UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

For the Quarterly Period Ended September 30, 2016

OR

For the Transition Period From _________ to _________

Commission File Number 0-28551

 

Nutrisystem, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

(215) 706-5300

(Registrant's telephone number, including area code)

 

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  ☒    No  ☐

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of October 28, 2016:

 

 

 

 

 

 

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NUTRISYSTEM, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q

 

 

 

 

 

 

 

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NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except par value amounts)

 

 

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

 

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NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share amounts)

 

 

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

 

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NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited, in thousands)

 

 

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

 

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NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited, in thousands)

 

 

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

 

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NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 

 

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

 

 

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NUTRISYSTEM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

Nature of the Business

Nutrisystem, Inc. (the “Company” or “Nutrisystem”) is a provider of weight management products and services, including nutritionally balanced weight loss programs, multi-day kits and single items available at select retail locations and digital tools to support weight loss. The weight loss programs are designed for women and men. Additionally, the Nutrisystem® D® program is designed specifically 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. 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.

Presentation of Financial Statements

The Company’s consolidated financial statements include 100% of the assets and liabilities of Nutrisystem, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Interim Financial Statements

The Company’s consolidated financial statements as of and for the three and nine months ended September 30, 2016 and 2015 are unaudited and, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the Company’s financial position and results of operations for these interim periods. Accordingly, readers of these consolidated financial statements should refer to the Company’s audited consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), and the related notes thereto, as of and for the year ended December 31, 2015, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015 (the “2015 Annual Report”) as certain footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted from this report pursuant to the rules of the Securities and Exchange Commission (the “SEC”).  The results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results to be expected for the year ending December 31, 2016.

Cash, Cash Equivalents and Short Term Investments

Cash equivalents include only securities having a maturity of three months or less at the time of purchase. At September 30, 2016 and December 31, 2015, demand accounts and money market accounts comprised all of the Company’s cash and cash equivalents.  

Short term investments consist of investments in government and agency securities and corporate debt securities with original maturities of greater than three months at the time of purchase. The Company classifies these investments as available-for-sale securities. These investments are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income (loss), a component of stockholders’ equity, net of related tax effects.

At September 30, 2016, cash, cash equivalents and short term investments consisted of the following:

 

 

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At December 31, 2015, cash, cash equivalents and short term investments consisted of the following:

 

 

Fixed Assets

Fixed assets are stated at cost. Depreciation expense is calculated using the straight-line method over the estimated useful lives of the related assets, which are generally two to seven years. Leasehold improvements are amortized on a straight-line basis over the lesser of the estimated useful life of the asset or the related lease term. Expenditures for repairs and maintenance are charged to expense as incurred, while major renewals and improvements are capitalized.

Included in fixed assets is the capitalized cost of internal-use software and website development incurred during the application development stage. Capitalized costs are amortized using the straight-line method over the estimated useful life of the asset, which is generally two to five years. Costs incurred related to planning or maintenance of internal-use software and website development are charged to expense as incurred. The net book value of capitalized software was $18,066 and $15,022 at September 30, 2016 and December 31, 2015, respectively.

During the three months ended September 30, 2016, the Company determined certain software licenses were no longer expected to be used as more enhanced software options have become available to handle its evolving business needs and a charge of $1,297 was recorded to write-down these assets. The charge was recorded as depreciation and amortization in the accompanying consolidated statements of operations.

Revenue Recognition

Revenue from direct to consumer product sales is recognized when the earnings process is complete, which is upon transfer of title to the product. Recognition of revenue upon shipment meets the revenue recognition criteria in that persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable and collection is reasonably assured. The Company also sells prepaid program cards to wholesalers and retailers. Revenue from these cards is recognized after the card is redeemed online at the Company’s website or via telephone by the customer and the product is shipped to the customer. Revenue from the retail programs is recognized when the product is received at the seller’s location.

Deferred revenue consists primarily of unredeemed prepaid gift cards and unshipped foods. When a customer orders the frozen program, two separate shipments are delivered. One contains Nutrisystem’s shelf-stable food and the other contains the frozen food. Both shipments qualify as separate units of accounting and the fair value is based on estimated selling prices of both units.  

