Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

for the fiscal year ended December 31, 2004

for the transition period from              to             

Commission File Number 0-28551

NutriSystem, Inc.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (215) 706-5300

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $.001 par value

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x    No  ¨.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes  ¨    No  x.

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2004, was $29,686,639. Such aggregate market value was computed by reference to the closing price of the common stock as reported on the American Stock Exchange on June 30, 2004.

Number of shares outstanding of the Registrant’s Common Stock, $0.001 par value, as of March 24, 2005: 30,725,184 shares

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be filed with the Securities and Exchange Commission for NutriSystem, Inc.’s Annual Meeting of Stockholders to be held on May 24, 2005, are incorporated by reference into Part III of this Form 10-K.

Table of Contents

NutriSystem, Inc.

Table of Contents

2

Table of Contents

PART I

ITEM 1. BUSINESS

Background

NutriSystem, Inc., (a Delaware corporation), together with its subsidiaries (“NutriSystem” or the “Company”), provides weight management and fitness products and services. The NutriSystem diet program was originally developed by the Company’s predecessor businesses that operated through company-owned and franchised weight loss centers. Currently, there are no Company-operated centers and the Company terminated its last franchise agreements in 2003. There are 15 independent center-based distributors who operate without franchise agreements (“Case Distributors”). In 1998, the Company initiated a marketing program using independent commissioned representatives. In late 1999, the Company began selling directly to the consumer through the Internet and by telephone. In 2001, the Company began selling foods through QVC, a television shopping network. The Company’s pre-packaged foods are now sold to weight loss program participants directly via the Internet and telephone (the “Direct” channel) and through independent commissioned representatives (the “Field Sales” channel), Case Distributor weight loss centers (the “Case Distributor” channel) and QVC. On December 2, 2004, NutriSystem Inc. acquired Slim and Tone LLC, a franchisor of women’s express fitness centers. Slim and Tone franchisees now sell the NutriSystem diet program in their centers as independent commissioned representatives.

Since the NutriSystem businesses began in 1972, the businesses have operated in various organizational and legal structures, and were subject to a bankruptcy proceeding in 1993, which was discharged in 1994. NutriSystem became a publicly traded company in October 1999. In September 2000, the Company changed its name from nutrisystem.com inc. to Nutri/System, Inc. and in 2003, the Company changed its name to NutriSystem, Inc.

In 2001, the Company discontinued sales of the Sweet Success line of diet meal replacement products it had acquired the year before. In December 2002, the Company sold the intellectual property associated with Sweet Success. Sweet Success is reflected in the Consolidated Financial Statements as a discontinued operation.

In December 2002, HJM Holdings LLC and NewSpring Ventures, L.P. collectively acquired 58.4% of the outstanding shares of common stock from existing stockholders effecting a change in control of the Company. The Company was not a party to the transaction. In 2004, HJM Holdings LLC distributed its NutriSystem shares to its partners and dissolved. Currently, no affiliated group owns more than 15% of the common stock of the Company.

Industry

Weight loss is a challenge for a significant portion of the American population. According to a study published in the October 2002 Journal of the American Medical Association, approximately 127 million Americans are overweight. Furthermore, according to the National Center for Health Statistics, the incidence of obesity in the United States, as defined by federal guidelines, increased between 1980 and 2000 from 15% to 31% of the adult population. Many medical studies have documented a link between obesity and a variety of health concerns. With obesity rates escalating, Americans are increasingly at risk for diseases such as diabetes, certain cancers and various forms of heart disease that may be linked to obesity.

The weight loss industry consists of a wide variety of diet foods and meal replacement bars and shakes, appetite suppressants, nutritional supplements, pharmaceutical products and weight loss programs. The domestic market for weight loss programs, diet foods and diet related books and other information, excluding vitamins, supplements and minerals, was estimated by Market Data Enterprises, Inc. to be in excess of $7 billion in 2000.

Products and Services

For 30 years, the NutriSystem name has been recognized as a leader in the weight loss industry. By telephone and through its web site, www.nutrisystem.com, NutriSystem provides a comprehensive weight management program, consisting of support for dieters and a pre-packaged food program. Online support for dieters includes individualized diet and exercise plans, online counseling, support groups, bulletin boards, online classes and chat rooms. Trained counselors are available 126 hours a week to answer questions and custom-design and recommend an exercise program to help each member achieve his or her weight loss and fitness goals. Members share information and encouragement with each other through hosted chat rooms and bulletin boards. These services are complemented with relevant information on diet, nutrition, exercise and well-being provided on the web site. NutriSystem provides free membership and access to telephone and online support.

3

Table of Contents

In December 2003, the Company introduced NutriSystem Nourish, a new line of pre-packaged, portion-controlled food sold under the NutriSystem brand. The NutriSystem Nourish program consists of a menu of over 140 food selections with a low glycemic index that provide dieters with a balanced intake of “good” carbohydrates. NutriSystem Nourish also features new, easy-to-use exercise and behavior modification programs.

Typically, our customers purchase monthly food packages containing 28 breakfasts, lunches, dinners and snacks, which they supplement with fresh milk, fruit and vegetables. Most customers order on an auto delivery basis in which the Company sends food to the customer on an ongoing monthly basis until notified by the customer to cease shipments. With the auto delivery program, a full day’s supply of entrees and snacks currently are priced at less than $10.00 a day. The food is shelf stable at room temperature, making it relatively inexpensive to ship and store. On the web site, members can order food 24 hours a day, seven days a week.

The Company’s telephone and online support addresses many of the most common limitations of traditional weight loss programs, including high initiation and recurring membership fees, the inconvenience of traveling to weight loss centers for scheduled appointments and lack of privacy. In addition, the Company’s program allows members to participate conveniently and privately from their own homes or offices.

The Company’s pre-packaged foods are also sold to weight loss program participants through QVC, as well as through the Field Sales and Case Distributor channels.

On December 2, 2004, NutriSystem Inc. acquired Slim and Tone LLC, a franchisor of women’s express fitness centers. Slim and Tone franchisees provide women with an exercise facility that is safe, quick, comfortable, supportive and one that meets their unique needs. Customers obtain a 30 minute workout using hydraulic resistance training equipment. Franchise operators now offer the NutriSystem Nourish program to their clients, providing a comprehensive weight loss program that brings together diet and exercise.

Marketing

The Company’s primary marketing objective is to leverage NutriSystem’s established brand cost effectively to build sales of its food program through its Direct channel. The Company uses a combination of online and traditional offline advertising and promotional strategies.

