Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of the issuer’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. o

 

 

 

 

ITEM 1.

DESCRIPTION OF BUSINESS

 

 

 

 

 

i.

Organic growth

 

 

ii.

New acquisitions

 

 

 

 

 

 

 

Immediately following the executive’s resignation, we implemented a cost reduction program that reduced operating expense by approximately $600,000 annually, while affording us the ability to sustain our product development efforts. In October 2006 an operations management consultant was retained to revitalize the operational performance of the toy and craft business by refocusing on the our original “non-promotional” or “specialty” brand and distribution strategies. In February 2007, the executive was named President and Chief Operating Officer. During his tenure, we developed new products for our I Dig Dinosaurs® and Play and Store^TM lines and reestablished a relationship with the original creator of Curiosity Kits^® to generate new product for the brand. Contemporaneously, a new theme brand called Crazy for Cupcakes^TM was created to capitalize on the growing popularity of the sweet bakery treat.

 

Net sales for the year ended December 31, 2007 were $6,100,400 compared to $7,437,100 in 2006, which represented an 18% decrease. This was largely due to a decrease in sales to mass market accounts. Similarly, sales of Curiosity Kits and Jay Jay The Jet Plane™ also decreased; with the decrease in Jay Jay The Jet Plane™ sales reflecting a decline in nationwide television carriage of the Jay Jay children’s show.. In response to these circumstances, we curtailed operating expenses and increased our investments in product development while restructuring our sales and marketing management.

 

Market Opportunity

 

Consumers are transitioning to on-line supported product purchases. We continue to seek new businesses to acquire which will expand our revenue potential and better leverage our fixed cost base. While distribution systems continue to change at an increased rate, the consumer trends gravitate to increasingly knowledgable parents and child caring adults. These more informed purchasers seek products and services that treat their children as learners rather than merely a consumer.

The principal markets for our toy and craft division’s products are consumers who purchase through specialty retailers, toy stores, the toy departments of national and regional chain retailers, museums and attractions, parent/teacher stores, mail order catalogs and increasingly the Internet. We currently compete primarily in the preschool and elementary school age categories in the United States and some international markets. We believe we are well positioned to grow faster than the traditional retail markets we participate in and our long-term goal is to capture a significant share of these markets.

We expect consumer preferences to drive increased spending on educational products and redefine markets for our toy and activity markets. Parents are concerned about the education of their children including the influence of safe and positive play. This concern is influenced by a number of factors, including the growing pressure for children to excel in an increasingly knowledge-based society. In turn, there is increasing emphasis in the United States and internationally on promoting interest in, and encouraging appreciation of, education, “edutainment” natural sciences and our environment. In sum, there has been a an upward trend in home activities noted in reports on do-it-yourself and at home or “nesting” activities. We believe these trends provide Action Products a significant market opportunity and can act in concert with the growing dependency on the Internet –a new conduit into ‘speak’ directly with consumers regarding their preferences, our products and services, and their availability.  

 

Several of our product lines which include I Dig™, Curiosity Kits® and Space Voyagers® appeal to the international consumer. We expect our foreign sales to grow in the future as we continue to execute on globalizing our testing and packaging and establishing new distribution agreements with foreign customers.

Our Market Position

 

Unlike promotional toys, Action Products brands emphasize quality and are a healthy alternative for consumers looking to avoid the negative influences of less positive play patterns and the exploitative, short-lived aspects of promotional toys. We believe we are well positioned to capitalize on the increased worldwide emphasis on education, “edutainment” and the trend towards encouraging children’s interest in positive play and their surroundings. We believe our innovative products meet this increasingly important market need.

Our Corporate Strategy

Our Corporate goal is to maximize value for our stakeholders. We are implementing strategies for expansion through mergers, acquisitions, distribution agreements and strategies to expand our current toy and craft business. Our goal is to become the leading provider of educational, positive, non-violent toys for ages 2-10 through specialty retailers and selected chain stores in the U.S. and international markets.

