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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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(Mark One)

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



For the fiscal year ended December 31, 2003



| ̈ | 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.)



|                                         |  |           
|---------------------------------------- |  | ----------
|202 Welsh Road, Horsham, Pennsylvania    |  | 19044     
|(Address of principal executive offices) |  | (Zip Code)



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



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



None



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



Common Stock, $.001 par value



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



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



The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2003, was $10,817,679. Such aggregate market value
was computed by reference to the closing price of the common stock as reported on the NASDAQ OTC Bulletin Board on June 30, 2003.



Number of shares outstanding of the Registrants Common Stock, $.001 par value, as of March 23, 2004: 28,876,937 shares



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the definitive Proxy Statement to be filed with the Securities
and Exchange Commission for NutriSystem, Inc.s Annual Meeting of Stockholders to be held on May 6, 2004, are incorporated by reference into Part III of this Form 10-K.



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NutriSystem, Inc.



Table of Contents



|         |  |                                                                                                  |  |     
|-------- |  | ------------------------------------------------------------------------------------------------ |  | ----
|         |  |                                                                                                  |  | Page
|PART I  
|         |  |                                                                                                 
|Item 1.  |  | Business                                                                                         |  | 3   
|         |  |                                                                                                 
|Item 2.  |  | Properties                                                                                       |  | 10  
|         |  |                                                                                                 
|Item 3.  |  | Legal Proceedings                                                                                |  | 10  
|         |  |                                                                                                 
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                              |  | 10  
|        
|PART II 
|         |  |                                                                                                 
|Item 5.  |  | Market for the Registrants Common Stock and Related Stockholder Matters                         |  | 10  
|         |  |                                                                                                 
|Item 6.  |  | Selected Consolidated Financial Data                                                             |  | 11  
|         |  |                                                                                                 
|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations            |  | 14  
|         |  |                                                                                                 
|Item 7A. |  | Quantitative and Qualitative Disclosure about Market Risk                                        |  | 22  
|         |  |                                                                                                 
|Item 8.  |  | Financial Statements and Supplementary Data                                                      |  | 22  
|         |  |                                                                                                 
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure             |  | 22  
|         |  |                                                                                                 
|Item 9A. |  | Controls and Procedures                                                                          |  | 22  
|        
|PART III
|         |  |                                                                                                 
|Item 10. |  | Directors and Executive Officers of the Registrant                                               |  | 23  
|         |  |                                                                                                 
|Item 11. |  | Executive Compensation                                                                           |  | 23  
|         |  |                                                                                                 
|Item 12. |  | Securities Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |  | 23  
|         |  |                                                                                                 
|Item 13. |  | Certain Relationships and Related Transactions                                                   |  | 23  
|         |  |                                                                                                 
|Item 14. |  | Principal Accountant Fees and Services                                                           |  | 23  
|        
|PART IV 
|         |  |                                                                                                 
|Item 15. |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                                  |  | 24  



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PART I



ITEM 1. BUSINESS



Background



NutriSystem, Inc., (a Delaware corporation), together with its subsidiaries
(NutriSystem or the Company), provides weight loss programs and distributes pre-packaged foods. The NutriSystem diet program was originally developed by the Companys predecessor businesses, including Nutri/System L.P.
and Nutri/System Direct, L.L.C. (collectively, the 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 24 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 (the Field Sales channel), Case Distributor
weight loss centers (the Case Distributor channel) 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 million and a Stock Exchange and Purchase Agreement to acquire the beneficial interests in NutriSystem Direct, L.L.C. for $400,000 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. NutriSystem became a publicly traded company in October of 1999.



On August 25, 2000, the Company acquired certain assets of the Sweet Success
line of diet meal replacement products. In December 2000, the Company determined that it would be unable to obtain the funding required to rebuild the Sweet Success brand, and it discontinued sales of the products in the second quarter of 2001. In
December 2002, the Company sold the intellectual property associated with Sweet Success. Sweet Success is reflected in the Consolidated Financial Statements as a discontinued operation.



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



Industry



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



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



Products and Services



For 30 years, the NutriSystem name has been recognized as a leader in the weight loss industry. By telephone and through its
web site, www.nutrisystem.com, NutriSystem provides a comprehensive weight management program, consisting of support for dieters and a pre-packaged food program. Online support for dieters includes individualized diet and exercise plans, online
counseling, support groups, bulletin boards, online classes and chat rooms. Trained



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counselors are available 100 hours a week to answer questions and custom-design and recommend an exercise program to help
each member achieve his or her weight loss and fitness goals. Members share information and encouragement with each other through hosted chat rooms and bulletin boards. These services are complemented with relevant information on diet, nutrition,
exercise and well-being provided on the web site. NutriSystem provides free membership and access to telephone and online support.



In December 2003, the Company introduced NutriSystem Nourish, a new line of pre-packaged, portion-controlled food sold under the NutriSystem brand. The
NutriSystem Nourish program consists of a menu of over 100 food selections with a low glycemic index that provide dieters with a balanced intake of good carbohydrates. NutriSystem Nourish also features new, easy-to-use exercise and
behavior modification programs.



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



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



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



Marketing



The
Companys primary marketing objective is to leverage NutriSystems established brand cost effectively to build participation in the Companys web site and sales of its food program. The Company uses a combination of online and
traditional offline advertising and promotional strategies.



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



Online advertising. The Companys online advertising strategy includes the use of banner, keyword and
sponsorship placements, email newsletters and targeted direct email programs, primarily to its own email database of current and prior members. Since the start of its online advertising activities, the Company has moved aggressively to eliminate
sites that have not proven cost effective, and currently places the bulk of its online banner advertising with affiliate programs that are compensated on a cost per customer acquired (CPA) basis.



Promotion. Starting in the fourth quarter of 2003, the Company
expanded its efforts to generate visibility in various press, television and radio outlets and improve public awareness of the brand. In particular, the Company had promotional success through Zora Andrich, a spokesperson who was the winner of the
Joe Millionaire reality TV show.



Fulfillment



The Company currently leases approximately 54,600 square feet of office and
warehouse space in Horsham, Pennsylvania pursuant to a lease expiring in 2009 at an annual rent of $451,956. Under the lease, the Company will rent an additional 33,200 feet of adjoining warehouse space beginning in June of 2004 at an additional
annual rent of $139,839. In December 2003, the Company obtained additional fulfillment capacity in central Pennsylvania and Sparks, Nevada through an outsourced provider.To date, management has been satisfied with the outsourced fulfillment
operations and it believes the Horsham facility and the outsourced fulfillment capacity are adequate for the Companys needs for the foreseeable future. In March 2003, the Company closed its own 37,000 square foot order fulfillment center in
Reno, Nevada after determining it was not operating cost effectively.



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



Except in days of unusually high demand,
management believes that virtually all Direct customer orders received by 5:00 p.m. weekdays are shipped on the day received. Direct customers are not charged for their orders until the ordered product is shipped. The Company estimates that it can
ship to 75% of the domestic population from the Horsham fulfillment center within four business days using standard ground transportation and over 90% of the domestic population within five business days. With the recent addition of outsourced
fulfillment in Nevada, the Company has reduced the time required to deliver most orders to the West Coast. The Company ships to its members using either Federal Express or United Parcel Service. It does not currently charge customers for shipping
and handling on autoship food orders.



Technology



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



Competition



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



The principal competitive factors in the weight loss market are:



| |  | the ability to attract and retain customers through promotion and personal referral;
| | - | ------------------------------------------------------------------------------------



| |  | the availability, convenience and effectiveness of the weight reduction program;
| | - | --------------------------------------------------------------------------------



| |  | brand recognition and trustworthiness; and
| | - | ------------------------------------------



| |  | program pricing.
| | - | ----------------



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



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



Seasonality



Typically,
revenues of weight loss business, including the Company and the Predecessor Businesses, are lowest in the fourth calendar quarter and during the summer months.