Offline advertising. Offline advertising is used to encourage qualified customers to call or visit the Company’s web site and increase awareness of the online program. Offline, NutriSystem reaches its target audience primarily through a combination of television, print, and direct mail advertising. On television and in print, direct response-focused advertisements capitalize on the NutriSystem brand name and focus on “before and after” comparison and/or the program’s simplicity, convenience and “good carb” features. Direct mail is a companion to the media advertising and consists of mailings to Direct members who have purchased or signed up for membership.

Online advertising. The Company’s online advertising strategy includes the use of keyword search terms, affiliate programs, email newsletters and targeted direct email programs, primarily to its own email database of current and prior members. The Company currently places the bulk of its online banner advertising through affiliate programs that compensate advertisers on a cost per customer acquired (CPA) basis.

Promotion. Starting in the fourth quarter of 2003, the Company expanded its efforts to generate visibility in various press, television and radio outlets and improve public awareness of the brand. For example, the Company had promotional success through Zora Andrich, a spokesperson who was the winner of the Joe Millionaire reality TV show, as a featured dieter in a television reality makeover show, and as a subject of various magazine articles on dieting.

Fulfillment

The Company currently leases approximately 97,600 square feet of office and warehouse space in Horsham, Pennsylvania pursuant to a lease expiring in 2009 at an annual rent of $667,248. In December 2003, the Company obtained additional fulfillment capacity in central Pennsylvania and Sparks, Nevada through an outsourced provider. Management believes the Horsham facility combined with the outsourced fulfillment capacity are adequate for the Company’s needs for the foreseeable future. The Company also maintains 1,400 square feet of office space in Yardley, Pennsylvania in connection with the Slim and Tone acquisition. This lease expires in 2006 at an annual rent of $24,615.

4

Table of Contents

The Company operates an integrated order receipt, billing, picking, shipping and delivery tracking system comprised of proprietary and third party components. This system integrates the front end, or web site customer interface, with order processing and shipping, and allows Internet customers to access shippers’ order tracking numbers online. The Company’s computer-assisted picking system allows for virtually paperless order picking in all warehouse facilities. Management believes the integration of its shipping systems with the operations of its outsourced fulfillment operations is satisfactory.

Except in periods of unusually high demand, management believes that virtually all Direct customer orders received by 2:00 p.m. weekdays are shipped on the day received. Direct customers are not charged for their orders until the ordered product is shipped. Management estimates that it can ship to 90% of the domestic population from its owned or outsourced warehouse facilities within four business days using standard ground transportation. The Company ships to its customers using either Federal Express, United Parcel Service or US Mail. It does not currently charge customers for shipping and handling on auto delivery food orders.

Technology

The Company’s web site is hosted at a remote third party hosting facility with a backup at the Company’s headquarters in Horsham, PA. The hosting facility provides technologically advanced physical and fire security and electric power back up for the equipment on which the Company’s web site operates. The Company’s servers and its network are monitored 24 hours a day, seven days a week. Servers at both sites are connected on a continuous, real-time basis, which allows the Company to move the website from primary to backup without any loss of data.

Competition

The weight loss industry consists of pharmaceutical products and weight loss programs, as well as a wide variety of diet foods and meal replacement bars and shakes, appetite suppressants and nutritional supplements. The weight loss market is served by a diverse array of competitors. Potential customers seeking to manage their weight can turn to traditional center-based competitors, medically supervised programs, online diet-oriented sites or other self-administered products and programs.

The principal competitive factors in the weight loss market are:

Management believes it can compete effectively on these factors. However, it has no control over how successful competitors will be in addressing these factors. By providing a well-recognized food-based program using the Direct channel, management believes it has gained a competitive advantage in that market.

The women’s express workout market is dominated by Curves, which operates in approximately 8,000 locations. To succeed as a franchisor, Slim and Tone must have a successful network of franchisees and it must attract new franchisees to the business.

The principal competitive factors in the women’s express workout market are:

5

Table of Contents

Management believes it can compete effectively on these factors. It believes the addition of the NutriSystem diet program enhances Slim and Tone’s market position and provides additional brand recognition.

In both the diet and workout markets, many current and potential competitors have larger customer bases, similar or greater brand recognition and significantly greater financial, marketing and other resources than the Company’s. Competitors have and are expected to continue to adopt aggressive pricing schemes and innovative product and service offerings. Increased competition may result in reduced operating margins, an inability to increase market share and a diminished brand franchise for NutriSystem and Slim and Tone.

Seasonality

Typically, revenues of weight loss business are lowest in the fourth calendar quarter and during the summer months. As a franchisor in the women’s express workout market, Slim and Tone experiences relatively little seasonality.

Employees

As of March 15, 2005, the Company had 102 administrative employees including counselors and customer service personnel, 40 employees dedicated to fulfillment and 13 employees in marketing. None of the Company’s employees are represented by a labor union and the Company considers its relations with its employees to be good.

Available Information

All periodic and current reports, registration statements, code of conduct, code of ethics and other material that the Company is required to file with the Securities and Exchange Commission (“SEC”), including the Company’s annual report on Form 10-K, quarterly reports on Form10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 (the “1934 Act Reports”), are available free of charge through the Company’s investor relations page at www.nutrisystem.com. Such documents are available as soon as reasonably practicable after electronic filing of the material with the SEC. The Company’s Internet web site and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.

The public may also read and copy any materials filed by the Company with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site, www.sec.gov, which contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

Executive Officers of the Company

The Company’s executive officers and their respective ages and positions as of December 31, 2004 are as follows:

Michael J. Hagan was appointed Chairman of the Board of Directors and Chief Executive Officer of the Company on December 20, 2002. Prior to joining the Company, Mr. Hagan was the co-founder of Verticalnet, Inc., a business-to-business internet and software company, and held a number of executive positions at Verticalnet since its founding in 1995, including Chairman of the Board from February 2002 to the present, president and Chief Executive Officer from January 2001 to February 2002, Executive Vice President and Chief Operating Officer from January 2000 to January 2001 and Senior Vice President prior to that time. Prior to founding Verticalnet, Mr. Hagan was a Vice President and

6

Table of Contents

Senior Manager at Merrill Lynch Asset Management from 1990 to 1995, and worked for Bristol Meyers Squibb from 1988 to 1990. Mr. Hagan is a director of Verticalnet, Inc. and American Financial Realty Trust. Mr. Hagan is also a trustee of Saint Joseph’s University. Mr. Hagan was a CPA in the State of Pennsylvania (license lapsed).

George Jankovic was appointed President and Chief Operating Officer of the Company on December 20, 2002. Prior to joining the Company, Mr. Jankovic was the founder, Chairman and Chief Executive Officer of beMany, Inc., a provider of residential telecom and energy services, from September 1999 to November 2002. Mr. Jankovic was Vice President of Product Development of Verticalnet, Inc. from September 1998 to September 1999. Mr. Jankovic was co-founder and Chief Executive Officer of RF Globalnet, Inc. from March 1996 until it was acquired by Verticalnet in September 1998.