 

Our Products

Our products consist of toys and activity kits for children packaged and marketed under a diversified portfolio of brands. This mitigates the risks associated with single brand strategies and builds influence with our distribution channels as a provider of multiple best selling product lines designed to create long-term sales streams for our retail dealers and us. We realize not all brands have the same sales, distribution or longevity potential, however we believe creating brand equity amongst a core of diversified brands is important to our long term success and in the best interest of our shareholders. Following are descriptions of several of our key brands:

Curiosity Kits®

Founded in 1988 and acquired by Action Products in 2004, Curiosity Kits has been a leading brand in the children’s arts & crafts segment. Curiosity Kits encompasses a variety of craft activity kits, with everything from innovative science kits to activities with sculpting, drawing and painting for self-expression. Curiosity Kits focuses on offering high quality materials, tools, and the information needed to imagine and create lasting treasures while learning and having fun. In 2007 we reestablished a creative relationship with the original creator of the brand and will be introducing over twenty-five new products in 2008. Curiosity Kits has received several awards including the Dr Toy’s 100 Best in 2006, Creative Child Magazine Top Creative Toy Award and the Preferred Choice Award Toy of the Year Finalist in 2006 and 2005 and the Oppenheim Toy Portfolio Gold Award in 1998, 2000, 2001, 2002 and, 2004.

 

I Dig^TM Excavation Adventures

Our I Dig™ Excavation Adventures let children imagine they are modern day dinosaur hunters, archaeologists and treasure seekers. Using steel tools, children dig through dust free “rock” to unearth replica dinosaur bones, buried treasure and Egyptian artifacts. This line was expanded in 2007 with the introduction of two I Dig™ Adventures: an Arrowhead and Gold Rush dig. New for 2007 are more dinosaurs and other archaeological themes with the core I Dig scientific slant, and in development are some very imaginative themes with greater emphasis on the fun aspect of the digs.

Space Voyagers®

Our Space Voyagers® line combines vehicles from space programs of the past, present, and near future. This line of astronaut action figures and accessories is designed to appeal to both children and parents on two levels. The products are physically designed, decorated and packaged to appeal to the child’s sense of “cool” state-of-the-art figure based play, with scenarios of risk and heroism. The absence of violence and the inherently educational attributes of space exploration, science and discovery appeal to a wide variety of consumers.

Climb@Tron™

Climb@trons are interplanetary robots that climb up, down, around, and even upside down on smooth surfaces like windows, mirrors and cabinets using powerful suction cups and vacuum technology and auto reverse action to keep Climb@Tron™ going even after bumping into barriers. This is a consistent seller for Action Products in museums and attractions.

 

Jay Jay The Jet Plane™

Based on the animated series, Jay Jay The Jet Plane, Action Products’ Jay Jay the Jet Plane Wooden Adventure System™ comprised of characters and accessories, has been designed specifically for children ages 2 to 5, using high quality wood. In 2006 we executed a quality improvement program with our vendors in China, yielding an improved level of safety, thoroughly testing each wooden character, allowing us to announce in 2007 that age grading decreased to 2+ for the 14 wooden characters; this more closely reflects the identified younger audience of children who are Jay Jay fans. The television reach for Jay Jay The Jet Plane™ moved to the exciting new PBS Kids SPROUT TV network. This new private/public national cable and satellite network is a more strongly supported joint venture including HIT Entertainment, Comcast, and Sesame Workshop, providing a new, national platform for Jay Jay the Jet Plane. New items were initiated in 2006 with the goals of: supporting the child’s play of the complete system, drive gift giving of the Jay Jay character, and build products and promotions that enhance the retailer’s presentation in the store.

Kidz Workshop™

Our Kidz Workshop line includes the award winning EZ Build Projects™ that promote confidence-building, fun-to-assemble where one tool does it all; Kidz Workshop fits the bill for children ages 7 and up. EZ Build Projects are winners of Dr. Toy’s 10 Best Socially Responsible Toys and 2002 100 Best Children’s Products awards.

 

Licensing 

In December 2001 we signed a licensing agreement with Porchlight Entertainment 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 popularity of this PBS children’s cartoon made for a very successful launch of the product in the fourth quarter of 2002. The initial term of the agreement which expired in December 2004 and was extended at our election to December 2005. In January 2006 we signed a new licensing agreement that expires in December 2008.

 

In February 2007 we signed an agreement exiting the exclusive licensing agreement with Taffy Entertainment, LLC, to develop and distribute various lines of soft toys based on the new preschool entertainment series ToddWorld®. The term of the original Agreement was for four years expiring on February 28, 2009, with a two-year extension through February 28, 2011 subject to our company meeting certain minimum royalty requirements during the initial term. As a result of poor sales in 2005 and 2006 with no future expected benefit to our company, Taffy Entertainment, LLC and our company mutually agreed, in February, 2007, to terminate the contract for a final settlement amount of $35,000 plus remaining licensed product.