Direct to consumer customers may return unopened shelf-stable products within 30 days of purchase in order to receive a refund or credit. Frozen products are non-returnable and non-refundable unless the order is canceled within 14 days of delivery. Estimated returns are accrued at the time the sale is recognized and actual returns are tracked monthly.

The Company reviews the reserves for customer returns at each reporting period and adjusts them to reflect data available at that time. To estimate reserves for returns, the Company considers actual return rates in preceding periods and changes in product offerings or marketing methods that might impact returns going forward. To the extent the estimate of returns changes, the Company will adjust the reserve, which will impact the amount of revenue recognized in the period of the adjustment. The provision for estimated returns for the three and nine months ended September 30, 2016 was $2,706 and $12,367, respectively, and $3,424 and $11,293 for the three and nine months ended September 30, 2015, respectively. The reserve for estimated returns incurred but not received and processed was $1,169 and $870 at September 30, 2016 and December 31, 2015, respectively, and has been included in other accrued expenses and current liabilities in the accompanying consolidated balance sheets.

Revenue from product sales includes amounts billed for shipping and handling and is presented net of estimated returns and billed sales tax. Revenue from the retail programs is also net of any trade allowances, reclamation reserves or broker commissions. Revenue from shipping and handling charges was $687 and $2,290 for the three and nine months ended September 30, 2016, respectively, and

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$647 and $2,121 for the three and nine months ended September 30, 2015, respectively. Shipping-related costs are included in cost of revenue in the accompanying consolidated statements of operations.

Dependence on Suppliers

Approximately 12% and 11%, respectively, of inventory purchases for the nine months ended September 30, 2016 were from two suppliers. The Company has a supply arrangement with one of these suppliers that requires the Company to make minimum purchases. For the nine months ended September 30, 2015, these suppliers supplied approximately 18% and 18%, respectively, of inventory purchases.

The Company outsources 100% of its fulfillment operations to a third-party provider. Additionally, more than 98% of its direct to consumer orders are shipped by one third-party provider and more than 98% of its orders for the retail programs are shipped by another third-party provider.

Fair Value of Financial Instruments

A three-tier fair value hierarchy has been established by the Financial Accounting Standards Board (the “FASB”) to prioritize the inputs used in measuring fair value. These tiers are as follows:

Level 1—Valuations based on quoted prices for identical assets and liabilities in active markets.

Level 2—Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3—Valuations based on unobservable inputs reflecting the Company’s own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

The fair values of the Company’s Level 1 instruments are based on quoted prices in active exchange markets for identical assets. The Company had no Level 2 or 3 instruments at September 30, 2016 and December 31, 2015.

The following table summarizes the Company’s financial assets measured at fair value at September 30, 2016:

 

 

The following table summarizes the Company’s financial assets measured at fair value at December 31, 2015:

 

 

Earnings Per Share

The Company uses the two-class method to calculate earnings per share (“EPS”) as the unvested restricted stock issued under the Company’s equity incentive plans are participating shares with nonforfeitable rights to dividends. Under the two-class method, earnings per common share are computed by dividing the sum of distributed earnings to common stockholders and undistributed earnings allocated to common stockholders by the weighted average number of common shares outstanding for the period. In applying

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the two-class method, undistributed earnings are allocated to both common shares and participating securities based on the number of weighted average shares outstanding during the period. Undistributed losses are not allocated to unvested restricted stock as the restricted stockholders are not obligated to share in the losses. The following table sets forth the computation of basic and diluted EPS:

 

 

In the three and nine months ended September 30, 2016, common stock equivalents representing 212 and 394 shares of common stock, respectively, were excluded from weighted average shares outstanding for diluted income per common share purposes because the effect would be anti-dilutive or the minimum performance requirements for such common stock equivalents have not yet been met. In the three and nine months ended September 30, 2015, common stock equivalents representing 165 and 262 shares of common stock, respectively, were excluded from weighted average shares outstanding for diluted income per common share purposes because the effect would be anti-dilutive or the minimum performance requirements for such common stock equivalents have not been met.