James D. Brown has been the Company’s Chief Financial Officer since December 1999 and its Treasurer since February 2000. Prior to joining NutriSystem, Mr. Brown was Chief Financial Officer of ImageMax, Inc., a document management company, from 1997 to 1999, and Chief Financial Officer of LMR Holdings, a holding company for textile component manufacturers, from 1996 to 1997. During 1995, Mr. Brown was President of Main Line Management, a management consulting firm, and from 1990 to 1994 he was Chief Financial Officer of Liberty Broadcasting Group, a consolidator of radio broadcasting properties, and Controller of Lancer Industries, Inc., a diversified manufacturer. Mr. Brown was a CPA in the State of New York (license lapsed).

Brendon R. Perero has been NutriSystem’s Chief Information Officer since August 1999. From 1997 to 1999, Mr. Perero was a Vice President and Senior Programmer/Developer of INetU, Inc., a firm engaged in Internet hosting and consulting. From 1997 to 1998, Mr. Perero was also a member of the Design Council for IBM Net.Commerce and collaborated with IBM for third party development of e-commerce software.

RISK FACTORS

You should consider carefully the following risks and uncertainties when reading this Annual Report on Form 10-K. If any of the events described below actually occur, the Company’s business, financial condition and operating results could be materially adversely affected.

If consumers do not widely accept an online or telephonic source for weight loss products and services, the Company will be unable to increase its customer base.

The Company’s success depends on attracting and retaining a high volume of online or telephonic customers. Factors that could impair consumer acceptance of purchasing weight loss products and services online or by telephone include problems with or customer concerns about:

If the Company does not receive adequate supply from its food and other manufacturers, revenues and earnings could suffer.

The Company relies solely on contract manufacturers to supply all of the food and other products it sells. The Company does not have written contracts with any suppliers and it is subject to numerous risks associated with these suppliers’ businesses, including labor disruptions, delivery problems, shortages of ingredients and equipment failure. If the Company cannot supply a sufficient quantity, quality and variety of products to its customers on acceptable commercial terms, it would lose revenues and market share, or incur higher costs.

7

Table of Contents

The Company is dependent on its Chief Executive Officer and other key managers for future success, and these persons are not obligated to stay with the Company.

The Company’s future success depends to a significant degree on the skills, experience and efforts of Michael J. Hagan, its Chief Executive Officer, and other key managerial personnel. The loss of the services of any of these individuals could harm the business. The Company does not have an employment agreement with Mr. Hagan or certain other key personnel. In addition, the Company has not obtained key person life insurance on any key employees. If any key employees left NutriSystem or were seriously injured and became unable to work, the business could be harmed.

The Company may be subject to health-related claims from members or customers.

The Company’s weight loss program does not include medical treatment or medical advice, and the Company does not engage physicians or nurses to monitor the progress of its members. A registered dietician is available to our diet counselors continuously. Many persons who are overweight suffer from other physical conditions, and NutriSystem’s target consumers could be considered a high-risk population in some respects. A member who experiences health problems could bring a lawsuit against the Company alleging that such problems were caused by participation in the weight loss program because certain side effects can be associated with weight loss. For example, the Company’s Predecessor Businesses suffered substantial losses due to allegations that their weight loss programs led to gall bladder disease, even though no medical link was proven. Persons who suffer side effects while participating in the program may assert claims against the Company whether or not the program was responsible for causing the effects. Although the Company carries general liability insurance, its insurance does not cover claims of these types.

The weight loss industry is subject to adverse publicity, which could harm the business.

The weight loss industry receives adverse publicity from time to time, and the occurrence of such publicity could harm the Company, even if the adverse publicity is not directly related to NutriSystem. In the early 1990s, the Company’s predecessor businesses were subject to extremely damaging adverse publicity relating to a large number of lawsuits alleging that the NutriSystem weight loss program led to gall bladder disease. This publicity was a factor that contributed to the bankruptcy of our predecessor businesses in 1993. More recently, predecessors to the Company were severely impacted by significant litigation and damaging publicity related to the use by members of the weight loss program of fen-phen as an appetite suppressant, which the Food and Drug Administration (the “FDA”) ordered withdrawn from the market in September 1997. The significant decline in business resulting from the fen-phen problems caused the predecessor businesses to close all of their company-owned weight loss centers. Congressional hearings about certain practices in the weight loss industry have also resulted in adverse publicity and a consequent decline in the revenues of weight loss businesses. Future research reports or publicity that are perceived as unfavorable or that question certain weight loss programs, products or methods could result in a decline in the Company’s revenues. Because of the Company’s dependence on consumer perceptions, adverse publicity associated with illness or other undesirable effects resulting from the consumption of the Company’s products or competitors’ similar products, whether or not accurate, could also damage customer confidence in the NutriSystem weight loss program and result in a decline in revenues. Adverse publicity could arise even if the unfavorable effects associated with weight loss products or services resulted from the user’s failure to use such products or services appropriately.

New weight loss products or services may put the Company at a competitive disadvantage.

On an ongoing basis, many existing and potential providers of weight loss solutions, including many pharmaceutical firms with significantly greater financial and operating resources than NutriSystem, are developing new products and services. The creation of a weight loss solution, such as a drug therapy, that was perceived to be safe, effective and “easier” than a portioned controlled meal plan, would put the Company at a disadvantage in the marketplace and results of operations could be negatively affected.

The weight loss industry is subject to governmental regulation that could increase in severity and hurt results of operations.

Certain advertising practices in the weight loss industry have led to investigations from time to time by the Federal Trade Commission (the “FTC”) and other governmental agencies. Many companies in the weight loss industry, including the Company’s predecessor businesses, have entered into consent decrees with the FTC relating to weight loss claims and other advertising practices. The Company continues to be subject to such consent decrees. These consent decrees restrict the manner in which the Company’s advertising describes the success members have achieved in losing weight through the program and require the Company to include the phrase “results not typical” in such advertisements.

8

Table of Contents

The Company cannot be sure that this regulation will not increase in scope or severity in the future, which could have a material adverse impact on its business. Remedies available in administrative actions may include requiring the Company to refund amounts paid by all affected customers or pay other damages, which could be substantial.

The Company may be subject to health-related claims or other liabilities by customers of certain predecessor businesses, and such claims or liabilities could adversely affect results of operations.