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Employees



As of March 22, 2004, the Company had 107 full-time employees. None of the Companys employees are represented by a labor union and the
Company considers its relations with its employees to be good.



Available
Information



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



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



Executive Officers of the Company



The Companys executive officers and their respective ages and
positions as of December 31, 2003 are as follows:



|                          |  |     |  |                                                
|------------------------- |  | --- |  | -----------------------------------------------
|Name                      |  | Age |  | Position                                       
|Michael J. Hagan          |  | 41  |  | Chairman, Chief Executive Officer and Director 
|Djordje (George) Jankovic |  | 36  |  | President, Chief Operating Officer and Director
|James D. Brown            |  | 45  |  | Chief Financial Officer, Secretary & Treasurer 
|Brendon Perero            |  | 27  |  | Chief Information Officer                      



Michael J.
Hagan was appointed Chairman of the Board of Directors and Chief Executive Officer of the Company on December 20, 2002. Prior to joining the Company, Mr. Hagan was the co-founder of Verticalnet, Inc., a business-to-business internet and software
company, and held a number of executive positions at Verticalnet since its founding in 1995, including Chairman of the Board from February 2002 to the present, president and Chief Executive Officer from January 2001 to February 2002, Executive Vice
President and Chief Operating Officer from January 2000 to January 2001 and Senior Vice President prior to that time. Prior to founding Verticalnet, Mr. Hagan was a Vice President and Senior Manager at Merrill Lynch Asset Management from 1990 to
1995, and worked for Bristol Meyers Squibb from 1988 to 1990. Mr. Hagan is a director of Verticalnet, Inc. and American Financial Realty Trust. Mr. Hagan is also a trustee of Saint Josephs University.



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



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



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



RISK FACTORS



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



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



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



| |  | the security of online or telephonic transactions;
| | - | --------------------------------------------------



| |  | the loss of privacy with respect to personal weight and health information;
| | - | ---------------------------------------------------------------------------



| |  | delays in responses to inquiries;
| | - | ---------------------------------



| |  | delivery time associated with telephone or online orders, compared to the immediate receipt of products at a store or weight loss center;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------



| |  | shipping charges, which do not apply to shopping at stores or traditional weight loss centers;
| | - | ----------------------------------------------------------------------------------------------



| |  | concern about the ability to return or exchange orders;
| | - | -------------------------------------------------------



| |  | the absence of face-to-face contact with counselors and other dieters; and
| | - | --------------------------------------------------------------------------



| |  | the loss of the discipline, accountability and support associated with group sessions.
| | - | --------------------------------------------------------------------------------------



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



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



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



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



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



The Companys weight loss program does not include medical
treatment or medical advice, and the Company does not engage physicians or nurses to monitor the progress of its members. A registered dietician is available to our diet counselors continuously. Many persons who are overweight suffer from other
physical conditions, and NutriSystems target consumers could be considered a high-risk population in some respects. A member who experiences health problems could bring a lawsuit against the Company alleging that such problems were caused by



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participation in the weight loss program because certain side effects can be associated with weight loss. For example,
the Companys Predecessor Businesses suffered substantial losses due to allegations that their weight loss programs led to gall bladder disease, even though no medical link was proven. Persons who suffer side effects while participating in the
program may assert claims against the Company whether or not the program was responsible for causing the effects. Although the Company carries general liability insurance, its insurance does not cover claims of these types.



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



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



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



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



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



Certain
advertising practices in the weight loss industry have led to investigations from time to time by the Federal Trade Commission (the FTC) and other governmental agencies. Many companies in the weight loss industry, including the
Predecessor Businesses, have entered into consent decrees with the FTC relating to weight loss claims and other advertising practices. The Company continues to be subject to such consent decrees. These consent decrees restrict the manner in which
the Companys advertising describes the success members have achieved in losing weight through the program and require the Company to include the phrase results not typical in such advertisements. The Company cannot be sure that
this regulation will not increase in scope or severity in the future, which could have a material adverse impact on its business. Remedies available in administrative actions may include requiring the Company to refund amounts paid by all affected
customers or pay other damages, which could be substantial.



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



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



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



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



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



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



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



The Company and its Predecessor Businesses have incurred losses in four of
the last six years. As of December 31, 2003, the Company had an accumulated deficit of $22 million. The Company needs to continue to generate significant revenues to maintain profitability, and it may not be able to do so.



The Companys stock price has been volatile and its trading volume has been low.
These conditions may continue or worsen.



The
Companys common stock was delisted from the NASDAQ National Market on May 25, 2001, and before and since it has, at times, traded at very low volumes. The Company cannot predict when a more consistently liquid trading market may develop. In
addition, the Companys share price may decline for reasons related, or unrelated, to future operating results. For example, in October 2000, the Companys share price declined substantially for reasons it believes are unrelated to
operating performance. There are many factors, including the risk factors described in this Annual Report on Form 10-K, that may cause operating results to fluctuate or have a significant adverse effect on the market price of the Companys
common stock.



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



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



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



9



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##### Table of Contents

ITEM 2. PROPERTIES



The Company
currently leases approximately 54,600 square feet of office and warehouse space in Horsham, Pennsylvania pursuant to a lease expiring in 2009 at an annual rent of $451,956. Under the lease, the Company will rent an additional 33,200 feet of
adjoining warehouse space beginning in June 2004 at an additional annual rent of $139,839. As discussed in Item 1, the Company also outsources some of its fulfillment operations. Management believes the Horsham facility, combined with its outsourced
fulfillment capacity, is adequate for the Companys needs for the foreseeable future.



ITEM 3. LEGAL PROCEEDINGS



On July
3, 2002, certain franchise operators filed a suit against the Company and certain of its affiliates alleging that the Company has violated the terms of its franchise agreements and certain other trade laws. The suit was filed in the Circuit Court of
the First Judicial Circuit, County of Jackson, State of Illinois. In September 2003, the parties to the dispute reached a settlement under the auspices of the District Court overseeing the action. The District Court filed an Order of Dismissal on
September 15, 2003, and in December 2003 the settlement was finalized. Under the terms of the settlement, the plaintiffs have terminated their franchise agreements and now operate as Case Distributors.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS IN THE FOURTH QUARTER OF FISCAL 2003



None submitted.



PART II



ITEM 5. MARKET FOR REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER MATTERS



The Companys common stock traded on the NASDAQ National Market from June 16, 2000 to May 25, 2001, and currently trades on the NASDAQ OTC Bulletin
Board. The Companys common stock trades under the symbol THIN. The following table sets forth, for the periods indicated, the high and low closing prices for the Companys common stock as reported on the NASDAQ OTC Bulletin
Board.



|                    |  |      |      |     |   |     
|------------------- |  | ---- | ---- | --- | - | ----
|                    |  | High |      | Low
|2002 First Quarter  |  | $    | 0.88 |     | $ | 0.35
|2002 Second Quarter |  |      | 0.90 |     |   | 0.70
|2002 Third Quarter  |  |      | 0.85 |     |   | 0.62
|2002 Fourth Quarter |  |      | 1.10 |     |   | 0.50
|                    |  |     
|2003 First Quarter  |  | $    | 0.95 |     | $ | 0.61
|2003 Second Quarter |  |      | 0.82 |     |   | 0.51
|2003 Third Quarter  |  |      | 1.50 |     |   | 0.57
|2003 Fourth Quarter |  |      | 2.14 |     |   | 1.16



On March 22, 2004, the
closing bid price of the Companys common stock on the NASDAQ OTC Bulletin Board was $3.10. As of March 22, 2004, the Company had approximately 327 record holders of its common stock.



