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ALUF HOLDINGS, INC. - Quarter Report: 2008 September (Form 10-Q)

Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(Mark One)
x
Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2008
or
o
Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from _________ to _________

000-13118
(Commission File No.)

ACTION PRODUCTS INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)

Florida
59-2095427
(State or other jurisdiction of
(IRS Employer Identification No.)
incorporation or organization)
  

1101 North Keller Rd., Suite E, Orlando, Florida, 32810
(Address of principal executive offices, Zip Code)

Registrant's telephone number, including area code (407) 481-8007

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES x  NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 

Large accelerated filer o Accelerated filer o  Non-accelerated filer Smaller reporting company x
 
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): YES o NO x 

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of latest practicable date.
Class
Outstanding at November 11, 2008
Common Stock, $.001 par value
5,676,400


INDEX

   
Page
   
Number
PART I. FINANCIAL INFORMATION
  
     
Item 1.
Financial Statements
  
     
Condensed Consolidated Balance Sheets at September 30, 2008 (unaudited) and December 31, 2007
 3
   
Condensed Consolidated Statements of Operations - Three and nine months ended September 30, 2008 and 2007 (unaudited)
 4
   
Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 2008 and 2007 (unaudited)
 5
   
Notes to Condensed Consolidated Financial Statements (unaudited)
 6
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
11
     
Item 4.
Controls and Procedures
13
     
PART II. OTHER INFORMATION
  
     
Item 1.
Legal Proceedings
14
     
Item 2.
Unregistered Sales of Securities and Use of Proceeds
14
     
Item 4.
Submission of Matters to Vote of Shareholders
14
     
Item 5.
Other Information
15
     
Item 6.
Exhibits
15
     
SIGNATURE PAGE
16

Page 2 of 16

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

ACTION PRODUCTS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

   
September 30, 2008
      
   
(Unaudited)
  
December 31, 2007
  
           
ASSETS
CURRENT ASSETS
              
Cash and cash equivalents
  
$
7,800
  
$
44,400
  
Investment securities
    
295,000
   
475,000
 
Accounts receivable, net of allowance of $26,100 and $47,200
    
1,395,100
   
1,429,800
 
Other receivable
    
-
    
3,233,700
 
Inventories, net
    
1,502,100
   
2,131,800
 
Prepaid expenses and other assets
    
235,500
   
197,700
 
TOTAL CURRENT ASSETS
    
3,435,500
   
7,512,400
 
               
PROPERTY, PLANT AND EQUIPMENT
    
3,680,200
   
3,650,400
 
Less accumulated depreciation and amortization
    
(2,875,600
)
  
(2,761,100
)
NET PROPERTY, PLANT AND EQUIPMENT
    
804,600
   
889,300
 
               
GOODWILL
    
1,890,300
   
1,405,300
 
OTHER ASSETS
    
504,300
   
276,100
 
TOTAL ASSETS
  
$
6,634,700
  
$
10,083,100
  
               
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
              
Accounts payable
  
$
1,100,900
  
$
1,811,900
  
Accrued expenses, payroll and related expenses
    
686,300
    
593,900
 
Borrowings under line of credit
    
1,556,500
    
1,960,400
 
Borrowings under investment account
    
66,300
    
141,800
 
Other current liabilities
    
19,800
    
89,600
 
TOTAL CURRENT LIABILITIES
    
3,429,800
   
4,597,600
 
               
SHAREHOLDERS' EQUITY
Preferred stock - $.001 par value; 10,000,000 shares authorized, 40,000 and -0- shares issued, respectively
    
-
    
-
  
Common stock -$.001 par value; 15,000,000 authorized;5,916,000 and 5,660,000 shares issued, respectively
    
5,900
   
5,700
 
Treasury stock - 240,600 and 208,600 shares, at par, respectively
    
(200
)
  
(200
)
Additional paid-in capital
    
9,875,300
   
9,260,200
 
Unearned share based compensation cost
    
(113,500
)
  
(256,300
)
Accumulated deficit
    
(6,562,600
)
  
(3,523,900
)
TOTAL SHAREHOLDERS' EQUITY
    
3,204,900
   
5,485,500
 
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
  
$
6,634,700
  
$
10,083,100
  

See Accompanying Notes

Page 3 of 16

ACTION PRODUCTS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

   
Three Months Ended September 30
  
Nine Months Ended September 30
  
   
2008
  
2007
  
2008
  
2007
  
                   
GROSS SALES
  
$
1,790,400
  
$
1,776,400
  
$
4,204,600
  
$
4,685,200
  
SALES RETURNS AND ALLOWANCES
    
57,300
   
91,500
   
136,800
   
198,400
 
NET SALES
    
1,733,100
    
1,684,900
    
4,067,800
    
4,486,800
  
                           
COST OF SALES
    
1,397,800
   
998,000
    
2,877,900
    
2,630,000
  
GROSS PROFIT
    
335,300
    
686,900
    
1,189,900
    
1,856,800
  
                           
OPERATING EXPENSES
                          
Selling
    
545,600
   
359,500
   
1,386,200
    
1,175,900
  
General and administrative
    
777,100
   
724,500
    
2,507,700
    
2,041,300
  
TOTAL OPERATING EXPENSES
    
1,322,700
    
1,084,000
    
3,893,900
    
3,217,200
  
                           
LOSS FROM OPERATIONS
    
(987,400
)
  