Certain of the Company’s predecessor businesses were subject to numerous claims based on various health-related concerns during their 30-year operating history, including most recently, claims related to the use of fen-phen. Wyeth (f/k/a American Home Products) has agreed to indemnify a predecessor business against the fen-phen claims. The Company has not been named in any such litigation, however, if it were, it would need to defend itself against such claims. Such litigation, regardless of its merit and ultimate outcome, is often lengthy and costly. Therefore, if the Company becomes involved in any such litigation, results of operations could be negatively affected.

The sale of ingested products involves product liability and other risks.

Like any other distributor of products that are ingested, the Company faces an inherent risk of exposure to product liability claims if the use of its products results in illness or injury. The food that the Company resells is subject to certain laws and regulations of the FDA, which establishes manufacturing practices and quality standards for food products. If the Company does not have adequate insurance or contractual indemnification from its suppliers, product liability claims could have a material adverse effect on the business. Distributors of weight loss food products, vitamins, nutritional supplements and minerals, including certain predecessor businesses, have been named as defendants in product liability lawsuits from time to time. The successful assertion or settlement of an uninsured claim, a significant number of insured claims or a claim exceeding the limits of the Company’s insurance coverage would harm it by adding costs to the business and by diverting the attention of senior management from the operation of the business. The Company may also be subject to claims that its products contain contaminants, are improperly labeled, include inadequate instructions as to use or inadequate warnings covering interactions with other substances. Product liability litigation, even if not meritorious, is very expensive and could also entail adverse publicity for the Company and reduce its revenues.

The Company may be subject to claims that its personnel are unqualified to provide proper weight loss advice.

Most of the Company’s counselors for our diet program do not have extensive training or certification in nutrition, diet or health fields and have only undergone the training they receive from the Company. NutriSystem may be subject to claims from its members alleging that its personnel do not have the qualifications necessary to provide proper advice regarding weight loss. The Company may also be subject to claims that its personnel have provided inappropriate advice or have inappropriately referred or failed to refer members for matters other than weight loss. Although the Company carries relevant liability insurance, such claims could result in damage to the Company’s reputation.

NutriSystem has a history of operating losses and an accumulated deficit and it may become unprofitable.

The Company incurred an operating loss in two of the last five years. As of December 31, 2004, the Company had an accumulated deficit of $21 million. The Company needs to continue to generate significant revenues to maintain profitability, and it may not be able to do so.

The Company’s stock price has been volatile and, in the past, its trading volume was low. These conditions may continue or worsen.

The Company’s common stock has, at times, traded at very low volumes. The Company cannot be assured of a consistently liquid trading market. In addition, the Company’s share price may decline for reasons related, or unrelated, to future operating results. For example, in October 2000, the Company’s share price declined substantially for reasons it believes are unrelated to operating performance. There are many factors, including the risk factors described in this Annual Report on Form 10-K, that may cause operating results to fluctuate or have a significant adverse effect on the market price of the Company’s common stock.

9

Table of Contents

Certain anti-takeover provisions in the Company’s certificate of incorporation and Delaware law may deter or prevent a change in control of the Company, even if that change would be beneficial to its stockholders.

Provisions of the Company’s certificate of incorporation, bylaws and Delaware law may have the effect of deterring unsolicited takeovers or delaying or preventing changes in control of the Company, including transactions in which its stockholders might otherwise receive a premium for their shares over then current market prices. In addition, these provisions may limit the ability of stockholders to approve transactions that they may deem to be in their best interests.

The Company’s certificate of incorporation permits its Board of Directors to issue preferred stock without stockholder approval upon such terms as its Board of Directors may determine. The rights of the holders of its common stock will be junior to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, a majority of the Company’s outstanding common stock. The issuance of a substantial number of preferred shares could adversely affect the price of the Company’s common stock.

10

Table of Contents

ITEM 2. PROPERTIES

The Company currently leases approximately 97,600 square feet of office and warehouse space in Horsham, Pennsylvania pursuant to a lease expiring in 2009 at an annual rent of $667,248. As discussed in Item 1, the Company also outsources some of its fulfillment operations. Management believes the Horsham facility, combined with its outsourced fulfillment capacity, is adequate for the Company’s needs for the foreseeable future. The Company also maintains 1,400 square feet of office space in Yardley, Pennsylvania as a result of the Slim and Tone LLC acquisition. This lease expires in 2006 at an annual rent of $24,615.

ITEM 3. LEGAL PROCEEDINGS

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None submitted.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s common stock traded on the NASDAQ OTC Bulletin Board from May 26, 2001 to May 11, 2004 and currently trades on the American Stock Exchange. The Company’s common stock trades under the symbol “NSI.” The following table sets forth, for the periods indicated, the high and low closing prices for the Company’s common stock as reported on the NASDAQ OTC Bulletin Board and American Stock Exchange.

On March 24, 2005, the closing price of the Company’s common stock on the American Stock Exchange was $6.21. As of March 24, 2005, the Company had approximately 383 record holders of its common stock.

The Company has not paid any dividends since its inception and currently does not foresee any future dividend payments. The declaration and payment of dividends in the future will be determined by the Company’s Board of Directors in light of conditions then existing, including the Company’s earnings, financial condition, capital requirements and other factors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources and other Financial Data.”

Recent Sales of Unregistered Securities

On February 12, 2004, the Company issued 10,000 and 1,000 shares of common stock to Zora Andrich and Ray Manzella, respectively, in consideration for marketing services. In granting the shares, the Company relied upon the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.

On June 28,2004, the Company issued 22,500 shares of common stock to CEOcast Inc., in consideration for Investor Relations services. In granting the shares, the Company relied upon the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.

11

Table of Contents

ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data presented below have been derived from the Company’s Consolidated Financial Statements for each of the periods indicated. The data set forth below is qualified by reference to and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s Consolidated Financial Statements included as Items 7 and 8 in this Annual Report on Form 10-K.

12

Table of Contents

Selected Consolidated Financial Data

(in thousands, except per share data)

13

Table of Contents

The Company has not paid any dividends since its inception and currently has no plans to begin paying dividends.

14

Table of Contents

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

Except for the historical information contained herein, this Annual Report on Form 10-K contains certain forward-looking statements that involve substantial risks and uncertainties. When used in this AnnualReport, the words “anticipate,” “believe,” “estimate,” “expect” and similar expressions, as they relate to NutriSystem, Inc. or its management, are intended to identify such forward-looking statements. The Company’s actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute to such differences include those set forth in “Business—Risk Factors.” Accordingly, there is no assurance that the results in the forward-looking statements will be achieved.

The following discussion should be read in conjunction with the financial information included elsewhere in this Annual Report on Form 10-K. Dollar amounts are stated in thousands, except share and per share data.

