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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(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, 2004



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



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NutriSystem, Inc.

(Exact name of Registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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)



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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 August 9, 2004:



|                              |  |                  
|----------------------------- |  | -----------------
|Common Stock, $.001 par value |  | 29,295,087 shares



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##### Table of Contents

NutriSystem, Inc.



INDEX TO FORM 10-Q



|                               |  |                                                                                                |  |                                             |  |     
|------------------------------ |  | ---------------------------------------------------------------------------------------------- |  | ------------------------------------------- |  | ----
|                               |  |                                                                                                |  |                                             |  | Page
|PART I - FINANCIAL INFORMATION
|                               |  |                                                                                               
|                               |  | Item 1 - Financial Statements                                                                  |  |                                            
|                               |  |                                                                                                | 
|                               |  |                                                                                                |  | 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                             |  | 17                                         
|                               |  |                                                                                               
|                               |  | Item 4 
Controls and Procedures                                                               |  | 17                                         
|                               | 
|PART II - OTHER INFORMATION    |  |                                                                                               
|                               |  |                                                                                               
|                               |  | Item 1 
Legal Proceedings                                                                     |  | 18                                         
|                               |  |                                                                                               
|                               |  | Item 2 -
Changes in Securities and Use of Proceeds                                             |  | 18                                         
|                               |  |                                                                                               
|                               |  | Item 3 
Defaults Upon Senior Securities                                                       |  | 18                                         
|                               |  |                                                                                               
|                               |  | Item 4 
Submission of Matters to a Vote of Security Holders                                   |  | 18                                         
|                               |  |                                                                                               
|                               |  | Item 5 
Other Information                                                                     |  | 19                                         
|                               |  |                                                                                               
|                               |  | Item 6 -
Exhibits and Reports on Form 8-K.                                                     |  | 19                                         
|                               | 
|SIGNATURES                     |  | 20                                                                                            



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NUTRISYSTEM, INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



(Amounts in
thousands, except share data)



|                                                                                                                                                              |  |               |         |   |                   |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                              |  | June 30, 2004 |         |   | December 31, 2003 |  
|                                                                                                                                                              |  | (Unaudited)   |         |   | (Audited)         |  
|ASSETS                                                                                                                                                        |  |               |         |   |                   |   |         |  
|CURRENT ASSETS:                                                                                                                                               |  |               |         |   |                   |   |         |  
|Cash and cash equivalents                                                                                                                                     |  | $             | 5,547   |   |                   | $ | 2,684   |  
|Restricted cash                                                                                                                                               |  |               |        |   |                   |   | 250     |  
|Trade receivables                                                                                                                                             |  |               | 742     |   |                   |   | 448     |  
|Inventories                                                                                                                                                   |  |               | 2,361   |   |                   |   | 4,524   |  
|Deferred tax asset                                                                                                                                            |  |               | 1,716   |   |                   |   | 1,716   |  
|Other current assets                                                                                                                                          |  |               | 504     |   |                   |   | 437     |  
|                                                                                                                                                              |  |               |         |   |                   |   |         |  
|Total current assets                                                                                                                                          |  |               | 10,870  |   |                   |   | 10,059  |  
|                                                                                                                                                              |  |              
|FIXED ASSETS, net                                                                                                                                             |  |               | 800     |   |                   |   | 753     |  
|                                                                                                                                                              |  |              
|DEFERRED TAX ASSET                                                                                                                                            |  |               | 2,026   |   |                   |   | 2,753   |  
|                                                                                                                                                              |  |              
|OTHER ASSETS                                                                                                                                                  |  |               | 123     |   |                   |   | 123     |  
|                                                                                                                                                              |  |               |         |   |                   |   |         |  
|                                                                                                                                                              |  | $             | 13,819  |   |                   | $ | 13,688  |  
|                                                                                                                                                              |  |               |         |   |                   |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                          |  |               |         |   |                   |   |         |  
|CURRENT LIABILITIES:                                                                                                                                          |  |               |         |   |                   |   |         |  
|Accounts payable                                                                                                                                              |  | $             | 1,545   |   |                   | $ | 3,531   |  
|Accrued payroll and related benefits                                                                                                                          |  |               | 380     |   |                   |   | 189     |  
|Deferred revenue                                                                                                                                              |  |               |        |   |                   |   | 13      |  
|Other current liabilities                                                                                                                                     |  |               | 210     |   |                   |   | 662     |  
|                                                                                                                                                              |  |               |         |   |                   |   |         |  
|Total current liabilities                                                                                                                                     |  |               | 2,135   |   |                   |   | 4,395   |  
|NON-CURRENT LIABILITIES                                                                                                                                       |  |               |        |   |                   |   | 2       |  
|                                                                                                                                                              |  |               |         |   |                   |   |         |  
|Total liabilities                                                                                                                                             |  |               | 2,135   |   |                   |   | 4,397   |  
|                                                                                                                                                              |  |               |         |   |                   |   |         |  
|COMMITMENTS AND CONTINGENCIES (Note 4)                                                                                                                        |  |               |         |   |                   |   |         |  
|                                                                                                                                                              |  |              
|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 29,193,087 at June 30, 2004 and 28,511,021
at December 31, 2003) |  |               | 29      |   |                   |   | 28      |  
|Additional paid-in capital                                                                                                                                    |  |               | 32,301  |   |                   |   | 31,238  |  
|Warrants                                                                                                                                                      |  |               | 103     |   |                   |   | 277     |  
|Accumulated deficit                                                                                                                                           |  |               | (20,749 | ) |                   |   | (22,252 | )
|                                                                                                                                                              |  |               |         |   |                   |   |         |  
|Total stockholders equity                                                                                                                                    |  |               | 11,684  |   |                   |   | 9,291   |  
|                                                                                                                                                              |  |               |         |   |                   |   |         |  
|                                                                                                                                                              |  | $             | 13,819  |   |                   | $ | 13,688  |  
|                                                                                                                                                              |  |               |         |   |                   |   |         |  



