SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended March 31, 2004

Commission file number 0-21630

ACTION PERFORMANCE COMPANIES, INC.

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 [X] No [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [  ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Table of Contents

PART I- FINANCIAL INFORMATION

ITEM 1. Financial Statements

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ACTION PERFORMANCE COMPANIES, INC.

The accompanying notes are an integral part of these consolidated financial statements.

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The accompanying notes are an integral part of these consolidated financial statements.

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ACTION PERFORMANCE COMPANIES, INC.

The accompanying notes are an integral part of these consolidated financial statements.

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ACTION PERFORMANCE COMPANIES, INC.

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 (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):

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 March 31:

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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 unconsolidated partnerships, 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 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):

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(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 sales to Hasbro, quarterly, through May 2006. The additional consideration is added to the cost of the trademark quarterly. During fiscal 2004, $1.7 million was accrued as additional consideration payable under the earn-out provisions of the Funline acquisition agreement. The amount recorded for the Funline trademarks, included in the domestic die-cast segment, was increased by the amount of the additional consideration. In addition, during the first quarter of fiscal 2004, a revision of the preliminary purchase price allocation for the initial consideration for Funline resulted in a $3.6 million reduction in the amount 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 $30.3 million in cash and cash equivalents at March 31, 2004, and $45.4 million in cash and cash equivalents at September 30, 2003.

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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):

The impact of options and warrants outstanding for the purchase of 2.0 million and 1.4 million shares of common stock, at an average price of $25.93 and $28.79, were not included in the calculation of diluted EPS for the three months ended March 31, 2004 and 2003, because to do so would be antidilutive. The impact of options and warrants outstanding for the purchase of 1.4 million and 1.3 million shares of common stock, at an average price of $29.31 and $30.09 were not included in the calculation of diluted EPS for the six months ended March 31, 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 six months ended March 31, 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 six months ended March 31, 2004 because to do so also would be antidilutive. The notes could potentially dilute EPS in the future.

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.

On April 26, 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 requesting that the court rule as a matter of law that NHS be precluded from asserting any claims against us. Subsequently, on May 5, 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.

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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 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 collection is probable. Most distributor sales are recognized when product is shipped to a distributor because title to the product passes to the distributor 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 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 QVC ships the product to the consumer. Internet and other sales are generally recognized when delivered to the consumer.

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Cost of Sales

Cost of sales consists primarily of the cost of products procured from third-party manufacturers, royalty payments to licensors, depreciation of tooling and dies, and freight charges. 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.

Selling, General, and Administrative Expenses

Selling, general, and administrative expenses consist primarily of employee compensation, advertising and promotion, rent and other facility costs, and depreciation and amortization. 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 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.

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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. 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.

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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 March 31:

The following table sets forth net sales by channel of distribution and net sales from the operations of acquired businesses for the periods ended March 31 (in thousands):

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Three Months Ended March 31, 2004, Compared with Three Months Ended March 31, 2003

Net sales decreased to $83.9 million in the quarter ended March 31, 2004, from $91.1 million in the prior year quarter. Excluding $10.6 million in revenues from Funline operations, acquired in September 2003, net sales declined $17.7 million, or 19.5%, from the prior year quarter. Domestic die-cast sales, excluding the $10.6 million Funline revenues, decreased $15.2 million, or 43.9%, from the prior year quarter. Foreign die-cast sales increased $0.9 million, or 10.4%, from the prior quarter. The decrease in domestic die-cast sales resulted, in part, from timing issues surrounding the finalization of sponsor relationships and promotional strategies, 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 $0.2 million, or 0.7%, from the prior year quarter. Trackside sales decreased $3.2 million in the second quarter compared to the prior year quarter, to $10.8 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.

Gross profit was 29.2% of net sales in the second quarter of 2004, compared to 35.2% in the 2003 second quarter. The decline reflected the effects of product mix in which our lower margin products represented a higher percentage of total revenues, unanticipated charges, the impact of ratable amortization of annual tooling depreciation, which will reduce the margins in quarters of lower revenues, and lower margins from our NASCAR die-cast and stylized die-cast businesses.