 

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.

 

We will continue to selectively seek out appropriate licensing agreements that support our objective to develop exclusive quality brands with long-term sales growth potential.

 

Manufacturing, Logistics and Other Operations

Our manufacturing and operations strategy is designed to maximize the use of outsourced product manufacturing services and to concentrate our internal resources on product development, sales and marketing. We believe our outsourcing strategy also enhances the scalability of our manufacturing efforts. We use several OEM contract manufacturers to source components and build finished products to our specifications. We currently use approximately 25 contract manufacturers located in the United States, Hong Kong and China to build our finished products. The suppliers are selected based on their technical and production capabilities and are matched to particular products to achieve cost and quality efficiencies.

During 2007 and 2006 our largest single manufacturer supplied 25% and 29% respectively, of our products and our top three manufacturers combined supplied a total of 60% for both periods. We believe that other manufacturers are available to us should any of our significant manufacturers, including our largest manufacturer, be unable or unwilling to continue to manufacture our products for us.

Based on our net sales in 2007, major retailers and international distributors took title to approximately 5% of our products directly from our manufacturing facilities in Asia. However, the majority of our product is shipped directly to our warehouse in Ocala, Florida and is later shipped to meet the demands of our major U.S. retailers and other retailers and distributors throughout the U.S. and Canada.

Marketing, Sales and Advertising

We exhibit our product lines at toy, gift and related industry trade shows. Our most important trade show is the American International Toy Fair held in New York City each February. In January 2007 we held our debut exhibit at the International trade fair of the Craft & Hobby Association, to positive reviews.

We sell our product lines through a network of manufacturer representative firms and an internal, direct-sales department. Our direct sales department includes a team that focuses on selling to our original customer base in the attraction and museum categories. Our sales department also has a customer service team that manages and supports our retailers and the manufacturer representative firms with marketing collateral, product information, order processing and selected customer presentations.

We capitalize on strategic marketing campaigns, point of purchase displays and creative package design to build brand equity and promote product sell-through. We partner with our retail customers nationally to sponsor I Dig™ Dinosaurs Play Days, featuring a dinosaur dig site allowing groups of children to participate in a live product demonstration. We also promote an in-store Woodkits Fixture Program, placing new merchandise racks in retail outlets throughout the U.S. and Canada. Retailers ordering a prescribed assortment and quantity of wood kit products are eligible for this program.

 

 

Trade advertising remained a core marketing tool in 2007. We placed ads throughout the year in trade publications including Playthings, The Toy Book and publications of the American Specialty Toy Retailers Association (ASTRA) ) as well as consumer catalogs published by retailers and advertising cooperative groups such as Learning Express, and The Good Toy Group.

 

Sales and Distribution

 

We service customers in all fifty U.S. states and the District of Columbia, and export to a number of foreign countries including the United Kingdom, Spain, Canada, Germany and Kuwait.

Our management focuses its efforts on growing our customer base by increasing our penetration and presence in new and existing distribution channels. Museum stores and attractions throughout the U.S. and around the world served as our primary customer base since the inception of our company. While this niche provided us with a solid foundation for growth, we have successfully expanded our distribution to national toy stores, specialty retailers and other available retail outlets. We have a diversified customer base including some of the major toy retailers in the U.S. and Canada. Ten large customers accounted for approximately 28% of our net sales in 2007. Our largest single customer accounted for approximately 5% of our total net sales.

Our sales team seeks to work in conjunction with store buyers from our key retailers to forecast demand for our products, develop the store floor footprint, secure retail shelf space for our products and agree upon pricing components, including cooperative advertising allowances. The large retail chains generally provide us with a preliminary forecast of their expected purchases of our products. While these and subsequent forecasts are not contractually binding, they provide important feedback that we use in our planning process throughout the year. We work closely with our key retailers during the year to establish and revise our expected demand forecasts and plan our production and delivery needs accordingly. Most retailers issue purchase orders to us, as they need product. Based on these purchase orders, we prepare shipments for delivery through various methods. For large retail chains, we generally deliver our products directly to these retailers’ warehouses from our third-party manufacturing factories. For our smaller retailers, we generally ship our products to our warehouse in Florida, and from there to the retailers’ respective locations. We sell to smaller volume retail stores through a combination of sales representatives and direct salespeople.