(397,100
)
  
(2,704,000
)
  
(1,360,400
)
                           
OTHER INCOME (EXPENSE)
                          
Interest expense
    
(20,800
)
  
(42,200
)
  
(85,900
)
  
(100,600
)
Other
    
(139,600
)
  
(90,000
)
  
(225,900
)
  
132,500
  
TOTAL OTHER INCOME (EXPENSE)
    
(160,400
)
  
(132,200
)
  
(311,800
)
  
31,900
  
                           
LOSS BEFORE INCOME TAX PROVISION
    
(1,147,800
)
  
(529,300
)
  
(3,015,800
)
  
(1,328,500
)
INCOME TAX PROVISION
    
23,100
    
-
    
23,100
    
-
  
                           
NET LOSS
  
$
(1,170,900
)
$
(529,300
)
$
(3,038,900
)
$
(1,328,500
)
                           
LOSS PER SHARE
                          
Basic and Diluted
  
$
(0.21
)
$
(0.10
)
$
(0.56
)
$
(0.25
)
                           
Weighted average number of common shares outstanding:
                          
Basic and Diluted
    
5,529,500
    
5,227,100
    
5,473,400
    
5,229,600
  

See Accompanying Notes

Page 4 of 16


ITEM 1. Financial Statements (cont.)

ACTION PRODUCTS INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

   
Nine Months Ended September 30
  
   
2008
  
2007
  
CASH FLOWS FROM OPERATING ACTIVITIES
              
Net Loss
  
$
(3,038,900
)
$
(1,328,400
)
Adjustments to reconcile net loss to net cash provided by/(used in) operating activities
              
Depreciation
    
114,500
   
135,800
 
Amortization
    
227,000
   
66,000
 
Unrealized (gain)loss on investment securities
    
274,100
   
(80,100
)
Stock based compensation expense
    
238,700
   
13,500
 
Provision for bad debts
    
77,500
   
(33,400
)
Loss on disposal of other assets
    
-
    
52,400
 
Changes in:
              
Litigation settlement receivable
    
3,233,700
   
-
  
Accounts receivable
    
(24,300
)
  
608,500
 
Investment securities
    
(94,100
)
  
(249,100
)
Inventories
    
629,700
   
(1,160,300
)
Prepaid expenses
    
(35,100
)
  
111,900
 
Other assets
    
(466,100
)
  
(168,100
)
Accounts payable
    
(711,000
)
  
1,316,400
 
Accrued expenses, payroll and related expenses
    
22,500
    
62,700
 
Deferred revenue
    
-
    
(18,800
)
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
    
448,200
   
(671,000
)
               
CASH FLOWS FROM INVESTING ACTIVITIES
              
Acquisition of property, plant and equipment
    
(29,800
)
  
(61,500
)
               
CASH FLOWS FROM FINANCING ACTIVITIES
              
Purchase of treasury stock
    
(32,700
)
  
(7,700
)
Repayment of mortgage principal
    
-
    
(41,100
)
Proceeds from exercise of warrants and sale of preferred stock
    
57,100
    
-
  
Common stock options and warrants issuance costs
    
-
    
(900
)
Net change in borrowings under line of credit
    
(403,900
)
  
401,600
 
Net change in borrowings under investment account
    
(75,500
)
  
46,800
 
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
    
(455,000
)
  
398,700
 
               
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
(36,600
)
  
(333,800
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    
44,400
   
369,900
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  
$
7,800
  
$
36,100
  
               
Supplemental disclosures - cash paid for:
              
Interest
  
$
85,900
  
$
74,100
  
Income Taxes
  
$
23,100
  
$
-
  

See Accompanying Notes

Page 5 of 16

ACTION PRODUCTS INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.
Condensed financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all normal recurring adjustments necessary to present fairly the financial position of Action Products International, Inc. (the “Company”), at September 30, 2008 and December 31, 2007, the results of its (i) operations for the three and nine month periods ended September 30, 2008 and 2007 and (ii) cash flows for the nine month periods ended September 30, 2008 and 2007. The financial information included herein is taken from the books and records of the Company and is unaudited.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s annual report on Form 10-KSB for the year ended December 31, 2007. The results of operations for the three and nine month periods ended September 30, 2008 are not necessarily indicative of the operating results for the full year. Through September 30, 2008, the Company has been able to meet its obligations as they come due; however, it is at least reasonably possible that if the Company continues to incur losses and negative cash flows, it will have to obtain additional sources of debt or equity financing to maintain its liquidity (See Note 3). There can be no assurance that such financing will be available or available on terms acceptable to the Company, if needed.