Selling, general, and administrative expenses were $20.7 million, or 24.7% of sales, in the quarter ended March 31, 2004, compared to $19.8 million, or 21.7% of sales, in the prior year quarter. Excluding the operating expenses of Funline, acquired in September 2003, expenses in the 2004 second quarter decreased $0.5 million, or 2.5%, from the prior year second quarter.

Interest expense of $0.5 million for the three months ended March 31, 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 $0.3 million in the three months ended March 31, 2004, versus a foreign currency gain of $0.9 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 second quarter compared to $0.9 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 $0.1 million on a forward exchange contract.

The effective tax rate of 37.8% in the second 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.

Six Months Ended March 31, 2004, Compared with Six Months Ended March 31, 2003

Net sales decreased to $155.4 million in the six months ended March 31, 2004, from $176.9 million in the prior year period. Excluding $23.8 million in revenues from Funline operations, acquired in September 2003, net sales in the six months declined $45.3 million, or 25.6%, from the prior year period. Domestic die-cast sales, excluding the $23.8 million Funline revenues, decreased $35.2 million, or 46.9%, from the prior year period while foreign die-cast sales increased $1.1 million, or 6.6%, from the prior period. The decrease in domestic die-cast sales resulted, in part, from timing issues surrounding the finalization of sponsor relationships and promotional strategies, 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 $7.7 million, or 12.4%, in the 2004 first half compared to the 2003 first half. 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 $3.5 million in the first six months of 2004 to $16.9 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.

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Gross profit declined to 27.9% of sales in the six months ended March 31, 2004, excluding a $1 million charge to increase estimated royalty reserves applicable to calendar year 2003 and a $0.6 million write-off of Pontiac NASCAR tooling due to the withdrawal of Pontiac from NASCAR, compared to 35.4% in the comparable fiscal 2003 period. The decline reflected the effects of product mix in which our lower margin products represented a higher than normal percentage of total revenues, lower margins from our NASCAR die-cast and stylized die-cast businesses and the impact of ratable amortization of annual tooling depreciation, which will reduce the margins in periods of lower revenues.

Selling, general, and administrative expenses were $40.8 million, or 26.3% of sales, in the six months ended March 31, 2004, compared to $37.2 million, or 21.0% of 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 six months of 2004 were $37.1 million, which was comparable to the prior year period.

Interest expense of $0.9 million for the six months ended March 31, 2004, was $0.3 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 $0.6 million in the six months ended March 31, 2004, versus a foreign currency gain of $2.3 million in the prior year six months. Changes in the euro-to-U.S. dollar exchange rate resulted in translation gains of $0.9 million in the 2004 six months and $2.2 million in the 2003 six 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 $0.3 million on a forward exchange contracts.

The effective tax rate of 37.8% in the six months ended March 31, 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.

Liquidity and Capital Resources

Working capital increased $0.5 million to $114.1 million at March 31, 2004, from $113.6 million at September 30, 2003. Cash decreased $15.5 million to $34.0 million at March 31, 2004, from $49.5 million at September 30, 2003. Cash increased as a result of decreases in accounts receivable ($17.4 million). This increase in cash was offset by reductions in cash for net property and equipment expenditures ($13.4 million), payments for acquisitions of businesses and intangibles ($2.4 million), increases in inventory ($12.1 million), dividends to common and minority interest shareholders ($3.0 million), increases in other current assets, and decreases in other current liabilities.

Days sales outstanding, calculated on quarterly sales, were 57.2 days as of March 31, 2004, compared to 60.6 days as of September 30, 2003, and 50.6 days at March 31, 2003. The increase in DSOs from March 31, 2003, reflects the larger portion of revenues coming from retail channels that have longer dating terms and the timing of die-cast shipments.

Inventories at March 31, 2004, increased $13.2 million over amounts at September 30, 2003. Of this increase, $4.5 million was attributable to Funline due to inventory requirements for the mass retailers, $1.2 million was due to in-transit inventories, and a $2.9 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.

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Domestic and foreign die-cast, including Funline product, backlog was $71 million and $67 million at March 31, 2004 and 2003. Apparel and memorabilia backlog was $18 million and $19 million at March 31, 2004 and 2003. Backlog on any date in a given year is not necessarily indicative of future sales.

