, 2005, and $0.6 million at September 30, 2004, and earnings on our
investment in the joint venture were $0.1 million and $0.2 million for the three months ended March
31, 2005 and 2004, and were $0.4 million and $0.8 million for the six months ended March 31, 2005
and 2004. SUPPLEMENTAL CASH FLOW INFORMATION During the six months ended March 31, 2005, we recorded a $2.5 million allowance for doubtful
accounts to reserve for estimated uncollectible receivables from distributors and recorded a $1.6
million write-down of Jeff Hamilton inventory. 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 our financial position, results of operations, or cash flows. In October 2004, we settled a lawsuit with New Hampshire Speedway, Inc., filed in May 2004 against
us in the United States District Court for the District of New Hampshire for $0.8 million. The
$0.8 million was accrued as of September 30, 2004 and paid in October 2004. During December 2004, we were served with a class action securities lawsuit entitled The Cornelia
Crowell, GST Trust v. Action Performance Companies, Inc., et al., which was filed in the United
States District Court of New Mexico. The complaint names as defendants our Company and certain of
our current and former officers. The complaint alleges that we made false and misleading
statements concerning our financial results and business during the period from July 23, 2003 to
October 22, 2003, resulting in violations of Section 10(b) and 20(a) of the Securities Exchange Act
of 1934. The complaint seeks unspecified monetary damages and equitable relief. We dispute the
claims and intend to defend the lawsuit vigorously. 
 ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations Current Events We have announced our plans to improve our financial performance. These plans include the
following:  
    Improving the way our die-cast product is marketed and distributed;
    Controlling expenditures; and
    Expanding our traditional retail channels. 10




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Significant actions we have taken to date to improve the way our die-cast products are marketed and
distributed include:  
    Eliminated over 60% of our NASCAR die-cast SKUs. As a result of focusing our product
line on the most popular and profitable SKUs, we believe that we will realize the following
benefits.  °
    Reduced future capital expenditures to support the business.°
    Better utilization of those future capital expenditures.°
    A simplified and more efficient approval and production process.  We recognized approximately $0.2 million in the three months ended March 31, 2005, of
additional depreciation on tooling for those SKUs that were either discontinued outright or
will be eliminated in various stages during the remainder of the year. We expect to
recognize comparable additional depreciation expense in the three months ended June 30, 2005
and September 30, 2005 associated with discontinuing tooling.
    Reorganized the departments that handle the product design, approval, and production
process of die-cast.
    Announced our plan to restructure our wholesale NASCAR die-cast distribution model from
a distributor-based model to a direct-to-retail model. We announced that our existing
Charlotte, North Carolina operations, which currently manages wholesale apparel operations,
would also handle fulfillment for wholesale NASCAR die-cast and apparel effective October
1, 2005. We will also add a call center at that facility for order processing and customer
service. We believe the benefits of bringing in-house our distribution are as follows:  °
    A significantly lower cost profile for the business. These lower costs
will allow us to invest in both retail level marketing and sales efforts to improve
the longer term volume potential of the business, as well as improve the
profitability of the business.°
    Allow us to communicate and deal directly with the retailer of our
products to improve our speed to market, as well as recognize consumer trends,
preferences, and buying habits sooner.°
    We have restricted credit to six of our fifteen distributors and
recorded a $2.5 million allowance for doubtful accounts in the first quarter of
2005 to reserve for estimated uncollectible receivables as a result of changing
distribution models. Actions taken to control expenditures include:  
    Reduced the workforce at our Tempe headquarters by approximately 20%. In addition, we
anticipate selling our 25% fractional ownership in a corporate aircraft in May of 2005,
from which we will receive proceeds of approximately $0.8 million. The three months ended
March 31, 2005, includes $0.5 million in associated accelerated depreciation.
    Closed the Los Angeles location of Jeff Hamilton Collections and consolidated the
operations. The Jeff Hamilton product line is now distributed through our apparel
division.
    Decided not to declare a dividend in the quarter ending March 31, 2005. The evaluation
of paying dividends will be made on a quarter-by-quarter basis, although at the current
time we do not anticipate paying a dividend for the foreseeable future.
    Established a policy for capital expenditures to limit future annual spending to a level
below annual depreciation.
    Initiated plans to open a sourcing office in mainland China to reduce the cost of
production. Plans to expand our traditional retail channels include:  
    Consolidating procurement, marketing, sales, and distribution functions of our Winners
Circle die-cast and Funline brands to better leverage the combined size of these two
businesses. 11




