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NTRI > SEC Filings for NTRI > Form 10-K on 10-Mar-2014All Recent SEC Filings

Show all filings for NUTRI SYSTEM INC /DE/

Form 10-K for NUTRI SYSTEM INC /DE/


10-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the financial information included elsewhere in this Annual Report.

Background

We provide weight management products and services and offer nutritionally balanced weight loss programs designed for women, men, and seniors, as well as our Nutrisystem® D® program specifically designed to help people with type 2 diabetes who want to lose weight and manage their diabetes. Our programs are based on over 40 years of nutrition research and on the science of the low Glycemic Index. Our 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 through retail programs.

Revenue consists primarily of food sales. For 2013, 2012 and 2011, the direct channel accounted for 92%, 96% and 95%, respectively, of total revenue compared to 3%, 3% and 4%, respectively, for QVC. During 2013, 5% of total revenue came from retail. During 2012 and 2011, 1% of total revenue came from other channels. 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.

In December 2013, we launched Nutrisystem My Way, a program tailored to the individual's metabolism, along with our Fast 5™ kit, a one-week kick start that can help customers lose five pounds in their first week of dieting. The Nutrisystem® My Way® program uses an algorithm to estimate each customer's metabolic rate in order to create a customized program tailored to the amount of calories needed for healthy weight loss. Customers are given a meal plan and exercise suggestions and are encouraged to check in periodically with a Nutrisystem counselor as their needs change in response to weight loss.

Additionally, we introduced new 5-day Jumpstart Your Weight Loss Kits in 2013 which were available exclusively at Walmart and represent a significant departure from our traditional 28-day program. This partnership with Walmart provides us with great brand exposure, offering consumers who may not be aware of our program an opportunity to sample Nutrisystem at an attractive price point.

As we began 2013, we renewed our focus on the following key areas: 1) a return to direct marketing fundamentals including building and leveraging our database;
2) margin improvement; 3) product and program


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innovation; and 4) prioritization of growth initiatives. During 2013, we have reduced the size of the senior management team and reorganized the workforce to align around key priorities resulting in approximately $2.4 million in severance, including $696,000 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 2013 to settle certain disputes that had arisen with a supplier over a legacy contract. Retail and reactivation revenue as well as the average selling price increased during 2013. Despite these improvements, as well as revenue growth in the second half of 2013 as compared to the comparable period of 2012, revenue remains down for the year ended December 31, 2013 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.

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. Management considers the following accounting estimates to be the most critical in preparing our consolidated financial statements. These critical accounting estimates are discussed with our audit committee quarterly.

Reserves for Returns. We review the reserves for customer returns at each reporting period and adjust them to reflect data available at that time. To estimate reserves for returns, we consider actual return rates in preceding periods and changes in product offerings or marketing methods that might impact returns going forward. To the extent the estimate of returns changes, we will adjust the reserve, which will impact the amount of product sales revenue recognized in the period of the adjustment. The provision for estimated returns for the years ended December 31, 2013, 2012 and 2011 was $10.8 million, $10.4 million and $12.9 million, respectively. The returns percentage has increased primarily due to the introduction of a tiered pricing strategy in 2012. The reserve for estimated returns incurred but not received and processed was $637,000 and $652,000 at December 31, 2013 and 2012, respectively, and has been included in other accrued expenses and current liabilities in the accompanying consolidated balance sheets.

Excess and Obsolete Inventory. We continually assess the quantities of inventory on hand to identify excess or obsolete inventory and a provision is recorded for any estimated loss. We estimate the reserve for excess and obsolete inventory based primarily on our forecasted demand and/or our ability to sell the products, introduction of new products, future production requirements and changes in our customers' behavior. The reserve for excess and obsolete inventory was $725,000 and $636,000 at December 31, 2013 and 2012, respectively.

Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets are evaluated for future realization and reduced by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent earnings and expectations of future taxable income and other relevant factors. We estimate the annual effective income tax rate at the beginning of each year and revise the estimate at each reporting period based on a number of factors including operating results, level of tax exempt interest income, charitable contributions and sales by state, among other items.


