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NTRI > SEC Filings for NTRI > Form 10-Q on 6-Nov-2013All Recent SEC Filings

Show all filings for NUTRI SYSTEM INC /DE/

Form 10-Q for NUTRI SYSTEM INC /DE/


6-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Special Note Regarding Forward-Looking Statements

From time to time, information provided by us, including but not limited to statements in this Quarterly Report, or other statements made by or on our behalf, may contain "forward-looking" information within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "believe," "estimate," "will be," "will," "would," "expect," "anticipate," "plan," "project," "intend," "could," "should," or other similar words or expressions often identify forward-looking statements.

Such statements are based on current expectations only, and are subject to certain risks, uncertainties, and assumptions, many of which are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results, performance, or achievements may vary materially from those anticipated, estimated, or projected. Among the factors that could cause actual results to materially differ include:

• competition from other weight management industry participants or the development of more effective or more favorably perceived weight management methods;

• our ability to continue to develop innovative new programs and enhance our existing programs, or the failure of our programs to continue to appeal to the market;

• the effectiveness of our marketing and advertising programs;

• loss, or disruption in the business of, any of our food suppliers;

• loss, or disruption in the business, of our fulfillment provider;

• disruptions in the shipping of our food products;

• health or advertising related claims by consumers;

• failure to attract or negative publicity with respect to any of our spokespersons;

• our ability to successfully make acquisitions or enter into joint ventures, including our ability to successfully integrate, operate or realize the projected benefits of such businesses;

• general business and economic conditions, particularly the pace, continuation, and possible reversal of the recovery in the worldwide economy;

• the seasonal nature of our business;

• our ability to enforce our intellectual property rights, as well as the impact of our involvement in any claims related to intellectual property rights;

• uncertainties regarding the satisfactory operation of our information technology or systems;

• risks associated with unauthorized penetration of our information security;

• the impact of existing and future laws and regulations;

• the impact of our debt service obligations and restrictive debt covenants;

• our inability to recruit and retain key executive officers; and

• other risks and uncertainties, including those detailed from time to time in our periodic reports filed with the Securities and Exchange Commission.


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We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Our 2012 Annual Report on Form 10-K listed various important factors that could cause actual results to differ materially from projected and historic results. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. Readers can find them in Part I, Item 1A, of that filing under the heading "Risk Factors." We incorporate that section of that Annual Report on Form 10-K in this filing and investors should refer to it. Reference is also made to Part II, Item 1A, "Risk Factors," of this Quarterly Report on Form 10-Q. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete set of all potential risks or uncertainties.

The following discussion should be read in conjunction with the financial information included elsewhere in this Quarterly Report on Form 10-Q.

Background

Nutrisystem, Inc. (the "Company" or "Nutrisystem"), a provider of weight management products and services, offers nutritionally balanced weight loss programs designed for women, men, and seniors, as well as the Nutrisystem® D® program, specifically designed to help people with type 2 diabetes who want to lose weight and manage their diabetes. The Nutrisystem® programs are based on over 40 years of nutrition research and on the science of the low glycemic index. The Company's pre-packaged foods are sold directly to weight loss program participants primarily through the Internet and telephone (including the redemption of prepaid program cards), referred to as the direct channel, through QVC, a television shopping network, and retail programs.

Revenue consists primarily of food sales. For the nine months ended September 30, 2013, the direct channel accounted for 92% of total revenue compared to 4% for QVC and 4% for retail. For the nine months ended September 30, 2012, the direct channel accounted for 96% of total revenue compared to 3% for QVC and 1% for other. We incur significant marketing expenditures to support our brand as we continue to advertise across various media channels. New media channels are tested on a continual basis and we consider our media mix to be diverse. We market our weight management system through television, print, direct mail, Internet, public relations and social media. We review and analyze a number of key operating and financial metrics to manage our business, including the number of new customers, revenue per customer, total revenues, marketing per new customer, operating margins and reactivation revenue.