 

Our distribution strategy is focused on the specialty retail and selected mass-market channels. This includes selectively differentiating the products we distribute through each channel to address the divergent pricing, packaging and merchandising requirements of customers in the specialty and mass market channels. 

International Operations, Sales and Manufacturing

 

Overall revenues from our international sales represented approximately $0.4 million or 6% of our total revenues in 2007 and $0.5 million or 6% in 2006. Slightly less than 85% of international sales were made in Canada and the United Kingdom. Revenues from other international customers still represent a limited percentage of our total revenues.

 

Although we have a formal distribution agreement for The United Kingdom, we also sell to other international accounts and distributors on a direct basis.

In general, international sales are subject to inherent risks including, but not limited to, transportation delays and interruptions, political and economic disruptions, the imposition of tariffs and import and export controls, changes in government policies, cultural differences affecting product demands and the burdens of complying with a variety of foreign laws. Our products are produced by approximately 25 outside manufacturing companies in the U.S., Hong Kong and China, and are imported directly by us as finished goods. Though we did experience some delays in shipment in the fall of 2002 due to a prolonged work stoppage at 28 west-coast shipping ports, the effect was mainly a delay in sales and over the long term did not have a materially adverse effect on our business. We do not expect this event to reoccur any time soon, nor do we expect to be impacted by any of the other risks listed below. There are no assurances that such events will not occur in the future and possibly result in increases in costs and delays of, or interference with, product deliveries resulting in losses of sales and goodwill. We experience minimal currency risk because these foreign sourcing transactions are conducted using U.S. dollars.

The implementation of the General Agreement on Tariffs and Trade in 1996 reduced or eliminated customs duties on many products we import. We believe that the capacity of our facilities and the supply of completed products we purchase from unaffiliated manufacturers are adequate to meet the foreseeable demand for the product lines we market. Over a period of time, our reliance on external sources of manufacturing can be shifted to alternative sources of supply should such change be necessary. However, if we were prevented from obtaining products from a substantial number of our current Far East suppliers due to political, labor or other factors beyond our control, our operations would be disrupted while alternative sources of products were secured. The imposition of trade sanctions by the U.S. against a class of products imported by us could significantly increase the cost of importing our products into the U.S.

 

Competition

Our business is highly competitive and we compete for shelf space with various toy manufacturers, importers and distributors, such as Leapfrog with approximately $500 million in sales of educational toys; Learning Curve (which was acquired by RC2 Corporation) with over $100 million in sales to specialty retailers; Jakks Pacific which keys its growth to acquisitions; and a number of smaller companies primarily having single product lines and often privately owned. Our ability to compete successfully is based upon our core competencies, including our experience in conceptualizing and developing quality toys that are themed as non-violent and educational, our unique ability to perform a wide range of specialized “same day” shipment on most domestic orders and outstanding customer service. Our manufacturer representative firms and in-house sales professionals maintain regular and close contact with direct customers. Our reputation, customer service and unique brand offerings enable us to build and maintain customer loyalty.

Product Design & Development

The company works to refresh and redesign existing toy product lines and to develop innovative new toy product lines. During 2007 and 2006 we spent $259,800 and $64,100, respectively, in connection with the design and development of new products.

Intellectual Property

Our products are sold and protected under trademarks, service marks, trade names and copyrights, and a number of those products are produced using a patented method owned by us. We consider our intellectual property rights to be important assets in that they provide product recognition and protection. Our products are also protected in as many other countries as allowed by trademark, copyright and patent laws to the extent that such protection is available and meaningful. We currently believe our rights to these properties are adequately protected, but we cannot assure you that our rights can be successfully asserted in the future or that such rights will not be invalidated, circumvented or challenged.

Government Regulation

Our toys are subject to the provisions of the Consumer Product Safety Act, the Federal Hazardous Substances Act and the Flammable Fabrics Act, and all of the regulations promulgated hereunder. The Consumer Product Safety Act and the Federal Hazardous Substances Act enable the Consumer Product Safety Commission (CPSC) to exclude from the market consumer products that fail to comply with applicable product safety regulations or otherwise create a substantial risk of injury, and articles that contain excessive amounts of a banned hazardous substance. The Flammable Fabrics Act enables the CPSC to regulate and enforce flammability standards for fabrics used in consumer products. The CPSC may also require the repurchase by the manufacturer of articles that are banned. Similar laws exist in some states and cities and in various international markets.