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



10



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##### Table of Contents

Recent Sales of Unregistered Securities



In the period covered by this Report, we have issued the following securities that were not registered under the Securities Act:



On September 30, 2003, we issued 2,300,000 shares of common stock to the investors listed
below in consideration for $2,300,000. Based on the fact that the listed investors were accredited investors that had an understanding of our business plan, we made these sales in reliance on the exemption from registration set forth in Section 4(2)
of the Securities Act of 1933 and Rule 506 of Regulation D thereunder.



|                           |  |          
|-------------------------- |  | ---------
|Kinderhook Partners L.L.C. |  | 1,260,000
|Stephen J. Clearman        |  | 415,000  
|Madhavi Shah               |  | 15,000   
|James F. Basili            |  | 10,000   
|Tushar Shah                |  | 20,000   
|Richard A. Vines           |  | 25,000   
|Timothy M. Riley           |  | 100,000  
|Lawrence W. Lepard         |  | 75,000   
|Vinodray Shah              |  | 80,000   
|Bruce Evans                |  | 100,000  
|Kathleen A. Tornetta       |  | 25,000   
|Joseph F. Tornetta         |  | 75,000   
|William Kronenberg III     |  | 100,000  
|                           |  |          
|Total shares               |  | 2,300,000
|                           |  |          



On October 1, 2003, we issued 15,000
shares of common stock to Ken Hitchcock in consideration for marketing services. In granting the shares, we relied upon the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.



On October 23, 2003, we issued 10,000 and 1,000 shares of common stock to Zora Andrich and
Ray Manzella, respectively, in consideration for marketing services. In granting the shares, we relied upon the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.



On November 17, 2003, we issued 43,518 shares of common stock to Investec, Inc. upon the
exercise of a warrant to purchase common stock. Based on the fact that Investec, Inc. was an accredited investor that had an understanding of our business plan, we made these sales in reliance on the exemption from registration set forth in Section
4(2) of the Securities Act of 1933 and Rule 506 of Regulation D thereunder.



On
November 24, 2003, we issued 10,000 and 5,000 shares of common stock to Mark Miller and Ray Manzella, respectively, in consideration for marketing services. In granting the shares, we relied upon the exemption from registration set forth in Section
4(2) of the Securities Act of 1933.



ITEM 6. SELECTED FINANCIAL DATA



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



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##### Table of Contents

Selected Consolidated Financial Data

(in thousands, except per share data)



|                                                   |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|-------------------------------------------------- |  | ----------------------- | ------ | ---- | ---- | - | ------ | ---- |  | - | ------ | --- |  | ---- | ------- | ---- |  | - | ------ | ---
|                                                   |  | Year Ended December 31, |       
|                                                   |  | 2003                    |        |      | 2002 |   |        | 2001 |  |   | 2000   |     |  | 1999 |        
|Statement of Operations Data:                      |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|                                                   |  |                         |        |      |     
|Revenues:                                          |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Total revenues                                     |  | $                       | 22,575 |      |      | $ | 27,569 |      |  | $ | 23,798 |     |  | $    | 20,202  |      |  | $ | 8,584  |    
|                                                   |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Costs and expenses:                                |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Cost of revenues                                   |  |                         | 13,372 |      |      |   | 15,653 |      |  |   | 13,114 |     |  |      | 11,055  |      |  |   | 6,196  |    
|Marketing                                          |  |                         | 3,627  |      |      |   | 1,392  |      |  |   | 3,565  |     |  |      | 8,432   |      |  |   | 520    |    
|General and administrative                         |  |                         | 7,239  |      |      |   | 7,775  |      |  |   | 6,440  |     |  |      | 6,088   |      |  |   | 11,666 | (a)
|New program development                            |  |                         | 599    |      |      |   |       |      |  |   |       |     |  |      |        |      |  |   |       |    
|Depreciation and amortization                      |  |                         | 223    |      |      |   | 336    |      |  |   | 418    |     |  |      | 307     |      |  |   | 99     |    
|                                                   |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Operating income (loss) from continuing operations |  |                         | (2,485 | )    |      |   | 2,413  |      |  |   | 261    |     |  |      | (5,680  | )    |  |   | (9,897 | )  
|                                                   |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Other income (loss)                                |  |                         |       |      |      |   | (100   | )    |  |   | 77     |     |  |      | 84      |      |  |   |       |    
|Equity in losses of affiliate                      |  |                         | (157   | )    |      |   | (143   | )    |  |   |       |     |  |      |        |      |  |   |       |    
|Interest income, net                               |  |                         | 57     |      |      |   | 41     |      |  |   | 98     |     |  |      | 198     |      |  |   | 56     |    
|Minority interest                                  |  |                         |       |      |      |   |       |      |  |   |       |     |  |      |        |      |  |   | 208    |    
|Income tax provision (benefit)                     |  |                         | (3,397 | )(b) |      |   |       |      |  |   |       |     |  |      |        |      |  |   |       |    
|Discontinued operation                             |  |                         |       |      |      |   | 200    | (c)  |  |   | 813    | (c) |  |      | (8,586  | )(c) |  |   |       |    
|                                                   |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Net income (loss)                                  |  | $                       | 812    |      |      | $ | 2,411  |      |  | $ | 1,249  |     |  | $    | (13,984 | )    |  | $ | (9,633 | )  
|                                                   |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Basic and diluted earnings (loss) per share:       |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Continuing operations                              |  | $                       | 0.03   |      |      | $ | 0.08   |      |  | $ | 0.01   |     |  | $    | (0.19   | )    |  | $ | (0.45  | )  
|Discontinued operation                             |  |                         |       |      |      |   |       |      |  |   | 0.03   |     |  |      | (0.03   | )    |  |   |       |    
|Disposal of discontinued operation                 |  |                         |       |      |      |   | 0.01   |      |  |   |       |     |  |      | (0.28   | )    |  |   |       |    
|                                                   |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Basic and diluted                                  |  | $                       | 0.03   |      |      | $ | 0.09   |      |  | $ | 0.04   |     |  | $    | (0.50   | )    |  | $ | (0.45  | )  
|                                                   |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Weighted average shares outstanding                |  |                         |        |      |      |   |        |      |  |   |        |     |  |      |         |      |  |   |        |    
|Basic                                              |  |                         | 26,733 |      |      |   | 26,475 |      |  |   | 28,156 |     |  |      | 28,006  |      |  |   | 21,449 |    
|Diluted                                            |  |                         | 27,064 |      |      |   | 26,917 |      |  |   | 28,201 |     |  |      | 28,006  |      |  |   | 21,449 |    



|                                                  |  |              |        |      |   |       |  |      |       |      |   |       |  |   |      
|------------------------------------------------- |  | ------------ | ------ | ---- | - | ----- |  | ---- | ----- | ---- | - | ----- |  | - | -----
|                                                  |  | December 31,
|                                                  |  | 2003         |        | 2002 |   | 2001  |  | 2000 |       | 1999
|Balance Sheet Data:                               |  |              |        |      |   |       |  |      |       |      |   |       |  |   |      
|Cash, cash equivalents and short-term investments |  | $            | 2,684  |      | $ | 3,005 |  | $    | 1,118 |      | $ | 1,638 |  | $ | 2,902
|Working capital                                   |  |              | 5,664  |      |   | 4,445 |  |      | 2,310 |      |   | 1,434 |  |   | 3,509
|Total assets                                      |  |              | 13,688 |      |   | 8,277 |  |      | 6,387 |      |   | 5,908 |  |   | 5,856
|Non-current liabilities                           |  |              | 2      |      |   | 255   |  |      | 123   |      |   | 145   |  |   | 133  
|Stockholders equity                              |  |              | 9,291  |      |   | 5,249 |  |      | 3,488 |      |   | 2,901 |  |   | 4,391

---

|(a) | Compensation charges of $8,202 were recorded in 1999 in connection with the issuance of 8,200,000 shares of common stock to the former president of the Company.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(b) | 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 prior 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 and liability were recorded on the
consolidated balance sheet and an income tax benefit was recorded in the statement of operations.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(c) | In 2000 and 2001, the Company recorded a loss from discontinued operation of $713 and an operating profit of $813, respectively. Also in 2000, the Company recorded a loss on
disposal of $7,873 consisting of a write off of intangibles of $7,650 and $223 of other shutdown related costs. In 2002, the Company recorded a gain of $200 upon the sale of the intellectual property associated with Sweet Success. See discussion
relating thereto in Note 3 of the Notes to the Consolidated Financial Statements.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



Except for the historical information contained herein, this Report on Form 10-K 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. Accordingly, there is no assurance that the results in the forward-looking statements will be achieved.