Background

NutriSystem provides weight management and fitness products and services. The NutriSystem diet program was originally developed by the Company’s predecessor businesses that operated through company-owned and franchised weight loss centers. Currently, there are no Company-operated centers and the Company terminated its last franchise agreements in 2003. There are 15 independent center-based distributors who operate without franchise agreements (“Case Distributors”). In 1998, the Company initiated a marketing program using independent commissioned representatives. In late 1999, the Company began selling directly to the consumer through the Internet and by telephone. In 2001, the Company began selling foods through QVC, a television shopping network. The Company’s pre-packaged foods are now sold to weight loss program participants directly via the Internet and telephone (the “Direct” channel) and through independent commissioned representatives (the “Field Sales” channel), Case Distributor weight loss centers (the “Case Distributor” channel) and QVC.

On December 2, 2004, NutriSystem Inc. acquired Slim and Tone LLC, a franchisor of women’s express fitness centers. Slim and Tone franchisees now sell the NutriSystem diet program in their centers as independent commissioned representatives. NutriSystem purchased Slim and Tone for $1,000 in cash at closing, $450 paid into escrow and a seller note for $450 payable over 36 months. As of February 28, 2004, there are 120 Slim and Tone franchise centers opened and operating.

Since the NutriSystem businesses began in 1972, the businesses have operated in various organizational and legal structures, and were subject to a bankruptcy proceeding in 1993, which was discharged in 1994. NutriSystem became a publicly traded company in October 1999. In September 2000, the Company changed its name from nutrisystem.com inc. to Nutri/System, Inc. and in 2003, the Company changed its name to NutriSystem, Inc.

In 2001, the Company discontinued sales of the Sweet Success line of diet meal replacement products it had acquired the year before.

In December 2002, HJM Holdings LLC and NewSpring Ventures, L.P. collectively acquired 58.4% of the outstanding shares of common stock from existing stockholders effecting a change in control of the Company. The Company was not a party to the transaction. In 2004, HJM Holdings LLC distributed its NutriSystem shares to its partners and dissolved. Currently, no affiliated group owns more than 15% of the common stock of the Company.

Discontinued Operation

On August 25, 2000, the Company acquired certain assets of the Sweet Success product line from Nestle USA, Inc. (the “Seller”) in return for 900,000 shares of the Company’s common stock, representing 3.1% of the shares outstanding after the transaction. The shares of common stock issued to the Seller were included in a registration statement that became effective in December 2003.

As a result of a determination made in December 2000, the Company discontinued sales of the Sweet Success product line in June 2001. In December 2002, the Company sold the intellectual property associated with Sweet Success. The sale of the Sweet Success intellectual property is reflected in the Consolidated Financial Statements as a discontinued operation.

15

Table of Contents

Critical Accounting Policies and Estimates

The Company’s Consolidated Financial Statements are prepared in accordance with United States generally accepted accounting principles. The Company’s 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 revenues 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 the consolidated financial statements. These critical accounting estimates have been discussed with the Company’s audit committee.

Reserves for Returns. Management reviews the reserves for customer returns at each reporting period and adjusts them to reflect data available at that time. To estimate a return for reserves, management considers 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 is inaccurate, management will adjust the reserve, which will impact the amount of product sales revenue recognized in the period of the adjustment.

Impairment of Fixed Assets and Intangibles. Management continually assesses the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operating performance of the Company. Future events could cause management to conclude that impairment indicators exist and the carrying values of fixed and intangible assets may be impaired. Any resulting impairment loss would be limited to the value of net fixed and intangible assets.

Income Taxes. NutriSystem experienced losses in 1999 and 2000. As a result, the Company has federal and state tax net operating loss (NOL) carryforwards of approximately $8,700 as of December 31, 2004. As a result of a change of control transaction which occurred in December 2002, approximately $2,000 of the NOL’s are subject to usage limitations pursuant to the rules of Internal Revenue Code section 382. Through March 2003, a valuation allowance had been maintained for the deferred tax asset based on management’s assessment that the deferred tax asset would not be realized given the historical taxable levels of income (loss), the uncertainty of future operating results, tax planning strategies, and the expiration date of net operating loss carryforwards. In the second quarter of 2003, management determined that recognition of the benefits related to deferred tax assets was more likely than not based on an analysis of the cumulative level of pretax profits over the past three years, projected levels of profits, schedule of reversal of deferred taxes, and tax strategies. As a result, the valuation allowance was eliminated, a deferred tax asset was recorded on the consolidated balance sheet and an income tax benefit was recorded in the statement of operations.

Currently, the Company is recording income taxes at a rate equal to the combined federal and state effective rates. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause the Company’s provision for income taxes to vary significantly from period to period. For the year ended December 31, 2003, the Company recorded an income tax benefit of $3,397 reflecting the elimination of the tax valuation allowance. For the year ended December 31, 2004, the Company recorded income tax expense of $680, which reflects an estimated annual effective tax rate of 40%.

Results of Operations

Revenues and expenses consist of the following components:

Revenues. Revenues consist 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. Revenues for Slim and Tone consist primarily of franchise fees and royalties. Revenues for franchise fees are recognized when a franchise center opens for business. Royalties are paid monthly and recognized in the month the royalty is earned.

16

Table of Contents

Cost of Revenues. Cost of revenues consists primarily of the cost of the products sold, including the write-off of obsolete packaging and product, incoming and outgoing shipping costs, charge card discounts, packing material, compensation related to fulfillment and the costs of outside fulfillment. Cost of products sold includes products provided at no charge as part of promotions and the non-food materials provided with customer orders. Cost of revenues also includes the fees paid to independent distributors and sales commissions. Cost of revenues for Slim and Tone consist of the costs incurred associated with the opening of a franchise center, including the cost of the exercise equipment, training costs, and promotional materials provided to the operators.

Marketing Expense. Marketing expense includes advertising, marketing and promotional expenses and payroll related expenses for personnel engaged in these activities. The Company follows the American Institute of Certified Public Accountants (“AICPA”) Statement of Position 93-7, “Reporting for Advertising Costs.” Internet advertising expense is recognized 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 payment terms. Direct-response 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.

General and Administrative Expenses. General and administrative expenses consist of compensation for administrative, information technology, counselors and customer service personnel, facility expenses, web site development costs, professional service fees and other general corporate expenses.

New Program Development. New program development includes various costs charged by third parties associated with the creation of the Company’s NutriSystem Nourish diet program, including new package design costs and development of program specifications.

Interest Income/Expense. Interest consists of interest income earned on cash balances, net of interest expense.