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##### Table of Contents




    Recruiting for individuals with sales and/or marketing expertise to help realize the
potential of these two businesses.
    Consolidating our mass apparel and novelty logistics and distribution function in our
facility in Atlanta, Georgia. We are also evaluating the profitability of, and synergies among, our various product lines, and
may determine to dispose of one or more of them, or to acquire other complimentary businesses, as
we move forward with our business plan. 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 with the goal of achieving higher levels of sales with limited
increases in operating expenses and capital investments. The principal elements of this operating
structure include the following:  
    NASCAR die-cast unit manufacturing costs are largely fixed due to outsourcing under
fixed-price contracts.
    Royalties are paid generally as a percentage of sales, although often subject to
guaranteed minimums.
    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 have historically distributed our products through a broad range of channels, including a
network of wholesale distributors, leading mass-merchant 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 amount is fixed or determinable, and 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-merchant 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. 12




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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;
    additional charges related to lower than minimum order quantities and cancellation of
specific purchase orders; and
    the impact of minimum royalty guarantees. 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 such costs 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 our products for shipment.
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. 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 13




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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 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. 14




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##### Table of Contents



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 currently 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). Under 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. When we adopt SFAS 123(R), we will record compensation
expense for these options and the charge to earnings might be significant (See Stock Based
Compensation Note). Results of Operations The following table sets forth the percentage of net sales represented by certain expense and
revenue items for the periods ended March 31: Three Months Ended
    
    
    Six Months Ended2005
    
    
    2004
    
    
    2005
    
    
    2004Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    73.1
    
    
    
    71.1
    
    
    
    75.8
    
    
    
    73.5Gross profit
    
    
    26.9
    
    
    
    28.9
    
    
    
    24.2
    
    
    
    26.5Selling, general, and
administrative expenses
    
    
    27.4
    
    
    
    24.4
    
    
    
    28.8
    
    
    
    26.0Amortization of licenses and
other intangibles
    
    
    1.2
    
    
    
    1.1
    
    
    
    1.2
    
    
    
    1.2Income (loss) from operations
    
    
    (1.7
    )
    
    
    3.4
    
    
    
    (5.8
    )
    
    
    (0.7
    )Interest expense
    
    
    (0.5
    )
    
    
    (0.6
    )
    
    
    (0.5
    )
    
    
    (0.6
    )Foreign exchange gains (losses)
    
    
    (1.2
    )
    
    
    (0.3
    )
    
    
    0.6
    
    
    
    0.7Earnings from joint venture
    
    
    0.1
    
    
    
    0.2
    
    
    
    0.3
    
    
    
    0.5Other income
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.1Other expense
    
    
    (0.6
    )
    
    
    (0.4
    )
    
    
    (0.5
    )
    
    
    (0.5
    )Income (loss) before income taxes
    
    
    (3.8
    )
    
    
    2.4
    
    
    
    (5.8
    )
    
    
    (0.5
    )Income taxes
    
    
    0.1
    
    
    
    0.9
    
    
    
    (1.5
    )
    
    
    (0.2
    )Net income (loss)
    
    
    3.9
    
    
    
    1.5
    
    
    
    (4.3
    )
    
    
    (0.3
    )
 15




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The following table sets forth net sales by channel of distribution for the periods ended March 31
(in thousands): Three Months Ended
    
    
    Six Months Ended2005
    
    
    2004
    
    
    2005
    
    
    2004Domestic Die-cast:Wholesale distribution and promotion
    
    $
    11,846
    
    
    $
    12,098
    
    
    $
    24,154
    
    
    $
    23,929Wholesale to mass-merchant retailers
    
    
    7,829
    
    
    
    13,659
    
    
    
    25,367
    
    
    
    31,495Retail through collectors catalog club
    
    
    4,098
    
    
    
    4,145
    
    
    
    7,869
    
    
    
    8,049Total domestic die-cast
    
    
    23,773
    
    
    
    29,902
    
    
    