Our mix of revenue for the direct channel can be divided into three categories. First, new customer revenue is all revenue within a quarter from customers joining within that quarter. New customer revenue is the main driver of revenue growth. Second, on-program revenue is all revenue from customers who joined in previous quarters but who are still within their first nine months on the program. Third, reactivation revenue is all revenue generated from customers who are more than nine months from their initial purchase.

Our eCommerce, direct-to-consumer business model provides flexibility which allows us to manage marketing spend according to customer demand. We believe this flexibility is especially valuable due to the current instability in general economic conditions. Additionally, we initiated a concerted effort to improve lifetime customer economics, length of stay, and overall customer satisfaction and have recently upgraded our eCommerce platform and website. We are able to test new commercials and offers, as well as, improvements to our website to allow us to be more responsive to customer needs and attempt to drive conversion. Our product offerings have expanded to include frozen foods, and we entered into the retail channel and introduced the Nutrisystem® D® program during the last several years. Further, we have taken steps to reduce our overall operating costs.

Over the past several years our financial performance has been adversely impacted by a number of factors, including the economic downturn, declines in consumers' discretionary spending and increased competitive activity. We believe these factors have primarily driven the decline in the number of new customer starts.

As we began 2013, we renewed our focus to the following key areas: 1) a return to direct marketing fundamentals including building and leveraging our database;
2) margin improvement; 3) product and program innovation; and 4) prioritization of growth initiatives. During the nine months ended September 30, 2013, we have reduced the size of the senior management team and reorganized the workforce to align around key priorities resulting in


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approximately $1.4 million in severance, including $326,000 of non-cash expense related to the acceleration of previously awarded equity-based awards. Gross margins have been aided by eliminating unprofitable free promotional items and process re-engineering. These positive margin items have been partially offset by a $5.0 million charge recorded in the three months ended September 30, 2013 to settle certain disputes that had arisen with a supplier over a legacy contract. We have improved average selling price through the execution of cross-sell initiatives and reduced discounting as well as improved our reactivation rates. Despite these improvements as well as revenue growth in the three months ended September 30, 2013 as compared to three months ended September 30, 2012, revenue for the nine months ended September 30, 2013 remains down as compared to the comparable period of 2012.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are described in Note 2 of the consolidated financial statements included in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2012.

The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Management develops, and changes periodically, these estimates and assumptions based on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The accounting estimates we consider critical include reserves for returns, excess and obsolete inventory and income taxes. These critical accounting estimates are discussed with our audit committee quarterly.

During the nine months ended September 30, 2013, we did not make any material change to our critical accounting policies.

Results of Operations

Revenue and expenses consist of the following components:

Revenue. Revenue consists primarily of food sales. Food sales include sales of food, supplements, shipping and handling charges billed to customers and sales credits and adjustments, including product returns. No revenue is recorded for food products provided at no charge as part of promotions.

Cost of Revenue. Cost of revenue consists primarily of the cost of the products sold, including compensation related to fulfillment, the costs of outside fulfillment, incoming and outgoing shipping costs, charge card fees and packing material. Cost of products sold includes products provided at no charge as part of promotions and the non-food materials provided with customer orders.

Marketing Expense. Marketing expense includes media, advertising production, marketing and promotional expenses and payroll-related expenses, including share-based payment arrangements, for personnel engaged in these activities. Internet advertising expense is recorded based on either the rate of delivery of a guaranteed number of impressions over the advertising contract term or on a cost per customer acquired, depending upon the terms. Direct-mail advertising costs are capitalized if the primary purpose was to elicit sales to customers who could be shown to have responded specifically to the advertising and results in probable future economic benefits. The capitalized costs are amortized to expense over the period during which the future benefits are expected to be received. All other advertising costs are charged to expense as incurred or the first time the advertising takes place.

General and Administrative Expense. General and administrative expense consists of compensation for administrative, information technology, counselors, customer service and sales personnel, share-based payment arrangements for related employees, facility expenses, website development costs, professional service fees and other general corporate expenses.

Interest Expense, net. Interest expense, net consists of interest expense on our outstanding indebtedness net of interest income earned on cash balances and short term investments.