Income Taxes. The Company is subject to corporate level income taxes. No income tax benefit on the excess of the tax basis of assets over the financial reporting carrying amount was recorded from September 1999 to March 2003 in light of the historical taxable levels of income (loss), the uncertainty of future operating results, tax planning strategies, and the expiration date of net operating loss carryforwards. In the second quarter of 2003, management determined that recognition of the benefits related to deferred tax assets was more likely than not based on an analysis of the cumulative level of pretax profits over the past three years, projected levels of profits, schedule of reversal of deferred taxes, and tax strategies. As a result, the valuation allowance was eliminated, a deferred tax asset was recorded on the consolidated balance sheet and an income tax benefit was recorded in the statement of operations.

Reclassifications. Beginning with the second quarter of 2004, the Company reclassified compensation related to fulfillment, the costs of outside fulfillment and commissions paid on Direct sales from general and administrative expenses to cost of revenues. At the same time, the Company reclassified the cost of non-food materials provided with customer purchases from marketing to cost of revenues. Prior year amounts have been reclassified to conform to the current period presentation.

Overview of the Direct Channel

The Company began selling directly to consumers when it launched its web site on October 15, 1999. In 2004, the Direct channel represented 81% of the Company’s net revenues. For the Direct channel of distribution, the Company’s primary financial objectives are to generate growth while maintaining profit margins. The Company measures growth in terms of the number of new customers, revenues per customer and total revenues. A new customer is defined as a first time purchaser through the Direct channel. Profit margins are measured in terms of gross margin (revenues less cost of revenues as a percentage of revenues) and total advertising and marketing expense as a percentage of revenues.

In January 2004 the Company merged duplicate customer profiles that had been created over time. This reduced new customer counts by approximately 10% in 2003 and by a smaller amount in prior years, and it increased the sales per customer, as cumulative customer purchases were also aggregated. Merging duplicate profiles also raised the amount of sales that were attributed by customers acquired in prior periods. The changes affected customer counts and had no impact on the Company’s audited financial statements.

17

Table of Contents

FINANCIAL AND OPERATING STATISTICS FOR THE DIRECT CHANNEL

(in thousands, except customer data)

Direct revenues increased 109.3% from 2003 to 2004. Direct revenues are largely a function of the number of new customers acquired, the revenues generated from each new customer and the revenues generated from returning customers (customers that initially purchased food in a prior year). From 2003 to 2004, the number of new customers acquired increased by 28,823 or 125.5%. The increase in new customers is primarily attributable to higher marketing spending; marketing increased 113.6% from 2003 to 2004. In terms of spending per new customer acquired, the effectiveness of the marketing spending also improved; overall marketing per new customer was $154 in 2003 and $146 in 2004. The Company increased marketing spending in 2004 as the spending became more effective.

From 2003 to 2004, revenues per new customer increased $79 or 20.7%. The increase is primarily a function of an increased emphasis on obtaining program new customers. For analytic purposes, the Company defines a customer with an initial purchase of $100 or more to be a “program” new customer. These customers tend to stay on a weight loss program longer and spend substantially more than customers that make an initial purchase of less than $100. In 2004, program new customers represented 93% of all new customers, while in 2003, these customers represented 73% of all new customers. In addition, program new customers acquired in 2004 generated more revenue in 2004 than the same customer group did in 2003. Finally, in 2004 a higher percentage of new customers were obtained in December, which implies more revenues from 2004 new customers will fall into the subsequent year than was the case in 2003.

Customers that initially purchased in a prior year contributed approximately $7,000 and $6,000 to revenues in 2004 and 2003, respectively.

Direct revenues decreased 8.8% from 2002 to 2003. From 2002 to 2003, the number of new customers acquired dropped by 2,106 or 8.4%. Low spending for advertising media over the course of 2002 and through August 2003 was the primary reason for a declining new customer count throughout this period. In September and October 2003, the Company increased spending for marketing media in selected markets, resulting in increased new customer counts in these markets. Overall, the new customer counts in the fourth quarter of 2003 were 48.7% higher than the same quarter of 2002.

From 2002 to 2003, revenues from each new customer acquired declined by $47 or 11.0%. The decline in revenues per new customer obtained in each year was triggered by two factors: a) market testing for a portion of 2003 that attracted more new customers that made an initial purchase of less than $100, and b) in 2003 a higher portion of the

18

Table of Contents

new customers were acquired later in the year. Customers with an initial purchase of less than $100 comprised 27.2% of all new customers in 2003 but only 21.9% of new customers in 2002; individuals that spend less than $100 tend to purchase “trials”, though the Company has had some success in converting these “trial size” customers into sustained program participants. The Company generated $467 and $484 per program new customer in 2003 and 2002, respectively. The Company had 16,744 and 19,579 program new customers in 2003 and 2002, respectively. Timing also affected sales per new customer. In 2003, a higher proportion of customers were generated late in the year. Customers acquired later in a calendar year have less time to contribute revenues within the calendar year.

Customers that initially purchased in a prior year contributed $6,000 and $5,400 to revenues in 2003 and 2002, respectively.

Direct gross margin increased from 48.1% in 2003 to 49.9% in 2004 primarily due to a charge in 2003 of $529 related to the write-off of obsolete old program product and packaging. The write-off also explains the decline in gross margins from 2002 to 2003.

Overview of Television Infomercial Distribution

In the second quarter of 2001, the Company began distribution of its proprietary prepackaged food through QVC, the shopping television network. In 2004, this channel represented 11% of the Company’s net revenue. On the QVC network, the Company reaches a large, incremental audience in a 50 minute, infomercial format that enables the Company to convey fully the benefits of the NutriSystem diet foods. QVC viewers purchase NutriSystem products directly from QVC and are not directed to the NutriSystem web site. Retail prices (including shipping and handling) offered on QVC to consumers are similar to prices offered on the web site. The Company generates a lower gross margin (as a percent of sales) on sales to QVC relative to direct sales, but QVC sales require no incremental advertising and marketing expense and, management believes, exposure on QVC raises consumer awareness of the NutriSystem brand. Net sales through the television infomercial distribution channel were $4,167, $4,617 and $7,376 for the years ended December 31, 2004, 2003 and 2002, respectively. Sales declined year over year because the Company aired fewer shows on QVC and sales per minute of air-time declined. During 2004, the Company and QVC did business without a contractual agreement.

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

Revenues. Revenues increased from $22,575 for the year ended December 31, 2003 to $37,996 for the year ended December 31, 2004. The revenue increase of $15,421, or 68.3%, resulted from increased Direct sales ($16,086) and the Field Sales channel ($129) plus the addition of the Slim and Tone division ($84), offset by decreased sales to QVC ($450) and Case Distributor ($428). In the year ended December 31, 2004, Direct accounted for 81% of total revenues, while QVC, Field Sales and Case Distributor revenues accounted for 11%, 5% and 3% of total revenues, respectively. In 2003, the comparable percents were 65%, 21%, 8% and 6%, respectively.

