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Management's Discussion of Results of Operations (Excerpts)

For purposes of readability, Zenith attempts to strip out all tables in excerpts from the Management Discussion. That information is contained elsewhere in our articles. The idea of this summary is simply to review how well we believe Management does its reporting. Also, this highlights what Management believes is important.

In our Decision Matrix at the end of each article, a company with 0 to 2 gets a "-1", and 3 to 5 gets a "+1."

On a scale of 0 to 5, 5 being best, Zenith rates this company's Management's Discussion as a 5.


Overview

We are committed to providing innovative, quality solutions to help people 
achieve a fit and healthy lifestyle. Our principal business activities include 
designing, developing, sourcing and marketing high-quality cardio and strength 
fitness products and related accessories for consumer use, primarily in the 
U.S., Canada and Europe. Our products are sold under some of the 
most-recognized brand names in the fitness industry: Nautilus®, Bowflex®, 
Octane Fitness®, Schwinn® and Universal®.

We market our products through two distinct distribution channels, Direct and 
Retail, which we consider to be separate business segments. Our Direct business 
offers products directly to consumers through television advertising, catalogs 
and the Internet. Our Retail business offers our products through a network of 
independent retail companies and specialty retailers with stores and websites 
located in the U.S. and internationally. We also derive a portion of our 
revenue from the licensing of our brands and intellectual property.

Net sales for the first nine months of 2017 were $278.4 million, a decrease of 
$1.9 million, or 0.7%, as compared to net sales of $280.3 million for the first 
nine months of 2016. Net sales of our Direct segment decreased $12.1 million, 
or 7.6%, in the first nine months of 2017, compared to the first nine months of 
2016, primarily due to a decline in TreadClimber® sales. Net sales of our 
Retail segment increased by $10.5 million, or 8.9%, in the first nine months of 
2017, compared to the first nine months of 2016, reflecting increases for both 
traditional and e-commerce customers across multiple product categories.

Gross profit for the first nine months of 2017 was $141.4 million, or 50.8% of 
net sales, a decrease of $6.0 million, or 4.1%, as compared to gross profit of 
$147.4 million, or 52.6% of net sales, for the first nine months of 2016. The 
decrease in gross profit dollars was primarily due to the decrease in net 
sales. Gross margin percentage points decreased 1.8%, due to a shift in segment 
mix, reflecting an increased percentage of Retail sales, and a decline in the 
Direct channel margin.

Operating expenses for the first nine months of 2017 were $111.5 million, a 
decrease of $1.8 million, or 1.6%, as compared to operating expenses of $113.3 
million for the first nine months of 2016. The decrease in operating expenses 
was primarily related to decreased sales and marketing expense. The decrease in 
sales and marketing expense was due to a retroactive financing fees rebate of 
$2.1 million, and a $1.0 million settlement payment received in connection with 
an indemnification claim.

Operating income for the first nine months of 2017 was $29.9 million, a 
decrease of $4.2 million, or 12.3%, as compared to operating income of $34.1 
million for the first nine months of 2016. The decrease in operating income for 
the first nine months of 2017 compared to the first nine months of 2016 was 
driven primarily by the lower net sales and gross margin dollars.

Income from continuing operations was $19.1 million for the first nine months 
of 2017, or $0.61 per diluted share, compared to income from continuing 
operations of $23.1 million, or $0.74 per diluted share, for the first nine 
months of 2016. The effective tax rates for the first nine months of 2017 and 
2016 were 34.7% and 29.4%, respectively. The 5.3% year-over-year percentage 
rate increase was due to the release of previously unrecognized tax benefits 
associated with certain non-U.S. filing positions during the third quarter of 
2016.

Net income for the first nine months of 2017 was $17.8 million, compared to net 
income of $22.6 million for the first nine months of 2016. Net income per 
diluted share was $0.57 for the first nine months of 2017, compared to $0.72 
for the first nine months of 2016.

Discontinued Operations

Results from discontinued operations relate to the disposal of our former 
Commercial business, which was completed in April 2011. We reached substantial 
completion of asset liquidation at December 31, 2012. Although there was no 
revenue related to the Commercial business in either the 2017 or 2016 periods, 
we continue to have product liability and other legal expenses associated with 
product previously sold into the Commercial channel.