Cash Flow Information

The Company made payments for income taxes of $11,900 and $11,602 in the nine months ended September 30, 2016 and 2015, respectively. Interest payments in the nine months ended September 30, 2016 and 2015 were $126 and $144, respectively. For the nine months ended September 30, 2016 and 2015, the Company had non-cash capital additions of $897 and $726, respectively, of unpaid invoices in accounts payable and other accrued expenses and current liabilities.  

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” (“ASU 2014-09”). ASU 2014-09 outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This new revenue recognition model provides a five-step analysis in determining when and how revenue is recognized. The new model will require an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. It also requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. This guidance is effective for annual periods beginning on or after December 15, 2017, including interim reporting periods within that reporting period and should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. The Company is currently assessing the impact that adopting this new accounting standard will have on the consolidated financial statements and footnote disclosures.

In April 2015, the FASB issued ASU No. 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” to provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The new standard was effective for annual periods beginning after December 15, 2015, and interim periods within those annual periods. The adoption of this new accounting standard did not have a material impact on the Company’s consolidated financial statements and footnote disclosures.

In July 2015, the FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory.” An entity using an inventory method other than last-in, first-out or the retail inventory method should measure inventory at the lower of cost and net realizable value. The new guidance clarifies that net realizable value is the estimated selling price in the ordinary course of business, less reasonably

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predictable costs of completion, disposal and transportation. This guidance is effective for annual periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The adoption of this new accounting standard is not expected to have a material impact on the Company’s consolidated financial statements and footnote disclosures.

In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes,” which eliminates the current requirement to present deferred tax assets and liabilities as current and noncurrent amounts in a classified statement of financial position. Instead, entities will be required to classify all deferred tax assets and liabilities as noncurrent in a statement of financial position. This standard is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early application is permitted. If the Company had adopted this new accounting standard at September 30, 2016, it would have resulted in a reclassification of $1,068 from current deferred income taxes to noncurrent deferred income taxes in the accompanying consolidated balance sheets.

In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. This standard is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements and footnote disclosures.

In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. This standard is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements and footnote disclosures.

In August 2016, the FASB issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments,” which clarifies and provides guidance on eight cash flow classification issues and is intended to reduce existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This standard is effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years.  Early adoption is permitted, including adoption in an interim period. The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements and footnote disclosures.

Use of Estimates

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and operating expenses during the reporting period. Actual results could differ from these estimates.

 

 

On December 17, 2015, the Company acquired the South Beach Diet (“SBD”) brand for a cash payment of $15,000. The following table summarizes the Company’s identifiable intangible assets:

 

 

Amortization expense for intangible assets was $750 for the nine months ended September 30, 2016. Estimated amortization expense for the next five years is expected to be as follows:

 

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Additionally, the Company had $84 of domain names acquired in previous years with indefinite lives that are not being amortized.

 

 

On November 6, 2015, the Company entered into an Amended and Restated Credit Agreement that provides for a $50,000 unsecured revolving credit facility (the “Credit Facility”) with a lender. The Credit Facility can be drawn upon through November 6, 2020, at which time all amounts must be repaid. There were no borrowings outstanding at September 30, 2016 or December 31, 2015.

The Credit Facility provides for interest at either a base rate or a LIBOR rate, in each case plus an applicable margin. The base rate will be the highest of (i) the Administrative Agent’s prime rate, (ii) 0.50% above the Federal Funds Rate and (iii) the LIBOR rate for deposits in dollars for a one-month interest period as determined three business days prior to such date, plus 1.50%. The LIBOR rate is equal to the London Inter-Bank Offered Rate for the relevant term. The applicable margin is subject to adjustment based on the Company’s consolidated fixed charge coverage ratio and ranges from 0.00-0.50% per year for base rate loans and from 1.25-1.75% per year for LIBOR rate loans. The Company will also pay an unused line fee. The unused line fee is 0.25% of the total available credit. During both the three and nine months ended September 30, 2016, the Company incurred no interest expense and $32 and $95, respectively in an unused line fee under the Credit Facility. In the comparable periods of 2015, the Company incurred no interest expense and $25 and $88 in unused line fees, respectively.  Interest payments and unused line fees are classified within interest (income) expense, net in the accompanying consolidated statements of operations.

