##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---



FORM 10-Q



---



(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the Quarterly Period Ended June 30, 2005



OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



For the Transition Period From  to



Commission File Number 0-28551



---



NutriSystem, Inc.

(Exact name of Registrant as specified in its charter)



---



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 23-3012204                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|200 Welsh Road, Horsham, Pennsylvania                          |  | 19044                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



(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  x    No ̈



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



Indicate the number of shares outstanding of each of the issuers classes of common stock as of June 30, 2005:



|                              |  |                  
|----------------------------- |  | -----------------
|Common Stock, $.001 par value |  | 34,085,331 shares



---



---

##### Table of Contents

NutriSystem, Inc.



INDEX TO FORM 10-Q



|                                                                                               |  |     
|---------------------------------------------------------------------------------------------- |  | ----
|                                                                                               |  | Page
|PART I  FINANCIAL INFORMATION                                                                 |  |     
|                                                                                               | 
|Item 1 -
Financial Statements (unaudited)                                                      |  |     
|                                                                                               | 
|Consolidated Balance Sheets                                                                    |  | 1   
|                                                                                               | 
|Consolidated Statements of Operations                                                          |  | 2   
|                                                                                               | 
|Consolidated Statements of Cash Flows                                                          |  | 3   
|                                                                                               | 
|Notes to Consolidated Financial Statements                                                     |  | 4   
|                                                                                               | 
|Item 2 -
Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 10  
|                                                                                               | 
|Item 3 
Quantitative and Qualitative Disclosure About Market Risk                             |  | 16  
|                                                                                               | 
|Item 4 
Controls and Procedures                                                               |  | 16  
|                                                                                               | 
|PART II -
OTHER INFORMATION                                                                    |  |     
|                                                                                               | 
|Item 1 
Legal Proceedings                                                                     |  | 17  
|                                                                                               | 
|Item 2 
Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 17  
|                                                                                               | 
|Item 3 
Defaults Upon Senior Securities                                                       |  | 17  
|                                                                                               | 
|Item 4 
Submission of Matters to a Vote of Security Holders                                   |  | 17  
|                                                                                               | 
|Item 5 
Other Information                                                                     |  | 17  
|                                                                                               | 
|Item 6 -
Exhibits.                                                                             |  | 17  
|                                                                                               | 
|SIGNATURES                                                                                     |  | 18  



---

##### Table of Contents

Item 1. Financial Statements (unaudited)



NUTRISYSTEM, INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



(Unaudited, in
thousands except share data)



|                                                                                                                                                              |  |              |         |   |                  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                              |  | June 30,2005 |         |   | December 31,2004 |  
|ASSETS                                                                                                                                                        |  |              |         |   |                  |   |         |  
|                                                                                                                                                              |  |             
|CURRENT ASSETS                                                                                                                                                |  |              |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                                                     |  | $            | 37,693  |   |                  | $ | 4,201   |  
|Trade receivables                                                                                                                                             |  |              | 3,785   |   |                  |   | 1,028   |  
|Inventories                                                                                                                                                   |  |              | 9,777   |   |                  |   | 3,679   |  
|Deferred income taxes                                                                                                                                         |  |              | 421     |   |                  |   | 421     |  
|Other current assets                                                                                                                                          |  |              | 1,837   |   |                  |   | 1,149   |  
|                                                                                                                                                              |  |              |         |   |                  |   |         |  
|Total current assets                                                                                                                                          |  |              | 53,513  |   |                  |   | 10,478  |  
|                                                                                                                                                              |  |             
|FIXED ASSETS, net                                                                                                                                             |  |              | 1,722   |   |                  |   | 1,197   |  
|IDENTIFIABLE INTANGIBLE ASSETS, net                                                                                                                           |  |              | 1,475   |   |                  |   | 1,615   |  
|GOODWILL                                                                                                                                                      |  |              | 465     |   |                  |   | 465     |  
|DEFERRED INCOME TAXES                                                                                                                                         |  |              | 1,148   |   |                  |   | 3,938   |  
|OTHER ASSETS                                                                                                                                                  |  |              | 140     |   |                  |   | 132     |  
|                                                                                                                                                              |  |              |         |   |                  |   |         |  
|                                                                                                                                                              |  | $            | 58,463  |   |                  | $ | 17,825  |  
|                                                                                                                                                              |  |              |         |   |                  |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                          |  |              |         |   |                  |   |         |  
|                                                                                                                                                              |  |             
|CURRENT LIABILITIES                                                                                                                                           |  |              |         |   |                  |   |         |  
|Current portion of note payable and capital lease obligation                                                                                                  |  | $            | 167     |   |                  | $ | 136     |  
|Accounts payable                                                                                                                                              |  |              | 7,091   |   |                  |   | 4,359   |  
|Accrued payroll and related benefits                                                                                                                          |  |              | 1,681   |   |                  |   | 368     |  
|Deferred revenue                                                                                                                                              |  |              | 333     |   |                  |   | 311     |  
|Other current liabilities                                                                                                                                     |  |              |        |   |                  |   | 204     |  
|                                                                                                                                                              |  |              |         |   |                  |   |         |  
|Total current liabilities                                                                                                                                     |  |              | 9,272   |   |                  |   | 5,378   |  
|                                                                                                                                                              |  |             
|NOTE PAYABLE AND CAPITAL LEASE OBLIGATION                                                                                                                     |  |              | 416     |   |                  |   | 272     |  
|                                                                                                                                                              |  |              |         |   |                  |   |         |  
|Total liabilities                                                                                                                                             |  |              | 9,688   |   |                  |   | 5,650   |  
|                                                                                                                                                              |  |              |         |   |                  |   |         |  
|COMMITMENTS AND CONTINGENCIES (Note 5)                                                                                                                        |  |              |         |   |                  |   |         |  
|                                                                                                                                                              |  |             
|STOCKHOLDERS EQUITY:                                                                                                                                         |  |              |         |   |                  |   |         |  
|                                                                                                                                                              |  |             
|Preferred stock, $.001 par value (5,000,000 shares authorized, no shares issued and outstanding)                                                              |  |              |        |   |                  |   |        |  
|Common stock, $.001 par value (100,000,000 shares authorized; shares issued and outstanding 34,085,331 at June 30, 2005 and 30,132,860
at December 31, 2004) |  |              | 34      |   |                  |   | 30      |  
|Additional paid-in capital                                                                                                                                    |  |              | 62,425  |   |                  |   | 33,378  |  
|Accumulated deficit                                                                                                                                           |  |              | (13,684 | ) |                  |   | (21,233 | )
|                                                                                                                                                              |  |              |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                                    |  |              | 48,775  |   |                  |   | 12,175  |  
|                                                                                                                                                              |  |              |         |   |                  |   |         |  
|                                                                                                                                                              |  | $            | 58,463  |   |                  | $ | 17,825  |  
|                                                                                                                                                              |  |              |         |   |                  |   |         |  



