Greetings, my fellow small-cap fans! Today, we'll get to combine two huge passions in America -- investing and auto racing. While looking through the latest Foolish 8 spreadsheet, I ran across a company called Action Performance (NYSE: ATN). You've heard it before in Fooldom, and you'll hear it again: Sometimes it can be rewarding to "buy what you know." And the company we're looking at today can be easily understood by most everyone.

Action Performance designs and sells collectibles and apparel (like T-shirts, hats, and jackets) related to the motorsports industry. NASCAR (National Association for Stock Car Auto Racing) products are its biggest sellers, accounting for 70% of revenue in 2001. It also sells Formula One racing and NHRA (National Hot Rod Association) products.

The company is best known for its die-cast racing car replicas. These are detailed models of actual vehicles that sell for $10 on up to $150 or more. Action Performance does not manufacture these replicas, but it does design them and make the tools and dies. It also screen prints and embroiders some of the apparel it sells.

It markets these products worldwide through a distribution network that targets specialty stores, mass-market retailers like Wal-Mart (NYSE: WMT), and trackside stores. The company also has an agreement with QVC, the electronic retailing giant that reaches over 100 million households around the world through its a 24-hour television shopping channel. Besides marketing through television, QVC also maintains and operates Action Performance's website ( and its members-only collectibles club.

In order to legally sell all these products, Action Performance must have licensing agreements with the different racing circuits, as well as the individual drivers and team owners involved. It has to identify and come to agreement with the drivers and teams it believes will enjoy the most success and be most marketable over the near term. For now, this includes NASCAR Winston Cup Points champions Jeff Gordon, Dale Jarrett, Bobby Labonte, Bill Elliott, and Rusty Wallace and 11-time NHRA Funny Car champion John Force... just to name a few.

Each of the agreements requires the company to pay royalties based on a percentage of the wholesale or retail price of the products. This is a significant expense -- about $46 million in 2001 -- but the higher this figure goes, of course, the better the company is doing sales-wise.

The big picture
You can begin to see an appealing pattern here. Action Performance is able to concentrate on what it does best (licensing, designing, etc.), while farming out most of the manufacturing and letting marketing expert QVC handle that aspect of its business. As a result, you have a company that generated $323 million in sales last year, while employing only 500 people.

Tumultuous 2000
It wasn't always roses, though. After growing by leaps and bounds in previous years, the company went through a strange and tumultuous 2000. First and foremost, its core business experienced a big downturn, and revenue suddenly declined by 25%. Cash flow and liquidity were negatively affected. It canceled a planned IPO of, and virtually abandoned its Internet strategy. It wrote off goodwill from acquisitions, endorsements and sponsorships that never materialized, and over $13 million in inventory. It underwent a $47 million restructuring that included a reduction in employees. During all this, the stock price plummeted from the $40 range to $2.25.

Action Performance was on the rocks, but as today's $48 stock price clearly shows, the decision to scale back to its core competency has worked. Revenue has returned to pre-2000 levels, and the company is more profitable than ever before.

The future
So, the business is easy enough to understand, and the model looks rather attractive. What's harder to nail down, however, is Action Performance's growth potential. Year-over-year comparisons are almost meaningless because of what happened in 2000. Fiscal 2002 earnings are expected to be in the $2.35 to $2.38 per-share range -- which would be some 70% higher than 2001 levels -- but don't count on that kind of growth over the next few years.

In fact, taking into account company guidance and the different analyst estimates floating around out there, potential investors should probably look for no more than 25% earnings growth over the next year or two -- which is still very, very good.

Risk factors
What could throw a monkey wrench into such lofty growth rates? The most-watched factor is probably the popularity of auto racing in general and NASCAR in particular. The sport's appeal is at an all-time high as the likes of Jeff Gordon and the late Dale Earnhardt Sr. are now household names. But what happens if that popularity dips? Certainly that would affect Action Performance's revenue.

Another concern for me involves the near-bankruptcy of 2000. I wouldn't think about investing in Action Performance until I learned all I could about the reasons for the weirdness of that year, as well as the factors that have led to such a stunning return from the dead. The company did hire a new chief financial officer in August 2000, but the chairman and CEO, Fred Wagenhals, is the founder and has thus been around since 1992. How do you grade a management team that has one big minus and one big plus to its credit?

To conclude, I think there's enough here to warrant further research. Action Performance meets all the Foolish 8 criteria, has a light business model that scales well (thanks to partners like QVC), and has shown the ability to grow earnings even in a poor economic climate.

One last note: Do you like breaking down small-cap companies? If so, sleejohnson on the Foolish 8 discussion board has a challenge for you.

Rex Moore spotted five planets in the western sky and Comet Ikeya-Zhang in the dragon's head of Draco last night. The Motley Fool's disclosure policy requires him to tell you he owns a telescope but no companies mentioned in this column.