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Income Taxes. We are subject to corporate level income taxes and record a provision (benefit) for income taxes based on an estimated effective income tax rate for the year.

Overview of the Direct Channel

In the nine months ended September 30, 2013 and 2012, the direct channel represented 92% and 96%, respectively, of our revenue. Revenues through the direct channel were $77.3 million and $265.0 million in the three and nine months ended September 30, 2013 compared to $79.6 million and $319.9 million in the comparable periods of 2012. Revenue is primarily generated through customer starts, reactivation of former customers and the customer ordering behavior, including length of time on our program and the diet program selection. The decrease in revenue is primarily attributable to declines in new customers from the first half of 2013 due to a weak response to our 2013 diet season advertising. Additionally, decreased on-program revenue contributed to the decline as we entered 2013 with fewer on-program customers and had fewer new customers in the first half of 2013. Critical to increasing customer starts is our ability to deploy marketing dollars while maintaining marketing effectiveness. Factors influencing our marketing effectiveness include the quality of the advertisements, promotional activity by our competitors, as well as the price and availability of appropriate media.


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Three Months Ended September 30, 2013 Compared to Three Months Ended
September 30, 2012



                                              Three Months Ended September 30,
                                      2013          2012        $ Change       % Change
                                                       (in thousands)

    REVENUE                         $ 85,360      $ 81,276      $   4,084              5 %


    COSTS AND EXPENSES:
    Cost of revenue                   47,627        43,835          3,792              9 %
    Marketing                         19,983        18,458          1,525              8 %
    General and administrative        14,336        14,490           (154 )           (1 )%
    Depreciation and amortization      1,912         2,570           (658 )          (26 )%


    Total costs and expenses          83,858        79,353          4,505              6 %


    Operating income                   1,502         1,923           (421 )          (22 )%

    INTEREST EXPENSE, net                (41 )        (244 )          203             83 %


    Income before income taxes         1,461         1,679           (218 )          (13 )%
    INCOME TAX EXPENSE (BENEFIT)       1,105          (911 )        2,016            221 %

    Net income                      $    356      $  2,590      $  (2,234 )          (86 )%


    % of revenue
    Gross margin                        44.2 %        46.1 %
    Marketing                           23.4 %        22.7 %
    General and administrative          16.8 %        17.8 %
    Operating income                     1.8 %         2.4 %

Revenue. Revenue increased to $85.4 million in the third quarter of 2013 from $81.3 million for the third quarter of 2012. The increase in revenue is primarily attributable to a greater number of new customers and increased retail, QVC and reactivation revenue slightly offset by decreases in on-program revenue. In the third quarter of 2013, the direct channel accounted for 91% of total revenue compared to 5% for QVC and 4% for retail. In the third quarter of 2012, the direct channel accounted for 98% of total revenue compared to 2% for QVC.

Costs and Expenses. Cost of revenue increased to $47.6 million in the third quarter of 2013 from $43.8 million in the third quarter of 2012. Gross margin as a percent of revenue decreased to 44.2% in the third quarter of 2013 from 46.1% for the third quarter of 2012. In the third quarter of 2013, we recorded a $5.0 million charge to settle certain disputes that had arisen with a supplier over a legacy contract. Additionally, we had a higher mix of lower margin products in the third quarter of 2013 as compared to the third quarter of 2012. These increases were partially offset by our continued pricing discipline, the removal of certain promotional items and free food promotions and process re-engineering.

Marketing expense increased to $20.0 million in the third quarter of 2013 from $18.5 million in the third quarter of 2012. Marketing expense as a percent of revenue increased to 23.4% in the third quarter of 2013 from 22.7% for the third quarter of 2012. Substantially all marketing spending promoted the direct business. The increase in marketing expense was primarily attributable to increased spending for television production ($1.0 million) and advertising media ($867,000). These increases were offset by a decrease in public relations ($282,000). In total, media spending was $15.7 million in the third quarter of 2013 and $14.8 million in the third quarter of 2012.