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



1



---

##### Table of Contents

NUTRISYSTEM, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF OPERATIONS



(Unaudited, in thousands, except per share amounts)



|                                     |  |                             |        |                           |   |        |  |      |        |  |   |       
|------------------------------------ |  | --------------------------- | ------ | ------------------------- | - | ------ |  | ---- | ------ |  | - | ------
|                                     |  | Three Months Ended June 30, |        | Six Months Ended June 30,
|                                     |  | 2005                        |        | 2004                      |   | 2005   |  | 2004
|REVENUES                             |  | $                           | 40,943 |                           | $ | 9,179  |  | $    | 78,371 |  | $ | 22,462
|                                     |  |                             |        |                           |   |        |  |      |        |  |   |       
|COSTS AND EXPENSES:                  |  |                             |        |                           |   |        |  |      |        |  |   |       
|Cost of revenues                     |  |                             | 20,850 |                           |   | 5,201  |  |      | 41,324 |  |   | 12,760
|Marketing                            |  |                             | 8,834  |                           |   | 1,020  |  |      | 16,902 |  |   | 3,691 
|General and administrative           |  |                             | 3,942  |                           |   | 1,637  |  |      | 7,277  |  |   | 3,387 
|Depreciation and amortization        |  |                             | 175    |                           |   | 67     |  |      | 347    |  |   | 131   
|                                     |  |                             |        |                           |   |        |  |      |        |  |   |       
|Total costs and expenses             |  |                             | 33,801 |                           |   | 7,925  |  |      | 65,850 |  |   | 19,969
|                                     |  |                             |        |                           |   |        |  |      |        |  |   |       
|Operating income                     |  |                             | 7,142  |                           |   | 1,254  |  |      | 12,521 |  |   | 2,493 
|                                     |  |                             |        |                          
|INTEREST INCOME, net                 |  |                             | 58     |                           |   | 9      |  |      | 60     |  |   | 12    
|                                     |  |                             |        |                           |   |        |  |      |        |  |   |       
|Income before income taxes           |  |                             | 7,200  |                           |   | 1,263  |  |      | 12,581 |  |   | 2,505 
|                                     |  |                             |        |                          
|INCOME TAXES                         |  |                             | 2,879  |                           |   | 505    |  |      | 5,032  |  |   | 1,002 
|                                     |  |                             |        |                           |   |        |  |      |        |  |   |       
|Net income                           |  | $                           | 4,321  |                           | $ | 758    |  | $    | 7,549  |  | $ | 1,503 
|                                     |  |                             |        |                           |   |        |  |      |        |  |   |       
|BASIC INCOME PER SHARE               |  | $                           | 0.14   |                           | $ | 0.03   |  | $    | 0.24   |  | $ | 0.05  
|                                     |  |                             |        |                           |   |        |  |      |        |  |   |       
|DILUTED INCOME PER SHARE             |  | $                           | 0.12   |                           | $ | 0.02   |  | $    | 0.22   |  | $ | 0.05  
|                                     |  |                             |        |                           |   |        |  |      |        |  |   |       
|WEIGHTED AVERAGE SHARES OUTSTANDING: |  |                             |        |                           |   |        |  |      |        |  |   |       
|Basic                                |  |                             | 31,845 |                           |   | 29,076 |  |      | 31,121 |  |   | 28,859
|Diluted                              |  |                             | 34,789 |                           |   | 31,875 |  |      | 34,071 |  |   | 31,985



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



2



---

##### Table of Contents

NUTRISYSTEM, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS



(Unaudited, in thousands)



|                                                                                  |  |                           |        |   |      |   |        |  
|--------------------------------------------------------------------------------- |  | ------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                  |  | Six Months Ended June 30, |       
|                                                                                  |  | 2005                      |        |   | 2004 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |                           |        |   |      |   |        |  
|Net income                                                                        |  | $                         | 7,549  |   |      | $ | 1,503  |  
|Adjustments to reconcile net income to net cash provided by operating activities- |  |                           |        |   |      |   |        |  
|Depreciation and amortization                                                     |  |                           | 347    |   |      |   | 131    |  
|Deferred tax expense                                                              |  |                           | 2,790  |   |      |   | 727    |  
|Stock-based costs                                                                 |  |                           | 103    |   |      |   | 253    |  
|Tax benefit from stock option exercises                                           |  |                           | 2,243  |   |      |   | 275    |  
|Imputed interest expense                                                          |  |                           | 11     |   |      |   |       |  
|Changes in operating assets and liabilities-                                      |  |                           |        |   |      |   |        |  
|Restricted cash                                                                   |  |                           |       |   |      |   | 250    |  
|Trade receivables                                                                 |  |                           | (2,757 | ) |      |   | (294   | )
|Inventories                                                                       |  |                           | (6,098 | ) |      |   | 2,163  |  
|Other assets                                                                      |  |                           | (696   | ) |      |   | (67    | )
|Accounts payable                                                                  |  |                           | 2,732  |   |      |   | (1,986 | )
|Accrued payroll and related benefits                                              |  |                           | 1,313  |   |      |   | 191    |  
|Deferred revenue                                                                  |  |                           | 22     |   |      |   | (13    | )
|Other current liabilities                                                         |  |                           | (204   | ) |      |   | (452   | )
|                                                                                  |  |                           |        |   |      |   |        |  
|Net cash provided by operating activities                                         |  |                           | 7,355  |   |      |   | 2,681  |  
|                                                                                  |  |                           |        |   |      |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |                           |        |   |      |   |        |  
|Capital additions                                                                 |  |                           | (568   | ) |      |   | (178   | )
|                                                                                  |  |                           |        |   |      |   |        |  
|Net cash used in investing activities                                             |  |                           | (568   | ) |      |   | (178   | )
|                                                                                  |  |                           |        |   |      |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                             |  |                           |        |   |      |   |        |  
|Issuance of common shares                                                         |  |                           | 25,399 |   |      |   |       |  
|Exercise of stock options and warrants                                            |  |                           | 1,306  |   |      |   | 360    |  
|                                                                                  |  |                           |        |   |      |   |        |  
|Net cash provided by financing activities                                         |  |                           | 26,705 |   |      |   | 360    |  
|                                                                                  |  |                           |        |   |      |   |        |  
|NET CHANGE IN CASH AND CASH EQUIVALENTS                                           |  |                           | 33,492 |   |      |   | 2,863  |  
|                                                                                  |  |                          
|CASH AND CASH EQUIVALENTS, beginning of period                                    |  |                           | 4,201  |   |      |   | 2,684  |  
|                                                                                  |  |                           |        |   |      |   |        |  
|CASH AND CASH EQUIVALENTS, end of period                                          |  | $                         | 37,693 |   |      | $ | 5,547  |  
|                                                                                  |  |                           |        |   |      |   |        |  