The Credit Facility contains financial and other covenants including a minimum consolidated fixed charge coverage ratio (applicable if there are outstanding borrowings), and limitations on, among other things, liens, indebtedness, certain acquisitions, consolidations and sales of assets. As of September 30, 2016, the Company was in compliance with all covenants contained in the Credit Facility.

At September 30, 2016, the Company had $19 of unamortized debt issuance costs associated with the Credit Facility that are being amortized over its remaining term.

 

 

Common Stock

The Company issued 181 and 280 shares of common stock upon the exercise of stock options in the nine months ended September 30, 2016 and 2015, respectively, and received proceeds of $1,839 and $2,762, respectively. During the nine months ended September 30, 2016 and 2015, employees surrendered to the Company 128 and 137 shares of common stock, respectively, valued at $2,652 and $2,548, respectively, in satisfaction of minimum tax withholding obligations associated with the vesting of equity awards. These shares are included in treasury stock. Also, in the nine months ended September 30, 2016 and 2015, the Company issued 27 and 22 shares of common stock, respectively, as compensation to board members. Costs recognized for these stock grants issued were $700 and $509 for the nine months ended September 30, 2016 and 2015, respectively. During each of the three and nine months ended September 30, 2016 and 2015, the Company paid a dividend of $0.175 per share to all stockholders of record. Subsequent to September 30, 2016, our Board of Directors declared a quarterly dividend of $0.175 per share payable on November 17, 2016 to stockholders of record as of November 7, 2016.

 

On May 3, 2016, the Company announced that its Board of Directors had authorized the repurchase of up to $50,000 of its outstanding shares of common stock in open-market transactions or otherwise over the next 18-month period. The timing, number and amount of any shares repurchased will be determined by the Company at its discretion and will be based on a number of factors including its evaluation of general market and economic conditions, the trading price of the common stock, regulatory requirements and compliance with the terms of the Company’s outstanding indebtedness. The stock repurchase program may be suspended or discontinued at any time without prior notice. No shares were repurchased during the nine months ended September 30, 2016.

Preferred Stock

The Company has authorized 5,000 shares of preferred stock issuable in series upon resolution of the Board of Directors. Unless otherwise required by law, the Board of Directors can, without stockholder approval, issue preferred stock in the future with voting

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and conversion rights that could adversely affect the voting power of the common stock. The issuance of preferred stock may have the effect of delaying, averting or preventing a change in control of the Company.

The following table summarizes the Company’s stock option activity during the nine months ended September 30, 2016:  

 

 

The Company recorded compensation expense of $264 and $819 in the accompanying consolidated statements of operations during the three and nine months ended September 30, 2016, respectively, for stock option awards. During the three and nine months ended September 30, 2015, the Company recorded compensation expense of $159 and $492, respectively. The total intrinsic value of stock options exercised during the three and nine months ended September 30, 2016 was $1,610 and $3,010, respectively, and $2,665 and $4,677, respectively, for the comparable periods of 2015.

The Company has issued restricted stock to employees generally with vesting terms ranging from two to four years. The fair value is equal to the market price of the Company’s common stock on the date of grant. Expense for restricted stock is amortized ratably over the vesting period. The following table summarizes the restricted stock activity for the nine months ended September 30, 2016:

 

 

Additionally, the Company grants performance-based restricted stock units. The performance-based units have performance conditions and service-based vesting conditions. Each vesting tranche is treated as an individual award and the compensation expense is recognized on a straight-line basis over the requisite service period for each tranche. The requisite service period is a combination of the performance period and the subsequent vesting period based on continued service. The level of achievement of such goals may cause the actual amount of units that ultimately vest to range from 0% to 200% of the original units granted. The Company recognizes expense ratably over the vesting period for performance-based restricted stock units when it is probable that the performance criteria specified will be achieved. The fair value is equal to the market price of the Company’s common stock on the date of grant.  

The following table summarizes the restricted stock unit activity for the nine months ended September 30, 2016:  

 

 

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The Company recorded compensation expense of $1,204 and $3,615 in the accompanying consolidated statements of operations for the three and nine months ended September 30, 2016, respectively, and $1,050 and $3,254, respectively for the comparable periods of 2015 in connection with the issuance of the restricted stock and restricted stock units. As of September 30, 2016, the Company expects 207 shares of restricted stock and 207 restricted stock units to vest.