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)



|                                     |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|------------------------------------ |  | ------------------------- | ------ | ---- | ------------------------ | ------ | ---- |  | ---- | ------ |  | - | ------ | -
|                                     |  | Three Months EndedJune 30 |        |      | Six Months Ended June 30 |       
|                                     |  | 2004                      |        | 2003 |                          |        | 2004 |  | 2003 |       
|REVENUES                             |  | $                         | 9,179  |      | $                        | 6,315  |      |  | $    | 22,462 |  | $ | 13,511 |  
|                                     |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|COSTS AND EXPENSES:                  |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|Cost of revenues                     |  |                           | 5,201  |      |                          | 4,000  |      |  |      | 12,760 |  |   | 8,526  |  
|Marketing                            |  |                           | 1,020  |      |                          | 647    |      |  |      | 3,691  |  |   | 1,151  |  
|General and administrative           |  |                           | 1,637  |      |                          | 1,419  |      |  |      | 3,387  |  |   | 2,781  |  
|Depreciation and amortization        |  |                           | 67     |      |                          | 53     |      |  |      | 131    |  |   | 130    |  
|                                     |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|Total costs and expenses             |  |                           | 7,925  |      |                          | 6,119  |      |  |      | 19,969 |  |   | 12,588 |  
|                                     |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|Operating income                     |  |                           | 1,254  |      |                          | 196    |      |  |      | 2,493  |  |   | 923    |  
|                                     |  |                           |        |     
|EQUITY IN LOSSES OF AFFILIATE        |  |                           |       |      |                          | (1     | )    |  |      |       |  |   | (91    | )
|                                     |  |                           |        |     
|INTEREST INCOME, net                 |  |                           | 9      |      |                          | 16     |      |  |      | 12     |  |   | 30     |  
|                                     |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|Income before income taxes           |  |                           | 1,263  |      |                          | 211    |      |  |      | 2,505  |  |   | 862    |  
|                                     |  |                           |        |     
|INCOME TAX PROVISION (BENEFIT)       |  |                           | 505    |      |                          | (1,887 | )    |  |      | 1,002  |  |   | (1,887 | )
|                                     |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|Net income                           |  | $                         | 758    |      | $                        | 2,098  |      |  | $    | 1,503  |  | $ | 2,749  |  
|                                     |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|BASIC INCOME PER SHARE               |  | $                         | 0.03   |      | $                        | 0.08   |      |  | $    | 0.05   |  | $ | 0.10   |  
|                                     |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|DILUTED INCOME PER SHARE             |  | $                         | 0.02   |      | $                        | 0.08   |      |  | $    | 0.05   |  | $ | 0.10   |  
|                                     |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|WEIGHTED AVERAGE SHARES OUTSTANDING: |  |                           |        |      |                          |        |      |  |      |        |  |   |        |  
|                                     |  |                           |        |     
|Basic                                |  |                           | 29,076 |      |                          | 26,174 |      |  |      | 28,859 |  |   | 26,197 |  
|                                     |  |                           |        |     
|Diluted                              |  |                           | 31,875 |      |                          | 26,632 |      |  |      | 31,985 |  |   | 26,737 |  



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)



|                                                                                  |  |                          |        |   |      |   |        |  
|--------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                  |  | Six Months Ended June 30 |       
|                                                                                  |  | 2004                     |        |   | 2003 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |                          |        |   |      |   |        |  
|Net income                                                                        |  | $                        | 1,503  |   |      | $ | 2,749  |  
|Adjustments to reconcile net income to net cash provided by operating activities- |  |                          |        |   |      |   |        |  
|Equity in losses of affiliate                                                     |  |                          |       |   |      |   | 91     |  
|Depreciation and amortization                                                     |  |                          | 131    |   |      |   | 130    |  
|Deferred tax expense                                                              |  |                          | 727    |   |      |   | (1,909 | )
|Loss on disposal of fixed assets                                                  |  |                          |       |   |      |   | 132    |  
|Stock-based costs                                                                 |  |                          | 253    |   |      |   | 42     |  
|Tax benefit from stock option exercises                                           |  |                          | 275    |   |      |   |       |  
|Changes in operating assets and liabilities-                                      |  |                          |        |   |      |   |        |  
|Restricted cash                                                                   |  |                          | 250    |   |      |   | 75     |  
|Trade receivables                                                                 |  |                          | (294   | ) |      |   | (119   | )
|Inventories                                                                       |  |                          | 2,163  |   |      |   | 1,517  |  
|Other assets                                                                      |  |                          | (67    | ) |      |   | 361    |  
|Accounts payable                                                                  |  |                          | (1,986 | ) |      |   | (552   | )
|Accrued payroll and related benefits                                              |  |                          | 191    |   |      |   | (31    | )
|Deferred revenue                                                                  |  |                          | (13    | ) |      |   | (283   | )
|Other liabilities                                                                 |  |                          | (452   | ) |      |   | (241   | )
|                                                                                  |  |                          |        |   |      |   |        |  
|Net cash provided by operating activities                                         |  |                          | 2,681  |   |      |   | 1,962  |  
|                                                                                  |  |                          |        |   |      |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |                          |        |   |      |   |        |  
|Capital additions, net of proceeds from dispositions                              |  |                          | (178   | ) |      |   | (17    | )
|Investment in affiliate                                                           |  |                          |       |   |      |   | (50    | )
|                                                                                  |  |                          |        |   |      |   |        |  
|Net cash used in investing activities                                             |  |                          | (178   | ) |      |   | (67    | )
|                                                                                  |  |                          |        |   |      |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                             |  |                          |        |   |      |   |        |  
|Exercise of stock options and warrants                                            |  |                          | 360    |   |      |   |       |  
|Treasury stock purchases, at cost                                                 |  |                          |       |   |      |   | (104   | )
|                                                                                  |  |                          |        |   |      |   |        |  
|Net cash provided by (used in) financing activities                               |  |                          | 360    |   |      |   | (104   | )
|                                                                                  |  |                          |        |   |      |   |        |  
|NET CHANGE IN CASH AND CASH EQUIVALENTS                                           |  |                          | 2,863  |   |      |   | 1,791  |  
|                                                                                  |  |                         
|CASH AND CASH EQUIVALENTS, beginning of period                                    |  |                          | 2,684  |   |      |   | 3,005  |  
|                                                                                  |  |                          |        |   |      |   |        |  
|CASH AND CASH EQUIVALENTS, end of period                                          |  | $                        | 5,547  |   |      | $ | 4,796  |  
|                                                                                  |  |                          |        |   |      |   |        |  



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



(In thousands, except share and per share amounts)



(Unaudited)



1. BACKGROUND



Nature of the Business



NutriSystem, Inc. (a Delaware corporation) together with its subsidiaries (the Company) provides weight loss programs and
distributes pre-packaged foods. In September 2000, the Company changed its name from nutrisystem.com inc. to Nutri/System, Inc. and in 2003 the Company changed its name to NutriSystem, Inc.