RESULTS OF OPERATIONS


Direct

Direct net sales increased 0.8% for the three month period ended September 30, 
2017 compared to the same period of 2016 as new products, including the Bowflex 
HVTTM, offset a decline in TreadClimber® sales. For the nine months ended 
September 30, 2017, Direct net sales decreased 7.6% compared to the same period 
of 2016 due to a decline in TreadClimber® sales, partially offset by a 33.0% 
increase in strength product sales.

Combined consumer credit approvals by our primary and secondary U.S. 
third-party financing providers for the third quarter of 2017 were 53.7%, 
compared to 47.9% in the same period of 2016. We continue to experience 
improved credit approval rates due to our media strategy, which focuses on 
generation of responses from consumers with relatively high credit quality. 
Additionally, our Tier 1 credit provider has noted strong performance from our 
account portfolio, and, due to that credit profile, has progressively expanded 
its approval standards. We remain focused on maintaining a healthy payment 
balance between cash and financed purchases.

The $0.8 million increase in cost of sales of our Direct business for the three 
month period ended September 30, 2017 compared to the same period of 2016 was 
due to the higher volume of sales. The $1.2 million decrease in cost of sales 
of our Direct business for the nine months ended September 30, 2017 compared to 
the same period of 2016 was due to lower net sales.

For the three and nine month periods ended September 30, 2017, Direct gross 
margins decreased 220 and 190 basis points, respectively, as compared to the 
same periods of 2016 primarily due to unfavorable product mix and higher 
discounting for older products.

Retail

Retail net sales increased 15.8% and 8.9% for the three and nine month periods 
ended September 30, 2017 compared to the same periods of 2016. The increases in 
both periods reflected growth in traditional and e-commerce customers across 
multiple product categories.

The increases in cost of sales of our Retail business for the three and nine 
month periods ended September 30, 2017 compared to the same periods of 2016 
were primarily related to the increases in Retail net sales as discussed above.

For the three and nine month periods ended September 30, 2017, Retail gross 
margin increased by 60 and 130 basis points, respectively, compared to the same 
periods of 2016 due to favorable absorption of fixed costs over the increased 
sales volume and the one-time settlement of an indemnification claim.

Selling and Marketing

The $3.4 million decrease in selling and marketing expense in the three month 
period ended September 30, 2017 compared to the same period of 2016 was due to 
lower variable selling expenses of $2.6 million, primarily related to lower 
financing fees reflecting a retroactive contract adjustment of $2.1 million and 
receipt of a one-time settlement payment of $1.0 million for an indemnification 
claim.

The $2.0 million decrease in selling and marketing expense in the nine month 
period ended September 30, 2017 as compared to the same period of 2016 was 
related to a $4.7 million decrease in variable selling costs, including the 
factors noted above, and lower marketing program costs of $1.0 million, offset 
by increases of $2.9 million in media advertising and $0.8 million in photo and 
video production costs.

Media advertising expense of our Direct business is the largest component of 
selling and marketing and was as follows:

The increases in media advertising in the three and nine month periods ended 
September 30, 2017 compared to the same periods of 2016 reflected lower 
response rates that drove the increased investments in advertising.

General and Administrative

The increase in general and administrative for the three months ended September 
30, 2017 compared to the same period of 2016 was primarily due to higher legal 
expenses of $0.4 million, offset by $0.4 million lower integration costs and 
administrative cost savings related to Octane incurred in the same comparative 
period.

The decrease in general and administrative for the nine months ended September 
30, 2017 compared to the same period of 2016 was primarily due to $0.8 million 
savings related to lower integration costs and administrative cost savings 
related to Octane, and lower employee incentives and compensation costs of $0.9 
million. These costs were partially offset by higher litigation-related 
expenses of $1.3 million for the same comparative period.

Research and Development

The increases in research and development in the three and nine month periods 
ended September 30, 2017 compared to the same periods of 2016 were primarily 
due to our investment in additional engineering and product development 
headcount as we continue to supplement our new product development resources 
required to innovate and broaden our product portfolio.