General and administrative expense decreased to $14.3 million in the third quarter of 2013 compared to $14.5 million in the third quarter of 2012. General and administrative expense as a percent of revenue decreased to 16.8% in the third quarter of 2013 from 17.8% for the third quarter of 2012. The prior period of 2012 included a $2.1 million


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impairment charge related to advances paid to a frozen food supplier. Additionally, non-cash expense for share based payment arrangements decreased ($318,000). These decreases were offset by an increase in compensation, benefits, and temporary help ($2.4 million).

Depreciation and amortization expense decreased to $1.9 million in the third quarter of 2013 compared to $2.6 million in the third quarter of 2012 due to the normal retirement of capital expenditures on both our website and assets purchased when we relocated our corporate headquarters.

Interest Expense, net. Interest expense, net was $41,000 in the third quarter of 2013 compared to $244,000 in the third quarter of 2012 as no amounts were outstanding under the debt facility during the three months ended September 30, 2013. During the three months ended September 30, 2012, we had $30.0 million in borrowings outstanding.

Income Tax Expense (Benefit). In the third quarter of 2013, we recorded an income tax expense of $1.1 million, which reflects an effective income tax rate of 75.6%. In the third quarter of 2012, we recorded an income tax benefit of $911,000, which reflects an effective income tax rate of (54.3)%. In the third quarter of 2013, we recorded a charge of $800,000 to record a valuation allowance against the deferred tax asset generated for our charitable contributions that might not be realized due to the short carryforward period for this temporary difference. Additionally, the change in the effective income tax rate was due to changes in executive compensation.


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Nine Months Ended September 30, 2013 Compared to Nine Months Ended September 30, 2012

                                              Nine Months Ended September 30,
                                     2013           2012         $ Change       % Change
                                                       (in thousands)

   REVENUE                         $ 288,213      $ 334,353      $ (46,140 )          (14 )%


   COSTS AND EXPENSES:
   Cost of revenue                   147,696        180,783        (33,087 )          (18 )%
   Marketing                          80,549         92,671        (12,122 )          (13 )%
   General and administrative         42,937         50,776         (7,839 )          (15 )%
   Depreciation and amortization       6,803          8,112         (1,309 )          (16 )%


   Total costs and expenses          277,985        332,342        (54,357 )          (16 )%


   Operating income                   10,228          2,011          8,217            409 %

   OTHER EXPENSE                           0            (78 )           78            100 %

   INTEREST EXPENSE, net                (123 )         (754 )          631             84 %


   Income before income taxes         10,105          1,179          8,926            757 %
   INCOME TAX EXPENSE (BENEFIT)        4,030         (1,045 )        5,075            486 %

   Net income                      $   6,075      $   2,224      $   3,851            173 %


   % of revenue
   Gross margin                         48.8 %         45.9 %
   Marketing                            27.9 %         27.7 %
   General and administrative           14.9 %         15.2 %
   Operating income                      3.5 %          0.6 %

Revenue. Revenue decreased to $288.2 million in the nine months ended September 30, 2013 from $334.4 million in the comparable period of 2012. The revenue decrease occurred primarily due to declines in on-program revenue and new customers, slightly offset by increased retail, reactivation and QVC revenue. In the nine months ended September 30, 2013, the direct channel accounted for 92% of total revenue compared to 4% for QVC and 4% for retail. In the nine months ended September 30, 2012, the direct channel accounted for 96% of total revenue compared to 3% for QVC and 1% for other.

Costs and Expenses. Cost of revenue decreased to $147.7 million in the nine months ended September 30, 2013 from $180.8 million in the comparable period of 2012. Gross margin as a percent of revenue increased to 48.8% in the nine months ended September 30, 2013 from 45.9% for the comparable period of 2012. The increase in the gross margin percent was primarily attributable to pricing discipline, the removal of certain promotional items and free food promotions and process re-engineering. These items offset a higher mix of lower margin products and a $5.0 million charge to settle certain disputes that had arisen with a supplier over a legacy contract.