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



3



---

##### Table of Contents

NUTRISYSTEM, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



(In thousands, except share and per share amounts)

(Unaudited)



1. BACKGROUND



Nature of the Business



NutriSystem, Inc. (the Company or NutriSystem) provides weight management and fitness products and services. The Companys pre-packaged foods are sold to weight loss program participants
directly via the Internet and telephone, referred to as the direct channel, and through independent commissioned representatives, the field sales channel, through 14 independent center-based distributors, the case distributor channel, and through
QVC, a television shopping network.



On December 2, 2004, the Company acquired
Slim and Tone LLC (Slim and Tone), a franchisor of womens express fitness centers. Slim and Tone franchisees now sell NutriSystems diet program in their centers as commissioned representatives. As of June 30, 2005, there were
121 Slim and Tone franchise centers currently open and operating.



On June 2,
2005, the Company completed a secondary public offering of 2,476,625 shares of common stock that raised net proceeds of $25,399 (Note 3).



2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Presentation of Financial Statements



The Companys consolidated financial statements include the accounts 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 June 30, 2005
and for the three and six months ended June 30, 2005 and 2004 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. The results of operations for the three and six months ended June 30, 2005 are not necessarily indicative of the results to be expected for any other interim period or the year
ending December 31, 2005.



Cash and Cash Equivalents



The Company considers all highly liquid investments with an original maturity of three
months or less when purchased to be cash equivalents for the purpose of determining cash flow. Cash and cash equivalents include cash on hand, cash in bank and money market investments.



Dependence on Key Customer



Approximately 11% and 15% of the Companys revenues for the six months ended June 30,
2005 and 2004, respectively, relate to sales through QVC. Accounts receivable from QVC at June 30, 2005 were $875.



Inventories



Inventories consist principally of packaged food held in the Companys warehouse or in outside fulfillment locations. Inventories are valued at the lower of cost or market, with cost determined using the
first-in, first-out (FIFO) method.



4



---

##### Table of Contents

Fixed Assets



Fixed assets are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the related assets, which are generally three
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. Capital leases are amortized on a straight-line basis over the terms of the respective
leases. Expenditures for repairs and maintenance are charged to expense as incurred, while major renewals and improvements are capitalized.



Identifiable Intangible Assets and Goodwill



Identifiable intangible assets and goodwill arose from the acquisition of Slim and Tone in December 2004. Identifiable intangible assets represent trade names and
trademarks, customer relationships, procedural manuals and covenants not to compete acquired in the transaction. Goodwill represents the excess of the purchase price over the net tangible and identifiable intangible assets acquired of Slim and Tone.
The Company does not amortize trade names, trademarks and goodwill due to their indefinite life, but management reviews these assets at least annually for impairment. The other intangible assets are presented at cost, net of accumulated
amortization, and are amortized over their estimated useful lives.



Valuation of Long-Lived Assets



The Company continually
evaluates whether events or circumstances have occurred that indicate that the remaining useful lives of its long-lived assets, primarily fixed assets and purchased identifiable intangibles subject to amortization, should be revised or that the
remaining balance of such assets may not be recoverable using objective methodologies. Such methodologies include evaluations based on the undiscounted cash flows generated by the underlying assets or other determinants of fair value. As of June 30,
2005 and December 31, 2004, respectively, management believes that no reductions to the remaining useful lives or write-downs of long-lived assets are required.



Revenue Recognition



Revenues for food sales are recognized when the related products are shipped to the end-consumer or to case distributors.



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. Slim
and Tone franchise fee payments received prior to a franchise center opening are recorded as deferred revenue. Royalties are paid monthly and recognized in the month the royalty is earned.



Revenues from pre-packaged food sales include amounts billed for shipping and handling, and
are presented net of returns and free food products provided to consumers. Revenues from shipping and handling charges were $460 and $230 for the six months ended June 30, 2005 and 2004, respectively.



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. At June 30, 2005 and December 31, 2004, $761 and $253, respectively, of prepaid advertising was included in prepaid expenses. Media expense was $15,691 and $3,041 for the six
months ended June 30, 2005 and 2004, respectively.



Income Taxes



Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases and operating loss and
tax credit carryforwards. Deferred tax assets and



5



---

##### Table of Contents

liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of operations in the period that includes the enactment date.



Fair Value of Financial Instruments



The carrying values of the Companys financial instruments, including cash, cash
equivalents, trade receivables and accounts payable, approximate the fair values due to the short-term nature of these instruments. The carrying amount of the notes payable approximates the fair value.



Net Income Per Common Share



The Company applies Statement of Financial Accounting Standards (SFAS) No. 128,
Earnings per Share, which requires dual presentation of basic and diluted earnings per share (EPS) for complex capital structures on the face of the statement of operations. Basic EPS is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from the exercise or conversion of securities into common stock, such as stock options and warrants. The following table sets forth the
computation of basic and diluted earnings per share:



|                                              |  |                                          |        |                           |   |        |  |      |        |  |   |       
|--------------------------------------------- |  | ---------------------------------------- | ------ | ------------------------- | - | ------ |  | ---- | ------ |  | - | ------
|                                              |  | Three Months Ended June 30,              |        | Six Months Ended June 30,
|                                              |  | 2005                                     |        | 2004                      |   | 2005   |  | 2004
|                                              |  | (in thousands, except per share amounts)
|Net income:                                   |  | $                                        | 4,321  |                           | $ | 758    |  | $    | 7,549  |  | $ | 1,503 
|                                              |  |                                          |        |                           |   |        |  |      |        |  |   |       
|Weighted average shares outstanding:          |  |                                          |        |                           |   |        |  |      |        |  |   |       
|Basic                                         |  |                                          | 31,845 |                           |   | 29,076 |  |      | 31,121 |  |   | 28,859
|Effect of dilutive stock options (net of tax) |  |                                          | 2,944  |                           |   | 2,799  |  |      | 2,950  |  |   | 3,126 
|                                              |  |                                          |        |                           |   |        |  |      |        |  |   |       
|Diluted                                       |  |                                          | 34,789 |                           |   | 31,875 |  |      | 34,071 |  |   | 31,985
|                                              |  |                                          |        |                           |   |        |  |      |        |  |   |       
|Earnings per common share:                    |  |                                          |        |                           |   |        |  |      |        |  |   |       
|Basic                                         |  | $                                        | 0.14   |                           | $ | 0.03   |  | $    | 0.24   |  | $ | 0.05  
|                                              |  |                                          |        |                           |   |        |  |      |        |  |   |       
|Diluted                                       |  | $                                        | 0.12   |                           | $ | 0.02   |  | $    | 0.22   |  | $ | 0.05  
|                                              |  |                                          |        |                           |   |        |  |      |        |  |   |       