    57,390
    
    
    
    63,473Foreign Die-cast  wholesale
distribution and promotion
    
    
    9,767
    
    
    
    9,000
    
    
    
    20,100
    
    
    
    18,437Total die-cast
    
    
    33,540
    
    
    
    38,902
    
    
    
    77,490
    
    
    
    81,910Domestic Apparel and Memorabilia:Wholesale distribution and promotion
    
    
    17,721
    
    
    
    21,430
    
    
    
    31,390
    
    
    
    34,683Wholesale to mass-merchant retailers
    
    
    12,737
    
    
    
    11,427
    
    
    
    21,759
    
    
    
    19,717Total apparel and memorabilia
    
    
    30,458
    
    
    
    32,857
    
    
    
    53,149
    
    
    
    54,400Retail at Trackside
    
    
    10,364
    
    
    
    10,826
    
    
    
    18,983
    
    
    
    16,922Royalties and Other
    
    
    964
    
    
    
    1,011
    
    
    
    1,758
    
    
    
    1,571Net Sales
    
    $
    75,326
    
    
    $
    83,596
    
    
    $
    151,380
    
    
    $
    154,803
 Three Months Ended March 31, 2005, Compared with Three Months Ended March 31, 2004 Net sales decreased $8.3 million, or 9.9%, to $75.3 million for the three months ended March 31,
2005, compared to $83.6 million in the prior year quarter. Domestic die-cast sales decreased $6.1 million, or 20.5%, from the prior year quarter while foreign
die-cast sales increased $0.8 million, or 8.5%. The domestic die-cast segment sales decrease of
$6.1 million is comprised of a $0.3 million decrease in our wholesale distribution and promotion
revenues and a $5.8 million decrease in domestic die-cast wholesale sales to mass-merchant
retailers. We expect domestic die-cast wholesale distribution and promotion revenues in 2005 to
fall below 2004 levels as we continue to work to improve our die-cast distribution model and reduce
the number of die-cast SKUs. We expect collectors catalog club revenues in 2005 to remain
comparable to 2004. Domestic die-cast wholesale sales to mass-merchant retailers consisted of $6.4
million of Funline sales and $1.4 million of NASCAR sales in the second quarter of 2005, compared
to $10.5 million of Funline sales and $3.2 million of NASCAR sales in the second quarter of 2004.
We expect NASCAR die-cast sales to mass-merchant retailers in 2005 to increase over 2004, with
increased sales in the second half of 2005, based on recent merchant feedback. We expect Funline
die-cast sales to mass-merchant retailers in 2005 to continue to be below 2004 levels, based on
recent merchant feedback. The 8.5% increase in foreign die-cast sales from the prior year second
quarter, was partly the result of the 4.8% change in the euro-to-U.S. dollar exchange rate between
the periods. Domestic apparel and memorabilia segment sales, exclusive of trackside, decreased $2.4 million, or
7.3%, to $30.5 million in the quarter ended March 31, 2005, compared to $32.9 million in the
quarter ended March 31, 2004. Trackside sales decreased $0.5 million, or 4.3%, due to five events occurring in the quarter ended
March 31, 2005 compared to seven events in the quarter ended March 31, 2004. On comparable events
during the quarter, sales increased approximately 8%. In addition there was one venue change
during the quarter from Rockingham, North Carolina to Fontana, California, which led to an
approximately $1.4 million increase in sales for that race weekend. The 2.0% decline in gross profit, to 26.9% of net sales in the second quarter of 2005, from 28.9%
in the second quarter of 2004, was impacted by changes in segment gross margins as follows: 16




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WeightedGross
    
    
    Gross% of
    
    
    Margin
    
    
    MarginNet
    
    
    Increase
    
    
    IncreaseSales
    
    
    (Decrease)
    
    
    (Decrease)Domestic die-cast
    
    
    33.5
    %
    
    
    (8.7
    )%
    
    
    (2.9
    )%Domestic apparel and memorabilia
    
    
    57.4
    
    
    
    (0.5
    )
    
    
    (0.3
    )Foreign die-cast
    
    
    13.0
    
    
    
    0.5
    
    
    
    0.1Corporate and other
    
    
    (3.9
    )
    
    
    
    
    