2.
Operations. The Company incurred significant losses during the three and nine month periods ended September 30, 2008. In its effort to eliminate these losses, the Company has recently changed certain key members of management, has focused efforts on increasing sales and is evaluating its product lines for profitable margin contributions. In addition, management has implemented various cost reductions in compensation and facility expense and is evaluating additional reductions. In conjunction, the product development process and plans for 2009 are being streamlined to focus investments in market segments that are anticipated to generate higher sales growth. Management believes that it will be successful in its plans to return the Company to profitability; accordingly, no adjustments have been made to the accompanying financials that might be necessary if the Company were unable to return to profitable operations.
 
3.
Line of credit. On June 25, 2008, the Company and Presidential Financial Corporation entered into a Loan Agreement and Security Agreement which replaced the previous facility with Regions Bank and was funded on July 1, 2008. The Loan Agreement provides the Company the ability to borrow up to $2 million at any time during the term of the Loan Agreement. The amount that the Company may have outstanding under the Loan Agreement at any time is the sum of 85% of the Company’s receivables approved by the Lender plus 50% of the Company’s eligible inventory. The maximum amount of the inventory loan the Company may have outstanding against its inventory is the lesser of $600,000, or $700,000 from July 1 through September 30, and the loan amount outstanding against the Company’s receivables. Borrowings under the Loan Agreement will bear interest at a rate equal to 1% over the prime rate as quoted in the Wall Street Journal adjusted upon each change in such prime rate. The Company shall also pay the Lender a monthly service charge of 0.6% of the average daily outstanding balance during the month. The Company shall also pay an annual facility fee equal to 1% of the $2 million maximum loan amount. The Lender may audit the Company’s records at the Company’s expense of $550 per day, up to a maximum amount of $8,000 per year.
 
The Loan Agreement renews annually each twelve months, unless the Company notifies the Lender of its intention to terminate at least 60 days before the end of such anniversary. If the Company pays the loan or otherwise terminates the Loan Agreement prior to each anniversary date, whether voluntarily or by default, then the Company shall pay the Lender 1% of the $2 million maximum loan amount.
 
The loan is secured by substantially all of the Company’s assets, including a first priority $1.5 million mortgage on the Company’s warehouse in Ocala, Florida. The outstanding balance under the loan is evidenced by a Demand Secured Promissory Note and is due upon demand by the Lender. The Loan

Page 6 of 16

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
 
Agreement contains non-financial covenants including restrictions on the Company’s ability to obtain loans, incur liens, dispose of assets and merge with other entities. In addition, the Loan Agreement requires the Company provide the Lender with certain periodic financial information as well as access to the Company’s records.
 
The Company had $1,556,500 and $1,960,400 of borrowings outstanding under the line of credit with Presidential Financial and Regions Bank as of September 30, 2008 and December 31, 2007, respectively.

Cash paid for interest on all borrowing arrangements and lease obligations for the nine months ended September 30, 2008 and September 30, 2007 was $85,900 and $74,100, respectively.

4.
Borrowings under Investment Account. As part of the normal arrangement with the broker handling the Company’s marketable securities investments, the Company has the opportunity to borrow under a margin arrangement, for investment, when appropriate. The balance on the borrowing is secured by the securities in the portfolio and interest is charged at a variable rate on the average balance. The rate at September 30, 2008 ranged from 3.99 percent to 6.99 percent based on the balance borrowed. Borrowings under this account were $66,300 and $141,800 as of September 30, 2008 and December 31, 2007, respectively.

5.
Earnings (loss) per share. Common stock equivalents were not included in the computation of diluted earnings (loss) per share for the three and nine month periods ended September 30, 2008 and 2007, as their effect would have been anti-dilutive. Common share equivalents excluded from the diluted earnings per share computations were 7,034,400 and 7,121,600 for the three and nine months ended September 30, 2008 and September 30, 2007 respectively.

6.
Common Stock and Equity Securities. On May 17, 2007, the Board of Directors authorized effective immediately, a program to repurchase up to 150,000 of the outstanding common shares. Repurchases may be made by the Company from time to time in the open market at prevailing prices, in either block purchases or in privately negotiated transactions. The share repurchase program does not have a fixed expiration date. However, the Board may discontinue or suspend the program at any time. During the three month period ended September 30, 2008 the Company repurchased 11,949 shares of its common stock at a cost of $17,600 and 115,182 shares remain available for repurchase under the plan.

In 2003, the Company’s shareholders were issued one warrant for each share of common stock owned as of June 12, 2003, the record date. Each warrant entitles the holder to purchase one common share at an exercise price of $2.00. On June 6, 2006, the Company’s Board of Directors extended the expiration date of the warrants from June 9, 2006 to December 31, 2010. All other terms of the warrants remain the same. As of September 30, 2008 approximately 3,272,100 warrants had been issued and 1,566,700 had been exercised.