On June 2, 2005, the Company completed
a secondary public offering of 2,476,625 shares of common stock. These shares are included in the weighted average shares outstanding for the three and six month periods ended June 30, 2005 (Note 3).



For the three and six months ended June 30, 2005 and 2004, common stock equivalents
representing 72,000, 142,000, 320,334 and 315,334 shares of common stock, respectively, were excluded from weighted average shares outstanding for diluted net income per share purposes since the effect would be anti-dilutive.



Stock Options



The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation, (SFAS No. 123) established accounting and disclosure requirements using a fair-value-based method of accounting for
stock-based employee compensation plans. As allowed by SFAS No. 123, as amended in SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure (SFAS No. 148), the Company has elected to continue to
apply the intrinsic-value-based method of accounting and has adopted only the disclosure requirements.



6



---

##### Table of Contents

Had compensation cost for the Companys common stock options been determined based upon the fair value of the
options at the date of grant, as prescribed under SFAS No. 123, as amended by SFAS No. 148, the Companys net income and net income per share would have been changed to the following pro forma amounts:



|                                                                                                                      |  |                                          |       |   |                           |   |      |      |  |   |       |   |  |   |       |  
|--------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ----- | - | ------------------------- | - | ---- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                                                                                      |  | Three Months Ended June 30,              |       |   | Six Months Ended June 30, |  
|                                                                                                                      |  | 2005                                     |       |   | 2004                      |   |      | 2005 |  |   | 2004  |  
|                                                                                                                      |  | (in thousands, except per share amounts) |      
|Net income:                                                                                                           |  |                                          |       |  
|As reported                                                                                                           |  | $                                        | 4,321 |   |                           | $ | 758  |      |  | $ | 7,549 |   |  | $ | 1,503 |  
|Add stock-based employee compensation expense included in reported net income, net of tax                             |  |                                          |      |   |                           |   |     |      |  |   |      |   |  |   |      |  
|Impact of total stock-based compensation expense determined under fair-value based method for all rewards, net of tax |  |                                          | (278  | ) |                           |   | (137 | )    |  |   | (497  | ) |  |   | (212  | )
|                                                                                                                      |  |                                          |       |   |                           |   |      |      |  |   |       |   |  |   |       |  
|Pro forma                                                                                                             |  | $                                        | 4,043 |   |                           | $ | 621  |      |  | $ | 7,052 |   |  | $ | 1,291 |  
|                                                                                                                      |  |                                          |       |   |                           |   |      |      |  |   |       |   |  |   |       |  
|Basic net income per share:                                                                                           |  |                                          |       |   |                           |   |      |      |  |   |       |   |  |   |       |  
|As reported                                                                                                           |  | $                                        | 0.14  |   |                           | $ | 0.03 |      |  | $ | 0.24  |   |  | $ | 0.05  |  
|                                                                                                                      |  |                                          |       |   |                           |   |      |      |  |   |       |   |  |   |       |  
|Pro forma                                                                                                             |  | $                                        | 0.13  |   |                           | $ | 0.02 |      |  | $ | 0.23  |   |  | $ | 0.04  |  
|                                                                                                                      |  |                                          |       |   |                           |   |      |      |  |   |       |   |  |   |       |  
|Diluted net income per share:                                                                                         |  |                                          |       |   |                           |   |      |      |  |   |       |   |  |   |       |  
|As reported                                                                                                           |  | $                                        | 0.12  |   |                           | $ | 0.02 |      |  | $ | 0.22  |   |  | $ | 0.05  |  
|                                                                                                                      |  |                                          |       |   |                           |   |      |      |  |   |       |   |  |   |       |  
|Pro forma                                                                                                             |  | $                                        | 0.12  |   |                           | $ | 0.02 |      |  | $ | 0.21  |   |  | $ | 0.04  |  
|                                                                                                                      |  |                                          |       |   |                           |   |      |      |  |   |       |   |  |   |       |  



In calculating pro forma compensation,
the fair value of each stock option is estimated on the date of grant using the Black-Scholes option pricing model and the following weighted-average assumptions:



|                         |  |                             |   |  |                           |   |  |       |   |  |       |  
|------------------------ |  | --------------------------- | - |  | ------------------------- | - |  | ----- | - |  | ----- | -
|                         |  | Three Months Ended June 30, |   |  | Six Months Ended June 30, |  
|                         |  | 2005                        |   |  | 2004                      |   |  | 2005  |   |  | 2004  |  
|Dividend yield           |  | None                        |   |  | None                      |   |  | None  |   |  | None  |  
|Expected volatility      |  | 117.9                       | % |  | 124.7                     | % |  | 118.1 | % |  | 127.2 | %
|Risk-free interest rate  |  | 4.1                         | % |  | 3.9                       | % |  | 4.0   | % |  | 3.8   | %
|Expected life (in years) |  | 5.6                         |   |  | 4.7                       |   |  | 5.6   |   |  | 4.7   |  



The weighted average fair value of the
options issued in the three and six months ended June 30, 2005 and 2004, were $5.95, $5.15, $2.06 and $1.57, respectively.



Cash Flow Information



The Company made no payments for income taxes and minimal interest payments for the six months ended June 30, 2005 and 2004, respectively.



In the six months ended June 30, 2005, the Company entered into a capital lease obligation for $183.



Recently Issued Accounting Pronouncements



In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123R, Share-Based Payment. SFAS 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 requires
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, and related interpretation, that the Company currently uses. The Company is required to adopt SFAS No. 123R beginning in 2006. 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 2006 and thereafter.



7



---

##### Table of Contents

Use of Estimates



The preparation of financial statements in accordance with generally accepted accounting principles 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 revenues and operating expenses during the reporting period. Actual results could differ from these estimates.



