SECURITIES AND EXCHANGE COMMISSION

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.

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.

Table of Contents

PART I- FINANCIAL INFORMATION

ITEM 1. Financial Statements

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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)

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

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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)

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

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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)

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

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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:

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):

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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

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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):

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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 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.

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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.

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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.

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	•	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.

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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

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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.

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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:

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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 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:

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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.

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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:

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

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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.

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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:

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

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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):

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).

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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.

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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 Agreement
	10.79	Form of Action Performance Companies, Inc. 2000 Stock Option Plan Stock Option Agreement
	10.80	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 Officer
	31.2	Rule 13a-14(a) and Rule 15d-14(a) Certification of Chief Financial Officer
	32.1	Section 1350 Certification of Chief Executive Officer
	32.2	Section 1350 Certification of Chief Financial Officer

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99.1

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

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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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