In 2006, the Company’s shareholders were issued one warrant for each share of common stock owned as of January 18, 2006, the record date. Each warrant entitles the holder to purchase one common share at exercise prices of $3.25 and $3.75. On January 30, 2008, the Company’s Board of Directors extended the expiration dates of the warrants such that the warrants will allow the holders of each warrant owned to purchase one share of common stock at an exercise price of $3.25 per share until January 31, 2009 or $3.75 per share from February 1, 2009 until January 31, 2011. As of September 30, 2008 5,197,200 warrants had been issued and 5,900 had been exercised.

Share-Based Compensation. The Company has a stock-based employee compensation plan (the “Plan”) that provides incentives through the grant of stock options. The exercise price of stock options granted under the Plan shall not be less than the fair market value of the shares on the date of grant. As of September 30, 2008, 1,400,000 shares of common stock are reserved for issuance under the Plan.

Page 7 of 16

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
Common Stock and Equity Securities (cont.)
 
Share-based compensation is recorded in accordance with SFAS 123R. Share-based compensation cost is measured at date of grant, based on the fair value of each employee and director grant of options to purchase common stock using the Black-Scholes option-pricing model. The fair value of restricted common stock grants is measured based upon the quoted market price of the Company’s common stock on the date of grant. Compensation expense is recognized over the requisite service period underlying the arrangement. On September 30, 2008 the Company had one share-based compensation plan. The compensation costs charged as operating expense for grants under the plan were approximately $47,400 and $900 for the three months ended September 30, 2008 and September 30, 2007, respectively and $238,700 and $13,500 for the nine months ended September 30, 2008 and September 30, 2007, respectively.

During the three months ended September 30, 2008 we did not grant any shares of restricted common stock and we did grant options to purchase common stock, to directors of the Company.

A summary of option activity under the plan as of September 30, 2008, and changes during the nine months then ended are presented below:

Options
  
Number of 
Options
  
Weighted-
Average 
Exercise Price
  
Weighted-
Average 
Remaining 
Contractual Term
  
Weighted-Average 
Grant Date Fair 
Value
  
                                                                   
Outstanding at January 1, 2008
 
 
204,000
 
$
3.13
 
 
1.2
 
$
1.84
 
Grants
 
 
70,000
 
$
1.20
 
 
4.3
 
$
0.59
 
Exercises
 
 
-
 
$
-
 
 
-
 
$
-
 
Cancellations
 
 
(10,000)
 
$
3.04
 
 
-
 
$
1.36
 
Outstanding at March 31, 2008
 
 
264,000
 
$
2.62
 
 
1.9
 
$
1.57
 
Grants
 
 
-
 
$
-
 
 
-
 
$
-
 
Exercises
 
 
-
 
$
-
 
 
-
 
$
-
 
Cancellations
 
 
(6,000)
 
$
6.25
 
 
-
 
$
1.79
 
Outstanding at June 30, 2008
 
 
258,000
 
$
2.54
 
 
1.7
 
$
1.55
 
Grants
 
 
45,000
 
$
1.80
 
 
4.7
 
$
1.07
 
Exercises
 
 
-
 
$
-
 
 
-
 
$
-
 
Cancellations
 
 
-
 
$
-
 
 
-
 
$
-
 
Outstanding at September 30, 2008
 
 
303,000
 
$
2.85
 
 
5.0
 
$
1.48
 
Shares exercisable at September 30, 2008
 
 
258,000
 
$
2.54
 
 
1.5
 
$
1.55
 

The Company’s weighted-average assumptions used in the pricing model and resulting fair values were as follows:

   
Nine months ended 
September 31, 2008
  
Risk-free rate
 
 
3.8%
 
Expected option life (in years)
 
 
4.4
 
Expected stock price volatility
 
 
80.0%
 
Dividend yield
 
 
0.0%
 
Weighted average grant date value
 
$
1.07
 

Page 8 of 16

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
Common Stock and Equity Securities (cont.)
 
On November 5, 2007 the Company granted an employee 225,000 shares of common stock to vest over a two year period, the compensation value was based on $1.40 per share market value on the date of grant. The compensation expense is being recognized over the vesting period. Unearned compensation cost from this grant was $74,200 and $256,300 as of September 30, 2008 and December 31, 2007 respectively.

In January 2008, the Company issued a warrant for services which entitles the holder to purchase 12,500 shares of common stock at an exercise price of $1.28 per share. The warrant expires on December 31, 2012 and is subject to redemption by the Company at $.001 per share following a 21 day written notice.