3. CAPITAL STOCK



Common Stock



In the first six months of 2005, the Company completed a secondary public offering of 2,476,625 shares of common stock that raised net proceeds of $25,399. The Company
issued 1,439,346 and 286,686 shares of common stock in the first six months of 2005 and 2004, respectively, upon the exercise of common stock options and received proceeds of $1,306 and $194. Also, in the first six months of 2005 and 2004,
respectively, the Company issued 36,500 and 83,500 shares of common stock and common stock options as compensation to board members, certain consultants and spokespersons per their contract. Costs recognized for these stock grants were $103 and $253
for the respective periods. In the six months ended June 30, 2004, the Company issued 311,880 shares of common stock upon the exercise of common stock warrants and received proceeds of $166.



Preferred Stock



The Company has authorized 5,000,000 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 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.



4. NOTE PAYABLE AND CAPITAL LEASE OBLIGATION



In connection with the acquisition of Slim and Tone (see Note 1), the Company issued a $450 note payable to the seller. The seller note bears no interest and, as such, has been recorded net of a discount of $43 computed at a 5.2% interest
rate. Amortization of the note discount was $11 for the six months ended June 30, 2005. Under the terms of the note agreement, the Company will make equal annual payments on December 31, 2005, 2006 and 2007. The seller is now an employee of the
Company.



In the second quarter of 2005, the Company entered into a capital
lease agreement for telephone systems. The lease is a five year lease that expires in the end of 2009 and contains a bargain purchase option. The present value of the lease payments is $183 based on an annual interest rate of 6%. The lease requires
a payment of $4 per month.



5. COMMITMENTS AND CONTINGENCIES



The Company is involved in certain various claims and routine litigation matters. In the
opinion of management, after consultation with legal counsel, the outcome of such matters will not have a material adverse effect on the Companys consolidated financial position, results of operations or cash flows in future years.



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.



In June 2005, the Company entered into an agreement with a food vendor for a term of three
years expiring June 1, 2008. The agreement requires the Company to make minimum cumulative purchases of $9,000 through 2005, $20,000 through 2006 and $33,000 through 2007. The Company will incur penalties of 15% of the shortfall if the Company does
not reach the required minimum purchases. The agreement also provides for annual pricing updates and rebates if certain volume thresholds are exceeded, as well as exclusivity in the production of certain products.



8



---

##### Table of Contents

6. INCOME TAXES



The Company recorded income tax expense in the quarters and six month periods ended June 30, 2005 and 2004 at the estimated annual effective tax rate of 40%. The Company
offsets taxable income for federal and state tax purposes with net operating loss carryforwards. Based on the level of taxable income expected in 2005, the net operating loss carryforwards of approximately $8,700 at December 31, 2004 will be
utilized in 2005.



9



---

##### Table of Contents

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



Except for the historical information contained herein, this Report on Form 10-Q contains certain forward-looking statements that involve substantial
risks and uncertainties. Words such as may, should, could, would, expect, plan, anticipate, believe, estimate, predict,
continue, or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Our 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 as disclosed in our Forms 10-K and 10-Q filed, respectively,
on March 30, 2005 and May 13, 2005 with the Securities and Exchange Commission. 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 Report on
Form 10-Q.



Background



We provide weight management and fitness products and services. Our diet
program was originally developed by predecessor businesses that operated through company-owned and franchised weight loss centers. We no longer operate company-owned weight loss centers and we terminated our last franchise agreements in 2003. As of
June 30, 2005, there were 14 independent center-based distributors who operate without franchise agreements, which we refer to as the case distributor channel. In 1998, we initiated a marketing program using independent commissioned representatives.
In late 1999, we began selling directly to the consumer through the Internet and by telephone, or our direct channel. In 2001, we began selling foods through QVC, a television shopping network. Our prepackaged foods are now sold to weight loss
program participants through the direct channel, QVC and other channels, including two legacy channels consisting of independent commissioned representatives, or the field sales channel, and the case distributor channel.



On December 2, 2004, we acquired Slim and Tone LLC, a franchisor of
womens express fitness centers. Slim and Tone franchisees now sell our diet program in their centers as commissioned representatives. We purchased Slim and Tone for $1.0 million in cash at closing, $450,000 paid into escrow and a seller note
for $450,000 payable in three annual installments commencing December 31, 2005. As of June 30, 2005, there were 121 Slim and Tone franchise centers open and operating.



Since our business began in 1972, it has operated in various organizational and legal structures, and was subject to a
bankruptcy proceeding in 1993, which was discharged in 1994. We became a publicly traded company in October 1999. In September 2000, we changed our name from nutrisystem.com inc. to Nutri/System, Inc. and in 2003, we changed our name to NutriSystem,
Inc.



Critical Accounting Policies and Estimates



Our consolidated financial statements are prepared in accordance with United
States generally accepted accounting principles. Our significant accounting policies are described in Note 2 of the consolidated financial statements included in Item 8 of our Form 10-K for the year ended December 31, 2004.



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 our consolidated financial statements. These critical accounting estimates have been discussed with our
audit committee.



Reserves for Returns. We review the
reserves for customer returns at each reporting period and adjust them to reflect data available at that time. To estimate reserves for returns we consider return rates in preceding periods and



10



---

##### Table of Contents

changes in product offerings or marketing methods that might impact returns going forward. To the extent the estimate of
returns is inaccurate, we will adjust the reserve, which will impact the amount of product sales revenue recognized in the period of the adjustment. Returns for the six months ended June 30, 2005 and 2004 were $7.2 million and $2.1 million,
respectively.



Impairment of Fixed Assets and
Intangibles. We continually assess 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 our operating performance. Future events could cause us 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. We experienced losses in 1999 and 2000. As a result, we had federal and state tax net operating loss (NOL) carryforwards of approximately $8.7 million at December 31, 2004. Based on the level of taxable income expected
in 2005, the NOL carryforwards will be utilized in 2005.



Currently, we are recording income taxes at a rate equal to the combined federal and state effective rates. For the six months ended June 30, 2005 and 2004, respectively, we recorded income tax expense of $5.0 million and $1.0 million,
which reflects an estimated annual effective tax rate of 40%. The effective tax rate may increase in 2005 if taxable income exceeds the current expected level.



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.



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.



Marketing Expense. Marketing expense
includes advertising, marketing and promotional expenses and payroll related expenses for personnel engaged in these activities. We follow the American Institute of Certified Public Accountants 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-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.



General and Administrative Expenses. General and administrative expenses consist of compensation for administrative,
information technology, counselors (excluding commissions) and customer service personnel, facility expenses, website development costs, professional service fees and other general corporate expenses.