NutriSystem, Inc. and its predecessor businesses, including NutriSystem L.P. and NutriSystem
Direct, L.L.C. (collectively, the Predecessor Businesses), have historically operated through Company-owned and franchised weight loss centers. Currently, 23 independent center-based distributors operate without franchise agreements
(Case Distributors) and there are no Company-operated or franchised weight loss centers. In 1998, the Company initiated NutriSystem Direct, L.L.C., a marketing program using independent commissioned representatives. In late 1999, the
Company began selling directly to the consumer through the Internet and by telephone. In 2001, the Company began selling foods through QVC, a shopping television network. The Companys pre-packaged foods are now sold to weight loss program
participants directly through the Internet, telephone, QVC, independent commissioned representatives and Case Distributor weight loss centers.



Since the inception of the NutriSystem business in 1972, the Company and its predecessors have operated in various organizational and legal structures. In early 1993, the
business was party to a bankruptcy proceeding. This case was converted to a Chapter 11 proceeding effective June 4, 1993. One of the Companys predecessors operated as a debtor in possession through December 1993. In 1999, the Company acquired
the Predecessor Businesses for cash of $3,400 plus 17,500,000 shares of common stock. In order to fund the Companys purchase of the Predecessor Businesses and planned investments, the Company completed a private placement in 1999 that raised
net proceeds of approximately $7,574. The Company completed another private placement in 2000 that raised net proceeds of $2,462. In September 2003, the Company completed a private placement that raised $2,300 from the sale of 2,300,000 shares of
common stock.



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 accompanying consolidated financial statements as of June 30, 2004 and for the three and six months ended June 30, 2004 and 2003 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, 2004 are not necessarily indicative of the results to be expected for any other interim period or the year ending December 31, 2004.



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##### Table of Contents

Restricted Cash



Restricted cash represented minimum cash deposited in banks required under certain vendor arrangements. The restrictions were eliminated in January 2004.



Inventories



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



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 and equipment under capital leases are amortized on a straight-line basis over the lesser of the estimated useful life of the asset or the related lease terms. Expenditures for repairs and maintenance are
charged to expense as incurred, while major renewals and improvements are capitalized.



Investment Carried Under the Equity Method



The Company has
invested $248 for a 25% interest in Imagine Weight Loss Center, LLC (Imagine), formerly known as Turning Point Weight Loss Centers, LLC, a start up company formed to provide diet and fitness programs in center locations. In addition to
the cash investments, the Company has provided indemnifications to certain affiliates of Imagine amounting to $52 and $159 at June 30, 2004 and 2003, respectively. For the six months ended June 30, 2004, the Company made no further investments in
Imagine. For the six months ended June 30, 2003, the Company recorded a loss of $91 in the statement of operations under the caption Equity in losses of affiliate, representing the Companys portion of the losses incurred by
Imagine. The Companys share of the losses of Imagine have reduced the carrying value of the investment to zero and a liability of $52 at June 30, 2004 and December 31, 2003, is included in Other current liabilities for the
remaining outstanding indemnification. As of June 30, 2004, the Company had no commitment to make further investments in Imagine.



Valuation of Long-Lived Assets



In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets (SFAS 144), management continually evaluates
whether events or circumstances have occurred that indicate that the remaining useful lives of the Companys long-lived assets, primarily fixed assets, 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, 2004 and December 31, 2003, respectively, management believes
that no reductions to the remaining useful lives or write-downs of long-lived assets are required.



Revenue Recognition



Revenues are
recognized when the related products are shipped to the end-consumer or to Case Distributors. For the six months ended June 30, 2004, the Company shipped products sold through QVC directly to the end-consumer and recognized revenues when the Company
shipped these products. In 2003, QVC shipped the Companys products and revenues for products distributed by QVC were recognized when QVC shipped the products from their distribution center to the end-consumer. Product inventory held by QVC was
carried in the Companys inventories and payments received from QVC in advance of shipments to the end-consumer were recorded as deferred revenue in the consolidated balance sheet.



Revenues are primarily from pre-packaged food sales, which include amounts billed for shipping and handling, and are presented net of
returns and free food products provided to consumers. Revenues also include the sale of print materials to Case Distributors and independent representatives. Revenues from shipping and handling charges were $230 and $164 for the six months ended
June 30, 2004 and 2003, respectively.



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##### Table of Contents

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, to account for Internet site-linking arrangements. 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, 2004 and December 31, 2003, $24 and $90, respectively, of prepaid advertising was included in prepaid expenses. Media expense was $3,041 and $600
during the six months ended June 30, 2004 and 2003, 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 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.



At December 31, 2002, deferred tax assets were offset by a full valuation allowance. In the second quarter of 2003, management determined based on an analysis of the
cumulative level of pretax profits over the past three years and projected level of profits that recognition of deferred tax assets was more likely than not. As a result, the valuation allowance was eliminated, a deferred tax asset and liability
were recorded on the consolidated balance sheet and an income tax benefit was recorded in the statement of operations (see Note 5).



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.



Net Income Per Common Share



Basic net income per common share is computed by dividing net income by
the weighted average number of shares of common stock outstanding. For the three and six months ended June 30, 2004 and 2003, diluted net income per common share reflects the potential dilution from the exercise of outstanding options and warrants
into common stock. For the three and six months ended June 30, 2004 and 2003, common stock equivalents representing 320,334, 315,334, 2,313,183 and 2,135,933 shares of common stock, respectively, were excluded from weighted average shares for
diluted net income per share purposes since the effect would be anti-dilutive.