    
    1.1Consolidated Total
    
    
    100.0
    %
    
    
    
    
    
    
    (2.0
    )%
 Domestic die-cast gross margins declined 8.7% as a result of lower gross margins on Funline product
sales. Results included write-downs of inventory in one Funline product line to net realizable
value in the second quarter of 2005 and lower margins on other Funline product lines. Domestic
apparel and memorabilia margins declined 0.5% as a result of second quarter write-downs of Jeff
Hamilton inventory of $0.4 million, partially offset by other margin improvements. The 0.5%
increase in foreign die-cast gross margins was principally a result of lower tooling charges as a
percentage of revenue, in part as a result of changes in the euro-to-dollar exchange rate. Selling, general, and administrative expenses were $20.7 million, or 27.4% of net sales, in the
three months ended March 31, 2005, compared to $20.4 million, or 24.4% of net sales, in the three
months ended March 31, 2004. The increase was $0.3 million, or 1.4%, from the prior year quarter.
Selling, general, and administrative expenses in the quarter ended March 31, 2005 included $0.3
million incremental Sarbanes-Oxley implementation costs, $0.5 million more depreciation of a
fractional interest in a corporate aircraft, and $0.3 million additional use and occupancy costs,
offset by $0.3 million lower bad debt expense for distributor receivables, $0.2 million lower
advertising costs, $0.2 million lower salaries and benefits and $0.1 million lower travel. The
lower advertising and travel expenses are the result of cost containment efforts put in place at
the end of the first quarter. We expect to sell the fractional interest in the corporate aircraft
in May of 2005 for $0.8 million. Savings from headcount reductions made in the second quarter are
expected in the second half of 2005 as first half savings were offset by costs of severance. We
anticipate incurring approximately $0.7 million in the second half of fiscal 2005 in incremental
Sarbanes-Oxley implementation costs. Interest expense of $0.4 million in the three months ended March 31, 2005, was $0.1 million lower
than interest expense in the comparable prior year period, as a result of convertible subordinated
note repurchases. Foreign currency losses were $0.9 million and $0.3 million for the three months ended March 31,
2005 and 2004. Changes in the euro-to-U.S. dollar exchange rate resulted in translation losses of
$0.9 million and $0.4 million for the three months ended March 31, 2005 and 2004. These losses
resulted from translation of German advances payable, which are denominated in U.S. dollars. In
the three months ended March 31, 2004, these translation losses were offset by a gain of $0.1
million on a forward exchange contract. The effective tax rate of (1.9%) for the three months ended March 31, 2005 was lower than the 37.8%
effective tax rate for the three months ended March 31, 2004. During the quarter we changed our
estimate of the annual effective rate to 25.5% due to lower projected pre-tax income (loss). The
quarter ended March 31, 2005, includes the impact of the change in estimated annual effective tax
rate to 25.5% from the 39.0% estimate used in the quarter ended December 31, 2004. The 25.5%
estimated 2005 effective rate is lower than the 2004 effective rate of 66.4% primarily as a result
of the change in mix of foreign and domestic pre-tax income (loss) as well as the impact of
nondeductible expenses on lower projected pre-tax income (loss). Our German subsidiary is subject
to higher tax rates than our domestic subsidiaries. Six Months Ended March 31, 2005, Compared with Six Months Ended March 31, 2004 Net sales decreased $3.4 million, or 2.2%, to $151.4 million for the six months ended March 31,
2005, compared to $154.8 million in the prior year period. 17