As of September 30, 2016, there was $6,596 of total unrecognized compensation expense related to unvested share-based compensation arrangements, which is expected to be recognized over a weighted-average period of 0.9 years. The total unrecognized compensation expense will be fully charged to expense through the third quarter of 2019.

 

 

Litigation

The Company is involved in various claims and routine litigation matters that arise in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the outcomes of such matters are not anticipated to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows in future years.

Contractual Commitments

The Company has entered into agreements with various food suppliers. These agreements may provide for annual pricing, annual purchase obligations, exclusivity in the production of certain products, as well as rebates if certain volume thresholds are exceeded, with terms of five years or less. The Company anticipates it will meet all annual purchase obligations in 2016.

The Company recorded income taxes at an estimated effective income tax rate applied to income before income tax expense of 35.6% and 34.7% in the three and nine months ended September 30, 2016, respectively, as compared to 33.4% and 34.0% in both the comparable periods of 2015.  The Company offsets taxable income for state tax purposes with net operating loss carryforwards. At December 31, 2015, the Company had net operating loss carryforwards of approximately $28,696 for state tax purposes. For state tax purposes, there is a limitation on the amount of net operating loss carryforwards that can be utilized in a given year to offset state taxable income and management believes that some of the net operating loss carryforwards will be subject to this annual limit in 2016. State net operating loss carryforwards will begin to expire in 2025. The total amount of gross unrecognized tax benefits as of September 30, 2016 and December 31, 2015 was $289 and $272, respectively. The total amount of unrecognized tax benefits that, if recognized, would affect the effective income tax rate is approximately $188 and $177 as of September 30, 2016 and December 31, 2015, respectively.

 

 

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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:

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 2015 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

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them in Part I, Item 1A, of that filing under the heading “Risk Factors.” We incorporate that section of the 2015 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. (“Nutrisystem,” the “Company,” “we,” “us,” or “our”) is a provider of weight management products and services, including nutritionally balanced weight loss programs, multi-day kits and single items available at select retail locations and digital tools to support weight loss. The weight loss programs are designed for women and men. Additionally, our Nutrisystem® D® program is designed specifically to help people with Type 2 diabetes who want to lose weight and manage their diabetes. Our programs are based on over 40 years of nutrition research. Our food is created to be nutritious, delicious and portioned for weight loss and management. Our pre-packaged foods are sold directly to weight loss program participants primarily through the Internet and telephone (including the redemption of prepaid program cards), referred to as the direct channel, through QVC, a television shopping network, and select retailers.  

Revenue consists primarily of food sales. For both the nine months ended September 30, 2016 and 2015, the direct channel accounted for 91% of revenue compared to 6% for retail and 3% 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, reactivation revenue, total revenue, marketing per new customer and operating margins.

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.

We offer a customizable four-week program. In December 2015, we announced the launch of our Turbo10 program, a clinically tested program that could deliver up to a 10-pound weight loss and a reduction of five inches overall in the first month of dieting. Customers are given a meal plan, access to trackers and tools via NuMi, educational digital content and exercise suggestions and are also encouraged to check in periodically with a Nutrisystem counselor as their needs change in response to weight loss.

Additionally, our multi-day weight loss kits are available at select retailers and represent a significant departure from our traditional four-week program. The retail channel provides us with great brand exposure, offering consumers who may not be aware of our program an opportunity to sample Nutrisystem at an attractive price point. Also, we continue to offer our program at Costco through the use of the prepaid program cards and gift cards. We are actively developing our retail product pipeline and have multiple kits and single items available for purchase.  

We believe these new product and program innovations are resonating well with our customers. We provide an increasingly diverse array of weight loss solutions for our customers through an expanding portfolio of products. Our customers now have greater flexibility in choosing between ready-to-go and frozen options, with no restrictions. We believe this translates into higher customer satisfaction and more profit. We had an effective acquisition marketing campaign with increased pricing which drove increases in customer activations and average selling price in the nine months ended September 30, 2016 as compared to the comparable period of 2015. We also introduced several add-on products, including shakes and additional flexible options which helped increase demand. Revenue for the nine months ended September 30, 2016 increased 17% from the comparable period of 2015 to $436.5 million. Our revenue growth was attributable primarily to the direct channel due to revenue from new customers in their initial diet cycle, the reactivation of former customers and increased sales of our premium product. Reactivation revenue increased due to higher volumes building off of recent increases in new customer counts and a higher reactivation rate. QVC and retail revenue also increased in the nine months ended September 30, 2016 as compared to the comparable period of 2015.

