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NTRI > SEC Filings for NTRI > Form 10-Q on 7-May-2014All Recent SEC Filings

Show all filings for NUTRI SYSTEM INC /DE/

Form 10-Q for NUTRI SYSTEM INC /DE/


7-May-2014

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 SEC.


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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 2013 Annual Report 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 the 2013 Annual Report 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.

Overview

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 select retailers.

Revenue consists primarily of food sales. For the first quarter of 2014, the direct channel accounted for 90% of revenue compared to 7% for retail and 3% for QVC. For the first quarter of 2013, the direct channel accounted for 92% of revenue compared to 3% for retail and 5% for QVC. 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 as it allows us to react to changing market conditions relatively quickly. Additionally, we are continually looking to make investments to improve lifetime customer economics, length of stay, and overall customer satisfaction. We are able to test new commercials, offers and website configurations to allow us to be more responsive to customer needs and attempt to drive conversion.

In December 2013, we launched Nutrisystem My Way, a customizable program, along with our Fast 5™ kit, a one-week starter kit that can help customers lose five pounds in their first week of dieting. The Nutrisystem® My Way® program uses an algorithm 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 Weight Loss Kits in 2013, which were available exclusively at Walmart, and represented a significant departure from our traditional 28-day program. Walmart provides us with significant brand exposure, offering consumers who may not be aware of our program an opportunity to sample Nutrisystem products at an attractive price point. We are actively developing our retail product pipeline and expect additional products/kits to launch and are continually exploring additional distribution opportunities for these products.


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We believe these new product and program innovations are resonating well with our customers. Revenue for the first quarter of 2014 increased 16% from the first quarter of 2013 to $122.2 million. We experienced increases in new customers, retail and on-program revenue, which offset decreased reactivation and QVC revenue. Retail revenue increased primarily from an increase in the number of stores carrying our product. On-program revenue increased in the first quarter of 2014 as compared to the same period of 2013 as it benefited from the increase of new customers through the fourth quarter of 2013, partially offset by a decline in the number of paid days a customer stayed on the program. Additionally, we had a higher average selling price in the first quarter of 2014 as compared to the same period of 2013. Reactivation revenue decreased from the decline of new customer starts in previous years and QVC decreased due to fewer shows and air time. Gross margins were pressured during the first quarter of 2014 due to certain promotional offers but are expected to improve as 2014 progresses. We spent more in marketing during the first quarter of 2014, as compared to the same period of 2013, yet our acquisition cost per order decreased resulting in a more efficient marketing spend. For the remainder of 2014, we look to continue to work towards growing our direct business, launching new products and programs at an accelerated pace, capturing greater retail market share through channel and product expansion and operating with continued cost discipline.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with GAAP. Our significant accounting policies are described in Note 2 of the consolidated financial statements included in Item 8 of our 2013 Annual Report.

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 three months ended March 31, 2014, 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.


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Interest Expense, Net. Interest expense, net consists of interest expense and unused line fees on our revolving credit facility 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 income taxes based on an estimated effective income tax rate for the year.

Overview of the Direct Channel

In the three months ended March 31, 2014 and 2013, the direct channel represented 90% and 92%, respectively, of our revenue. Revenues through the direct channel were $110.5 million in the three months ended March 31, 2014 compared to $97.1 million in the same period of 2013. 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 increase in revenue is primarily attributable to an increase in new customers and on-program revenue, which offset decreased reactivation revenue from the decline of new customer starts in previous years. We experienced a positive response to our program, Nutrisystem My Way with our Fast 5™ kit, which launched in December 2013, resulting in an increase in new customers. On-program revenue increased in the three months ended March 31, 2014 as compared to the same period of 2013 as it benefited from the increase of new customers through the fourth quarter of 2013, partially offset by a decline in the number of paid days a customer stayed on the program. Additionally, we had a higher average selling price in the three months ended March 31, 2014 as compared to the same period 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 March 31, 2014 Compared to Three Months Ended March 31, 2013



                                                                 Three Months Ended March 31,
                                                      2014           2013          $ Change       % Change
                                                                        (in thousands)

REVENUE                                             $ 122,228      $ 105,384       $  16,844             16 %


COSTS AND EXPENSES:
Cost of revenue                                        62,421         52,353          10,068             19 %
Marketing                                              41,744         36,316           5,428             15 %
General and administrative                             15,918         15,251             667              4 %
Depreciation and amortization                           1,758          2,549            (791 )          (31 )%


Total costs and expenses                              121,841        106,469          15,372             14 %


Operating income (loss)                                   387         (1,085 )         1,472            136 %

INTEREST EXPENSE, net                                      45             53              (8 )          (15 )%


Income (loss) before income tax expense (benefit)         342         (1,138 )         1,480            130 %

INCOME TAX EXPENSE (BENEFIT)                              118           (498 )           616            124 %

Net income (loss)                                   $     224      $    (640 )     $     864            135 %


% of revenue
Gross margin                                             48.9 %         50.3 %
Marketing                                                34.2 %         34.5 %
General and administrative                               13.0 %         14.5 %
Operating income (loss)                                   0.3 %         (1.0 )%

Revenue. Revenue increased to $122.2 million in the first quarter of 2014 from $105.4 million for the first quarter of 2013. The increase in revenue is primarily attributable to an increase in new customers, retail and on-program revenue which offset decreased reactivation and QVC revenue. Additionally, we had a higher average selling price in the first quarter of 2014 as compared to the same period of 2013. In the first quarter of 2014, the direct channel accounted for 90% of revenue compared to 7% for retail and 3% for QVC. In the first quarter of 2013, the direct channel accounted for 92% of revenue compared to 3% for retail and 5% for QVC.