Interest Expense Interest expense of $0.4 million and $1.2 million for the 
three and nine month periods ended September 30, 2017 decreased $0.1 million 
and $0.2 million, respectively, compared to the same periods of 2016. The 
decreases were due to reductions in principal balance on our term loan.

Income tax expense and effective tax rates from continuing operations for the 
three and nine month periods ended September 30, 2017 was primarily related to 
our profitable U.S and foreign operations. The reduced effective tax rates from 
continuing operations for the three and nine month periods ended September 30, 
2016 were primarily due to the release of, on a non-recurring basis, previously 
unrecognized tax benefits associated with certain non-U.S. filing positions. 
These resulted from completion of the deregistration process of a certain 
foreign entity. In addition, the effective tax rate for the nine months ended 
September 30, 2017 included $0.7 million of excess tax benefits related to 
stock-based compensation recognized as a current period benefit through the 
statement of operations, resulting from the adoption of ASU 2016-09 in January 
2017.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2017, we had $77.8 million of cash and investments compared 
to $79.6 million as of December 31, 2016. Cash provided by operating activities 
was $16.7 million for the nine months ended September 30, 2017, compared to 
$14.9 million for the nine months ended September 30, 2016. We expect our cash, 
cash equivalents and available-for-sale securities at September 30, 2017, along 
with cash expected to be generated from operations, to be sufficient to fund 
our operating and capital requirements for at least twelve months from 
September 30, 2017.

The increase in cash flows from operating activities for the nine months ended 
September 30, 2017 as compared to the same period of 2016 was primarily due to 
the changes in our operating assets and liabilities as discussed below, 
partially offset by the decline in operating performance.

Trade receivables decreased $6.9 million to $38.5 million as of September 30, 
2017, compared to $45.5 million as of December 31, 2016, due to seasonally 
lower net sales to specialty retail and commercial customers. Trade receivables 
as of September 30, 2017 compared to September 30, 2016 increased $7.3 million 
due to the increase in Retail net sales.

Inventories increased $10.6 million to $57.6 million as of September 30, 2017, 
compared to $47.0 million as of December 31, 2016 due to seasonal preparations 
for the fourth quarter. Inventories as of September 30, 2017 compared to 
September 30, 2016 increased by $8.4 million due to increased in-transit 
inventory.

Trade payables decreased $3.9 million to $62.1 million as of September 30, 
2017, compared to $66.0 million as of December 31, 2016, due to seasonality of 
the business. Trade payables as of September 30, 2017 compared to September 30, 
2016 increased $17.4 million. The higher amount outstanding as of September 30, 
2017 was due to the increased inventory.

Accrued liabilities decreased $4.8 million to $8.1 million as of September 30, 
2017, compared to $12.9 million as of December 31, 2016, due to payout of 
accrued incentive compensation during the first quarter of 2017 and settlement 
of a royalty dispute in the second quarter of 2017.

Cash used in investing activities of $18.2 million for the first nine months of 
2017 was primarily related to net purchases of marketable securities of $15.4 
million. In addition, $2.7 million was used for capital expenditures primarily 
related to production equipment tooling and implementation of new software 
systems. We anticipate spending between $4.5 million and $5.5 million in 2017 
for product tooling, computer equipment and software, and production equipment.

Cash used in financing activities of $17.0 million for the first nine months of 
2017 was primarily related to principal repayments on our term loan of $12.0 
million and share repurchases of $4.8 million.

Financing Arrangements We have a Credit Agreement with JPMorgan Chase Bank, 
N.A. (“Chase Bank”) that provides for an $80.0 million term loan and a $20.0 
million revolving line of credit. The term of the Credit Agreement expires on 
December 31, 2020 and is secured by substantially all of our assets.

The Credit Agreement, as amended, contains customary covenants, including 
minimum fixed charge coverage ratio and funded debt to EBITDA ratio, and 
limitations on capital expenditures, mergers and acquisitions, indebtedness, 
liens, dispositions, dividends and investments. The Credit Agreement also 
contains customary events of default. Upon an event of default, the lender may 
terminate its credit line commitment, accelerate all outstanding obligations 
and exercise its remedies under the continuing security agreement.