As of March 31, 2004, 4³/4% convertible subordinated notes with a face value of $29.9 million remained outstanding. The subordinated notes are 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. Interest on notes is payable semi-annually on April 1 and October 1 of each year. The notes mature on April 1, 2005. The notes are general unsecured obligations of our company, subordinated in right of payment to all existing and future senior indebtedness, as defined in the notes. The indenture governing the notes does not limit or prohibit our company or our subsidiaries from incurring additional debt, including senior indebtedness. We have the option to redeem the notes in whole or in part at any time, at redemption prices set forth in the indenture governing the notes. Upon the occurrence of a “change in control” or a “termination of trading,” as defined in the indenture, the holders of the subordinated notes will have the right to require us to repurchase all or any part of such holders’ notes at 100% of their principal amount, plus accrued and unpaid interest.

Capital expenditures related principally to ongoing investments in tooling and building additions in Aachen, Germany, $13.4 million for the six months ended March 31, 2004, and included $3.8 million applicable to foreign operations and $4.1 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 between $20 million to $24 million.

Under our loan and security agreement with Bank One, we are required to meet certain financial tests, principally related to debt coverage, tangible net worth, and funded indebtedness to EBIDA (earnings before interest, depreciation, and amortization). We were in compliance with those covenants at March 31, 2004. We have never borrowed under the agreement, originally dated September 2000. Outstanding letters of credit totaled $2.2 million at March 31, 2004.

Cash requirements over the next twelve months include the requirement to repay the $29.9 million of 4³/4% convertible subordinated notes due April 1, 2005. We believe that available cash, the loan and security agreement, cash generated from operations, and access to debt markets will be adequate to fund our capital requirements for this purpose and the foreseeable future.

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.

In July 2003, the Board of Directors approved a one-year program under which we may purchase up to 1.0 million shares of our common stock in the open market or in privately negotiated transactions.

A summary of dividends paid on common stock since September 30, 2003, follows (in thousands, except per share data):

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.

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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.

We currently use 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 $18.3 million at March 31, 2004. We have 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 do not qualify for hedge accounting and is recorded on the balance sheet at fair value. Changes in fair value are recorded each period in foreign currency gains and losses.

At March 31, 2004, we were party to a forward with a notional value of 5.0 million euros ($6.2 million as of March 31, 2004), maturing in May 2004, which remained unsettled. The notional amount does not quantify risk or represent our liability, but is used in calculation of cash settlements under the contract. As of March 31, 2004, $0.4 million of net unrealized losses on the contract were accrued on this forward. We realized $0.2 million of losses in May 2004 on a contract, which settled at maturity.

We are exposed to credit risk on this contract in the event of non-performance by the counterparty. However, the counterparty to this transaction is a major financial institution we deem credit worthy. We do not anticipate non-performance.

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, 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.

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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

The annual meeting of shareholders was held on March 5, 2004. The following nominees were elected to the board of directors to serve as directors until their successors are elected and qualified: Fred W. Wagenhals, R. David Martin, Melodee L. Volosin, John S. Bickford, Sr., Edward J. Bauman, Herbert M. Baum, Lowell L. Robertson, Robert L. Matthews, Roy A. Herberger, Jr. The shareholders also ratified the appointment of PricewaterhouseCoopers LLP as independent public accountants of our company for fiscal 2004, by the following vote: 16,975,446 for, 217,396 against, and 2,221 abstaining.

ITEM 5. Other Information

Not applicable

ITEM 6. Exhibits and Reports on Form 8-K

(a)

Exhibits

(b)		Reports on Form 8-K
		We filed a current report on Form 8-K, dated January 13, 2004, reporting that we issued a press release announcing anticipated net sales for the quarter ending December 31, 2003 and reiterated guidance for the year ending September 30, 2004.
		We filed a current report on Form 8-K, dated February 2, 2004, reporting that we issued a press release announcing our first quarter ended December 31, 2003, results.
		We filed a current report on Form 8-K, dated March 5, 2004, reporting that we issued a press release announcing that the Board of Directors declared a quarterly dividend of five cents ($0.05) per share of common stock for the quarter ending March 31, 2004.

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SIGNATURES

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

ACTION PERFORMANCE COMPANIES, INC.

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