Marketing expense decreased to $80.5 million in the nine months ended September 30, 2013 from $92.7 million in the comparable period of 2012. Marketing expense as a percent of revenue increased to 27.9% in the nine months ended September 30, 2013 from 27.7% for the comparable period of 2012. Substantially all marketing spending promoted the direct business. The decrease in marketing expense was primarily attributable to decreased spending for advertising media ($10.7 million) and public relations ($2.1 million). These decreases were partially offset by an increase in marketing consulting ($1.0 million). In total, media spending was $67.3 million in the nine months ended September 30, 2013 and $78.0 million in the nine months ended September 30, 2012.


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General and administrative expense decreased to $42.9 million in the nine months ended September 30, 2013 from $50.8 million in the comparable period of 2012. General and administrative expense as a percent of revenue decreased to 14.9% in the nine months ended September 30, 2013 from 15.2% in the comparable period of 2012. In the nine months ended September 30, 2013, we recorded approximately $1.4 million in severance, including $326,000 of non-cash expense related to the acceleration of previously awarded equity-based awards offset by decreased spending for professional, outside and computer services expense of $1.2 million. In the prior period of 2012, we recorded an impairment charge of $2.1 million related to advances paid to a frozen food supplier and $7.7 million of severance and related charges.

Depreciation and amortization expense decreased to $6.8 million in the nine months ended September 30, 2013 compared to $8.1 million in the nine months ended September 30, 2012 due to the normal retirement of capital expenditures on both our website and assets purchased when we relocated our corporate headquarters.

Interest Expense, net. Interest expense, net was $123,000 in the nine months ended September 30, 2013 compared to $754,000 in the comparable period of 2012 as no amounts were outstanding under the debt facility during the nine months ended September 30, 2013 versus $30.0 million in outstanding borrowings during the comparable period in 2012.

Income Tax Expense (Benefit). In the nine months ended September 30, 2013, we recorded an income tax expense of $4.0 million, which reflects an estimated annual effective income tax rate of 39.9%. In the comparable period of 2012, we recorded an income tax benefit of $1.0 million, which reflects an estimated annual effective income tax rate of (88.6)%. In the third quarter of 2013, we recorded a charge of $800,000 to record a valuation allowance against the deferred tax asset generated for our charitable contributions that might not be realized due to the short carryforward period for this temporary difference. In addition to the valuation allowance, the change in the estimated annual effective income tax rate was due to higher pre-tax income levels and changes in executive compensation.

Contractual Obligations and Commercial Commitments

As of September 30, 2013, our principal commitments consisted of obligations under supply agreements with food vendors, an agreement with our outside fulfillment provider, operating leases and employment contracts. In October 2013, we entered into a new supply agreement with a food vendor that specified minimum purchase commitments over a five year period. Although we have no material commitments for capital expenditures, we anticipate continuing requirements for capital expenditures. In addition, we have no off-balance sheet financing arrangements.

Liquidity, Capital Resources and Other Financial Data

At September 30, 2013, we had working capital of $25.1 million, compared to working capital of $31.4 million at December 31, 2012. Cash and cash equivalents at September 30, 2013 were $18.4 million, an increase of $2.2 million from the balance of $16.2 million at December 31, 2012. In addition, we had $22.8 million invested in short term investments at September 30, 2013 as compared to $3.2 million at December 31, 2012. Our principal sources of liquidity during this period were cash flows from operations.

On November 8, 2012, we entered into a $40.0 million secured revolving credit facility, as amended, with a lender. The $40.0 million credit facility provides for interest on borrowings at either a base rate or a London Inter-Bank Offered Rate, in each case plus an applicable margin, and is also subject to an unused fee payable quarterly. The $40.0 million credit facility contains financial and other covenants including a minimum consolidated fixed charge ratio, a minimum consolidated tangible net worth and a minimum consolidated liquidity ratio, and includes limitations on, among other things, capital expenditures, additional indebtedness, acquisitions, stock repurchases and restrictions on paying dividends in certain circumstances. The $40.0 million credit facility can be drawn upon through November 8, 2015, at which time all amounts must be repaid. As of September 30, 2013, no amounts were outstanding under the $40.0 million . . .

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