The following discussion should be read in conjunction with the financial
information included elsewhere in this Annual Report on Form 10-K. Dollar amounts are stated in thousands, except per share 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 24 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 and 41,000 shares of common stock
valued at an aggregate of $625 and $61 to service providers in 2000 and 2003, 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.



Discontinued Operation



On August 25, 2000, the Company acquired certain assets of the Sweet Success
product line from Nestle USA, Inc. (the Seller) in return for 900,000 shares of the Companys common stock, representing 3.1% of the shares outstanding after the transaction. Sweet Success is a diet meal replacement product line
distributed in traditional retail outlets such as drug and grocery stores and price clubs. In the transaction, the Company acquired certain assets directly related to the Sweet Success product line, including inventory, books and records, contracts
and intellectual property such as trademarks and product specifications. The Company did not acquire any customer receivables or fixed assets, and the Company did not assume any liabilities, beyond those obligations associated with certain
contracts, in connection with the acquisition. The shares of common stock issued to the Seller were included in a registration statement that became effective in December 2003.



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As a result of a determination made in December 2000, the Company discontinued sales of the Sweet Success
product line in June 2001. Under then existing market conditions, the Company was unable to obtain the funding required to rebuild the Sweet Success brand through consumer promotion. However, over the course of 2000 and 2001 the Company was able to
generate $1,753 in net positive cash flow from the product line, consisting of $7,773 in operating losses offset by $8,197 in non-cash expenses and a positive $1,329 in cash generated from reductions in working capital. In 2000 and 2001, the Sweet
Success product line provided a positive net cash flow of $1,212 and $541, respectively, as cash generated through the operation of the product line and the disposal of inventory exceeded payments related to the shut down of the product line.



The results of the Sweet Success product line have been
reported separately as a discontinued operation in the accompanying consolidated financial statements. Under the Companys ownership in 2000 and 2001, Sweet Success generated sales of $4,215 and $3,350, respectively, and incurred an operating
loss of $713 and an operating profit of $813, respectively. In conjunction with the discontinuance of operation, in 2000 the Company recorded a loss on disposition of $7,873, of which $7,650 related to the write down of intangible assets and the
remaining $223 related to various shut down costs. Except for a sale of intellectual property, Sweet Success was inactive in 2002. In December, 2002, the Company sold the intellectual property associated with Sweet Success for $150 cash, a $50
promissory note, deferred payments based on sales achieved by the buyer and a warrant to purchase equity of the buyer. At this time, management does not anticipate that the deferred payments or warrants will result in significant value to the
Company. The Company recorded a gain of $200 from the transaction.



Critical Accounting Policies and Estimates



The Companys consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The Companys significant accounting policies are described in Note 2 to the
consolidated financial statements included in Item 8.



The
preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements,
and the reported amounts of revenues and expenses during the reporting period. Management develops, and changes periodically, these estimates and assumptions based on historical experience and on various other factors that are believed to be
reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Management considers the following accounting estimates to be the most critical in preparing the consolidated financial
statements. These critical accounting estimates have been discussed with the Companys audit committee.



Reserves for Returns. Management reviews the reserves for customer returns at each reporting period and adjusts them to reflect data available at
that time. To estimate a return for reserves, management considers return rates in preceding periods and changes in product offerings or marketing methods that might impact returns going forward. To the extent the estimate of returns is inaccurate,
management will adjust the reserve, which will impact the amount of product sales revenue recognized in the period of the adjustment. Returns for 2001, 2002 and 2003 were $474, $1,482 and $1,174, respectively.



Impairment of Fixed Assets and Goodwill. 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 value of net fixed assets, which was $753 at December 31, 2003.



Income Taxes. NutriSystem experienced losses in 1999 and 2000. As a result, the Company has federal and state tax net operating loss (NOL) carryforwards of approximately $8 million as of December 31, 2003. 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



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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.



In future periods, the Company will provide for income taxes
at a rate equal to the combined federal and state effective rates. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause the Companys provision for income taxes to vary significantly from period to
period. For the year ended December 31, 2003, the Company recorded an income tax benefit of $3,397.



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 and packing material. Cost of products sold includes products provided at no charge as part of promotions. Cost of sales includes the fees paid to independent distributors.



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. All other advertising costs are charged to expense as incurred.



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



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



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



Income Taxes. Effective with the merger on September 27, 1999 (see
Background for discussion), the Company became 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.



Overview of the Direct Channel



The Company began selling directly to consumers when it launched its web
site on October 15, 1999. In 2003, the Direct channel represented 65% of the Companys net revenues. For the Direct channel of distribution, the Companys primary financial objectives are to generate growth while maintaining profit
margins. The Company measures growth in terms of the number of new customers, revenues per customer and total revenues. A new customer is defined as a first time purchaser through the Direct channel. Profit margins are measured in terms of gross
margin (revenues less cost of revenues as a percentage of revenues) and total advertising and marketing expense as a percentage of revenues. In the following table, cost of revenues for 2002 and 2001 have been restated to conform to current cost
allocation methodologies.



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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.



FINANCIAL AND OPERATING STATISTICS FOR THE DIRECT CHANNEL



(in thousands, except customer data)



|                                  |  |      |        |   |      |   |        |      |  |   |        |  
|--------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                  |  | 2003 |        |   | 2002 |   |        | 2001 | 
|Revenues                          |  | $    | 14,712 |   |      | $ | 16,127 |      |  | $ | 16,578 |  
|Cost of revenues                  |  |      | 7,359  |   |      |   | 7,042  |      |  |   | 7,382  |  
|                                  |  |      |        |   |      |   |        |      |  |   |        |  
|Gross margin                      |  | $    | 7,353  |   |      | $ | 9,085  |      |  | $ | 9,196  |  
|% of revenue                      |  |      | 50.0   | % |      |   | 56.3   | %    |  |   | 55.5   | %
|                                  |  |      |       
|Marketing                         |  | $    | 3,627  |   |      | $ | 1,392  |      |  | $ | 3,565  |  
|% of revenue                      |  |      | 24.7   | % |      |   | 8.6    | %    |  |   | 21.5   | %
|New customers                     |  |      | 22,960 |   |      |   | 25,066 |      |  |   | 39,761 |  
|                                  |  |      |       
|Marketing/new customer            |  | $    | 158    |   |      | $ | 56     |      |  | $ | 90     |  
|                                  |  |      |       
|New customer revenue/new customer |  | $    | 381    |   |      | $ | 428    |      |  | $ | 329    |  



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



From
2002 to 2003, revenues from each new customer acquired declined by $47 or 11.0%. The decline in revenues per new customer obtained in each year was triggered by two factors: a) an increased emphasis for a portion of 2003 on sales of smaller trial
packages of food, and b) in 2003 a higher portion of the new customers were acquired later in the year. Customers with an initial purchase of less than $100 comprised 27.2% of all new customers in 2003 but only 21.9% of new customers in 2002;
individuals that spend less than $100 tend to purchase trials, though the Company has had some success in converting these trial size customers into sustained program participants. The Companys focus is on customers
that go on a weight loss program; for analytic purposes, the Company defines a customer with an initial purchase of $100 or more to be a program new customer. The Company generated $467 and $484 per program new customer in 2003 and 2002,
respectively. The Company had 16,729 and 19,569 program new customers in 2003 and 2002, respectively. Timing also affected sales per new customer. In 2003, 45.5% of new customers were acquired in the second half of the year, while in 2002 only 33.0%
of new customers were added in the second half. Customers acquired later in a calendar year have less time to contribute revenues within the calendar year.