Borrowing availability under the revolving line of credit is subject to our 
compliance with certain financial and operating covenants at the time 
borrowings are requested. Letters of credit under the Credit Agreement are 
treated as a reduction of the available borrowing amount and are subject to 
covenant testing.

The interest rate applicable to the term loan, as well as each advance under 
the revolving line of credit, is based on either Chase Bank's floating prime 
rate or adjusted LIBOR, plus an applicable margin. As of September 30, 2017, 
our borrowing rate for both the term loan and line of credit advances was 
2.49%.

As of September 30, 2017, the balance on our term loan was $52.0 million, and 
we had no outstanding borrowings under the line of credit. As of September 30, 
2017, we were in compliance with the financial covenants of the Credit 
Agreement and $20.0 million was available for borrowing under the line of 
credit.

As of September 30, 2017, we had a $52.0 million receive-variable, pay-fixed 
interest rate swap outstanding with Chase Bank. The interest rate swap 
amortizes monthly in line with the outstanding principal balance on our term 
loan and is classified as a cash flow hedge. The swap matures on December 31, 
2020 and has a fixed rate of 1.42% per annum. The variable rate on the interest 
rate swap is the one-month LIBOR benchmark. At September 30, 2017, the 
one-month LIBOR rate was 1.24%.

Commitments and Contingencies For a description of our commitments and 
contingencies, refer to Note 14 to our condensed consolidated financial 
statements in Part I, Item 1 of this Form 10-Q.

Off-Balance Sheet Arrangements In the ordinary course of business, we enter 
into agreements that require us to indemnify counterparties against third-party 
claims. These may include: agreements with vendors and suppliers, under which 
we may indemnify them against claims arising from our use of their products or 
services; agreements with customers, under which we may indemnify them against 
claims arising from their use or sale of our products; real estate and 
equipment leases, under which we may indemnify lessors against third-party 
claims relating to the use of their property; agreements with licensees or 
licensors, under which we may indemnify the licensee or licensor against claims 
arising from their use of our intellectual property or our use of their 
intellectual property; and agreements with parties to debt arrangements, under 
which we may indemnify them against claims relating to their participation in 
the transactions.

The nature and terms of these indemnifications vary from contract to contract, 
and generally a maximum obligation is not stated. We hold insurance policies 
that mitigate potential losses arising from certain types of indemnifications. 
Management does not deem these obligations to be significant to our financial 
position, results of operations or cash flows, and therefore, no liabilities 
were recorded at September 30, 2017.

Stock Repurchase Program On May 4, 2016, our Board of Directors authorized the 
repurchase of up to $10.0 million of our outstanding common stock from time to 
time through May 4, 2018.

On April 25, 2017, our Board of Directors authorized an additional $15.0 
million share repurchase program, bringing the total authorization under 
existing programs to $25.0 million. Under the new program, shares of our common 
stock may be repurchased from time to time through April 25, 2019. Repurchases 
may be made in open market transactions at prevailing prices, in privately 
negotiated transactions, or by other means in accordance with federal 
securities laws. Share repurchases will be funded from existing cash balances, 
and repurchased shares will be retired and returned to unissued authorized 
shares.

For the nine months ended September 30, 2017, we had repurchased a total of 
305,371 shares for $4.8 million. As of September 30, 2017, there was $18.2 
million remaining available for repurchases under the share repurchase 
programs.

SEASONALITY

We expect our sales from fitness equipment products to vary seasonally. Sales 
are typically strongest in the first and fourth quarters, followed by the third 
quarter, and are generally weakest in the second quarter. We believe that, 
during the spring and summer months, consumers tend to be involved in outdoor 
activities, including outdoor exercise, which impacts sales of indoor fitness 
equipment. This seasonality can have a significant effect on our inventory 
levels, working capital needs and resource utilization.