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



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



11



---

##### Table of Contents

Overview of the Direct Channel



We began selling directly to consumers upon launching our e-commerce web site on October 15, 1999. In the first six months
of 2005 versus 2004, the direct channel represented 85% and 78%, respectively, of our net revenues. For the direct channel of distribution, our primary financial objectives are to generate growth while maintaining profit margins. We measure growth
in terms of the number of new customers, revenues per new customer and total revenues. A new customer is defined as a first time purchaser through the direct channel. We define a customer with an initial purchase of $100 or more to be a
program new customer. Profit margins are measured in terms of gross margin (revenues less cost of revenues) and total marketing expense as a percentage of revenues.



Financial and Operating Statistics for the Direct Channel



(in thousands, except new customer data)



|                                   |  |                             |        |   |                           |   |       |      |  |   |         |   |  |   |        |  
|---------------------------------- |  | --------------------------- | ------ | - | ------------------------- | - | ----- | ---- |  | - | ------- | - |  | - | ------ | -
|                                   |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                   |  | 2005                        |        |   | 2004                      |   |       | 2005 |  |   | 2004    |  
|Revenues                           |  | $                           | 35,763 |   |                           | $ | 7,675 |      |  | $ | 66,269  |   |  | $ | 17,453 |  
|                                   |  |                             |        |  
|Cost of revenues                   |  |                             | 16,911 |   |                           |   | 4,033 |      |  |   | 31,958  |   |  |   | 8,872  |  
|                                   |  |                             |        |   |                           |   |       |      |  |   |         |   |  |   |        |  
|Gross margin                       |  | $                           | 18,852 |   |                           | $ | 3,642 |      |  | $ | 34,311  |   |  | $ | 8,581  |  
|% of revenue                       |  |                             | 52.7   | % |                           |   | 47.4  | %    |  |   | 51.8    | % |  |   | 49.2   | %
|                                   |  |                             |        |  
|Marketing                          |  | $                           | 8,689  |   |                           | $ | 1,020 |      |  | $ | 16,650  |   |  | $ | 3,691  |  
|% of revenue                       |  |                             | 24.3   | % |                           |   | 13.3  | %    |  |   | 25.1    | % |  |   | 21.1   | %
|                                   |  |                             |        |  
|New customers                      |  |                             |        |   |                           |   |       |      |  |   |         |   |  |   |        |  
|Program                            |  |                             | 54,549 |   |                           |   | 8,677 |      |  |   | 117,315 |   |  |   | 26,732 |  
|Total                              |  |                             | 57,974 |   |                           |   | 9,471 |      |  |   | 122,009 |   |  |   | 28,735 |  
|                                   |  |                             |        |  
|Marketing /new customer            |  |                             |        |   |                           |   |       |      |  |   |         |   |  |   |        |  
|Program                            |  | $                           | 159    |   |                           | $ | 118   |      |  | $ | 142     |   |  | $ | 138    |  
|Total                              |  | $                           | 150    |   |                           | $ | 108   |      |  | $ | 136     |   |  | $ | 128    |  
|                                   |  |                             |        |  
|New customer revenues/new customer |  |                             |        |   |                           |   |       |      |  |   |         |   |  |   |        |  
|Program                            |  | $                           | 385    |   |                           | $ | 395   |      |  | $ | 486     |   |  | $ | 482    |  
|Total                              |  | $                           | 362    |   |                           | $ | 362   |      |  | $ | 467     |   |  | $ | 448    |  



Direct revenues
increased 366.0% in the second quarter of 2005 over the second quarter of 2004. Direct revenues are largely a function of the number of new customers acquired, revenues per new customer and the revenues generated from returning customers, which we
define as revenues obtained from customers that initially purchased food in a prior period. In the second quarter of 2005, the number of new customers acquired increased by 48,503 or 512.1% year over year. From the second quarter 2004 to the second
quarter 2005, revenues per new customer remained the same at $362 and revenues per program customer declined from $395 to $385. In a given quarter, revenue per new customer is influenced by the timing of customer acquisition. In the second quarter
of 2004, most new customers from the quarter (51%) were acquired in April, the first month of the quarter, while in the second quarter of 2005 only 34% of the quarters new customers were acquired in April. The timing of customer acquisition in
2004 allowed a higher proportion



12



---

##### Table of Contents

of customers more time in the quarter to make purchases than was the case in 2005, resulting in higher revenue per
program new customer. The remaining revenues in the quarter, derived from customers that originally purchased in a prior period, rose 247.4% to $14.8 million in the second quarter of 2005 from $4.2 million in the second quarter of 2004, primarily
because of the large number of new customers obtained in the first quarter of 2005. A number of factors drove the improved revenue performance: greater advertising spending, excellent consumer response to the NutriSystem Nourish program, higher
product pricing and a higher proportion of new customers selecting the autoship option. Under the autoship program, customers receive monthly product shipments automatically until they notify us they wish to end shipments.



Direct gross margin as a percent of direct revenues increased in the second
quarter to 52.7% in 2005 from 47.4% in 2004, primarily driven by price increases (which increased margins by approximately 4.7 percentage points) and, to a lesser extent, to lower fulfillment costs (0.7 percentage points) and rate of customer
returns (0.6 percentage points), offset by higher promotional food costs arising from our Week Free on initial orders (2.1 percentage points). Marketing costs increased by $7.7 million, or 751.9% in the second quarter of 2005 over the
second quarter of 2004. We believe marketing cost per new customer acquired increased to $150 from $108 because of a) the very low levels of marketing spending in the second quarter of 2004 overall, and b) high spending in 2005 on short form
television advertising, which has a relatively high customer acquisition cost. At an average customer acquisition cost of $150, we believe our marketing program is cost effective.



Direct results for the first half of 2005 also showed an increase in revenues over the same period in 2004. Revenues
increased 279.7% in the first half of 2005 compared to the first half of 2004. The spending on advertising and marketing increased by $13.0 million to $16.7 million in the first half of 2005 from $3.7 million in the first half of 2004. Marketing per
new customer increased to $136 in the first half of 2005 from $128 in the first half of 2004 due to the level and mix of advertising discussed above. Gross margin as a percentage of revenues increased to 51.8% in the first half of 2005 from 49.2% in
the first half of 2004, primarily driven by price increases (which increased margin by approximately 4.9 percentage points) offset by higher promotional food costs arising from our Week Free on initial orders (2.9 percentage points).