 

Our products are rated according to the American Society of Testing and Materials (ASTM) safety protocol adopted by the United States and the EN-71 safety protocol adopted by the European Community. In addition, we expect to certify our products according to the Japanese Toy Association safety criteria for consumer products. We also voluntarily comply with certain standards established by the ASTM. Although compliance with this much stricter standard is completely at the discretion of the manufacturer, it is our firm policy that our toys meet this superior level of safety. We also maintain a quality control program to ensure product safety compliance with the various federal, state and international requirements. Our membership in the Toy Manufacturer’s Association provides an important resource to remain informed of the latest safety guidelines.

 

Notwithstanding the foregoing, there can be no assurance that all of our products are or will be hazard free. Any material product recall could have an adverse effect on us, depending on the product, and could affect sales of our other products.

Personnel

As of December 31, 2007, we had 32 employees worldwide, including three executive officers, five sales and customer support personnel, five marketing and product development personnel, nine distribution personnel and ten administrative and procurement personnel. We offer our employees a benefits package that includes health and life insurance plans, a 401(k) plan and an employee-contributed IRC Section 125 health plan. Employees are required to sign a non-compete agreement prohibiting direct competition with us for at least a one-year period following termination of their employment. None of our employees are represented by a labor union or are subject to a collective bargaining agreement.

 

 

ITEM 2.

DESCRIPTION OF PROPERTY

 

Our corporate headquarters are located in Orlando, Florida, where we lease a 6,000 square foot suite in a business district near downtown Orlando, staffed by executive, sales, marketing, importing and graphics personnel. We are currently on a short-term sublease that expires July 12, 2008. We intend to extend the lease for an additional 12 months through July 2009. We believe the lease rate will be increased moderately .

 

In addition, we own a distribution facility in Ocala, Florida. The Ocala facility, which we have owned for over twenty years and houses our distribution center, is comprised of a 35,000 square foot mixed use building and 2.5 acres of land. This facility, which is situated in an industrial park comprised of similar facilities, is expected to be sufficient to meet the current major portion of our warehousing and distribution needs. When peak warehouse space has been required we have been successful at obtaining additional space at reasonable rates in the vicinity of our facility.

 

There are no current plans to renovate or expand the facility. We follow a course of regular repair and maintenance to the structure and fixtures that keep the facility in good operating condition. In addition we maintain sufficient insurance to effect the replacement or repair of the facility.

 

In April 2006, we entered into a one year lease for 15,200 square foot of temporary storage in Ocala primarily for bulky Curiosity Kits product. When the one year temporary storage lease expired in April 2007, we leased a different property in Ocala for one year with an option to renew on a monthly basis for up to one additional year.

 

ITEM 3.

LEGAL PROCEEDINGS

 

In November 2006, a final judgment was entered in the Circuit Court of the Eighth Judicial District in Alachua county, Florida, in the amount of $5.1 million (bearing annual interest at 9%) in a civil lawsuit against Kid Galaxy, Inc of Manchester, NH, and its parent company Lung Cheong International Holdings Ltd., and Timothy L. Young. The defendant filed notice of appeal and provided a cash bond to cover the verdict amount plus nine percent interest for two years. Through December 2007 the appellants’ petitions to overturn the ruling had been denied. In light of the appellants’ extremely limited avenues for further appeal, , the expected net proceeds from the judgment of approximately $3.23 million are included as other income in the statement of operations.

On February 15, 2008, approximately $5.66 million in gross proceeds was distributed to the Company and its legal counsel, net of costs and contingency fees the Company received approximately $3.23 million.

 

We do not believe there are any pending or threatened legal proceedings that, if adversely determined, would have a material adverse effect on us.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matters were submitted to a vote of shareholders during the fourth quarter of our fiscal year ended December 31, 2007.

 

PART II

 

ITEM 5.

MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information

Our common stock is traded on the Nasdaq Capital Market under the symbol “APII.” The following table represents the range of the high and the low bid quotations for each fiscal quarter for the last two fiscal years ended December 31, 2006 and 2007. These quotations represent prices between dealers, may not include retail mark-ups, markdowns or commissions, and may not necessarily represent actual transactions.

 

 

Fiscal Quarter Ended		Low			High
March 31, 2006		$	2.10		$	2.80
June 30, 2006		$	1.81		$	2.40
September 30, 2006		$	1.35		$	2.14
December 31, 2006		$	1.46		$	3.10
March 31, 2007		$	1.36		$	1.74
June 30, 2007		$	1.48		$