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Domestic die-cast sales decreased $6.1 million, or 9.6%, from the prior year period while foreign
die-cast sales increased $1.7 million, or 9.0%. The domestic die-cast segment sales decrease of
$6.1 million is comprised of a $0.2 million increase in our wholesale distribution and promotion
revenues, offset by a $0.2 million decrease in our die-cast retail collectors catalog club
revenues, and a $6.1 million decrease in domestic die-cast wholesale sales to mass-merchant
retailers. We expect domestic die-cast wholesale distribution and promotion revenues in 2005 to
fall below 2004 levels as we continue to work to improve our die-cast distribution model and reduce
the number of die-cast SKUs. We expect collectors catalog club revenues in 2005 to remain
comparable to 2004. Domestic die-cast wholesale sales to mass-merchant retailers consisted of
$19.4 million of Funline sales and $6.0 million of NASCAR sales in the six months ended March 31,
2005, compared to $23.7 million of Funline sales and $7.8 million of NASCAR die-cast sales in the
six months ended March 31, 2004. We expect NASCAR die-cast sales to mass-merchant retailers in
2005 to increase over 2004, with increased sales in the second half of 2005, based on recent
merchant feedback. We expect Funline die-cast sales to mass-merchant retailers in 2005 below 2004
levels, based on recent merchant feedback. The 9.0% increase in foreign die-cast sales from the
prior year period was partly the result of the 6.6% change in the euro-to-U.S. dollar exchange rate
between the periods. Domestic apparel and memorabilia segment sales, exclusive of trackside, decreased $1.3 million, or
2.3%, to $53.1 million in the six months ended March 31, 2005, compared to $54.4 million in the six
months ended March 31, 2004. Trackside sales increased $0.4 million, or 2.1%, after considering the impact of the timing of the
fall Talladega Superspeedway race ($1.7 million of 2005 sales), which occurred in October 2004 and
September 2003. In addition there was a venue change from Rockingham, North Carolina to Fontana,
California, which led to a $1.4 million increase in sales for that race weekend. On comparable
events during the six-month period, sales increased approximately 7%. There were 13 events in the
six months ended March 31, 2005, compared to 14 events in the six months ended March 31, 2004. The 2.3% decline in gross profit, to 24.2% of net sales in the six months ended March 31, 2005,
from 26.5% in the six months ended March 31, 2004, was impacted by changes in segment gross margins
as follows: % of
    
    
    Weighted
    
    
    GrossGross
    
    
    Margin
    
    
    MarginNet
    
    
    Increase
    
    
    IncreaseSales
    
    
    (Decrease)
    
    
    (Decrease)Domestic die-cast
    
    
    39.7
    %
    
    
    (7.1
    )%
    
    
    (2.8
    )%Domestic apparel and memorabilia
    
    
    49.4
    
    
    
    (1.6
    )
    
    
    (0.8
    )Foreign die-cast
    
    
    13.3
    
    
    
    1.3
    
    
    
    0.2Corporate and other
    
    
    (2.4
    )
    
    
    
    
    
    
    1.1Consolidated Total
    
    
    100.0
    %
    
    
    
    
    
    
    (2.3
    )%
 Domestic die-cast gross margins declined 7.1% as a result of lower gross margins on Funline product
sales. Results included write-downs of one Funline product line to net realizable value in the
first six months of 2005 and lower margins on other Funline product lines. Domestic apparel and
memorabilia margins declined 1.6% as a result of write-downs of Jeff Hamilton inventory of $1.6
million, offset by other margin improvements. The 1.3% increase in foreign die-cast gross margins
was principally a result of lower tooling charges as a percentage of revenue, in part as a result
of changes in the euro-to-dollar exchange rate. Selling, general, and administrative expenses were $43.6 million, or 28.8% of net sales, in the six
months ended March 31, 2005, compared to $40.3 million, or 26.0% of net sales, in the six months
ended March 31, 2004. The increase was $3.3 million, or 8.1%, from the prior year period.
Selling, general, and administrative expenses in the six months ended March 31, 2005 included a $2.3 million increase in bad debt expense for
distributor receivables, a $0.4 million severance expense for our former Chief Financial Officer,
$0.3 million incremental Sarbanes-Oxley implementation costs, $0.8 million additional trackside
variable commission and vehicle costs, $0.5 million more depreciation of a fractional interest in a
corporate aircraft, and $0.4 million additional salaries and commissions, offset by $0.9 million
lower litigation settlement costs, $0.4 million lower
advertising costs, and $0.1 million lower 18