Overview of Television Infomercial Distribution



In the second quarter of 2001, we began distribution of
our proprietary prepackaged food through QVC, the shopping television network. In the first six months of 2005, this channel represented 11% of our net revenues as compared to 15% of our net revenues in the first six months of 2004. On the QVC
network, we reach a large, incremental audience in a 50 minute infomercial format that enables us to convey fully the benefits of the NutriSystem diet foods. Under the terms of our agreement with QVC, 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. We generate a lower gross margin (as a percent of
revenues) 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 $3.3 million and $8.7 million for the three and six months ended months ended June 30, 2005 compared to $800,000 and $3.5 million for the three and six months ended June 30, 2004, respectively. QVC sales are a
function of the number of shows and the sales per minute on each show. Sales increased for the second quarter and first six months of 2005 versus 2004 because more shows aired and the sales per minute of air-time increased.



Three Months Ended June 30, 2005 Compared to Three Months Ended June 30,
2004



Revenues. Revenues increased to
$40.9 million in the second quarter of 2005 from $9.2 million for the second quarter of 2004. The revenue increase of $31.7 million, or 346.0%, resulted from increased sales to direct ($28.1 million), QVC ($2.5 million) and field sales ($540,000)
and the additional revenues from Slim and Tone ($600,000), which was acquired in December 2004. The direct channel represented 87% of total revenues in the second quarter of 2005 compared to 8% for QVC and 5% for other channels. In the second
quarter of 2004, the direct channel represented 84% of total revenues compared to 9% for QVC and 7% for other channels.



13



---

##### Table of Contents

Costs and Expenses. Cost of revenues increased $15.6 million to $20.8 million in the second
quarter of 2005 from $5.2 million in the second quarter of 2004. Gross margin as a percent of revenues was 49.1% in the second quarter of 2005 compared to 43.3% for the second quarter of 2004. The increase in margin was primarily attributable to a
5.3 percentage point improvement in our direct channel (discussed above), which represented 87% of revenues in the second quarter of 2005.



Advertising and marketing expenses increased $7.8 million to $8.8 million in the second quarter of 2005 from $1.0 million in the second quarter of 2004.
Virtually all advertising spending promoted the direct sales channel, and the increase in advertising is attributable to increased spending for advertising media ($7.6 million), particularly television and print advertising ($7.3 million).



General and administrative expenses increased $2.3 million to
$3.9 million in the second quarter of 2005 compared to $1.6 million in the second quarter of 2004. This increase is due primarily to higher costs associated with the increased scale of the business, especially compensation and benefits costs ($1.2
million), professional and computer services ($420,000), temporary personnel ($274,000) and telephone expense ($120,000).



Interest Income. Interest income, net of interest expense, increased $49,000 to $58,000 in the second quarter of 2005 compared to $9,000 in the
second quarter of 2004 primarily due to higher cash balances.



Income Taxes. In the second quarter of 2005, we recorded $2.9 million of income taxes due to the income for the current reporting period. In the second quarter of 2004, we recorded income tax expense of $505,000. Income taxes were
recorded in both periods at an estimated annual effective tax rate of 40%.



Net Income. In the second quarter of 2005, we recorded net income of $4.3 million, an increase of $3.5 million over $758,000 recorded in the second quarter of 2004. The increase in net income is primarily due
to higher gross profit from increased revenues offset by higher advertising and marketing spending and general and administrative expenses.



Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004



Revenues. Revenues increased to $78.4 million for the six months ended June 30, 2005 from $22.5 for the six months
ended June 30, 2004. The revenue increase of $55.9 million, or 248.9%, resulted from increased sales for direct ($48.8 million), QVC ($5.2 million) and field sales ($905,000) and the additional revenues from Slim and Tone ($1.1 million) acquired in
December 2004, offset by decreased sales to case distributors ($126,000). The direct channel represented 85% of total revenues in the first six months of 2005 compared to 11% for QVC and 4% for other channels. In the first six months of 2004, the
direct channel represented 78% of total revenues compared to 15% for QVC and 7% for other channels.



Costs and Expenses. Cost of revenues increased to $41.3 million in the six months ended June 30, 2005 from $12.8 million for the six months ended
June 30, 2004. Gross margin (revenues less cost of revenues as a percentage of revenues) increased to 47.3% in the six months ended June 30, 2005 from 43.2% for the six months ended June 30, 2004. The increase in margin was primarily attributable to
a 2.6 percentage point improvement in our direct channel (discussed above), which represented 85% of revenues in the first half of 2005.



Advertising and marketing expense increased to $16.9 million in the six months ending June 30, 2005 from $3.7 million in the first six months of 2004.
Virtually all advertising in these quarters promoted the direct channel with the increase in spending primarily related to higher media spending.



General and administrative expenses increased to $7.3 million for the six months ended June 30, 2005 from $3.4 million for the comparable period in 2004.
This increase of $3.9 million is due primarily to higher costs associated with the increased scale of the business, especially compensation and benefits ($1.9 million), temporary help ($730,000), professional and computer services ($569,000),
telephone expense ($242,000) and office and warehouse rent expense ($175,000).



Interest Income. Interest income (net of interest expense) increased $48,000 to $60,000 in the six months ended June 30, 2005 compared to $12,000 in the first half of 2004 primarily due to higher cash balances.



14



---

##### Table of Contents

Income Taxes. In the first six months of 2005, we recorded $5.0 million of income tax expense due
to taxable income for the current period compared to income tax expense of $1.0 million in the first six months of 2004. Income taxes were recorded in both periods at an estimated annual effective tax rate of 40%.



Net Income. We recorded net income of $7.5 million for the six months
ended June 30, 2005 compared to net income of $1.5 million for the six months ended June 30, 2004. The increase of $6.0 million is primarily due to higher gross profit from increased revenues offset by higher advertising and marketing spending and
general and administrative expenses.



Contractual Obligations and Commercial
Commitments



As of June 30, 2005, our principal
commitments consisted of obligations under a supply agreement with a food vendor, a capital lease, operating leases, employment contracts and a note payable related to the Slim and Tone acquisition. Although we have no material commitments for
capital expenditures, we anticipate continuing requirements for capital expenditures consistent with anticipated growth in operations, infrastructure and personnel approximately consistent with prior periods.



During the second quarter of 2005, we entered into a capital lease agreement
for our telephone systems. This is a five year lease that expires in the end of 2009 and contains a bargain purchase option. The present value of the lease payments is $183,000 based on an annual interest rate of 6%. The lease requires payments of
$4,000 per month.