Costs and Expenses. Cost of revenues increased $6,742 from $14,870 to $21,612 for the years ended December 31, 2003 and 2004, respectively. Gross margin as a percent of revenues increased from 34.1% in 2003 to 43.1% in 2004. The increase in gross margin is primarily due to a mix shift toward the higher margin Direct channel, to higher pricing for the new NutriSystem Nourish program and to a $529 write-off of old program inventory and packaging recorded in cost of sales in 2003. Marketing expenses increased $4,009 from $3,539 to $7,548 for 2003 to 2004. Almost all marketing spending promoted the Direct business, and the increase in marketing is attributable to increased spending for advertising media ($3,175), public relations ($436), production of television advertising ($419) and payroll related to marketing and advertising ($231) offset by a decrease in market research and consulting ($252). Fourth quarter 2004 marketing expenses included about $800 in production and talent costs for an infomercial and short form television advertisements that were charged to expense when they first aired in late December. Fourth quarter 2003 results included $751 in marketing expenses associated with the launch of the NutriSystem Nourish program.

General and administrative expenses ($5,829 and $7,039 in 2003 and 2004, respectively) increased $1,210 attributable to higher costs associated with the increase in revenues, especially compensation ($973) and rent ($177). In general and administrative expenses in 2003, the Company recorded litigation expense related to the franchise lawsuit of $238, and $198 expense related to the Reno warehouse closing costs. Primarily in the fourth quarter of 2003, the Company incurred $599 in expenses associated with new program development in order to create the NutriSystem Nourish program. New program expenses include the new package design costs and development of program

19

Table of Contents

specifications. For the year ended December 31, 2003, the Company recorded a loss of $157, respectively, under the caption “Equity in losses of affiliate,” representing the Company’s investment in an affiliate. In 2004, the Company made no additional investments in the affiliate.

Interest Income. Interest income net of interest expense decreased $21 from $57 in 2003 to $36 in 2004 primarily due to lower interest rates on invested funds.

Income taxes. In 2004, the Company recorded $680 of income taxes due to the income for the reporting period. The effective tax rate in 2004 is 40%. In 2003, the Company recorded a $3,397 income tax benefit related to the recognition of deferred tax assets (see Note 11 of the Consolidated Financial Statements).

Net Income. From 2003 to 2004, net income increased by $207 from net income of $812 to net income of $1,019. The increase in net income in 2004 is primarily due to higher gross profit in 2004 versus 2003 resulting from increased revenue offset by a $3,397 income tax benefit recorded in 2003 versus income tax expense of $680 recorded in 2004.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Revenues. Revenues decreased from $27,569 for the year ended December 31, 2002 to $22,575 for the year ended December 31, 2003. The revenue decrease of $4,994, or 18.1%, resulted from decreased sales to QVC ($2,759), Direct ($1,415), Case Distributor ($553) and the Field Sales channel ($267). In the year ended December 31, 2003, Direct accounted for 65% of total revenues, while QVC, Field Sales and Case Distributor revenues accounted for 21%, 8% and 6% of total revenues, respectively. In 2002, the comparable percents were 58%, 27%, 8% and 7%, respectively.

Costs and Expenses. Cost of revenues decreased $2,785 from $17,655 to $14,870 for the years ended December 31, 2002 and 2003, respectively. Gross margin as a percent of revenues decreased from 36.0% in 2002 as compared to 34.1% in 2003. The decrease in gross margin is attributable to $529 write-off of old program inventory and packaging recorded in cost of sales. Marketing expenses increased $2,276 from $1,263 to $3,539 from 2002 to 2003. All marketing spending promoted the Direct, and the increase in marketing is attributable to increased spending for advertising media ($898), market research and consulting ($529), payroll related to marketing and advertising ($364), production of television advertising ($299) and Internet advertising ($186). Fourth quarter 2003 results included $751 in marketing expenses associated with the launch of the NutriSystem Nourish program.

General and administrative expenses ($5,902 and $5,829 in 2002 and 2003, respectively) decreased $73 attributable to lower costs associated with the decline in revenues, especially compensation, and reduced costs associated with the closing of the Reno warehouse in the first quarter of 2003, offset by increased professional fees and consulting fees. In general and administrative expenses, the Company recorded litigation expense related to the franchise lawsuit of $302 and $238 in 2002 and 2003, respectively, and $198 expense related to the Reno warehouse closing costs. Included in general and administrative costs in 2002 are $481 in severance relating to the Company’s former Chief Executive Officer and $175 in charges relating to discontinued packaging and products. Primarily in the fourth quarter of 2003, the Company incurred $599 in expenses associated with new program development in order to create the NutriSystem Nourish program. New program expenses include the new package design costs and development of program specifications. Other expense in 2002 of $100 represents the cost of settling an employment-related complaint filed by certain employees of the Company’s former facility in Reno. For the year ended December 31, 2002 and 2003, the Company recorded a loss of $143 and $157, respectively, under the caption “Equity in losses of affiliate,” representing the Company’s investment in an affiliate.

Interest Income. Interest income net of interest expense increased $16 from $41 in 2002 to $57 in 2003 primarily due to interest earned on higher cash balances.

Income taxes. In 2003, the Company recorded a $3,397 income tax benefit related to the recognition of deferred tax assets (see Note 11 of the Consolidated Financial Statements).

Net Income. From 2002 to 2003, net income decreased by $1,599 from net income of $2,411 to net income of $812. The decrease in net income in 2003 is primarily due to lower revenues, increased marketing expense and costs associated with the development of a new program. These high costs were fully offset by an income tax benefit recorded in 2003.

20

Table of Contents

Contractual Obligations and Commercial Commitments

Following is a summary of contractual obligations of the Company. The Company has no other commercial commitments.

In 2004, the Company entered into two employment agreements. The agreements have terms ranging from one to two years, with automatic one-year renewal terms. These agreements provide for base compensation of $225 for each employee per year and other fringe benefits and payments upon termination.

Liquidity, Capital Resources and Other Financial Data

At December 31, 2004, the Company had net working capital of $5,100, a decrease of $564 from the $5,664 net working capital balance at December 31, 2003. Cash and cash equivalents at December 31, 2004 were $4,201, an increase of $1,517 from the balance of $2,684 at December 31, 2003. The Company’s principal source of liquidity during this period was cash flow from operations. At December 31, 2004, the Company had no bank debt or term or revolving credit facilities to fund operations or investment opportunities. In connection with the acquisition of Slim and Tone, the Company has a seller note obligation of $408 at the end of 2004. The Company currently has no off-balance sheet arrangements.