As of September 30, 2008 there was approximately $113,500 of total unrecognized compensation cost related to non-vested share-based compensation arrangements. This unearned share-based compensation cost is expected to be expensed in accordance with the following schedule:

Three months ended December 31, 2008
  
$
55,000
  
Year ended December 31, 2009
  
$
58,500
  
   
$
113,500
  
 
7.
Investment Securities. Investment securities are categorized as trading securities and stated at market value. Market value is determined using the quoted closing or latest bid prices. Realized gains and losses on investment transactions are determined by specific identification and are recognized as incurred in the statement of operations. Net unrealized gains and losses are reported in the statement of operations and represent the change in market value of investment holdings during the period. At September 30, 2008 marketable securities consisted of the following:

   
Value At September 30,
2008
  
Cumulative Unrealized
Gain (Loss) At September 30,
2008
  
Equity Securities
  
$
295,000
  
$
(272,300
)
Stock Options
  
$
(19,700
)
$
(1,800
)
Total
  
$
275,300
  
$
(274,100
)

8.
Related Party Transactions. During the nine months ended September 30, 2008 and 2007, the Company paid $39,000 and $34,400, respectively, to Warren Kaplan, $7,400 and $0 respectively, to Judith Kaplan and $79,400 and $75,100, respectively, for consulting services to Ronel Management Company, wholly owned by Warren Kaplan, former Chairperson of the Board and Judith Kaplan, former Board member.

Included in the nine month amounts noted above are payments made for the three months ended September 30, 2008 and 2007, $13,500 and $13,200, respectively, to Warren Kaplan, $4,300 and $-0-, respectively, to Judith Kaplan and $26,600 and $26,000, respectively, for consulting services to Ronel Management Company, wholly owned by Warren Kaplan, former Chairperson of the Board and Judith Kaplan, former Board member.

9.
Business Combination with BE Overseas. On August 25, 2008, the Company and a newly-formed wholly owned subsidiary of the Company, Action Healthcare Products, Inc., a Florida corporation, (“AHCP”) entered into a Membership Interest Purchase Agreement to acquire all of the membership interests of B.E. Overseas Investment Group, LLC, a Florida limited liability company (“B.E.”). The acquisition was closed on August 25, 2008. Under the terms of the Membership Interest Purchase Agreement, AHCP acquired all of the outstanding membership interests in B.E.

Page 9 of 16

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
Business Combination with BE Overseas (cont.)
 
B.E. Overseas Investment Group, LLC is a merchant bank and consulting company that provides foreign companies capital and intellectual property for access to United States markets. At the time of acquisition two primary companies were included in B.E.’s investment portfolio; B.E. Home Medical Products Group, through B.E. has established relationships to release several electronic home health products from overseas companies and Bunch of Expressions, a uniquely modeled import and distribution company selling fresh flowers from South and Central America in the United States.  
 
The Company’s primary purpose of the acquisition of B.E. and the appointment of Mr. Swartz as Chief Executive Officer was to strengthen its existing toy business and pursue additional lines of business in the consumer products sector. The Company has identified healthcare products as a consumer goods business with high profit margins and growth potential and that also complements the Company’s existing consumer goods distribution infrastructure that the Company has developed with its toy business.

As consideration for the membership interest in B.E., the Company agreed to issue an aggregate of 500,000 shares of its common stock. From such shares of common stock, 250,000 shares were withheld and are contingently issuable upon the Company’s receipt of all funds due under a separate securities purchase agreement discussed below. This acquisition has been recorded based upon the fair value of the common stock issued by the Company. Acquired identifiable tangible and intangible assets as well as liabilities were not significant which resulted in the recording of approximately $485,000 of goodwill. The fair value of the contingent consideration will be recorded upon the satisfaction of such contingency.

Pursuant to the terms of the escrow, each owner of B.E. would receive the escrowed shares if, on or before September 22, 2008, the Company receives $500,000 from the Investor as required by a Securities Purchase Agreement (“SPA”). If such funds were not received by September 22, 2008, then the escrowed shares would be returned to the Company. The parties agreed to extend, pursuant to an Omnibus Amendment Agreement, the term to fund the purchase of the Preferred Shares payable by the Investor to the Company through October 31, 2008. In order for the Company to agree to the extension, the Investor paid the Company a fee of $5,000. The Company received the first installment of $40,000 on September 23, 2008. Through October 31, 2008 the Company has received total proceeds of $195,000. The parties are currently in discussions to extend the term of the funding period under the SPA.
 
10.
Other Commitments. In January 2006, the Company renewed its License Agreement with Porchlight Entertainment, Inc., for the rights to market certain toy lines including a wooden adventure system and die cast metal collection under the Jay Jay The Jet Plane™ name. The term of the Agreement is for two years expiring on December 31, 2008, subject to the Company meeting certain minimum sales objectives and royalty requirements.

In May of 2007 the Company entered into a merchandising license agreement with the American Museum of Natural History to produce and sell its Ology brand products. The agreement expires June 30, 2010 and contains sales quotas and minimum royalty payments due for each annual period ending on June 30.
 