Also during the six months ended June 30,
2005, we entered into an agreement with a food vendor. The agreement is for a term of three years expiring June 1, 2008. The agreement requires us to make minimum cumulative purchases of $9.0 million through 2005, $20.0 million through 2006 and
$33.0 million through 2007. We will incur penalties of 15% of the shortfall if we do not reach the required minimum purchases. The agreement also provides for annual pricing updates and rebates if certain volume thresholds are exceeded.



Other than the lease and the agreement with a food vendor, there were no
items that significantly impacted our commitments and contingencies as disclosed in the notes to the consolidated financial statements for the year ended December 31, 2004 as filed on Form 10-K. In addition, we have no off balance sheet
arrangements.



Liquidity, Capital Resources and Other Financial Data



At June 30, 2005, we had net working capital of
$44.2 million, including cash and cash equivalents of $37.7 million, compared to $5.1 million at December 31, 2004. Our principal source of liquidity during this period was our secondary public offering of common stock that generated net proceeds of
$25.4 million. We currently have no bank debt or term or revolving credit facilities to fund operations or investment opportunities. Cash and cash equivalents include cash and highly liquid investments purchased with an original maturity of three
months or less. Cash equivalents at June 30, 2005 consist of monies in money market accounts.



In the six months ended June 30, 2005, we generated cash flow of $7.4 million from operations, an increase of $4.7 million from the $2.7 million operating cash flow generated in the first half of 2004. The increase in
operating cash flow is attributable to the higher operating profit generated in the first half of 2005. Net changes in operating assets and liabilities reduced cash flow from operations by $5.7 million in the six months ended June 30, 2005, with
changes in components generally due to the larger scale of the business, especially inventory, which increased by $6.1 million.



In the six months ended June 30, 2005, net cash used in investing activities consisted of $568,000 in capital expenditures. The capital expenditures
relate primarily to information technology costs and warehouse equipment.



In the six months ended June 30, 2005, net cash provided by financing activities was $26.7 million, representing net proceeds of $25.4 million from an underwritten secondary public stock offering and of $1.3 million
from the exercise of common stock options.



Based on our
ability to generate earnings, the variable nature of a portion of our expenditures, and our cash balance at June 30, 2005, management believes that we have the ability to continue operations through 2006. However, there can be no assurance that we
will be able to sustain profitability or, if necessary, obtain additional funds to meet operating and investment needs in the future. Currently, there is no credit facility in place to fund working capital or investment needs.



15



---

##### Table of Contents

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



Seasonality



Typically, our revenues are highest in the first quarter and lowest in the
fourth quarter of our fiscal year. However, in 2005, our second quarter revenues exceeded our first quarter revenues due to our increased level of advertising and marketing spending ($8.8 million and $8.1 million, respectively) and the associated
revenue generated from new customers acquired in the second quarter in addition to the significant increase in new customers in the first quarter who continued to purchase in the second quarter.



Recently Issued Accounting Pronouncements



In December 2004, the FASB issued SFAS No. 123R, Share-Based
Payment. SFAS 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 and related interpretation, that we currently use. We are required to adopt Statement No. 123R beginning in 2006. We have 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 we record as compensation expense in 2006 and thereafter.



Item 3. Quantitative and Qualitative Disclosure About Market Risk



We do not hold any investments in market risk sensitive instruments. Accordingly, we believe that the Company 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. We do not have any variable interest debt outstanding at June 30, 2005 and our cash and
cash equivalents at that date of $37.7 million were maintained in bank accounts. As such, a change in interest rates of 1 percentage point would not have a material impact on our operating results and cash flows.



Item 4. 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 June 30, 2005. Based upon this evaluation,
they concluded that, as of the date of the evaluation, the Companys disclosure controls and procedures as of June 30, 2005 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 instances 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.



16



---

##### Table of Contents

PART II  OTHER INFORMATION



Item 1. Legal Proceedings



None



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds



None



Item 3. Defaults Upon Senior Securities



None



Item 4. Submission of Matters to a Vote of Security Holders



NutriSystem held its Annual Meeting of Stockholders on June 8, 2005.



(1) The stockholders elected each of the seven nominees to the Board of Directors for a one-year term:



|                        |  |            |  |        
|----------------------- |  | ---------- |  | -------
|DIRECTOR                |  | FOR        |  | ABSTAIN
|Michael J. Hagan        |  | 25,782,830 |  | 287,655
|George Jankovic         |  | 26,031,130 |  | 39,355 
|Ian J. Berg             |  | 25,785,297 |  | 285,188
|Warren V. (Pete) Musser |  | 25,263,512 |  | 806,973
|Brian P. Tierney        |  | 26,032,730 |  | 37,755 
|Michael A. DiPiano      |  | 25,837,497 |  | 232,988
|Steven Zarilli          |  | 25,589,330 |  | 481,155



Item 5. Other Information



None



Item 6. Exhibits



31.1
Certifying Statement of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002



31.2 Certifying Statement of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002



32.1 Certifying Statement of the Chief Executive Officer pursuant to Section
1350 of Title 18 of the United States Code



32.2 Certifying
Statement of the Chief Financial Officer pursuant to Section 1350 of Title 18 of the United States Code



17



---

##### Table of Contents

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.



|                  |  |                                                   |  |               
|----------------- |  | ------------------------------------------------- |  | --------------
|NutriSystem, Inc. |  |                                                  
|                  |  |                                                  
|BY:               |  | /S/ MICHAEL J. HAGAN                              |  | August 3, 2005
|                  |  | Michael J. Hagan                                  |  |               
|                  |  | Chairman of the Board and Chief Executive Officer |  |               
|                  |  | (principal executive officer)                     |  |               



|    |  |                                                                      |  |               
|--- |  | -------------------------------------------------------------------- |  | --------------
|BY: |  | /S/ JAMES D. BROWN                                                   |  | August 3, 2005
|    |  | James D. Brown                                                       |  |               
|    |  | Executive Vice President, Administration and Chief
Financial Officer |  |               
|    |  | (principal financial and accounting officer)                         |  |               



18



---

##### Table of Contents

Exhibit Index



|     |  |                                                                                                                   
|---- |  | ------------------------------------------------------------------------------------------------------------------
|No.  |  | Description                                                                                                       
|31.1 |  | Certifying Statement of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002     
|     | 
|31.2 |  | Certifying Statement of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002     
|     | 
|32.1 |  | Certifying Statement of the Chief Executive Officer pursuant to Section 1350 of Title 18 of the United States Code
|     | 
|32.2 |  | Certifying Statement of the Chief Financial Officer pursuant to Section 1350 of Title 18 of the United States Code



19