On December 17, 2015, we acquired the SBD brand for a cash payment of $15.0 million. We are developing South Beach Diet meal programs, products and services as a distinct brand with the intent to launch in both the direct-to-consumer and retail channels. The acquisition will provide consumers with additional quality choices and we expect to capture an even more significant share of the

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commercial weight loss market as we further leverage our expertise in product development, marketing, ecommerce, supply chain logistics and retail.

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 2015 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 nine months ended September 30, 2016, 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. Revenue from the retail programs is also net of any trade allowances, reclamation reserves or broker commissions. No revenue is recorded for food products provided at no charge as part of promotions.  

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

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

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

Interest (Income) Expense, Net.  Interest (income) expense, net consists of interest income earned on cash balances and short term investments net of interest expense and unused line fees on our revolving credit facility.

Income Tax Expense.  We are subject to corporate level income taxes and record income taxes based on an effective income tax rate for the year.

Overview of the Direct Channel

In both the nine months ended September 30, 2016 and 2015, the direct channel represented 91% of our revenue. Revenue through the direct channel was $114.9 million and $398.9 million in the three and nine months ended September 30, 2016 compared to $96.4 million and $338.5 million in the same period of 2015. Revenue is generated primarily through customer starts, reactivation of former customers and the customer ordering behavior, including length of time on our program and the diet program selection. The revenue increase in 2016 was primarily attributable to revenue from new customers in their initial diet cycle, reactivation revenue and increased sales of our premium product. Additionally, we had a higher average selling price in the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015. Critical to increasing customer starts is our ability to deploy

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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.

Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015

 

 

Revenue.  Revenue increased to $124.6 million in the third quarter of 2016 from $104.9 million for the third quarter of 2015. The increase in revenue is attributable primarily to revenue from new customers in their initial diet cycle ($12.4 million), reactivation revenue ($5.6 million) and increased retail revenue ($1.1 million). In both the third quarter of 2016 and 2015, the direct channel accounted for 92% of revenue compared to 6% for retail and 2% for QVC.

Costs and Expenses.  Cost of revenue increased to $57.7 million in the third quarter of 2016 from $51.7 million in the third quarter of 2015. Gross margin as a percent of revenue increased to 53.7% in the third quarter of 2016 from 50.7% in the third quarter of 2015. The increase in gross margin was attributable primarily to increases in average selling prices and lower food costs partially offset by increased packaging and freight costs due to the increased sales of the frozen products.

Marketing expense increased to $33.5 million in the third quarter of 2016 from $25.6 million in the third quarter of 2015. Marketing expense as a percent of revenue increased to 26.9% in the third quarter of 2016 from 24.4% for the third quarter of 2015. Substantially all marketing spending promoted the direct business as well as recent investment initiatives. The increase in marketing expense was attributable primarily to increased spending for advertising media ($7.5 million), increased marketing compensation and benefits ($404,000) and higher public relations ($200,000). In total, media spending was $28.7 million in the third quarter of 2016 and $21.2 million in the third quarter of 2015.

General and administrative expense increased to $16.7 million in the third quarter of 2016 compared to $14.2 million in the third quarter of 2015. General and administrative expense as a percent of revenue decreased to 13.4% in the third quarter of 2016 from 13.6% for the third quarter of 2015. The increase in spending was primarily attributable to higher compensation, benefits and commissions ($1.4 million), higher computer services ($558,000) and increased non-cash expense for share-based payment arrangements ($223,000).

Depreciation and amortization expense increased to $4.3 million in the third quarter of 2016 compared to $2.3 million in the third quarter of 2015 due to a charge of $1.3 million to write-down certain software licenses that were no longer expected to be used as more enhanced software options have become available to handle the evolving business needs and increased capital expenditures for our website, digital tools and our new warehouse. Additionally, we incurred $250,000 in amortization expense in the third quarter of 2016 associated with acquisition of the SBD brand in December 2015.