In November 2007 the Company entered into a product development and royalty agreement with a consultant to revamp packaging of existing Curiosity Kits products and produce new product concepts for the Curiosity Kits brand. The agreement expires September 30, 2008 and provides for royalty payments on annual aggregate net sales for the life of the products specified in the agreement. 

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements:
 
Forward-looking statements in this Form 10-Q including, without limitation, statements relating to our plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements made in this report, other than statements of historical fact, are forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. The following factors, among others, could cause actual results to differ materially from those set forth in the forward-looking statements -- our ability to successfully develop our brands and proprietary products through internal development, licensing and/or mergers and acquisitions.
Additional factors include, but are not limited to, the size and growth of the market for our products, competition, pricing pressures, market acceptance of our products, the effect of economic conditions, intellectual property rights, the results of financing efforts, risks in product development and other risks identified in this report and our other periodic filings with the Securities and Exchange Commission.

Strategic Update
 
With  the acquisition of BE Overseas which brought a new management team and culture, the Company is focusing its efforts on building market share for its current line of award winning educational toy brands. Management will work to strengthen the Company’s presence in the educational toy and children’s segment while strategically transforming the Company from a one segment consumer product toy company to a global holding company, that builds profitability and shareholder value in established and growth stage consumer product companies.
 
Page 10 of 16
 
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
The Company believes it can develop unique untapped opportunity by maximizing its existing customer relationships through its established and unique multi-level channels of distribution. The Company’s award winning toy products have sold over 1.5 million units annually creating strong consumer acceptance and allowing additional market penetration with brand extensions and new product introductions. 
 
Today, in its 30th year, the Company has reshaped itself to strengthen its eight core quality consumer toy brands: Curiosity Kits® I Dig™ Excavation Adventures; Jay Jay the Jet Plane Wooden Adventure System™ Play & Store™ Space Voyagers® Kidz Workshop™ Climb@Tron™ and Woodkits™.  These toy lines include premium wooden toys, action figures, play-sets, activity kits, crafts and various other playthings with strategic emphasis on non-violent, educational and fun topics such as crafts, space, dinosaurs, science and nature.

Management believes the path to maximizing our current market position encompasses the following assets and operational strengths:

·
Accountable brand management philosophy
·
Eight award winning educational toy brands
·
35,000 sq ft distribution center
·
Outsourced/scalable manufacturing process
·
Leverage over 1.5 million units sold annually with cross-selling materials
·
Currently sold in 2,000+ retail stores across USA
·
500+ location-based edutainment venues: Museums, Zoos, Aquariums, Theme-parks & Attractions
·
Specialty & Department Retail Chains: Toy’s R’ Us, Barnes & Noble, JoAnn’s, Michaels, Lowes, Home Depot, JC Penney’s, Target, and others

Our operational focus for executing this strategy will be based on the following priorities:

·
Maximize existing relationships with retailers while opening new channels
·
Re-allocate resources to support our sales channel priorities
·
Promote all products to all customer segments to generate additional revenue opportunities
·
Become a recognized leader in the Educational toy children’s segment
·
Create a multi-media on-line experience for our consumers to entertain, educate and generate revenue
·
Build targeted retailer and consumer programs to maximize selling opportunities year round
·
Find other opportunities in the consumer products segment that can take advantage of existing infrastructure
·
Capitalize on business development through the BE acquisition

Results of Operations:
Three Months and Nine Months Ended September 30, 2008 Compared With Three Months and Nine Months Ended September 30, 2007

The following should be read in conjunction with our financial statements and the related notes thereto included elsewhere herein. The following table sets forth, as a percentage of sales, certain items appearing in our statements of operations.

Page 11 of 16

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)

   
Three Months
Ended
September 30,
2008
  
Three Months 
Ended 
September 30, 
2007
  
Nine Months 
Ended 
September30, 
2008
  
Nine Months 
Ended 
September 30, 
2007
  
Net Sales
    
100.0%
 
  
100.0%
 
  
100.0%
 
  
100.0%
 
Cost of Sales
    
80.7%
 
  
59.2%
 
  
70.7%
 
  
58.6%
 
Gross Profit
    
19.3%
 
  
40.8%
 
  
29.3%
 
  
41.4%
 
Selling Expense
    
31.5%
 
  
21.3%
 
  
34.1%
 
  
26.2%
 
General and Administrative Expense
    
44.8%
 
  
43.0%
 
  
61.6%
 
  
45.5%
 
Total Operating Expense
    
76.3%
 
  
64.3%
 
  
95.7%
 
  
71.7%
 
Loss from Operations
    
(57.0%)
 
  
(23.6%)
 
  
(66.4%)
 
  
(30.3%)
 
Other Income (Expense)
    
(9.3%)
 
  
7.8%
 
  
(7.7%)
 
  
0.7%
 
Loss before income taxes
    
(66.3%)
 
  
(31.4%)
 
  
(74.1%)
 