In the year ended December 31, 2004, the Company generated a cash flow of $2,795 from operations, an increase of $4,715 from the negative cash flow from operations of $1,920 at December 31, 2003. The increase in cash flow from operations is attributable to net income adjusted for non-cash charges, which provides most of the operating cash flow. Net income adjusted for non-cash items was $2,291 in 2004 versus a negative $1,833 in 2003. Net changes in operating assets and liabilities also increased cash flow from operations by $504 in 2004; in 2003, net changes in operating assets and liabilities reduced cash flow from operations by $87.

In the year ended December 31, 2004, net cash used in investing activities was $2,250, which primarily consisted of the acquisition of Slim and Tone, LLC ($1,562) (see Note 3 of the Consolidated Financial Statements) and net capital expenditures ($688) incurred to increase web site capacity, fulfillment operations, leasehold improvements related to the relocation of home office.

In the year ended December 31, 2004, net cash provided by financing activities was $972, representing proceeds from the exercise of stock options and warrants.

The Board of Directors has authorized the repurchase of up to 5,000,000 shares of the Company’s common stock. Through December 31, 2004, the Company had repurchased a total of 2,760,291 shares under the repurchase program, with the last purchase occurring in June of 2003.

As of December 31, 2004, the Company’s principal commitments consisted of obligations under operating leases. Although the Company has no material commitments for capital expenditures, it anticipates continuing requirements for capital expenditures consistent with anticipated growth in operations, infrastructure and personnel approximately consistent with prior periods.

In pursuing its business strategy, the Company may require additional cash for operating and investing activities. The Company expects future cash requirements, if any, to be funded from operating cash flow and financing activities, which may include additional offerings of equity securities or debt financing. Based on the Company’s ability to generate earnings in 2004, the variable nature of a portion of the Company’s expenditures, the cash balance at December 31, 2004 and management’s belief that additional equity financing, if required, can be raised, management

21

Table of Contents

believes that the Company has the ability to continue operations into 2006. However, there can be no assurance that the Company will be able to sustain profitability or, if necessary, obtain the capital to fund operating and investment needs in the future. Currently, there is no credit facility in place to fund working capital or investment needs.

There are no current plans or discussions in process relating to any material acquisition that is probable in the foreseeable future.

Factors Affecting Business and Prospects

The Company expects to experience significant fluctuations in future quarterly operating results due to a variety of factors, many of which are outside its control.

Inflation

The Company’s Consolidated Financial Statements are presented on a historical cost basis and do not fully reflect the impact of prior years’ inflation. While the U.S. inflation rate has been modest for several years, inflation issues may impact business in the future. The ability to pass on inflation costs is an uncertainty due to general economic conditions and competitive situations.

Recently Issued Accounting Pronouncements

In December 2004, the FASB issued Statement No. 123 (Revised 2004) Share-Based Payment. Statement No. 123R addresses all forms of share-based payment awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. It will require companies to recognize in the statement of earnings the grant-date fair value of stock options and other equity-based compensation issued to employees; but expresses no preference for a type of valuation model. The statement eliminates the intrinsic value-based method prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretation, that the Company currently uses. The Company is required to adopt Statement No. 123R beginning in the third quarter of 2005. The Company has not yet determined the impact of applying the various provisions of the statement; however, adoption of the statement is expected to significantly increase the amount the Company records as compensation expense in 2005.

In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities,” (“FIN 46R”) which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” which was issued January 2003. The Company is required to apply FIN 46R to variable interests in variable interest entities (“VIEs”) created after December 31, 2003. For variable interests in VIEs created before January 1, 2004, the Interpretation will be applied beginning on January 1, 2005. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. The adoption of FIN 46R did not have an impact on the Company’s Consolidated Financial Statements.

22

Table of Contents

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company does not hold any investments in market risk sensitive instruments. Accordingly, management believes that it is not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk instruments. The Company does not have any funded debt outstanding at December 31, 2004, and its cash and cash equivalents of $4,201 are maintained in bank accounts. As such, a change in interest rates of 1 percentage point would not have a material impact on the Company’s operating results and cash flows.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by this Item is set forth on pages 26 through 43 hereto and is incorporated by reference herein.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2004. Based upon this evaluation, they concluded that, as of the date of the evaluation, the Company’s disclosure controls and procedures as of December 31, 2004 have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Management believes that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instance of fraud, if any, within a company have been detected. Since the date of this evaluation, there have been no significant changes in the Company’s internal controls or in other factors that could significantly affect those controls.

ITEM 9B. OTHER INFORMATION

None.

23

Table of Contents

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information concerning directors and compliance with Section 16(a) of the Securities Exchange Act of 1934 and our Statement of Corporate Ethics and Code of Business Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer or controller called for by Item 10 of Form 10-K will be set forth under the captions “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Statement of Corporate Ethics and Code of Business Conduct” in our definitive proxy statement, to be filed within 120 days after the end of the fiscal year covered by this annual report on Form 10-K, and is incorporated herein by reference.

The required information as to executive officers is set forth in Part I hereof and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated by reference to the information contained in our definitive proxy statement for the 2005 annual meeting of stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by Item 12 is incorporated by reference to the information contained in our definitive proxy statement for the 2005 annual meeting of stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is incorporated by reference to the information contained in our definitive proxy statement for the 2005 annual meeting of stockholders.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by Item 14 is incorporated by reference to the information contained in our definitive proxy statement for the 2005 annual meeting of stockholders.

24

Table of Contents

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) 1. Financial Statements

See Index to the Consolidated Financial Statements which begins on page 26 of this Annual Report

2. Financial Statement Schedules

None, as all information required in these schedules is included in the Notes to the Consolidated Financial Statements.

3. Exhibits

Reference is made to the Exhibit Index on page 45 of this Annual Report for a list of exhibits required by Item 601 of Registration S-K to be filed as part of this Annual Report.

25

Table of Contents

NUTRISYSTEM, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

26

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

NutriSystem, Inc.:

We have audited the 2004 and 2003 consolidated financial statements of NutriSystem, Inc. and subsidiaries as listed in the accompanying index. These consolidated financial statements are the responsibility of the management of NutriSystem, Inc. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the 2004 and 2003 consolidated financial statements referred to above present fairly, in all material respects, the financial position of NutriSystem, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with United States generally accepted accounting principles.

As discussed in Note 2 to the consolidated financial statements, effective January 1, 2002, the Company adopted the provisions of Statements of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets.”

/S/ KPMG LLP

Philadelphia, Pennsylvania

February 16, 2005

27

Table of Contents

NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

The accompanying notes are an integral part of these consolidated financial statements.

28

Table of Contents

NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share amounts)

The accompanying notes are an integral part of these consolidated financial statements.

29

Table of Contents

NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except share amounts)