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travel. The lower advertising and travel expenses are the result of cost containment efforts put
in place at the end of the first quarter. We expect to sell the fractional interest in the
corporate aircraft in May of 2005 for $0.8 million. Savings from headcount reductions made in the
second quarter are expected in the second half of 2005 as first half savings were offset by
severance costs . We anticipate incurring approximately $0.7 million in the second half in
incremental Sarbanes-Oxley implementation costs. Interest expense of $0.7 million in the six months ended March 31, 2005, was $0.2 million lower
than interest expense in the comparable prior year period, as a result of convertible subordinated
note repurchases. Foreign currency gains were $0.9 million for the six months ended March 31, 2005, versus $1.2
million for the six months ended March 31, 2004. Changes in the euro-to-U.S. dollar exchange rate
resulted in translation gains that resulted from German advances payable, which are denominated in
U.S. dollars. In the six months ended March 31, 2004, these translation gains were offset by a
loss of $0.3 million on a forward exchange contract. The effective tax rate of 25.5% for the six months ended March 31, 2005 was lower than the 37.8%
effective tax rate for the six months ended March 31, 2004. The 25.5% estimated 2005 effective
rate is lower than the 2004 effective rate of 66.4% primarily as a result of the change in mix of
foreign and domestic pre-tax income (loss) as well as the impact of nondeductible expenses on lower
projected pre-tax income (loss). Our German subsidiary is subject to higher tax rates than our
domestic subsidiaries. Liquidity and Capital Resources Working capital decreased $12.0 million to $75.0 million at March 31, 2005, from $87.0 million at
September 30, 2004. Cash decreased $6.2 million to $6.4 million at March 31, 2005, from $12.6
million at September 30, 2004. Cash decreased as a result of cash used for net property and
equipment expenditures ($14.7 million), payments for acquisitions of businesses and intangibles
($2.1 million), dividends to common and minority interest shareholders ($2.7 million), increases in
other current assets, and decreases in other current liabilities. This decrease in cash was offset
by increases in cash for decreases in accounts receivable, net of allowances ($12.4 million) and
decreases in inventories ($1.0 million). Days sales outstanding, calculated on quarterly sales, was 47.1 days as of March 31, 2005, compared
to 48.9 days as of September 30, 2004, and 57.4 days as of March 31, 2004. The decrease from
September 30, 2004, reflects the smaller portion of revenues coming from mass-retail channels,
which have longer dating terms. Inventories at March 31, 2005, decreased $0.9 million from September 30, 2004. Of this decrease,
$1.1 million was attributable to a reduction of Jeff Hamilton inventory levels and $1.6 million was
attributable to a write-down of Jeff Hamilton inventory to net realizable value. During the first
quarter of 2005, we closed our Jeff Hamilton operations in California. Jeff Hamilton trademarked
product is now distributed through our other divisions. This decrease in inventory was offset by
increases in apparel inventory for the beginning of the race season. Except for Funline and collectors 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 report 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 stock inventory.
Trevco products are seasonal in nature and orders are received in our second and third fiscal
quarters and shipped in our third and fourth fiscal quarters. Domestic and foreign die-cast backlog, including Funline product, was $56.5 million and $71.1
million at March 31, 2005 and 2004. Apparel and memorabilia backlog was approximately $20.6
million and $17.5 million at March 31, 2005 and 2004. Backlog on any date in a given year is not
necessarily indicative of future sales. 19




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Capital expenditures related principally to ongoing investments in tooling were $14.7 million for
the six months ended March 31, 2005, and included $5.0 million applicable to foreign operations and
$3.9 million for Funline capital expenditures. Capital expenditures for 2005 are expected to total
approximately $21 million. During the first quarter of 2005, the results of Funlines operations were sufficient to meet
earn-out targets established in the Funline acquisition agreement. As a result, we issued 40
thousand shares of our common stock with a value of $0.4 million at December 31, 2004 and paid $1.7
million as additional consideration in the second quarter. The additional consideration increased
the amount recorded for the Funline trademarks at December 31, 2004. On June 30, 2004, we entered into an amended loan and security agreement. The amended agreement
increased available borrowings from $35.0 million to $75.0 million. The agreement consisted 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 and a three-year term loan of $10.0 million. In
May 2005, we refinanced the $9.3 million outstanding balance of the term loans with the revolving
credit facility and amended the agreement to consist of only the $63.3 million revolving credit
facility. Consequently we have reflected the balance of the term loans at March 31, 2005, as
current line-of-credit borrowings in the accompanying balance sheet. The agreement provides for
issuance of up to $30.0 million of letters of credit, to the extent not utilized for borrowings.
Outstanding letters of credit totaled $8.3 million at March 31, 2005. 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 did not meet the agreements required minimum fixed charge coverage ratio of 0.80 for the three
months ended March 31, 2005, however, the bank waived non-compliance. We amended the agreement in
May 2005. Under the amended agreement, we will be required to meet a minimum fixed charge coverage
ratio of 0.81 to 1.0 for the six months ended June 30, 2005, and 1.35 to 1.0 for the nine months
ended September 30, 2005, and 1.0 to 1.0 for each quarter thereafter. Based on current
projections, we expect to be in compliance with our covenants through March 31, 2006, however, we
expect our actual fixed charge coverage ratio to be close to the requirement throughout that
period. As of March 31, 2005, results of the other covenant calculations were as follows: Financial Covenant
    