Customers that initially purchased in a prior year contributed $6.0 million and $5.4 million to revenues in 2003 and 2002, respectively.



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##### Table of Contents

Direct gross margin declined from 56.3% in 2002 to 50.0% in 2003 primarily due to a charge of $529
related to the write-off of obsolete old program product and packaging and an increase in the proportion of sales that are discounted under the autoship program.



Direct revenues decreased 2.7% from 2001 to 2002. From 2001 to 2002, the number of new customers acquired dropped by 14,695
or 37.0%, while the revenue generated from each new customer increased 30.1% from $329 in 2001 to $428 in 2002. Returning customers generated $3.5 million in revenues in 2001 and $5.4 million in revenues in 2002. Direct revenues declined slightly in
the face of a sharp drop in new customers because sales from each new customer and sales from returning customers increased. The decline in new customers was caused by a large reduction in marketing spending, which dropped by $2.2 million or 60.9%
from 2001 to 2002. The increase in revenues obtained from each new customer is primarily attributable to the introduction of the autoship program in November 2001, in which the customer receives monthly product shipments automatically until they
notify the Company they wish to end shipments. Total revenues from returning customers increased as the number of former customers familiar with the Companys Direct channel increased.



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 2003, this channel represented 21% of the Companys net revenue. On the QVC network, the Company reaches a large, incremental audience in a 50 minute, infomercial
format that enables the Company to convey fully the benefits of the NutriSystem diet foods. 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 sales) on sales to QVC relative to direct sales, but QVC
sales require no incremental advertising and marketing expense and, management believes, exposure on QVC raises consumer awareness of the NutriSystem brand. Net sales through the television infomercial distribution channel were $4,617, $7,376 and
$2,681 for the years ended December 31, 2003, 2002 and 2001, respectively. Sales declined from 2002 to 2003 because the Company aired fewer shows on QVC and sales per minute of air-time declined.



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



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



Costs and Expenses. Cost of revenues
decreased $2,811 from $15,653 to $13,372 for the years ended December 31, 2002 and 2003, respectively. Gross margin as a percent of revenues decreased from 43.2% in 2002 as compared to 40.8% in 2003. The decrease in gross margin is attributable to
$529 write-off of old program inventory and packaging recorded in cost of sales. Marketing expenses increased $2,235 from $1,392 to $3,627 from 2002 to 2003. All marketing spending promoted the Direct, and the increase in marketing is attributable
to increased spending for advertising media ($898), market research and consulting ($529), payroll related to marketing and advertising ($323), production of television advertising ($299) and Internet advertising ($186). The Company incurred $751 of
marketing expense in the second half of December 2003 related to television media ($55), television production ($193), direct mail ($490) and Internet advertising ($13). Management believes that a significant portion of the revenue generated from
this spending will be recorded in 2004. General and administrative expenses ($7,775 and $7,239 in 2002 and 2003, respectively) decreased $536 attributable to lower costs associated with the decline in revenues, especially compensation, and reduced
costs associated with the closing of the Reno warehouse in the first quarter of 2003, offset by increased professional fees and consulting fees. In general and administrative expenses, the Company recorded litigation expense related to the franchise
lawsuit of $302 and $238 in 2002 and 2003, respectively (see Item 3), and $198 expense related to the Reno warehouse closing costs. Included in general and administrative costs in 2002 are $481 in severance relating to the Companys former
Chief Executive Officer and $175 in charges relating to discontinued packaging and products. Primarily in the fourth quarter of 2003, the Company incurred $599 in expenses associated with new program development in order to create the NutriSystem
Nourish program. New program expenses include the new package design costs and development of program specifications.Other expense in 2002 of $100 represents the cost of settling an employment-related complaint filed by certain employees of
the Companys former facility in Reno. For the year ended December 31, 2002 and 2003, the Company recorded a loss of $143 and $157, respectively, under the caption Equity in losses of affiliate, representing the Companys
investment in an affiliate.



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##### Table of Contents

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



Income taxes. In 2003, the Company recorded a $3,397 income tax benefit related to the recognition of deferred tax assets (see Note 8 of the Financial Statements).



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



Year Ended December 31, 2002 Compared to Year Ended December 31, 2001



Revenues. Revenues increased from $23,798 for the
year ended December 31, 2001 to $27,569 for the year ended December 31, 2002. The revenue increase of $3,771, or 15.9%, resulted from increased sales to QVC ($4,694) which began distributing the Companys products in the second quarter of 2001.
Offsetting these increases was a decline in sales of $451, $250 and $222 through the Direct, Case Distributor and Field Sales channels, respectively. In 2002, Direct accounted for 59% of total revenues, while QVC, Field Sales and Case Distributor
revenues accounted for 26%, 8% and 7% of total revenues, respectively. In 2001, the comparable percents were 70%, 11%, 10% and 9% of total revenues, respectively.



Costs and Expenses. Cost of revenues increased $2,539 from $13,114 to $15,653 for the years ended December 31, 2001
and 2002, respectively. Gross margin as a percent of revenues decreased from 44.9% in 2001 to 43.2% in 2002. The decrease in gross margin is due to lower margin QVC sales accounting for a higher percent of overall sales. In 2002 and 2001, gross
margin for Direct remained approximately the same. Marketing expenses decreased $2,173 from $3,565 to $1,392 from 2001 to 2002. All marketing promoted the Direct channel, and, as discussed above, the decline in marketing expense is attributable to
the decrease in television advertising. General and administrative expenses ($6,440 and $7,775 in 2001 and 2002, respectively) increased $1,335 from 27.1% of sales to 28.2% of sales. The Company incurred higher expenses in a variety of areas
including compensation, professional services, and packaging expenses. Included in general and administrative costs in 2002 are $481 in severance relating to the Companys former Chief Executive Officer and $175 in charges relating to
discontinued packaging and products. Also in general and administrative costs in 2002 is $239 in legal defense costs associated with the franchise lawsuit that was settled in 2003 (see Item 3).



Other expense in 2002 of $100 represents the cost of settling an
employment-related complaint filed by certain employees of the Companys Reno facility. In 2001, the Company had other income of $77 representing passive investment income.



Interest Income. Interest income net of interest expense decreased $57 from $98 in 2001 to $41 in 2002 primarily due
to lower interest rates.



Net Income. From 2001 to 2002,
the Company improved its net results from net income of $1,249 to net income of $2,411. In 2001 and 2002, the Companys net income included income from discontinued operations of $813 and $200, respectively. The Company generated operating
income from continuing operations of $261 in 2001 and $2,413 in 2002. This sharp increase in operating income of $2,152 is primarily related to the decrease in advertising spending.



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##### Table of Contents

Contractual Obligations and Commercial Commitments



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



|                               |  |                        |       |                 |   |            |  |            |       |              |   |       |  |   |    
|------------------------------ |  | ---------------------- | ----- | --------------- | - | ---------- |  | ---------- | ----- | ------------ | - | ----- |  | - | ---
|                               |  | Payments Due by Period
|Contractual obligations        |  | Total                  |       | Less Than1 Year |   | 1 - 3Years |  | 4  5Years |       | After5 Years
|Operating leases               |  | $                      | 3,895 |                 | $ | 614        |  | $          | 1,301 |              | $ | 1,351 |  | $ | 629
|Contract with former executive |  |                        | 246   |                 |   | 246        |  |            |      |              |   |      |  |   |   
|                               |  |                        |       |                 |   |            |  |            |       |              |   |       |  |   |    
|Total                          |  | $                      | 4,141 |                 | $ | 860        |  | $          | 1,301 |              | $ | 1,351 |  | $ | 629
|                               |  |                        |       |                 |   |            |  |            |       |              |   |       |  |   |    



Liquidity, Capital
Resources and Other Financial Data



At December 31, 2003,
the Company had net working capital of $5,664, an increase of $1,219 from the $4,445 net working capital balance at December 31, 2002. Cash and cash equivalents at December 31, 2003 were $2,684. The Companys principal source of liquidity
during this period is from a private placement of common stock completed in September 2003. The Company currently has no bank debt or term or revolving credit facilities to fund operations or investment opportunities. The Company currently has no
off-balance sheet arrangements.