  
(29.6%)
 
Income Taxes
    
1.3%
 
  
-
  
0.6%
 
  
-
Net Loss
    
(67.6%)
 
  
(31.4%)
 
  
(74.7%)
 
  
(29.6%)
 
 
Net sales for the three months ended September 30, 2008 were $1,733,100 compared with net sales of $1,684,900 for the three months ended September 30, 2007. Net sales for the nine months ended September 30, 2008 were $4,067,800 compared with net sales of $4,486,900 for the nine months ended September 30, 2007. The increase of $48,200 for the three-month period and decrease of $419,100 for the nine month period equates to 2.9% and 9.3% respectively. Management attributes the $48,200 increase for the three month period to an increase in Curiosity Kits sales resulting from shipments of new product received during the quarter largely offset by a decrease in I Dig sales. The $419,900 decrease in net sales for the nine month period, is principally attributable to a decrease in Curiosity Kits sales resulting from a transition to new product packaging being available for shipment starting in June and a decrease in I Dig sales. At the beginning of the 2008 fiscal period slow moving and overstocked items represented a significant portion of the Company’s inventory. As a result of improved purchasing procedures and disposing of slow moving product at approximately net realizable values, management has significantly reduced the levels of these overstocked items.
 
Gross profit decreased by $351,600 to $335,300 for the three months ended September 30, 2008, compared with $686,900 for the three months ended September 30, 2007 and decreased as a percent of net sales from 40.8% to 19.3% for the three-month periods ended September 30, 2007 and 2008, respectively. Gross profit decreased by $666,900 to $1,189,900 for the nine months ended September 30, 2008, compared with $1,856,800 for the nine months ended September 30, 2007. Gross profit as a percent of sales decreased from 41.4% to 29.3% for the nine-month periods ended September 30, 2007 and 2008, respectively. The decrease in gross profit percentage was almost entirely attributable to higher amortization of product development costs related to the Curiosity Kits brand and previously mentioned sales programs implemented to improve working capital by disposing of certain quantities of slow moving product at approximately net realizable values.

Selling, general and administrative (SG&A) expenses increased by $238,700 to $1,322,700 for the three month period ended September 30, 2008 from $1,084,000 for the three-month period ended September30, 2007. SG&A expenses increased by $676,700 to $3,893,900 for the nine months ended September 30, 2008 from $3,217,200 for the nine months ended September 30, 2007. These increases in SG&A expenses of 22.0%
for the three month period and 21.0% for the nine month period ended September30, 2008 are attributable primarily to the following:

·
An increase in compensation and related benefit costs of $155,100 and $446,900 for the three and nine month periods, respectively, principally as the result of additions of senior financial and sales personnel and an increase in stock based compensation;
·
An increase in professional services of $34,700 and $242,800 for the three and nine month periods, respectively, resulting primarily from Sarbanes-Oxley compliance consulting services, legal, investor relations services and recruiting fees;

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)

·
An increase in bad debt expense of $42,700 and $110,900 for the three and nine month periods, respectively; and

Page 12 of 16
 
The increase for the nine months ended September 30, 2008 was partially offset by:

·
A decrease in brand licensing expense of $44,600;
·
A decrease in commission expense of $21,800;
·
A decrease in travel expenses of $33,500 and
·
A reduction in insurance expense of $15,000

Interest expense related to current debt was $20,800 and $42,200 for the three month periods ended September 30, 2008 and 2007, respectively and $85,900 compared to $100,600 for the nine month periods ended September30, 2008 and 2007, respectively. The $21,400 decrease for the three month period was attributable to a decrease in the lending rate and lower borrowings under the line of credit. The $14,700 decrease for the nine month period was attributable principally to higher borrowings under the line of credit being more than offset by a decrease in the lending rate.

Other income and (expense), net during the three-month periods ended September 30, 2008 and 2007 was ($139,600) and ($90,000), respectively and ($225,900) compared to $132,500 for the nine month periods ended September 30, 2008 and 2007, respectively. The $49,600 change for the three month period and $358,400 change for the nine month period was mainly attributable to unrealized losses from investments in 2008.

Net loss, as a result of the foregoing, was $1,170,900 and $529,300 for the three months ended September 30, 2008 and 2007, respectively and $3,038,900 compared with $1,328,400 for the nine months ended September 30, 2008 and 2007, respectively.

Financial Condition, Liquidity, and Capital Resources:

As of September 30, 2008, we had cash and cash equivalents of $7,800, representing a decrease of $36,600 compared to $44,400 as of December 31, 2007.

After taking account of non-cash items and other adjustments, our cash provided by operations for the nine months ended September 30, 2008 was $448,200. The principal sources of cash from operating activities for the nine months ended September 30, 2008 were from collection of the litigation judgment $3,233,700, net decrease in inventories of $629,700. The principal uses of cash from operating activities for the same period were a decrease of $711,000 in accounts payable, an increase of $466,100 in other assets attributable to capitalized product development costs in addition to an increase of $94,100 in investment securities.