Costs and Expenses. Cost of revenue increased to $62.4 million in the first quarter of 2014 from $52.4 million in the first quarter of 2013. Gross margin as a percent of revenue decreased to 48.9% in the first quarter of 2014 from 50.3% for the first quarter of 2013. The decrease in gross margin was primarily attributable to a higher mix of lower margin products resulting from the increase in retail sales and certain promotional offers, including a free week of food and shakes, partially offset by a price increase.

Marketing expense increased to $41.7 million in the first quarter of 2014 from $36.3 million in the first quarter of 2013. Marketing expense as a percent of revenue decreased to 34.2% in the first quarter of 2014 from 34.5% for the first quarter of 2013. Substantially all marketing spending promoted the direct business. The increase in marketing expense was primarily attributable to increased spending for advertising media ($6.9 million). This increase was offset by a decrease in television production ($1.1 million) and marketing consulting ($213,000). In total, media spending was $38.3 million in the first quarter of 2014 and $31.4 million in the first quarter of 2013.

General and administrative expense increased to $15.9 million in the first quarter of 2014 compared to $15.3 million in the first quarter of 2013. General and administrative expense as a percent of revenue decreased to 13.0% in the first quarter of 2014 from 14.5% for the first quarter of 2013. The increase in spending was primarily attributable to higher compensation, benefits and temporary help ($1.3 million) and increased professional, outside and computer services expense ($322,000). These increases were partially offset by approximately $1.4 million in severance recorded during the first quarter of 2013, including $326,000 of non-cash expense related to the acceleration of previously awarded equity-based awards.


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Depreciation and amortization expense decreased to $1.8 million in the first quarter of 2014 compared to $2.5 million in the first quarter of 2013 as certain assets for 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 $45,000 in the first quarter of 2014 compared to $53,000 in the first quarter of 2013.

Income Tax Expense (Benefit). In the first quarter of 2014, we recorded income tax expense of $118,000, which reflects an effective income tax rate of 34.5%. In the first quarter of 2013, we recorded an income tax benefit of $498,000, which reflects an effective income tax rate of 43.8%. The decrease in the effective income tax rate was due to the pre-tax loss in the first quarter of 2013 and a discrete income tax benefit for the research and development tax credit recorded in the first quarter of 2013.

Contractual Obligations and Commercial Commitments

As of March 31, 2014, 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. In addition, we have no off-balance sheet financing arrangements.

Liquidity, Capital Resources and Other Financial Data

At March 31, 2014, we had working capital of $17.8 million, a decrease of $4.0 million from the $21.8 million working capital balance at December 31, 2013. The decrease in working capital is primarily due to increased accounts payable caused by the timing of payments. Cash and cash equivalents at March 31, 2014 were $12.9 million, an increase of $3.1 million from the balance of $9.8 million at December 31, 2013. In addition, we had $16.6 million invested in short term investments at both March 31, 2014 and December 31, 2013. 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 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 coverage 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. As of March 31, 2014, no amounts were outstanding under the credit facility.

In the three months ended March 31, 2014, we generated cash flows of $9.9 million from operating activities, a decrease of $12.5 million from the same period of 2013. The decrease in cash flows from operations was primarily attributable to net changes in operating assets and liabilities largely due to an increase in receivables due to increased purchases of our gift cards.

In the three months ended March 31, 2014, net cash used in investing activities was $1.3 million, a decrease of $11.4 million from the same period of 2013. The decrease was primarily due to a reduced level of short term investment purchases.

In the three months ended March 31, 2014, net cash used in financing activities was $5.4 million primarily for the payment of dividends.

Subsequent to March 31, 2014, our Board of Directors declared a quarterly dividend of $0.175 per share payable on May 22, 2014 to stockholders of record as of May 12, 2014. Although we intend to continue to pay regular quarterly dividends, the declaration and payment of future dividends are discretionary and will be subject to quarterly determination by our Board of Directors following its review of our financial performance.


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We believe that our available capital resources are sufficient to fund our working capital requirements, capital expenditures, income tax obligations and dividends for the foreseeable future.

Seasonality

Typically in the weight loss industry, revenue is strongest in the first calendar quarter and lowest in the fourth calendar quarter. We believe our business experiences seasonality, driven by the predisposition of dieters to initiate a diet at the start of a new year and the price and availability of certain media.

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