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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 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS 123, as amended in SFAS
148, Accounting for Stock-Based Compensation  An Amendment to FASB Statement No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting and has adopted only the disclosure requirements. 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 123, as amended by SFAS 148, the Companys net income and net income per share
would have been changed to the following pro forma amounts:



|                                                                                                                      |  |                           |      |   |                         |   |       |      |  |   |       |   |  |   |       |  
|--------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ---- | - | ----------------------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                                                                                      |  | Three Months EndedJune 30 |      |   | Six Months EndedJune 30 |  
|                                                                                                                      |  | 2004                      |      |   | 2003                    |   |       | 2004 |  |   | 2003  |  
|Net income:                                                                                                           |  |                           |      |   |                         |   |       |      |  |   |       |   |  |   |       |  
|As reported                                                                                                           |  | $                         | 758  |   |                         | $ | 2,098 |      |  | $ | 1,503 |   |  | $ | 2,749 |  
|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 |  |                           | (137 | ) |                         |   | (46   | )    |  |   | (212  | ) |  |   | (195  | )
|                                                                                                                      |  |                           |      |   |                         |   |       |      |  |   |       |   |  |   |       |  
|Pro forma                                                                                                             |  | $                         | 621  |   |                         | $ | 2,052 |      |  | $ | 1,291 |   |  | $ | 2,554 |  
|                                                                                                                      |  |                           |      |   |                         |   |       |      |  |   |       |   |  |   |       |  
|Basic net income per share:                                                                                           |  |                           |      |   |                         |   |       |      |  |   |       |   |  |   |       |  
|As reported                                                                                                           |  | $                         | 0.03 |   |                         | $ | 0.08  |      |  | $ | 0.05  |   |  | $ | 0.10  |  
|                                                                                                                      |  |                           |      |   |                         |   |       |      |  |   |       |   |  |   |       |  
|Pro forma                                                                                                             |  | $                         | 0.02 |   |                         | $ | 0.08  |      |  | $ | 0.04  |   |  | $ | 0.10  |  
|                                                                                                                      |  |                           |      |   |                         |   |       |      |  |   |       |   |  |   |       |  
|Diluted net income per share:                                                                                         |  |                           |      |   |                         |   |       |      |  |   |       |   |  |   |       |  
|As reported                                                                                                           |  | $                         | 0.02 |   |                         | $ | 0.08  |      |  | $ | 0.05  |   |  | $ | 0.10  |  
|                                                                                                                      |  |                           |      |   |                         |   |       |      |  |   |       |   |  |   |       |  
|Pro forma                                                                                                             |  | $                         | 0.02 |   |                         | $ | 0.08  |      |  | $ | 0.04  |   |  | $ | 0.10  |  
|                                                                                                                      |  |                           |      |   |                         |   |       |      |  |   |       |   |  |   |       |  



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 |  
|                         |  | 2004                       |   |  | 2003                     |   |  | 2004  |   |  | 2003  |  
|Dividend yield           |  | None                       |   |  | None                     |   |  | None  |   |  | None  |  
|Expected volatility      |  | 124.7                      | % |  | 104.2                    | % |  | 127.2 | % |  | 104.4 | %
|Risk-free interest rate  |  | 3.9                        | % |  | 2.2                      | % |  | 3.8   | % |  | 2.3   | %
|Expected life (in years) |  | 4.7                        |   |  | 5.3                      |   |  | 4.7   |   |  | 5.3   |  



The weighted-average fair value of the
options issued in the three and six months ended June 30, 2004 and 2003, were $2.06, $1.57, $0.46 and $0.47, respectively.



Cash Flow Information



For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Cash equivalents at
June 30, 2004 and December 31, 2003 consist of $0 and $250, respectively, in certificates of deposit.



The Company made no payments for income taxes and minimal interest payments for the six months ended June 30, 2004 and 2003, respectively.



Recently Issued Accounting Pronouncements



In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, (FIN 46R)
which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which was issued January 2003. The Company will be required to apply FIN 46R to variable interests in variable interest entities (VIEs) created after



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December 31, 2003. For variable interests in VIEs created before January 1, 2004, the Interpretation will be applied
beginning on January 1, 2005. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with
any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date
FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. The Company is evaluating the impact of applying FIN 46R to existing VIEs in which it has variable interests and has not yet completed this
analysis. At this time, it is anticipated that the adoption of FIN 46R will not have an impact on the Companys consolidated financial statements.



The FASB recently issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities and SFAS No. 150, Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and Equity. In addition, the Emerging Issues Task Force recently issued EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables. The adoption of these
accounting pronouncements did not have an impact on the Companys consolidated financial position or results of operations.



Use of Estimates



The preparation of financial statements in accordance with United States 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.



Certain Reclassifications



Certain prior year amounts have been reclassified to conform to the current year
presentation.



3. CAPITAL STOCK



Common Stock



The Company issued 286,686 and 51,667 shares of common stock in the first six months of 2004 and 2003, respectively, upon the exercise of
common stock options and received proceeds of $194. Also, in the first six months of 2004, the Company issued 83,500 shares of common stock as compensation to board members, certain consultants and spokespersons per their contract and issued 311,880
shares upon the exercise of common stock warrants and received proceeds of $166. Stock-based costs for stock options/stock issued to non-employees was $253 and $42 for the six months ended June 30, 2004 and 2003, respectively.



Treasury stock is accounted for using the cost method. In 2003, the Company purchased 220,100
shares of common stock for an aggregate cost of $123 (an average price of $0.56 per share). For the six months ended June 30, 2004, there were no treasury stock transactions. To date, all treasury stock has been retired. Management has been
authorized to repurchase up to 5,000,000 shares of common stock, and through June 30, 2004 a total of 2,760,291 shares have been repurchased.



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.



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4. CONTINGENCIES



In July 2002, six franchise operators filed a suit against the Company alleging that the Company had violated the terms of its franchise agreements and certain other
trade laws. In September 2003, the parties to the dispute reached a settlement under the auspices of the District Court overseeing the action. In December 2003, the settlement was finalized. As a result of the suit, the Company recorded a charge of
$302 in 2003 reflecting the incremental costs of the settlement and defense costs, net of insurance proceeds of $75. In the first six months of 2003, the Company had $98 of expense related to this suit. Under the terms of the settlement, the
plaintiffs have terminated their franchise agreements and now operate as Case Distributors.