The principle use of cash from investing activities of $29,800 was for molds utilized in toy production.

The use of cash from financing activities of $455,000 resulted from decreases in borrowings under the line of credit of $403,900, decrease in borrowings under investment account of $75,500 and stock repurchases of $32,700, partially offset by proceeds from exercise of warrants and sale of preferred stock of $57,100.

At September 30, 2008, borrowing under our line of credit was $1,556,500, a decrease of $403,900 from $1,960,400 as of December 31, 2007.

ITEM 4. Controls and Procedures.

Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report were effective such that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure. 

Page 13 of 16

There were no changes in the company's internal control over financial reporting known to the Chief Executive Officer and Chief Financial Officer that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

The Company is engaged in various legal proceedings incidental to its normal business activities, none of which, individually or in the aggregate, are deemed by management to be material risk to the Company’s financial condition.

ITEM 2. Unregistered Sales of Securities and Use of Proceeds

Repurchase of Securities

On May 17, 2007, our Board of Directors authorized, effective immediately, a program to repurchase up to 150,000 of our outstanding common shares. Repurchases may be made by us from time to time in the open market at prevailing prices, in either block purchases or in privately negotiated transactions. The share repurchase program does not have a fixed expiration date. However, our Board may discontinue or suspend the program at any time. As of September 30, 2008, we have repurchased 34,818 of our common shares and 115,182 remain available under the plan. 

Repurchases of Common Shares
 
 
 
Total number 
of common 
shares 
purchased
 
Average price 
paid per 
common 
share
 
Total number of 
common shares 
purchased as 
part of publicly 
announced 
plans or 
programs
 
Maximum 
number of 
common shares 
that may be 
purchased 
under the plans 
or programs
 
July 1, 2008 - July 31, 2008
 
 
-
 
$
-
 
 
-
 
 
127,131
 
August 1, 2008 - August 31, 2008
 
 
-
 
$
-
 
 
-
 
 
127,131
 
September 1, 2008 - September 30, 2008
 
 
11,949
 
$
1.35
 
 
11,949
 
 
115,182
 
Total
 
 
11,949
 
$
1.35
 
 
11,949
 
 
115,182
 
 
ITEM 4. Submission of Matters to Vote of Shareholders
 
The 2008 Annual Meeting of Shareholders was held in our offices at 1101 North Keller Road, Orlando, Florida on Tuesday, November 11, 2008. The total number of shares entitled to vote at the meeting was 5,929,100. The total number of shares represented at the meeting in person or by proxy was 4,735,951.
 
Proposal 1. Election of Directors
 

Page 14 of 16
 
NAME
  
FOR
  
WITHHELD
Neil Swartz
  
3,441,364
 
1,294,587
Ronald S. Kaplan
  
3,324,845
 
1,411,106
Scott Runkel
  
4,684,149
 
51,802
Ann E. W. Stone
  
4,591,149
 
144,802
Cecilia Sternberg
  
4,667,920
 
68,031
 
Proposal 2. Approval of Adoption of 2008 Long-Term Equity Incentive Plan
 
The second proposal brought before the shareholders was to approve the adoption of the 2008 Long-Term Equity Incentive Plan. As a result of the votes cast, as described below, the second proposal was not approved.
 
FOR
  
AGAINST
  
ABSTAIN
  
BROKER NON-VOTE
250,896
 
1,428,404
 
1,948,925
 
1,107,726
 
Proposal 3. Approval of Amendment to Amended and Restated Articles of Incorporation
 
The third proposal brought before the shareholders was to approve the amendment to the Amended and Restated Articles of Incorporation to increase the authorized Common Stock to 25,000,000 shares. As a result of the votes cast, as described below, the third proposal was approved.
 
FOR
  
AGAINST
  
ABSTAIN
  
BROKER NON-VOTE
4,562,695
  
134,480
  
38,776
  
-


ITEM 5. Other Information

(a) None.
(b) None. 

ITEM 6. Exhibits
A. 
 
Exhibit No. 
Description
   
31.1
Chief Executive Officer - Sarbanes-Oxley Act Section 302 Certification*
31.2
Chief Financial Officer - Sarbanes-Oxley Act Section 302 Certification*
32.1
Chief Executive Officer - Sarbanes-Oxley Act Section 906 Certification*
32.2
Chief Financial Officer - Sarbanes-Oxley Act Section 906 Certification*

Page 15 of 16

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 PRODUCTS INTERNATIONAL, INC.

Date: November 14, 2008
By:
/s/ NEIL SWARTZ
   
Neil Swartz
   
Chief Executive Officer (Principal Executive Officer)

Date: November 14, 2008
By:
/s/ ROBERT BURROWS
   
Robert Burrows
   
Chief Financial Officer (Principal Financial and
   
Accounting Officer)

Page 16 of 16