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Interest (Income) Expense, net. Interest income, net was $11,000 in the third quarter of 2016 compared to interest expense, net of $61,000 in the third quarter of 2015 due to increased interest income from our short term investments offset by a lower amount of capitalized debt issuance costs associated with our credit facility being amortized.

Income Tax Expense. In the third quarter of 2016, we recorded income tax expense of $4.4 million, which reflects an effective income tax rate of 35.6%. In the third quarter of 2015, we recorded an income tax expense of $3.7 million, which reflects an effective income tax rate of 33.4%. The increase in the effective income tax rate is due to a reduction in the research and development tax credit benefit in the third quarter of 2016 as compared to the third quarter of 2015.

Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015

 

 

Revenue.  Revenue increased to $436.5 million in the nine months ended September 30, 2016 from $372.4 million in the comparable period of 2015. The increase in revenue is attributable primarily to revenue from new customers in their initial diet cycle ($42.7 million), reactivation revenue ($16.9 million), retail revenue ($1.9 million) and revenue from QVC ($1.9 million). In both the nine months ended September 30, 2016 and 2015, the direct channel accounted for 91% of revenue compared to 6% for retail and 3% for QVC.

Costs and Expenses.  Cost of revenue increased to $205.4 million in the nine months ended September 30, 2016 from $180.2 million in the comparable period of 2015. Gross margin as a percent of revenue increased to 52.9% in the nine months ended September 30, 2016 from 51.6% for the comparable period of 2015. The increase in gross margin was attributable primarily to increases in average selling prices and lower food costs partially offset by increased packaging and freight costs due to the increased sales of the frozen products and increased promotional expenses for retail.

Marketing expense increased to $128.4 million in the nine months ended September 30, 2016 from $103.9 million in the comparable period of 2015. Marketing expense as a percent of revenue increased to 29.4% in the nine months ended September 30, 2016 from 27.9% for the comparable period of 2015. Substantially all marketing spending promoted the direct business as well as recent investment initiatives. The increase in marketing expense was attributable primarily to increased spending for advertising media ($22.4 million), television production ($1.0 million), higher marketing compensation and benefits ($777,000) and public relations ($319,000). In total, media spending was $112.5 million in the nine months ended September 30, 2016 and $90.1 million in the nine months ended September 30, 2015.

General and administrative expense increased to $51.7 million in the nine months ended September 30, 2016 from $47.5 million in the comparable period of 2015. General and administrative expense as a percent of revenue decreased to 11.9% in the nine months ended September 30, 2016 from 12.8% in the comparable period of 2015. The increase in spending was due primarily to increased computer

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services ($2.0 million), higher compensation, benefits and commissions ($1.4 million) and higher non-cash expense for share-based payment arrangements ($791,000).

Depreciation and amortization expense increased to $10.2 million in the nine months ended September 30, 2016 compared to $6.8 million in the comparable period of 2015 due to increased capital expenditures for our website, digital tools and our new warehouse, as well as a charge of $1.3 million to write-down certain software licenses that were no longer expected to be used as more enhanced software options have become available to handle the evolving business needs. Additionally, we incurred amortization expense of $750,000 in the nine months ended September 30, 2016 associated with acquisition of the SBD brand in December 2015.

 

Interest Expense, net. Interest expense, net was $23,000 in the nine months ended September 30, 2016 compared to $140,000 in the comparable period of 2015 due to a lower amount of capitalized debt issuance costs associated with our credit facility that are being amortized.

Income Tax Expense.  In the nine months ended September 30, 2016, we recorded income tax expense of $14.1 million, which reflects an effective income tax rate of 34.7%. In the comparable period of 2015, we recorded income tax expense of $11.5 million, which reflects an effective income tax rate of 34.0%.

Contractual Obligations and Commercial Commitments

As of September 30, 2016, our principal commitments consisted of obligations under agreements with food suppliers, 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.

Liquidity, Capital Resources and Other Financial Data

At September 30, 2016, we had working capital of $37.3 million as compared to $19.2 million at December 31, 2015. Cash and cash equivalents at September 30, 2016 were $27.0 million, an increase of $20.8 million from the balance of $6.2 million at December 31, 2015. In addition, we had $19.4 million invested in short term investments at September 30, 2016, as compared to $9.3 million at December 31, 2015, an increase of $10.1 million. Our principal sources of liquidity during this period were cash flows from operations.  