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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.

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

Overview of the Direct Channel

In 2013, 2012 and 2011, the direct channel represented 92%, 96% and 95%, respectively, of our revenue. Revenues through the direct channel were $327.8 million in 2013 compared to $380.8 million in 2012 and $382.8 million in 2011. 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 revenue decrease in 2013 was primarily attributable to declines in new customer starts and decreased on-program revenue partially offset by increased reactivation revenue and higher average selling prices. 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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Year Ended December 31, 2013 Compared to Year Ended December 31, 2012



                                                             Year Ended December 31,
                                            2013             2012            $ Change          % Change
                                                                  (in thousands)
REVENUE                                   $ 358,086        $ 396,878         $ (38,792 )             (10 )%

COSTS AND EXPENSES:
Cost of revenue                             184,210          213,095           (28,885 )             (14 )%
Marketing                                    95,784          111,095           (15,311 )             (14 )%
General and administrative                   58,227           66,332            (8,105 )             (12 )%
Depreciation and amortization                 8,896           10,724            (1,828 )             (17 )%

Total costs and expenses                    347,117          401,246           (54,129 )             (13 )%

Operating income (loss)                      10,969           (4,368 )          15,337               351 %
OTHER EXPENSE                                     0               78               (78 )            (100 )%
INTEREST EXPENSE, net                            89            2,034            (1,945 )             (96 )%

Income (loss) before income tax
expense (benefit)                            10,880           (6,480 )          17,360               268 %
INCOME TAX EXPENSE (BENEFIT)                  3,510           (3,675 )           7,185               196 %

Net income (loss)                         $   7,370        $  (2,805 )       $  10,175               363 %


% of revenue
Gross margin                                   48.6 %           46.3 %
Marketing                                      26.7 %           28.0 %
General and administrative                     16.3 %           16.7 %
Operating income (loss)                         3.1 %           (1.1 )%

Revenue. Revenue decreased to $358.1 million in 2013 from $396.9 million in 2012. The revenue decline occurred primarily due to declines in new customer starts and decreased on-program revenue partially offset by increased retail and reactivation revenue and higher average selling prices. In 2013, direct revenue accounted for 92% of total revenue compared to 3% for QVC and 5% for retail. In 2012, direct revenue accounted for 96% of total revenue compared to 3% for QVC and 1% for other channels.

Costs and Expenses. Cost of revenue decreased to $184.2 million in 2013 from $213.1 million in 2012. Gross margin as a percent of revenue increased to 48.6% in 2013 from 46.3% in 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 resulting from an increase in retail sales and a $5.0 million charge to settle certain disputes that had arisen with a supplier over a legacy contract.

Marketing expense decreased to $95.8 million in 2013 from $111.1 million in 2012. Marketing expense as a percent of revenue decreased to 26.7% in 2013 from 28.0% in 2012. Substantially all of the marketing spending in 2013 promoted the direct business. The decrease in marketing expense was attributable to decreased spending for media ($9.5 million) and for the production of television advertising ($1.4 million). There was also a decrease in public relations ($4.9 million) primarily due to the restructuring of certain third-party marketing vendor contracts in 2012. In total, media spending was $77.4 million in 2013 and $86.9 million in 2012.

General and administrative expense decreased to $58.2 million in 2013 from $66.3 million in 2012 and as a percent of revenue decreased to 16.3% in 2013 from 16.7% in 2012. The decrease was primarily attributable to lower non-cash expense for share-based payment arrangements of $3.6 million due to the acceleration of previously awarded equity-based awards in 2012 as certain employees terminated, a decrease in facilities expense of $2.5 million due to a charge incurred in 2012 to vacate a facility and an impairment charge of $2.1 million recorded in


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2012 related to advances paid to a frozen food supplier. Additionally, recruiting fees decreased $697,000, professional, outside and computer services decreased $383,000 and miscellaneous taxes decreased $392,000. These decreases were offset by increased compensation, benefits and temporary help of $1.8 million and new product development expenses of $371,000 due to business initiatives.