    Period
    
    Requirement
    
    ActualMinimum tangible net worth
    
    As of March 31, 2005
    
    > $105.2 million
    
    $106.2 millionLimitation
on capital expenditures
    
    October 1, 2004 to September 30, 2005
    
    < $35.0 million
    
    $14.7 million
 As amended, until September 30, 2005, our credit facility bears interest at LIBOR plus 2.50% or
prime plus 0.25% (5.75% at March 31, 2005). After September 30, 2005, the revolving credit
facility bears interest at LIBOR plus 2.00% - 2.75% or prime plus
0.25% - 0.50% depending on our
fixed coverage ratio, as defined. Interest on the term loans, prior to refinancing, was
approximately 1% higher. 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. 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 for the next twelve months.
As discussed above, however, we expect our fixed charge coverage ratio to be close to the minimum
requirement during the next year and we are close to the minimum tangible net worth that we must
maintain. If we do not maintain compliance with these covenants, our business or profitability
deteriorates or we incur unexpected expenses or asset impairments, it could have a material adverse effect on our liquidity and financial resources, including an inability to utilize
our revolving credit facility and an acceleration of the indebtedness outstanding thereunder. If
we are unable to utilize our revolving credit facility, we may be required to refinance all or part
of our existing debt, sell assets, borrow more money or 20




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obtain other additional financing. We
cannot guarantee that we would be able to do so on terms acceptable to us, if at all. In September 2002, we initiated a quarterly dividend policy with an initial dividend of $0.03 per
share. A summary of dividends paid on common stock after September 30, 2004, follows (in
thousands, except per share data): Amount
    
    Rate Per Share
    
    Declaration Date
    
    Record Date
    
    Paid$919
    
    $0.05
    
    August 19, 2004
    
    September 17, 2004
    
    October 18, 2004$924
    
    $0.05
    
    November 12, 2004
    
    December 17, 2004
    
    January 5, 2005
 Under our amended loan and security agreement, we are required to obtain written consent prior to
declaring dividends on our common stock. We have not declared a dividend since November 12, 2004.
The evaluation of paying dividends will be made on a quarter-by-quarter basis, although at the
current time we do not anticipate paying a dividend for the foreseeable future. Cautionary Statement Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements. The words believe,
expect, anticipate, forecast, plan and project and similar expressions identify
forward-looking statements, which speak only as of the date the statement was made. All such
statements are within the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements may include, but are not limited to, projections of sales, capital expenditures,
backlog; and other expenses; plans for future operations; financing needs or plans and liquidity;
the impact of changes in interest rates; the magnitude and timing of benefits relating to our
restructuring; the impact of changes in currency exchange rates; plans relating to the acquisition
or disposition of product lines; plans relating to our products; our plans and intentions with
respect to off-balance sheet arrangements; the expected outcome of legal proceedings against us;
the sufficiency of our capital resources to support our operating strategy; and the impact of new
accounting principles, as well as assumptions relating to the foregoing. Actual events and results may differ materially from those expressed in forward-looking statements
due to a number of factors. Risks identified in Exhibit 99.1 to this Quarterly Report on Form 10-Q
and in our Annual Report on Form 10-K for the year ended September 30, 2004, including those under
the caption Business  Risk Factors describe factors, among others, that could contribute to or
cause such differences. These factors may also affect our business generally and as a result, the
price of our stock may fluctuate dramatically. 
 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk There has been no significant change in our exposure to market risk since year-end. Our exposure
to market risk is limited to interest rate risk associated with our credit instruments and foreign
currency exchange rate risk associated with operations in Germany. Our debt is comprised of fixed
interest rate and variable interest rate debt. A 100 basis point change in the variable interest
rates (which fluctuate with either LIBOR or prime, at our discretion) would change our annual
interest expense $0.1 million, if our variable rate debt remains at March 31, 2005, levels. The
functional currency for our foreign operations is the euro. As such, changes in exchange rates
between the euro and the U.S. dollar could affect our future earnings. A 7% change in the euro
exchange rate would have changed the net income from that operation in the twelve months ended
March 31, 2005, by $0.1 million. During 2004 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 $16.3 million at March 31, 2005. In the six months ended March 31, 2005, a
1% change in the euro exchange rate would have resulted in a $0.1 million change in net income. 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 exchange gains (losses). 21