5. INCOME TAXES



At December 31, 2002,
the Company had net operating loss carryforwards of approximately $5 million for federal and state tax purposes. As a result of a change of control transaction which occurred in December 2002, approximately $2 million of the net operating loss
carryforwards are subject to usage limitations pursuant to the rules of Internal Revenue Code section 382. Net operating losses will begin to expire in 2014. In addition, deferred income taxes were recorded for other differences in bases of assets
and liabilities for financial reporting and income tax purposes. Through March 2003, a valuation allowance had been maintained for the deferred tax asset based on managements assessment that the deferred tax asset would not be realized given
the historical taxable levels of income (loss), the uncertainty of future operating results, tax planning strategies, and the expiration date of net operating loss carryforwards. In the second quarter of 2003, management determined based on an
analysis of the cumulative level of pretax profits over the past three years, projected levels of profits, schedule of reversal of deferred taxes, and tax strategies that recognition of the benefits related to deferred tax assets was more likely
than not. As a result, the valuation allowance was eliminated, a deferred tax asset was recorded on the consolidated balance sheet and an income tax benefit was recorded. A portion of the deferred tax asset recognized arose prior to a 1999 merger
transaction; in order to reflect the recognition of the deferred tax asset on the previously recorded merger transaction, the Company eliminated $290 of goodwill and credited equity by $790.



Starting in 2001, the Company offset taxable income for federal tax purposes with net
operating loss carryforwards. 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. However, the state taxable income in 2001 and 2002 is
below the annual limitation. At June 30, 2004, the Company had net operating loss carryforwards of approximately $6 million.



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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. When used in this Report, the words anticipate, believe, estimate, expect and similar expressions, as they relate to NutriSystem, Inc. or its management, are intended to
identify such forward-looking statements. The Companys actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute
to such differences include those set forth in BusinessRisk Factors as disclosed in the Companys Form 10K filed March 29, 2004 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. Dollar amounts are stated in thousands except per share data and new customer data.



Background



NutriSystem, Inc. provides weight loss programs and distributes pre-packaged
foods. The NutriSystem diet program was originally developed by the Companys predecessor businesses that operated through company-owned and franchised weight loss centers. Currently, there are no Company-operated centers and the Company
terminated its last franchise agreements in 2003. There are 23 independent center-based distributors who operate without franchise agreements (Case Distributors). In 1998, the Company initiated Nutri/System Direct, L.L.C., a marketing
program using independent commissioned representatives. In late 1999, the Company began selling directly to the consumer through the Internet and by telephone. In 2001, the Company began selling foods through QVC, a television shopping network. The
Companys pre-packaged foods are now sold to weight loss program participants directly via the Internet and telephone (the Direct channel) and through independent commissioned representatives (Field Sales), Case
Distributors and QVC. In September 2000, the Company changed its name from nutrisystem.com inc. to Nutri/System, Inc. and in 2003 the Company changed its name to NutriSystem, Inc.



Since the NutriSystem businesses began in 1972, the businesses have operated in various organizational and legal structures
and were subject to a bankruptcy proceeding in 1993, which was discharged in 1994. In August 1999, Ansama, a non-operating public corporation, entered into an Asset Purchase Agreement to acquire the operating assets and certain liabilities of
Nutri/System L.P. for $3,000 and a Stock Exchange and Purchase Agreement to acquire the beneficial interests in NutriSystem Direct, L.L.C. for $400 and 17,500,000 shares of Ansama common stock. Ansama was subsequently merged into the Company and the
Company assumed the Asset Purchase Agreement and the Stock Exchange and Purchase Agreement. In order to fund its cash obligations of $3,400 under the Asset Purchase and Stock Exchange and Purchase Agreements and the planned marketing program and
technology investment, the Company completed a private placement of 7,637,400 shares of common stock in October 1999, which, net of related expenses, resulted in proceeds of $7,574. In March 2000, the Company completed a private placement of 500,000
shares of common stock, which resulted in net proceeds of $2,462. In September 2003, the Company completed a private placement that raised $2,300 from the sale of 2,300,000 shares of common stock. The Company issued a total of 115,000, 41,000 and
57,500 shares of common stock valued at an aggregate of $625, $61 and $117 to service providers in 2000, 2003 and 2004, respectively. In 2001, 2002, and 2003, the Company repurchased 2,760,291 shares of common stock for an aggregate cost of $1,541
(an average price of $0.56 per share).



In December 2002, HJM
Holdings LLC and NewSpring Ventures, L.P. collectively acquired 58.4% of the outstanding shares of common stock from existing stockholders effecting a change in control of the Company. The Company was not a party to the transaction.



Critical Accounting Policies and Estimates



The Companys consolidated financial statements are prepared in
accordance with United States generally accepted accounting principles. 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.



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The Companys significant accounting policies are described in Note 2 to the consolidated financial
statements included in Item 8 of its Form 10-K for the year ended December 31, 2003. Management considers the following policies to be the most critical in understanding the more complex judgments that are involved in preparing the consolidated
financial statements and the uncertainties that could impact results of operations, financial position and cash flows. These critical accounting policies and estimates have been discussed with the Companys audit committee.



Reserves for Returns. Management reviews the reserves for customer
returns at each reporting period and adjusts them to reflect data available at that time. To estimate a return for reserves, management considers return rates in preceding periods and changes in product offerings or marketing methods that might
impact returns going forward. To the extent the estimate of returns is inaccurate, management will adjust the reserve, which will impact the amount of product sales revenue recognized in the period of the adjustment. Returns for the six months ended
June 30, 2004 and 2003 were $2,073 and $711, respectively.



Impairment of Fixed Assets. Management continually assesses the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Judgments regarding
the existence of impairment indicators are based on legal factors, market conditions and operating performance of the Company. Future events could cause management to conclude that impairment indicators exist and the carrying values of fixed assets
may be impaired. Any resulting impairment loss would be limited to the carrying value of net fixed assets, which was $800 at June 30, 2004.



