Share price as of Monday's close:

$11.77

Share price now:

$9.35

Change:

-20.6%

Volume:

2.2 million shares, daily average 258,800 shares

Last time this low:

Nov. 2, 2004

52-week high:

$16.17

52-week low:

$8.37

Forward P/E before announcement:

25.0 (based on 47 cents a share)

Forward P/E after announcement:

18.7 (based on 50 cents a share)

TOO MANY NASCAR CARS CROWDING

the same turn can instantly transform a race into a demolition derby.

But stationary die-cast racing miniatures can also produce a wipeout, when too many turn a collecting boom to bust, leaving behind a junk pile of unwanted inventory. That was the message behind the disappointing performance of Action Performance Tuesday.

Shares of the Phoenix-based auto racing merchandiser crashed 21% to $9.35 on Tuesday after it swung to a loss and suspended the quarterly dividend.

"The market for die-cast collectibles is soft and a lot of it is Action's own fault," says Dennis McAlpine, a principal at the independent research boutique McAlpine Associates. "It flooded the market to keep sales going. Action saturated it with new versions of the same things. Instead of one Jeff Gordon car with one paint scheme, it put out four or five paint schemes to get the collectors to buy them all, and it outlasted the collectors' ability to buy."

For the second quarter ended March 31, the company reported a net loss of $2.9 million, or 16 cents a share, reversing the year-ago profit of $1.3 million, or seven cents a share. Thomson First Call had a consensus estimate for a profit of six cents. Revenues fell 10% to $75.3 million, whereas the company had hoped to improve on first-quarter sales of $76.1 million.

In addition to the metal replicas of Nascar cars, Action markets t-shirts, hats and other racing memorabilia. It blamed the disappointing results on lower sales of die-cast collectibles to mass merchandisers and, to a lesser extent, lower apparel sales to wholesalers.

Domestic sales of die-cast cars fell 21% to $23.8 million, with the biggest area of weakness in the mass merchandise space, where sales plunged 43% to $7.8 million. Apparel sales slid 7% to $30.5 million, driven by a decline in sales of Jeff Hamilton merchandise.

"Our current business model has resulted in too much product being shipped into the channel, which pressures pricing and angers our core customer, reducing demand and creating financial stress for our distributors," said David Riddiford, Action's chief financial officer, during a conference call late Monday. "To break this vicious cycle, we identified that breaking our distribution channel is paramount with the emphasis for the organization to shift to profit growth rather than sales growth."

According to McAlpine, sales began to slump when collectors who bought the toy cars began to find them listed at a discount to the retail price on eBay.

Action recently announced plans to cut out distributors, keeping their cut for itself. It's also trying to restore its product's appeal by limiting supply, in the hope that the resulting scarcity will restore prices.

In the meantime, the yellow caution flag is out. CFO Riddiford said Action experienced a free cash flow drain of $8.1 million during the latest quarter. Cash flow from operations should turn around in the second half of the year as capital expenditures come down, he added.

To pay for the restructuring initiatives, the company will skip its traditional nickel-a-share dividend for the second consecutive quarter. As of March 31, Action had $6.4 million in cash, a little more than half the $12.5 million it reported six months earlier. Long-term debt was $4.3 million, and total debt was $18 million. The company said it would evaluate the dividend on a quarter-by-quarter basis.

"We view this as a transition quarter and remain encouraged that the longer-term turnaround remains on track," wrote William Chappell, an analyst at Atlanta investment bank SunTrust Robinson Humphrey in a note maintaining his Neutral rating. "While this plan and related elimination of its third-party distributors carries ample near-term risks, we believe it is the right step for streamlining the business and improving overall profitability. We believe the company is taking the right steps to improve the business model for 2006 and beyond... and believe the majority of the near-term risk is reflected in the current stock price."

Chappell's sources indicate Action will retain a key merchandising contract with racing star Dale Earnhardt, Jr. The deal, which expires at the end of the year, accounts for 26% of the company's revenues.

Action refrains from giving specific revenue and earnings guidance. The company did say it expects fiscal third-quarter revenue to gain sequentially, while falling short of the year-ago levels. Wholesale sales of die-cast models are expected to fall year-over-year as Action shakes up its supply chain. First Call has an earnings estimate of 16 cents a share. Action Performance did not return calls seeking comment.

Quote:
"I don't see any reason to buy or any reason to hold this stock," says McAlpine of McAlpine Associates. "The risk-reward ratio is very high. This is a company with a record of screwing up that is undergoing a major transition in its distribution system and has a lot of inventory in a damaged market. If you have a tendency to be conservative, this is not one to look at with its high risk and not great reward."

McAlpine doesn't own shares of Action Performance; McAlpine Associates doesn't do investment banking. Chappell doesn't own shares of Action Performance; SunTrust Robinson Humphrey doesn't have an investment-banking relationship with the company.