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##### Table of Contents



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 March 31, 2005. 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 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 control over financial reporting that have materially affected, or
are reasonably likely to materially affect, our internal control over financial reporting. 22




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##### Table of Contents



PART II - OTHER INFORMATION 
 ITEM 1. Legal Proceedings In October 2004, we settled a lawsuit with New Hampshire Speedway, Inc, filed in May 2004 against
us in the United States District Court for the District of New Hampshire for $0.8 million. The
$0.8 million was accrued as of September 30, 2004 and paid in October 2004. During December 2004, we were served with a class action securities lawsuit entitled The Cornelia
Crowell, GST Trust v. Action Performance Companies, Inc., et al., which was filed in the United
States District Court of New Mexico. The complaint names as defendants our Company and certain of
our current and former officers. The complaint alleges that we made false and misleading
statements concerning our financial results and business during the period from July 23, 2003 to
October 22, 2003, resulting in violations of Section 10(b) and 20(a) of the Securities Exchange Act
of 1934. The complaint seeks unspecified monetary damages and equitable relief. We dispute the
claims and intend to defend the lawsuit vigorously. 
 ITEM 2. Unregistered Sales of Equity 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 The annual meeting of shareholders was held on February 8, 2005. The following nominees were
elected to the board of directors to serve as directors until their successors are elected and
qualified: Fred W. Wagenhals, David M. Riddiford, Melodee L. Volosin, Herbert M. Baum, Edward J.
Bauman, Michael L. Gallagher , Roy A. Herberger Jr., Anne L. Mariucci, Robert L. Mathews, and
Lowell L. Robertson. The shareholders also ratified the appointment of PricewaterhouseCoopers LLP
as the independent registered public accounting firm of our company for fiscal 2005, by the
following vote: 17,271,614 for; 15,974 against; and 5,621 abstaining. 
 ITEM 5. Other Information Not applicable 
 ITEM 6. Exhibits  10.78
    Form of Action Performance Companies, Inc. 1998 Non-Qualified Stock Option
Plan Stock Option Agreement10.79
    Form of Action Performance Companies, Inc. 2000 Stock Option Plan Stock Option Agreement10.80
    Third Amendment to Amended and Restated Credit Agreement, dated May 6, 2005,
by and among Action Performance Companies, Inc. and certain subsidiaries and
affiliates, as guarantors, and Bank One, NA.31.1
    Rule 13a-14(a) and Rule 15d-14(a) Certification of Chief Executive Officer31.2
    Rule 13a-14(a) and Rule 15d-14(a) Certification of Chief Financial Officer32.1
    Section 1350 Certification of Chief Executive Officer32.2
    Section 1350 Certification of Chief Financial Officer 23




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99.1
    Private Securities Litigation Reform Act of 1995 Safe Harbor Compliance
Statement for Forward-Looking Statements 24




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ACTION PERFORMANCE COMPANIES, INC. Signature
    
    Capacity
    
    Date/s/ Fred W. Wagenhals
    
    Chairman of the Board, President, and
    
    May 10, 2005Fred W. Wagenhals
    
    Chief Executive Officer(Principal Executive Officer and DulyAuthorized Officer))/s/ David M. Riddiford
    
    Chief Financial Officer, Secretary, and Treasurer
    
    May 10, 2005David M. Riddiford
    
    (Principal Financial and Accounting Officer)
 25