Income Taxes. NutriSystem experienced losses in 1999 and 2000. As a result, the Company has federal and state tax net operating loss (NOL)
carryforwards of approximately $6 million as of June 30, 2004. As a result of a change of control transaction which occurred in December 2002, approximately $2 million of the NOLs are subject to usage limitations pursuant to the rules of
Internal Revenue Code section 382. Through March 2003, a valuation allowance had been maintained for the deferred tax asset based on managements assessment that the deferred tax asset would not be realized given the historical taxable levels
of income (loss), the uncertainty of future operating results, tax planning strategies, and the expiration date of net operating loss carryforwards. In the second quarter of 2003, management determined that recognition of the benefits related to
deferred tax assets was more likely than not based on an analysis of the cumulative level of pretax profits over the past three years, projected levels of profits, schedule of reversal of deferred taxes, and tax strategies. As a result, the
valuation allowance was eliminated, a deferred tax asset was recorded on the consolidated balance sheet and an income tax benefit was recorded in the statement of operations.



Currently, the Company is recording income taxes at a rate equal to the combined federal and state effective rates.
Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause the Companys provision for income taxes to vary significantly from period to period. For the six months ended June 30, 2004, the Company recorded
income tax expense of $1,002, which reflects an estimated annual effective tax rate of 40% in 2004.



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.



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.



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##### Table of Contents

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, to account
for Internet site-linking arrangements. Internet advertising expense is recognized based on either the rate of delivery of a guaranteed number of impressions over the advertising contract term or on a cost per customer acquired, depending upon the
payment terms. Direct-response advertising costs are capitalized if the primary purpose was to elicit sales to customers who could be shown to have responded specifically to the advertising and results in probable future economic benefits. The
capitalized costs are amortized to expense over the period during which the future benefits are expected to be received. All other advertising costs are charged to expense as incurred.



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



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



Overview of the Direct Channel



The Company began selling directly to consumers when it launched its web site on October 15, 1999. In the first six months of 2004 versus 2003, the Direct
channel represented 78% and 61%, respectively, of the Companys net revenues. For the Direct channel of distribution, the Companys primary financial objectives are to generate growth while maintaining profit margins. The Company measures
growth in terms of the number of new customers, revenues per customer and total revenues. A new customer is defined as a first time purchaser through the Direct channel. Profit margins are measured in terms of gross margin (revenues less cost of
revenues) and total marketing expense as a percentage of revenues.



As discussed above, certain costs have been reclassified from general and administrative and marketing expenses to cost of revenue. The reclassification reduces reported gross margin and reduces general and administrative and marketing
expenses, but does not change operating income.



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



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SELECTED FINANCIAL AND OPERATING STATISTICS FOR DIRECT SALES



(in thousands, except new customer data)



|                                  |  |                            |       |   |                          |   |       |      |  |   |        |   |  |   |        |  
|--------------------------------- |  | -------------------------- | ----- | - | ------------------------ | - | ----- | ---- |  | - | ------ | - |  | - | ------ | -
|                                  |  | Three Months Ended June 30 |       |   | Six Months Ended June 30 |  
|                                  |  | 2004                       |       |   | 2003                     |   |       | 2004 |  |   | 2003   |  
|Revenues                          |  | $                          | 7,675 |   |                          | $ | 4,204 |      |  | $ | 17,453 |   |  | $ | 8,264  |  
|Cost of revenues                  |  |                            | 4,033 |   |                          |   | 2,307 |      |  |   | 8,872  |   |  |   | 4,314  |  
|                                  |  |                            |       |   |                          |   |       |      |  |   |        |   |  |   |        |  
|Gross margin                      |  | $                          | 3,642 |   |                          | $ | 1,897 |      |  | $ | 8,581  |   |  | $ | 3,950  |  
|% of revenue                      |  |                            | 47.4  | % |                          |   | 45.1  | %    |  |   | 49.2   | % |  |   | 47.8   | %
|Marketing                         |  | $                          | 1,020 |   |                          | $ | 647   |      |  | $ | 3,691  |   |  | $ | 1,151  |  
|% of revenue                      |  |                            | 13.3  | % |                          |   | 15.4  | %    |  |   | 21.1   | % |  |   | 13.9   | %
|New customers                     |  |                            | 9,471 |   |                          |   | 5,951 |      |  |   | 28,735 |   |  |   | 12,451 |  
|Marketing/new customer            |  | $                          | 108   |   |                          | $ | 109   |      |  | $ | 128    |   |  | $ | 92     |  
|New customer revenue/new customer |  | $                          | 362   |   |                          | $ | 261   |      |  | $ | 448    |   |  | $ | 353    |  



Direct revenues
increased 82.6% from the second quarter of 2003 to the second quarter of 2004. Direct revenues are largely a function of the number of new customers acquired, the revenues generated from each new customer and the revenues generated from prior
customers (customers that initially purchased food in a prior period). In the second quarter of 2004 relative to the same quarter of 2003, performance improved in each area: new customers acquired, new customer revenue and prior customer revenue.
The number of new customers acquired increased by 3,520 or 59.1% year over year. The revenues per new customer in the second quarter was $261 in 2003 and rose to $362 in 2004, an increase of 38.6%. The remaining revenue in the quarter, derived from
customers that originally purchased in a prior quarter, rose over 60%, from $2.7 million in 2003 to $4.2 million in 2004, largely because of the large number of new customers obtained in the first quarter of 2004. A number of factors drove the
improved revenue performance: excellent consumer response to the new NutriSystem Nourish program, greater advertising spending, 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 the Company they wish to end shipments.



Gross margin as a percent of revenues increased in the second quarter from 45.1% in 2003 to 47.4% in 2004, largely due to higher prices charged for the
new food program and lower promotional food costs. Marketing costs increased by $373 from 2003 to 2004. Marketing cost per new customer acquired remained virtually the same ($108 in 2004 and $109 in 2003); however, advertising media made up a larger
portion of marketing costs in 2004 than in 2003.