Depreciation and amortization expense decreased to $8.9 million in 2013 from $10.7 million in 2012 as certain fixed assets for both our website and assets purchased when we relocated our corporate headquarters reached the end of their useful lives.

Interest Expense, Net. Interest expense, net, was $89,000 in 2013 compared to $2.0 million in 2012. No amounts were outstanding under the credit facility during 2013. During 2012, we had outstanding borrowings and additionally, in November 2012, we terminated and replaced our then existing credit facility. In connection with the termination, we wrote off the remaining unamortized debt issuance costs and also terminated the outstanding interest rate swap agreements resulting in a combined charge of $1.2 million.

Income Tax Expense (Benefit). In 2013, we recorded an income tax expense of $3.5 million, which reflects an effective tax rate of 32.3% as compared to $3.7 million of income tax benefit in 2012 with an effective tax rate of 56.7%. The change in the effective income tax rate was due to changes in executive compensation, reductions in tax reserves due to the lapse of the statute of limitations in 2013 and decreased levels of food donations which offset a charge to record a valuation allowance for charitable contributions that might not be realized due to the short carryforward period for this temporary difference.

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011



                                                             Year Ended December 31,
                                            2012              2011           $ Change          % Change
                                                                  (in thousands)
REVENUE                                   $ 396,878         $ 401,336        $  (4,458 )              (1 )%

COSTS AND EXPENSES:
Cost of revenue                             213,095           198,405           14,690                 7 %
Marketing                                   111,095           110,922              173                 0 %
General and administrative                   66,332            60,812            5,520                 9 %
Depreciation and amortization                10,724            12,068           (1,344 )             (11 )%

Total costs and expenses                    401,246           382,207           19,039                 5 %

Operating (loss) income                      (4,368 )          19,129          (23,497 )            (123 )%
OTHER EXPENSE                                    78                 0               78                NA
INTEREST EXPENSE, net                         2,034               468            1,566               335 %

(Loss) income before income tax
(benefit) expense                            (6,480 )          18,661          (25,141 )            (135 )%
INCOME TAX (BENEFIT) EXPENSE                 (3,675 )           6,400          (10,075 )            (157 )%

Net (loss) income                         $  (2,805 )       $  12,261        $ (15,066 )            (123 )%


% of revenue
Gross margin                                   46.3 %            50.6 %
Marketing                                      28.0 %            27.6 %
General and administrative                     16.7 %            15.2 %
Operating (loss) income                        (1.1 )%            4.8 %

Revenue. Revenue decreased to $396.9 million in 2012 from $401.3 million in 2011. The revenue decline occurred primarily due to declines in new customer starts, decreased on-program revenue and lower average


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selling prices partially offset by increased reactivation revenue. QVC revenue also decreased due to fewer shows and air time. In 2012, direct revenue accounted for 96% of total revenue compared to 3% for QVC and 1% for other channels. In 2011, direct revenue accounted for 95% of total revenue compared to 4% for QVC and 1% for other channels.

Costs and Expenses. Cost of revenue increased to $213.1 million in 2012 from $198.4 million in 2011. Gross margin as a percent of revenue decreased to 46.3% in 2012 from 50.6% in 2011. The decrease in gross margin was primarily attributable to the promotional inclusion of additional higher cost items with customer starts. Continued price promotions and the sale of our Nutrisystem Advanced inventory to a closeout retailer as we transitioned to the SUCCESS program also negatively impacted gross margins.

Marketing expense increased to $111.1 million in 2012 from $110.9 million in 2011. Marketing expense as a percent of revenue increased to 28.0% in 2012 from 27.6% in 2011. Substantially all of the marketing spending in 2012 promoted the direct business. The increase in marketing expense was attributable to increased spending for public relations ($3.2 million) primarily due to the restructuring of certain third-party marketing vendor contracts partially offset by decreased spending in media ($1.9 million) and for the production of television advertising ($2.6 million). In total, media spending was $86.9 million in 2012 and $88.8 million in 2011.

