NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for doubtful accounts, inventory valuation, warranty reserve, reserves for legal and product liability matters, recoverability of long-lived assets and valuation of deferred tax assets are the items that are most susceptible to changes in estimates.

Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. As of December 31, 2011 and 2010, the Company's cash equivalents consisted of a money market account. The carrying value of cash equivalents approximates fair value.

Trade Accounts Receivable

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is management's best estimate of the amount of probable credit losses in the Company's existing accounts receivable. Management determines the allowance based on historical write-off experience and a specific review of past due balances over a specified amount. Management reviews the Company's allowance for doubtful accounts monthly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Inventories

Inventories are valued at the lower of cost (first-in, first-out) or market. Cost includes materials, labor and manufacturing overhead.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Betterments and improvements are capitalized while repairs and maintenance costs are charged to expense as incurred. Depreciation is recorded using the straight-line method based on estimated useful lives for financial reporting purposes. The estimated useful lives for financial reporting purposes are 25 years for buildings and improvements and 3 to 10 years for furniture and equipment.

Impairment of Long-Lived Assets

The Company reviews property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying value of the assets to the undiscounted cash flows estimated to be generated by those assets. If a write down were necessary, an impairment charge would be recognized equal to the amount by which the carrying amount of the assets exceeds their fair value, as determined based upon quoted market prices or discounted cash flows. Management believes that no long-lived assets were impaired as of December 31, 2011 and 2010.

Accrued Warranty Obligations

All products are warranted for one to three years of labor and for parts ranging from one to ten years depending on the part and the type of equipment. Warranty expense was $4,554,000, $3,547,000 and $4,940,000 for the years ended December 31, 2011, 2010 and 2009, respectively. The accrued warranty obligation is provided at the time of product sale based on management estimates, which are developed from historical information and certain assumptions about future events and are subject to change. The amount expected to be paid in the following year is classified in accrued liabilities.

The following table sets forth the changes in the liability for product warranties for the years ended December 31, 2011 and 2010:


	Year Ended December 31,
	2011			2010
Balance as of January 1	$	3,392,000		$	3,988,000
Payments made under warranty		(3,718,000	)		(4,143,000	)
Accrual for product warranties issued		4,554,000			3,547,000

Balance as of December 31	$	4,228,000		$	3,392,000

Derivatives

At December 31, 2011, derivative instruments include one interest rate swap that hedges variable rate interest payments.

See Notes 7, 8 and 9 for further discussion of this financial instrument.

Translation of Foreign Currencies

Assets and liabilities of the Company's foreign subsidiary, whose functional currency is its local currency, is translated at year-end exchange rates. Income and expense items are translated at the average rates of exchange prevailing during the year. The adjustment resulting from translating the financial statements of such foreign subsidiary is reflected in accumulated other comprehensive loss within stockholders' equity.

Fair Value of Financial Instruments

The Company's financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, long-term debt and derivative instruments. The carrying values of cash equivalents, accounts receivable and accounts payable are considered to be representative of their respective fair values because of the short maturity of these instruments. Based on the terms of the Company's debt instruments that are outstanding as of December 31, 2011, the carrying values are considered to approximate their respective fair values.

Revenue Recognition

Revenue is recorded when products are shipped and the Company has no significant remaining obligations, persuasive evidence of an arrangement exists, the price to the buyer is fixed or determinable, and collection of the relevant receivable is probable. The Company does not offer its customers a right of return, price protection or inventory rotation programs. The Company classifies amounts billed to customers for shipping and handling as sales. Direct shipping and handling costs are classified as cost of sales. Internal salaries and overhead related to shipping and handling are classified as selling, general and administrative expense. Sales tax collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from revenues in the consolidated statements of operations.

Concentration of Risk, Geographic Segment Data and Enterprise-Wide Disclosures

More than half of the Company's net sales are through specialty fitness dealers and distributors. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. Sales to one customer in 2011, 2010 and 2009 were 12.8%, 13.0% and 13.6% of net sales, respectively. Accounts receivable from that customer was $1,641,000 and $1,779,000 at December 31, 2011 and 2010, respectively. Sales to another customer in 2011, 2010, and 2009 were 11.1%, 12.4%, and 10.6% of net sales, respectively. Accounts receivable from that customer was $2,252,000 and $1,265,000 at December 31, 2011 and 2010, respectively. No other single customer accounted for more than 10% of the Company's net sales in any of those years.

There is no single geographic area of significant concentration other than the U.S. Sales outside of North America accounted for approximately 32%, 31% and 29% of total net sales for the years ended December 31, 2011, 2010 and 2009, respectively. Long-lived assets located in foreign countries totaled $23,000 and $20,000 at December 31, 2011 and 2010, respectively.

The Company single sources its multi-gym and Home Arc products and certain raw materials and component parts, including drive motors, belts, running decks, molded plastic components, electronics and video monitors, where management believes that sole sourcing is beneficial for reasons such as quality control and reliability of the vendor or cost. The Company attempts to reduce the risk of sole source suppliers by maintaining varying levels of inventory. However, the loss of a significant supplier, or delays or disruptions in the delivery of components or materials, or increases in material costs, could have a material adverse effect on the Company's operations.