In the year ended December 31,
2003, the Company generated a negative cash flow of $1,920 from operations, primarily attributable to net income adjusted for non-cash items, including a deferred tax benefit. Including a $3,397 adjustment relating to the deferred tax benefit, net
income adjusted for non-cash items was a negative $1,833 in 2003. Net changes in operating assets and liabilities reduced cash flow from operations by $87 in 2003.



In the year ended December 31, 2003, net cash used in investing activities was $621, which primarily consisted of net
capital expenditures ($528) incurred to increase web site capacity, fulfillment operations, leasehold improvements related to the relocation of home office and an investment ($93) made in a start up company formed to provide diet and fitness
programs in center locations and capital .



In the year
ended December 31, 2003, net cash provided by financing activities was $2,220, representing proceeds from a private placement in exchange for 2,300,000 shares of common stock ($2,300), proceeds from the exercise of stock options ($25) offset by the
purchase of common stock in privately negotiated transactions ($105).



The Board of Directors has authorized the repurchase of up to 5,000,000 shares of the Companys common stock. Through December 31, 2003, the Company had repurchased a total of 2,760,291 shares under the repurchase program.



During the year ended December 31, 2003, the Company issued 43,518 shares
of common stock to warrant holders upon exercise of warrants and issued 41,000 shares to various parties in compensation for services provided.



Over the first nine months of 2001, the Company eliminated virtually all marketing agreements requiring future minimum fixed fees. As of December 31,
2003, the Companys principal commitments consisted of obligations under operating leases and severance payments to a former executive of the Company (see note 6 to Consolidated Financial Statements). Although the Company has no material
commitments for capital expenditures, it anticipates continuing requirements for capital expenditures consistent with anticipated growth in operations, infrastructure and personnel approximately consistent with prior periods.



In pursuing its business strategy, the Company may require additional cash
for operating and investing activities. The Company expects future cash requirements, if any, to be funded from operating cash flow and financing activities, which may include additional private offerings of equity securities or debt financing.
Based on the Companys ability to generate earnings in 2001 and 2002, the variable nature of a portion of the Companys expenditures, the cash



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balance at December 31, 2003 and managements belief that additional equity financing, if required, can be raised,
management believes that the Company has the ability to continue operations into 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 2002, the Financial Accounting Standards Board
(FASB) issued SFAS No. 148, Accounting for Stock-Based Compensation  an Amendment to FASB Statement No. 123, which amends SFAS 123, Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Management has elected to continue to apply the intrinsic-value based method of accounting under
Accounting Principals Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The disclosure requirements of SFAS No. 148 are included in Note 2 to the consolidated financial statements.



In December 2003, the FASB issued FASB Interpretation No. 46
(revised December 2003), Consolidation of Variable Interest Entities, (FIN46R) 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 non-controlling 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.



In November 2002, FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34, was issued. This Interpretation enhances the disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial
recognition and measurement provisions of the Interpretation were applicable to guarantees issued or modified after December 31, 2002 and the disclosure requirements were effective for financial statements of interim or annual periods ending after
December 15, 2002. The adoption of this recently issued accounting standard did not have an impact on the Companys consolidated financial statements.



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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.



ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK



The Company does not hold any investments in market risk sensitive instruments. Accordingly, management believes that it is not subject to any material
risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk instruments. The Company does not have any funded debt outstanding at December 31, 2003,
and its cash and cash equivalents of $2,684 are maintained in bank accounts. As such, a change in interest rates of 1 percentage point would not have a material impact on the Companys operating results and cash flows.



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



The information required by this Item is set forth on pages 25 through 43 hereto and is incorporated by reference herein.



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



None.



ITEM 9A. CONTROLS AND PROCEDURES



The Companys Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of the Companys disclosure controls and procedures as of 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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PART III



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



Directors



The
information required by Item 10 is incorporated herein by reference to the information contained in our definitive proxy statement related to the 2004 annual meeting of stockholders. Biographical information relating to the Companys executive
officers is set forth in Item 1 of Part I of this Report.



Executive
Officers



The information concerning our executive
officers required by this Item 10 is provided under the caption Executive Officers of the Registrant in Part I hereof.



Section 16(a) Beneficial Ownership Reporting Compliance



The information concerning Section 16(a) Beneficial Ownership Reporting Compliance by our directors and executive officers is incorporated by reference to
the information contained in our definitive proxy statement related to the 2004 annual meeting of stockholders.



ITEM 11. EXECUTIVE COMPENSATION



The information required by Item 11 is incorporated by reference to the information contained in our definitive proxy statement for the 2004 annual meeting of stockholders.



ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT



The information required by Item 12 is incorporated by reference to the information contained in our definitive proxy statement for the 2004 annual
meeting of stockholders.



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



The information required by Item 13 is incorporated by reference to the information contained in our definitive proxy statement for the 2004 annual meeting of stockholders.



ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES



The information required by Item 14 is incorporated by reference to the information contained in our definitive proxy statement for the 2004 annual meeting of stockholders.



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##### Table of Contents

PART IV



ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K



| | (a) 1. | Financial Statements
| | ------ | --------------------



See Index to the Consolidated Financial Statements which begins on page 25 of this Annual Report



| | 2. | Financial Statement Schedules
| | -- | -----------------------------



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



| | 3. | Exhibits
| | -- | --------



The exhibits listed in the accompanying index to exhibits are incorporated by reference as part of this Annual Report on Form 10-K.



(b) Reports on Form 8-K.



The Company furnished a Report on Form 8-K, dated October 29, 2003, that included information reported under Items 7 and 12 relating to
the Companys earnings for the nine month period ended September 30, 2003.



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##### Table of Contents

NUTRISYSTEM, INC. AND SUBSIDIARIES



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                |  |   
|----------------------------------------------- |  | --
|Independent Auditors Report                    |  | 26
|                                                | 
|Report of Independent Public Accountants        |  | 27
|                                                | 
|Consolidated Balance Sheets                     |  | 28
|                                                | 
|Consolidated Statements of Operations           |  | 29
|                                                | 
|Consolidated Statements of Stockholders Equity |  | 30
|                                                | 
|Consolidated Statements of Cash Flows           |  | 31
|                                                | 
|Notes to Consolidated Financial Statements      |  | 32



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##### Table of Contents

INDEPENDENT AUDITORS REPORT



The Board of Directors and Stockholders

NutriSystem, Inc.:



We have audited the 2003 and 2002 consolidated financial statements of NutriSystem, Inc. and
subsidiaries as listed in the accompanying index. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits. The 2001
consolidated financial statements of NutriSystem, Inc. and subsidiaries as listed in the accompanying index were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements in
their report dated February 13, 2002.



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



In our opinion, the 2003 and 2002 financial statements referred to above present fairly, in all material respects, the financial position of NutriSystem, Inc. and
subsidiaries as of December 31, 2003 and 2002 , and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.



As discussed in Note 2 to the consolidated financial statements, effective January 1, 2002,
the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.