Direct
results for the first half of 2004 also showed an increase in revenue over the same period in 2003. Revenues increased 111.2% from the first half of 2003 to the first half of 2004. The spending on advertising and marketing increased by $2,540 from
$1,151 in the first half of 2003 to $3,691 in the first half of 2004. Marketing per new customer increased from $92 to $128 from the first half of 2003 to 2004 primarily because a higher proportion of 2004 marketing spending went to higher cost TV
advertising. Gross margin as a percentage of revenues increased from 47.8% in the first half of 2003 to 49.2% in the first half of 2004.



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Overview of Television Infomercial Distribution



In the second quarter of 2001, the Company began distribution of its
proprietary prepackaged food through QVC, the shopping television network. In the first six months of 2004, this channel represented 15.4% of the Companys net revenues as compared to 24.4% of the Companys net revenues in the first six
months of 2003. On the QVC network, the Company reaches a large, incremental audience in a 50 minute, infomercial format that enables the Company to convey fully the benefits of the NutriSystem diet foods. Under the terms of the Companys
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. The Company generates 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 $800 and $3,457 for the three and six months ended months ended June 30, 2004 compared to $1,175 and $3,298 for the three and six months ended
June 30, 2003, respectively. QVC sales are a function of the number of shows and the sales per minute on each show. Sales decreased for the second quarter of 2004 versus 2003 because less shows aired and the sales per minute of air-time decreased.
However, the first six months of 2004 compared to 2003 still showed an increase because in the first quarter of 2004, the Company aired more shows on QVC and average sales per minute of air-time was above the previous year in the first quarter.



Three Months Ended June 30, 2004 Compared to Three Months
Ended June 30, 2003



Revenues. Revenues increased
from $6,315 for the second quarter ended June 30, 2003 to $9,179 for the second quarter ended June 30, 2004. The revenue increase of $2,864, or 45.4%, resulted from increased sales to Direct ($3,471) offset by a decrease in net sales by QVC ($375),
Case Distributors ($223) and the Field Sales channel ($10). In the second quarter of 2004, Direct sales accounted for 84% of total revenues, while QVC, Field Sales and Case Distributor revenues accounted for 9%, 5% and 2% of total revenues,
respectively. In the second quarter of 2003, these percentages were 67%, 18%, 8% and 7% of total revenues, respectively.



Costs and Expenses. Cost of revenues increased $1,201 from $4,000 to $5,201 for the quarters ended June 30, 2003 and 2004, respectively. Gross
margin as a percent of revenues was 36.7% and 43.3% for the quarters ended June 30, 2003 and 2004, respectively. The increase in margin was primarily attributable to the swing in the mix from QVC, which generates a lower gross margin, to Direct
which generates a higher gross margin and to the higher price charged for the new NutriSystem Nourish program.Advertising and marketing expenses increased $373 from $647 to $1,020 from the second quarter of 2003 to the second quarter 2004.
All advertising spending promoted the Direct sales, and the increase in advertising is attributable to increased spending for advertising media ($404), particularly television and Internet advertising. General and administrative expenses ($1,419 and
$1,637 in the second quarter of 2003 and 2004, respectively) increased $218 primarily attributable to higher compensation costs.



Interest Income. Interest income, net of interest expense, decreased $7 from $16 in the second quarter of 2003 to $9 in the second quarter of 2004
primarily due to lower interest rates.



Income taxes. In
the second quarter of 2004, the Company recorded $505 of income taxes due to the income for the current reporting period. In the second quarter of 2003, management determined that recognition of the benefits related to deferred tax assets was more
likely than not based on an analysis of the cumulative level of pretax profits over the past three years, projected levels of profits, schedule of reversal of deferred taxes, and tax strategies. As a result, the valuation allowance was eliminated, a
deferred tax asset was recorded on the consolidated balance sheet and an income tax benefit of $1,887 was recorded in the statement of operations.



Net Income. In the second quarter of 2004, net income decreased by $1,340 from net income of $2,098 for the second quarter of 2003 to net income of
$758 for the second quarter of 2004. The decrease is primarily due to an income tax benefit of $1,887 in 2003 versus a tax provision of $505 in 2004, which offset a $1,058 increase in operating profit.



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Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003



Revenues. Revenues increased from $13,511 for the six months ended
June 30, 2003 to $22,462 for the six months ended June 30, 2004. The revenue increase of $8,951, or 66.3%, resulted from increased sales for Direct ($9,189), QVC ($159) and Field Sales ($40) offset by decreased sales to Case Distributors ($437).



Costs and Expenses. Cost of revenues increased from
$8,526 to $12,760 for the six months ended June 30, 2003 and 2004, respectively. Gross margin (revenues less cost of revenues as a percentage of revenues) increased from 36.9% for the six months ended June 30, 2003 to 43.2% for the six months ended
June 30, 2004 primarily due to a mix shift toward the higher margin Direct channel and to stronger pricing for the new NutriSystem Nourish program. Marketing expense increased from $1,151 to $3,691 from the first six months of 2003 to the first six
months of 2004. Virtually all advertising in these quarters promoted the Direct program and the increase in spending is primarily related to higher media spending. General and administrative expenses increased from $2,781 to $3,387 from the first
half of 2003 to 2004. This increase of $606 is due primarily to higher costs associated with the increase in revenues, especially compensation, offset by a charge recorded upon the closing of the fulfillment center in Reno in 2003. For the six
months ended June 30, 2003, the Company recorded a loss of $91 under the caption Equity in losses of affiliate, representing the Companys remaining net investment in an affiliate.There was no additional investment made in
the first six months of 2004.



Interest Income. Interest
income (net of interest expense) decreased $18 from $30 in the first half of 2003 to $12 in the first half of 2004 primarily due to lower interest rates.



Income taxes. In the first half of 2004, the Company recorded $1,002 of income tax expense due to taxable income for the current period. In the
first half of 2003, the Company recorded a $1,887 income tax benefit related to the recognition of deferred tax assets (see Note 5 of the Financial Statements).



Net Income. The Company generated net income of $2,749 for the six months ended June 30, 2003 as compared to net income of $1,503 for the six
months ended June 30, 2004. The decrease of $1,246 in net income is primarily due to a $1,887 income tax benefit recorded in the second quarter of 2003 versus $1,002 of tax expense in 2004 offset by higher gross profit resulting from increased
revenues.