General and administrative expense increased to $66.3 million in 2012 from $60.8 million in 2011 and as a percent of revenue increased to 16.7% in 2012 from 15.2% in 2011. The increase was primarily attributable to higher compensation, benefits and temporary help ($879,000) and increased recruiting fees ($581,000) due to the cessation of Mr. Redling's employment. In total, we recorded approximately $5.7 million in severance for Mr. Redling, including approximately $3.3 million of non-cash expense related to the acceleration of previously awarded equity-based awards. The increase in compensation, benefits and temporary help was partially offset by savings achieved from the workforce reduction in 2011. Also, there were increased professional and outside computer services expenses ($998,000) due to increased legal fees and increased facilities expense ($1.5 million) due mainly to charges incurred to vacate a facility. Additionally, we recorded an impairment charge ($2.1 million) related to advances paid to a frozen food supplier as the supplier was in default with its bank lender and was in the process of negotiating a work out plan and exploring other strategic alternatives.

Depreciation and amortization expense decreased to $10.7 million in 2012 from $12.1 million in 2011 due to the normal retirement of assets during 2012.

Interest Expense, Net. Interest expense, net, was $2.0 million in 2012 compared to $468,000 in 2011. In November 2012, we terminated and replaced our then existing credit facility. In connection with the termination, we wrote off the remaining unamortized debt issuance costs and also terminated the outstanding interest rate swap agreements resulting in a combined charge of $1.2 million. Additionally, interest rates increased during 2012 as compared to 2011.

Income Tax (Benefit) Expense. In 2012, we recorded an income tax benefit of $3.7 million, which reflects an effective tax rate of 56.7% as compared to $6.4 million of income tax expense in 2011 with an effective tax rate of 34.3%. The change in the effective income tax rate was due to favorable book to tax differences including the elimination of the limitation on executive compensation deductions, reductions in tax reserves and increased food donations combined with lower pre-tax income levels which resulted in income tax benefits.

Contractual Obligations and Commercial Commitments

As of December 31, 2013, our principal commitments consisted of obligations under supply agreements with food vendors, an agreement with our outside fulfillment provider, agreements with our internet and networking providers, operating leases and employment contracts. Although we have no material commitments for capital expenditures, we anticipate continuing requirements for capital expenditures.


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Following is a summary of our contractual obligations.

                                                            Payments Due by Period (in millions)
                                                       Less Than                                             More Than
Contractual obligations                Total            1 Year           1-3 Years         4-5 Years          5 Years
Purchase obligations                  $   69.1        $      17.8       $      28.1       $      23.2       $       0.0
Operating leases                          24.6                3.3               5.4               5.5              10.4

                                      $   93.7        $      21.1       $      33.5       $      28.7       $      10.4

We have entered into supply agreements with various food vendors. Several of these agreements provide for annual pricing, annual purchase obligations, as well as exclusivity in the production of certain products, with terms of five years or less. Purchase obligations may vary depending on product mix. One agreement also provides for certain rebates to us if certain volume thresholds are exceeded. Several agreements require us to purchase specified percentages of our annual requirements for certain products. Those commitments have not been estimated and are not included in the above table. We anticipate that we will meet all annual purchase obligations.

Off-Balance Sheet Arrangements

We have no off-balance sheet financing arrangements.

Liquidity, Capital Resources and Other Financial Data

At December 31, 2013, we had working capital of $21.8 million, a decrease of $9.6 million from the $31.4 million working capital balance at December 31, 2012. Cash and cash equivalents at December 31, 2013 were $9.8 million, a decrease of $6.4 million from the balance of $16.2 million at December 31, 2012. In addition, we had $16.6 million invested in short term investments at December 31, 2013 as compared to $3.2 million at December 31, 2012. Our principal sources of liquidity during 2013 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 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 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 credit facility can be drawn upon through November 8, 2015, at which time all amounts must be repaid. There were no borrowings outstanding at December 31, . . .

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