/S/ KPMG LLP



Philadelphia, Pennsylvania

February 6, 2004



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The following is a copy of a report issued by Arthur Andersen LLP and included in the 2001 Form 10-K report for the
fiscal year ended December 31, 2001 filed on March 5, 2002. This report has not been reissued by Arthur Andersen LLP, and Arthur Andersen LLP has not consented to its use in this Annual Report on Form 10-K. For further discussion, see Exhibit 23.02
to this Form 10-K.



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To
Nutri/System, Inc.:



We have audited the accompanying consolidated balance
sheets of Nutri/System, Inc. (formerly nutrisystem.com inc.)(a Delaware corporation) and subsidiaries as of December 31, 2000 and 2001, and the related consolidated statements of operations, stockholders equity and cash flows for each of the
three years in the period ended December 31, 2001. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.



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



In our opinion, the
financial statements referred to above present fairly, in all material respects, the financial position of Nutri/System, Inc. and subsidiaries as of December 31, 2000 and 2001, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.



/S/ ARTHUR ANDERSEN LLP



Philadelphia, Pennsylvania,

February 13, 2002



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##### Table of Contents

NUTRISYSTEM, INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



(in thousands,
except share data)



|                                                                                                                                                                 |  |             |         |   |      |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------- | ------- | - | ---- | - | ------- | -
|                                                                                                                                                                 |  | December 31 |        
|                                                                                                                                                                 |  | 2003        |         |   | 2002 |  
|ASSETS                                                                                                                                                           |  |             |         |   |      |   |         |  
|CURRENT ASSETS:                                                                                                                                                  |  |             |         |   |      |   |         |  
|Cash and cash equivalents                                                                                                                                        |  | $           | 2,684   |   |      | $ | 3,005   |  
|Restricted cash                                                                                                                                                  |  |             | 250     |   |      |   | 325     |  
|Trade receivables                                                                                                                                                |  |             | 448     |   |      |   | 401     |  
|Inventories                                                                                                                                                      |  |             | 4,524   |   |      |   | 2,885   |  
|Deferred tax asset                                                                                                                                               |  |             | 1,716   |   |      |   |        |  
|Other current assets                                                                                                                                             |  |             | 437     |   |      |   | 602     |  
|                                                                                                                                                                 |  |             |         |   |      |   |         |  
|Total current assets                                                                                                                                             |  |             | 10,059  |   |      |   | 7,218   |  
|                                                                                                                                                                 |  |            
|FIXED ASSETS, net                                                                                                                                                |  |             | 753     |   |      |   | 600     |  
|                                                                                                                                                                 |  |            
|GOODWILL                                                                                                                                                         |  |             |        |   |      |   | 290     |  
|                                                                                                                                                                 |  |            
|DEFERRED TAX ASSET                                                                                                                                               |  |             | 2,753   |   |      |   |        |  
|                                                                                                                                                                 |  |            
|OTHER ASSETS                                                                                                                                                     |  |             | 123     |   |      |   | 169     |  
|                                                                                                                                                                 |  |             |         |   |      |   |         |  
|                                                                                                                                                                 |  | $           | 13,688  |   |      | $ | 8,277   |  
|                                                                                                                                                                 |  |             |         |   |      |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                             |  |             |         |   |      |   |         |  
|CURRENT LIABILITIES:                                                                                                                                             |  |             |         |   |      |   |         |  
|Accounts payable                                                                                                                                                 |  | $           | 3,531   |   |      | $ | 1,585   |  
|Accrued payroll and related benefits                                                                                                                             |  |             | 189     |   |      |   | 142     |  
|Deferred revenue                                                                                                                                                 |  |             | 13      |   |      |   | 506     |  
|Other current liabilities                                                                                                                                        |  |             | 662     |   |      |   | 540     |  
|                                                                                                                                                                 |  |             |         |   |      |   |         |  
|Total current liabilities                                                                                                                                        |  |             | 4,395   |   |      |   | 2,773   |  
|                                                                                                                                                                 |  |            
|NON-CURRENT LIABILITIES                                                                                                                                          |  |             | 2       |   |      |   | 255     |  
|                                                                                                                                                                 |  |             |         |   |      |   |         |  
|Total liabilities                                                                                                                                                |  |             | 4,397   |   |      |   | 3,028   |  
|                                                                                                                                                                 |  |             |         |   |      |   |         |  
|COMMITMENTS AND CONTINGENCIES (Note 6)                                                                                                                           |  |             |         |   |      |   |         |  
|STOCKHOLDERS EQUITY:                                                                                                                                            |  |             |         |   |      |   |         |  
|Preferred stock, $.001 par value (5,000,000 shares authorized, no shares outstanding)                                                                            |  |             |        |   |      |   |        |  
|Common stock, $.001 par value (100,000,000 shares authorized; shares issued and outstanding28,511,021 at December 31, 2003 and
26,218,937 at December 31, 2002) |  |             | 28      |   |      |   | 26      |  
|Additional paid-in capital                                                                                                                                       |  |             | 31,238  |   |      |   | 27,963  |  
|Warrants                                                                                                                                                         |  |             | 277     |   |      |   | 324     |  
|Accumulated deficit                                                                                                                                              |  |             | (22,252 | ) |      |   | (23,064 | )
|                                                                                                                                                                 |  |             |         |   |      |   |         |  
|Total stockholders equity                                                                                                                                       |  |             | 9,291   |   |      |   | 5,249   |  
|                                                                                                                                                                 |  |             |         |   |      |   |         |  
|                                                                                                                                                                 |  | $           | 13,688  |   |      | $ | 8,277   |  
|                                                                                                                                                                 |  |             |         |   |      |   |         |  



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



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NUTRISYSTEM, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF OPERATIONS



(in
thousands, except share and per share amounts)



|                                                             |  |                        |        |   |      |   |        |      |  |   |       
|------------------------------------------------------------ |  | ---------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------
|                                                             |  | Year Ended December 31
|                                                             |  | 2003                   |        |   | 2002 |   |        | 2001
|REVENUES                                                     |  | $                      | 22,575 |   |      | $ | 27,569 |      |  | $ | 23,798
|                                                             |  |                        |        |   |      |   |        |      |  |   |       
|COSTS AND EXPENSES:                                          |  |                        |        |   |      |   |        |      |  |   |       
|Cost of revenues                                             |  |                        | 13,372 |   |      |   | 15,653 |      |  |   | 13,114
|Marketing                                                    |  |                        | 3,627  |   |      |   | 1,392  |      |  |   | 3,565 
|General and administrative                                   |  |                        | 7,239  |   |      |   | 7,775  |      |  |   | 6,440 
|New program development                                      |  |                        | 599    |   |      |   |       |      |  |   |      
|Depreciation and amortization                                |  |                        | 223    |   |      |   | 336    |      |  |   | 418   
|                                                             |  |                        |        |   |      |   |        |      |  |   |       
|Total costs and expenses                                     |  |                        | 25,060 |   |      |   | 25,156 |      |  |   | 23,537
|                                                             |  |                        |        |   |      |   |        |      |  |   |       
|Operating income (loss) from continuing operations           |  |                        | (2,485 | ) |      |   | 2,413  |      |  |   | 261   
|                                                             |  |                        |       
|OTHER INCOME (LOSS)                                          |  |                        |       |   |      |   | (100   | )    |  |   | 77    
|                                                             |  |                        |       
|EQUITY IN LOSSES OF AFFILIATE                                |  |                        | (157   | ) |      |   | (143   | )    |  |   |      
|                                                             |  |                        |       
|INTEREST INCOME, net                                         |  |                        | 57     |   |      |   | 41     |      |  |   | 98    
|                                                             |  |                        |        |   |      |   |        |      |  |   |       
|Income (loss) before income taxes and discontinued operation |  |                        | (2,585 | ) |      |   | 2,211  |      |  |   | 436   
|                                                             |  |                        |       
|INCOME TAXES                                                 |  |                        | (3,397 | ) |      |   |       |      |  |   |      
|                                                             |  |                        |        |   |      |   |        |      |  |   |       
|Income before discontinued operation                         |  |                        | 812    |   |      |   | 2,211  |      |  |   | 436   
|                                                             |  |                        |       
|DISCONTINUED OPERATION (Note 3):                             |  |                        |        |   |      |   |        |      |  |   |       
|Income from operation                                        |  |                        |       |   |      |   |       |      |  |   | 813   
|Gain on disposal                                             |  |                        |       |   |      |   | 200    |      |  |   |      
|                                                             |  |                        |        |   |      |   |        |      |  |   |       
|Net income                                                   |  | $                      | 812    |   |      | $ | 2,411  |      |  | $ | 1,249 
|                                                             |  |                        |        |   |      |   |        |      |  |   |       
|BASIC AND DILUTED INCOME PER SHARE:                          |  |                        |        |   |      |   |        |      |  |   |       
|Continuing operations                                        |  | $                      | 0.03   |   |      | $ | 0.08   |      |  | $ | 0.01  
|Discontinued operation                                       |  |                        |       |   |      |   |       |      |  |   | 0.03  
|Disposal of discontinued operation                           |  |                        |       |   |      |   | 0.01   |      |  |   |      
|                                                             |  |                        |        |   |      |   |        |      |  |   |       
|                                                             |  | $                      | 0.03   |   |      | $ | 0.09   |      |  | $ | 0.04  
|                                                             |  |                        |        |   |      |   |        |      |  |   |       
|WEIGHTED AVERAGE SHARES OUTSTANDING:                         |  |                        |        |   |      |   |        |      |  |   |       
|                                                             |  |                        |       
|Basic                                                        |  |                        | 26,733 |   |      |   | 26,475 |      |  |   | 28,156
|Diluted                                                      |  |                        | 27,064 |   |      |   | 26,917 |      |  |   | 28,201