Contractual Obligations and Commercial
Commitments



As of June 30, 2004, the Companys
principal commitments consisted of obligations under operating leases and severance payments to a former executive of the Company. Although the Company has no material commitments for capital expenditures, it anticipates continuing requirements for
capital expenditures consistent with anticipated growth in operations, infrastructure and personnel approximately consistent with prior periods.



During the six months ended June 30, 2004, there were no items that significantly impacted the Companys commitments and contingencies as disclosed
in the notes to the consolidated financial statements for the year ended December 31, 2003 as filed on Form 10-K. In addition, the Company has no significant off balance sheet arrangements.



Liquidity, Capital Resources and Other Financial Data



At June 30, 2004, the Company had net working capital of $8,735. Cash
and cash equivalents were $5,547, an increase of $2,863 from the balance at December 31, 2003. The Companys principal source of liquidity during this period is cash flow from operations. The Company currently has no bank debt or term or
revolving credit facilities to fund operations or investment opportunities.



In the six months ended June 30, 2004, the Company generated cash flow of $2,681 from operations, primarily attributable to operating income, an increase of $719 from the $1,962 operating cash flow generated in the
first half of 2003. The increase in operating cash flow is attributable to the higher operating profit generated in the first half of 2004. Net changes in operating assets and liabilities reduced cash flow from operations by $208 in the six months
ended June 30, 2004, with changes in components generally due to the seasonality of the business.



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In the six months ended June 30, 2004, net cash used in investing activities consisted of $178 in capital
expenditures. The capital expenditures relate primarily to an office move and information technology costs.



In the six months ended June 30, 2004, net cash provided by financing activities was $360, representing proceeds from the exercise of common stock options
and warrants.



In pursuing its business strategy, it is
possible that the Company may require additional cash for operating and investing activities. The Company expects future cash requirements, if any, to be funded from operating cash flow and financing activities, which may include additional private
offerings of equity securities or debt financing. Based on the Companys ability to generate earnings recently, the variable nature of a portion of the Companys expenditures, the cash balance at June 30, 2004 and managements belief
that additional equity financing, if required, can be raised, management believes that the Company has the ability to continue operations through 2005. However, there can be no assurance that the Company will be able to sustain profitability or, if
necessary, obtain the capital to fund operating and investment needs in the future. Currently, there is no credit facility in place to fund working capital or investment needs.



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



Factors Affecting Business and
Prospects



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



Inflation



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



Recently Issued Accounting Pronouncements



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



The FASB recently issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities and SFAS No. 150,
Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. In addition, the Emerging Issues Task Force recently issued EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables.
The adoption of these accounting pronouncements did not have an impact on the Companys consolidated financial position or results of operations.



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Item 3. Quantitative and Qualitative Disclosure About Market Risk



The Company does not hold any investments in market risk sensitive instruments. Accordingly, management believes that it is not subject to any material
risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk instruments. The Company does not have any funded debt outstanding at June 30, 2004 and
its cash and cash equivalents of $5,547 are maintained in bank accounts. As such, a change in interest rates of 1 percentage point would not have a material impact on the Companys operating results and cash flows.



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



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##### Table of Contents

PART II  OTHER INFORMATION



Item 1. Legal Proceedings



In
July 2002, six franchise operators filed a suit against the Company alleging that the Company had violated the terms of its franchise agreements and certain other trade laws. In September 2003, the parties to the dispute reached a settlement under
the auspices of the District Court overseeing the action. In December 2003, the settlement was finalized.



Item 2. Changes in Securities and Use of Proceeds



22,500 shares of common stock were issued to CEOcast, Inc. on May 28, 2004 for services to be rendered.



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 May 6, 2004.



| | (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        |  | 24,885,614 |  | 52,059 
|George Jankovic         |  | 24,932,114 |  | 5,559  
|Ian J. Berg             |  | 24,932,114 |  | 5,559  
|Warren V. (Pete) Musser |  | 24,930,114 |  | 7,559  
|Brian P. Tierney        |  | 24,932,114 |  | 5,559  
|Michael A. DiPiano      |  | 24,885,614 |  | 52,059 
|Steven Zarilli          |  | 24,932,114 |  | 5,559  

|
|

| | (2) | The stockholders elected to increase the number of shares of common stock authorized for issuance under the Companys 2000 Equity Incentive Plan for Directors and Outside
Consultants.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|        |  |           
|------- |  | ----------
|FOR     |  | 18,270,746
|AGAINST |  | 618,717   
|ABSTAIN |  | 1,003     
|        |  |           
|TOTAL   |  | 18,890,466



| | (3) | The stockholders elected to increase the number of shares of common stock authorized for issuance under the Companys 2000 Equity Incentive Plan for Employees and the amendment
and restatement of the Employee Plan.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|        |  |           
|------- |  | ----------
|FOR     |  | 18,326,491
|AGAINST |  | 563,967   
|ABSTAIN |  | 8         
|        |  |           
|TOTAL   |  | 18,890,466



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##### Table of Contents

Item 5. Other Information



None



Item 6. Exhibits and Reports on Form 8-K



|a. | 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



|b. | Reports on Form 8-K:
|-- | --------------------



Report dated April 28, 2004 on press release setting forth NutriSystems earnings for the first quarter of 2004.



Report dated April 28, 2004 on press release issued by HJM Holdings, LLC
(HJM) terminating the lock up and voting arrangements between HJM and NewSpring Ventures, L.P. related to their NutriSystem, Inc. shares.



Report dated July 28, 2004 on press release setting forth NutriSystems earnings for the second quarter of 2004.



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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.



|                  |  |                                                          |  |               
|----------------- |  | -------------------------------------------------------- |  | --------------
|NutriSystem, Inc. |  |                                                         
|BY:               |  | /S/ MICHAEL J. HAGAN                                     |  | August 9, 2004
|                  |  | Michael J. Hagan                                         |  |               
|                  |  | Chairman of the Board and Chief Executive Officer        |  |               
|BY:               |  | /S/ JAMES D. BROWN                                       |  | August 9, 2004
|                  |  | James D. Brown                                           |  |               
|                  |  | Chief Financial Officer and Principal Accounting Officer |  |               



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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



21