On November 6, 2015, we entered into a $50.0 million unsecured revolving credit facility with a lender. The credit facility provides for interest on borrowings at either a base rate or the 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 (applicable if there are outstanding borrowings), and limitations on, among other things, liens, indebtedness, certain acquisitions, consolidations and sales of assets. The credit facility can be drawn upon through November 6, 2020, at which time all amounts must be repaid. There were no borrowings outstanding at September 30, 2016 or December 31, 2015.

In the nine months ended September 30, 2016, we generated cash flows of $55.9 million from operating activities, an increase of $19.3 million from the same period of 2015. An increase of $4.3 million in net income and $9.1 million of additional cash flow provided by the net change in operating assets and liabilities were the primary drivers of increased cash flow from operations largely due to the increase in demand for our products during recent years with decreases in accounts receivable, inventories and other assets generally due to the seasonality of our business.

In the nine months ended September 30, 2016, net cash used in investing activities was $20.5 million as we increased purchases of short term investments and increased capital additions to support our website and recent investment initiatives.

In the nine months ended September 30, 2016, net cash used in financing activities was $14.6 million and included $15.6 million for the payment of dividends and $2.7 million to satisfy the minimum tax withholding obligations associated with the vesting of equity awards partially offset by $1.8 million of proceeds received from the exercise of stock options. In the nine months ended September 30, 2015, net cash used in financing activities was $12.3 million and included $15.4 million for the payment of dividends and $2.5 million to satisfy the minimum tax withholding obligations associated with the vesting of equity awards partially offset by $2.8 million in proceeds received from the exercise of stock options.

On May 3, 2016, we announced our Board of Directors had authorized the repurchase of up to $50.0 million of our outstanding shares of common stock in open-market transactions or otherwise over the next 18-month period. The timing, number and amount of any shares repurchased will be determined by us at our discretion and will be based on a number of factors including our evaluation of general market and economic conditions, the trading price of the common stock, regulatory requirements and compliance with the

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terms of our outstanding indebtedness. The stock repurchase program may be suspended or discontinued at any time without prior notice. No shares were repurchased during the nine months ended September 30, 2016.

Subsequent to September 30, 2016, our Board of Directors declared a quarterly dividend of $0.175 per share payable on November 17, 2016 to stockholders of record as of November 7, 2016. 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.

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 greatest in the first calendar quarter and lowest in the fourth quarter. We believe our business experiences seasonality, driven primarily by the predisposition of dieters to initiate a diet at certain times of the year and the placement of our advertising, which is based on the price and availability of certain media at such times.  

We believe that we are not subject to any material risks arising from changes in foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk instruments. Our cash and cash equivalents at September 30, 2016 of $27.0 million were maintained in bank and money market funds. Additionally, we invested $19.4 million in short term investments, which are classified as available-for-sale securities and are reported at fair value in the accompanying consolidated balance sheets. A change in interest rates of 1 percentage point would not have a material impact on our operating results and cash flows.

(a)    Evaluation of Disclosure Controls and Procedures. The SEC defines the term “disclosure controls and procedures” to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Based on the evaluation of the effectiveness of our disclosure controls and procedures by our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, as of the end of the period covered by this report, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures at the end of the period covered by this report were effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure.

(b)    Changes in Internal Control Over Financial Reporting. No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II -- OTHER INFORMATION

Litigation

The Company is involved in various claims and routine litigation matters that arise in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the outcomes of such matters are not anticipated to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows in future years.

There have been no material changes to the risk factors disclosed in Part 1, Item 1A in our 2015 Annual Report under the heading “Risk Factors.”  

Recent Sales of Unregistered Securities

None.

Issuer Purchases of Equity Securities

There were no reportable purchases during the quarter ended September 30, 2016, provided however that 793 shares of common stock, at an average purchase price of $27.60, were surrendered by employees to the Company during such quarter for the payment of the minimum tax liability withholding obligations upon the vesting of shares of restricted stock.

None.

Not applicable.

None.

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

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Exhibit Index

 

 

 

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