The following table summarizes net sales over the past three years (in millions):


	Year Ended December 31,
	2011		2010		2009
Cardiovascular products	$	76.2	$	69.4	$	66.7
Strength systems		48.6		41.0		42.0
Parts		6.7		5.7		5.3
Freight and other revenue		8.6		6.9		6.5

	$	140.1	$	123.0	$	120.5

Advertising Costs

The Company charges advertising costs to expense as incurred. For the years ended December 31, 2011, 2010 and 2009, advertising expense was $2,738,000, $3,660,000 and $1,763,000, respectively, and is included in selling, general and administrative expenses.

Research and Development Costs

Research and development costs are charged to expense as incurred. Such costs were $5,726,000, $5,569,000, and $4,545,000 for the years ended December 31, 2011, 2010 and 2009, respectively, and are included in selling, general and administrative expenses.

Income Taxes

The asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if it is more-likely-than-not that such assets will not be realized.

Net Income (Loss) per Common Share

The table below sets forth the reconciliation of the basic and diluted net income (loss) per share computations:


	Year Ended December 31,
	2011		2010			2009
Net income (loss) attributable to common stockholders	$	34,255,000	$	(58,237,000	)	$	(2,437,000	)

Shares used in computing basic net income (loss) per share		17,120,000		17,120,000			17,175,000
Dilutive effect of options and warrants		—		—			—

Shares used in computing diluted net income (loss) per share		17,120,000		17,120,000			17,175,000

For the years ended December 31, 2011, 2010 and 2009, options to purchase 633,125, 791,125 and 577,375 shares of common stock at exercise prices ranging from $1.17 to $7.37, $1.17 to $7.37 and $1.20 to $7.37 per share, respectively, were outstanding but were not included in the computation of diluted net income (loss) per share as the result would be anti-dilutive.

Stock-Based Compensation

The Company records stock-based compensation to recognize the cost of employee services received in exchange for an award of equity instruments, with such cost recognized over the period that the employee is required to perform services in exchange for the award. The Company measures the cost of employee services received in exchange for an award based on the grant date fair value of the award. For 2011, the Company recorded stock-based compensation expense of $171,000, consisting of expenses related to stock options ($161,000) and stock issued to directors ($10,000). For 2010, the Company recorded stock-based compensation expense of $219,000, consisting of expenses related to stock options ($205,000) and stock issued to directors ($14,000). For 2009, the Company recorded stock-based compensation expense of $180,000, consisting of expenses related to stock options ($170,000) and stock issued to directors ($10,000).

No stock options were granted in 2011. The weighted average fair value of each stock option granted during the years ended December 31, 2010 and 2009 was $0.77 and $0.98, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

Year Ended December 31,

2011

2010

2009

Risk free interest rate

2.87% - 3.04%

2.27% - 3.05%

Expected dividend yield

—

Expected life

6.25 years

Expected volatility

70%

68% - 70%

Expected volatility—weighted average

70%

69%

*	Not applicable

Expected volatilities are calculated based on the historical volatility of the Company's stock over the expected term of the option. Management monitors stock option exercise and employee termination patterns to estimate forfeiture rates within the valuation model. The expected term of the option is derived using the simplified method. The risk free interest rate is based on the implied yield available on the U.S. Treasury yield curve with a term approximating the expected life of the option.

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (FASB) issued guidance to provide a consistent definition and measurement of fair value, as well as similar disclosure requirements between U.S. GAAP and International Financial Reporting Standards. The requirements include additional disclosure of transfers between Level 1 to Level 2, Level 3 measurement, an entity's use of an asset being different from its highest and best use, and for financial instruments not measured at fair value. The guidance is effective for periods beginning after December 15, 2011 and early adoption is permitted. The Company early adopted these requirements and there was no impact on the Company's consolidated financial condition, results of operations, or cash flows.

In June 2011, the FASB issued guidance to increase the prominence of other comprehensive income in the financial statements. This guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders' equity, and instead requires consecutive presentation of the statement of net income and other comprehensive income either in a continuous statement of comprehensive income or in two separate but consecutive statements. The standard also requires that items reclassified from other comprehensive income to net income be presented on the face of the financial statements. However, in December 2011, the FASB finalized a proposal to defer the requirement to present reclassifications from other comprehensive income to net income on the face of the financial statements and require that reclassification adjustments be disclosed in the notes to the financial statements, consistent with the existing disclosure requirements. The deferral does not change the requirement to present net income, components of other comprehensive income, and total comprehensive income in either one continuous statement or two separate but consecutive statements. This guidance is effective for the periods beginning after December 15, 2011 and early adoption is permitted. The Company has adopted these requirements early, with retrospective application to all periods presented, except with regard to the requirements to present reclassifications from other comprehensive income to net income on the face of the financial statements. The adoption of this guidance did not have any impact on the Company's consolidated financial condition, results of operations or cash flows.

Reclassifications

Certain reclassifications to prior period amounts have been made to conform to the current presentation.