Quantitative and Qualitative Disclosures About Market Risk

Interest Rate and Foreign Exchange Risk Our exposure to market risk from 
changes in interest rates relates primarily to our cash equivalents, marketable 
securities, derivative assets and variable-rate debt obligations. As of 
September 30, 2017, we had cash equivalents of $8.8 million held in a 
combination of money market funds and commercial paper, and marketable 
securities of $47.3 million, held in a combination of certificates of deposit, 
commercial paper, corporate bonds, and U.S. government bonds. Our cash 
equivalents mature within three months or less from the date of purchase. 
Marketable securities with original maturities of greater than three months and 
remaining maturities of less than one year are classified as short-term 
investments. Investments with maturities beyond one year may be classified as 
short-term based on their highly liquid nature and because such marketable 
securities represent the investment of cash that is available for current 
operations. We have classified our marketable securities as available-for-sale 
and, therefore, we may choose to sell or hold them as changes in the market 
occur. Because of the short-term nature of the instruments in our portfolio, a 
decline in interest rates would reduce our interest income over time, and an 
increase in interest rates may negatively affect the market price or liquidity 
of certain securities within the portfolio.

Our negotiated credit facilities generally charge interest based on a benchmark 
rate such as LIBOR. Fluctuations in short-term interest rates may cause 
interest payments on term loan principal and drawn amounts on the revolving 
line to increase or decrease. As of September 30, 2017, the outstanding 
balances on our credit facilities totaled $52.0 million.

As of September 30, 2017, we had a $52.0 million receive-variable, pay-fixed 
interest rate swap outstanding with Chase Bank, which amortizes monthly in line 
with the outstanding principal balance on our term loan. The swap is classified 
as a cash flow hedge and effectively fixes the interest rate on our 
variable-rate term loan. The interest rate swap matures on December 31, 2020 
and has a fixed interest rate of 1.42% per annum. The variable rate on the 
interest rate swap is the one-month LIBOR benchmark, which was 1.24% at 
September 30, 2017.

The fair value of our interest rate swap agreement represents the estimated 
receipts or payments that would be made to terminate the agreement. The amounts 
related to our cash flow hedge are recorded as deferred gains or losses in our 
consolidated balance sheets with the offset recorded in accumulated other 
comprehensive income, net of tax. At September 30, 2017, the fair value of our 
interest rate swap agreement was an asset of $0.2 million. The estimated amount 
expected to be reclassified into earnings within the next twelve months was 
less than $0.1 million at September 30, 2017.

We enter into foreign exchange forward contracts to offset the earnings impacts 
of exchange rate fluctuations on certain monetary assets and liabilities. Total 
notional amounts outstanding at September 30, 2017 were $18.3 million.

A hypothetical 10% increase in interest rates, or a 10% movement in the 
currencies underlying our foreign currency derivative positions, would not have 
material impacts on our results of operations, financial position or cash 
flows. We do not enter into derivative instruments for any purpose other than 
to manage our interest rate or foreign currency exposure. That is, we do not 
engage in interest rate or currency exchange rate speculation using derivative 
instruments.

Evaluation of Disclosure Controls and Procedures

In accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the 
“Exchange Act”), as of the end of the period covered by this Quarterly Report 
on Form 10-Q, our management evaluated, with the participation of our Chief 
Executive Officer and our Chief Financial Officer, the effectiveness of our 
disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 
15d-15(e) under the Exchange Act). Based upon their evaluation of these 
disclosure controls and procedures, our management, including the Chief 
Executive Officer and Chief Financial Officer, have concluded that our 
disclosure controls and procedures were effective as of the end of the period 
covered by this report. Changes in Internal Control over Financial Reporting

We are implementing an enterprise resource planning ("ERP") system and 
complementary systems that support our Retail operations related to Octane. 
During the third quarter of 2017, the technical design was completed and 
development of features of the ERP and complementary systems were in progress. 
We expect to continue developing and deploying these features during the fourth 
quarter of 2017 with full implementation planned to be completed in the second 
quarter of 2018. As each phase of the implementation occurs, we are taking 
steps to monitor and maintain appropriate internal control over financial 
reporting and will continue to evaluate these controls for effectiveness.

There were no other changes in our internal control over financial reporting 
that occurred during the three months ended September 30, 2017, that have 
materially affected, or are reasonably likely to materially affect, our 
internal control over financial reporting.