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



29



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NUTRISYSTEM, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY



(in thousands, except share amounts)



|                                                      |  |              |   |  |             |    |   |                          |   |        |                     |  |   |                    |   |  |               |         |   |       |   |       |   |  |   |       |  
|----------------------------------------------------- |  | ------------ | - |  | ----------- | -- | - | ------------------------ | - | ------ | ------------------- |  | - | ------------------ | - |  | ------------- | ------- | - | ----- | - | ----- | - |  | - | ----- | -
|                                                      |  | CommonShares |   |  | CommonStock |    |   | AdditionalPaid-inCapital |   |        | CommonStockWarrants |  |   | AccumulatedDeficit |   |  | TreasuryStock |         |   | Total |  
|BALANCE, January 1, 2001                              |  | 28,735,794   |   |  |             | 29 |   |                          |   | 29,272 |                     |  |   | 324                |   |  |               | (26,724 | ) |       |   |      |   |  |   | 2,901 |  
|                                                      |  |              |   |  |             |    |  
|Net income                                            |  |             |   |  |             |   |   |                          |   |       |                     |  |   |                   |   |  |               | 1,249   |   |       |   |      |   |  |   | 1,249 |  
|Stock-based costs                                     |  |             |   |  |             |   |   |                          |   | 61     |                     |  |   |                   |   |  |               |        |   |       |   |      |   |  |   | 61    |  
|Purchase of treasury stock                            |  | (1,670,400   | ) |  |             |   |   |                          |   |       |                     |  |   |                   |   |  |               |        |   |       |   | (723  | ) |  |   | (723  | )
|                                                      |  |              |   |  |             |    |   |                          |   |        |                     |  |   |                    |   |  |               |         |   |       |   |       |   |  |   |       |  
|BALANCE, December 31, 2001                            |  | 27,065,394   |   |  |             | 29 |   |                          |   | 29,333 |                     |  |   | 324                |   |  |               | (25,475 | ) |       |   | (723  | ) |  |   | 3,488 |  
|                                                      |  |              |   |  |             |    |  
|Net income                                            |  |             |   |  |             |   |   |                          |   |       |                     |  |   |                   |   |  |               | 2,411   |   |       |   |      |   |  |   | 2,411 |  
|Stock-based costs                                     |  |             |   |  |             |   |   |                          |   | 37     |                     |  |   |                   |   |  |               |        |   |       |   |      |   |  |   | 37    |  
|Exercise of stock options                             |  | 23,334       |   |  |             |   |   |                          |   | 8      |                     |  |   |                   |   |  |               |        |   |       |   |      |   |  |   | 8     |  
|Purchase of treasury stock                            |  | (869,791     | ) |  |             |   |   |                          |   |       |                     |  |   |                   |   |  |               |        |   |       |   | (695  | ) |  |   | (695  | )
|Retirement of treasury stock                          |  |             |   |  |             | (3 | ) |                          |   | (1,415 | )                   |  |   |                   |   |  |               |        |   |       |   | 1,418 |   |  |   |      |  
|                                                      |  |              |   |  |             |    |   |                          |   |        |                     |  |   |                    |   |  |               |         |   |       |   |       |   |  |   |       |  
|BALANCE, December 31, 2002                            |  | 26,218,937   |   |  |             | 26 |   |                          |   | 27,963 |                     |  |   | 324                |   |  |               | (23,064 | ) |       |   |      |   |  |   | 5,249 |  
|                                                      |  |              |   |  |             |    |  
|Net income                                            |  |             |   |  |             |   |   |                          |   |       |                     |  |   |                   |   |  |               | 812     |   |       |   |      |   |  |   | 812   |  
|Stock-based costs                                     |  | 41,000       |   |  |             |   |   |                          |   | 220    |                     |  |   |                   |   |  |               |        |   |       |   |      |   |  |   | 220   |  
|Exercise of stock options                             |  | 127,666      |   |  |             |   |   |                          |   | 43     |                     |  |   |                   |   |  |               |        |   |       |   |      |   |  |   | 43    |  
|Exercise of warrants                                  |  | 43,518       |   |  |             |   |   |                          |   | 47     |                     |  |   | (47                | ) |  |               |        |   |       |   |      |   |  |   |      |  
|Sale of common stock                                  |  | 2,300,000    |   |  |             | 2  |   |                          |   | 2,298  |                     |  |   |                   |   |  |               |        |   |       |   |      |   |  |   | 2,300 |  
|Purchase of treasury stock                            |  | (220,100     | ) |  |             |   |   |                          |   |       |                     |  |   |                   |   |  |               |        |   |       |   | (123  | ) |  |   | (123  | )
|Retirement of treasury stock                          |  |             |   |  |             |   |   |                          |   | (123   | )                   |  |   |                   |   |  |               |        |   |       |   | 123   |   |  |   |      |  
|Recognition of previously reserved deferred tax asset |  |             |   |  |             |   |   |                          |   | 790    |                     |  |   |                   |   |  |               |        |   |       |   |      |   |  |   | 790   |  
|                                                      |  |              |   |  |             |    |   |                          |   |        |                     |  |   |                    |   |  |               |         |   |       |   |       |   |  |   |       |  
|BALANCE, December 31, 2003                            |  | 28,511,021   |   |  | $           | 28 |   |                          | $ | 31,238 |                     |  | $ | 277                |   |  | $             | (22,252 | ) |       | $ |      |   |  | $ | 9,291 |  
|                                                      |  |              |   |  |             |    |   |                          |   |        |                     |  |   |                    |   |  |               |         |   |       |   |       |   |  |   |       |  



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



(in
thousands)



|                                                                                            |  |                        |        |   |      |   |       |      |  |   |        |  
|------------------------------------------------------------------------------------------- |  | ---------------------- | ------ | - | ---- | - | ----- | ---- |  | - | ------ | -
|                                                                                            |  | Year Ended December 31 |       
|                                                                                            |  | 2003                   |        |   | 2002 |   |       | 2001 | 
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                       |  |                        |        |   |      |   |       |      |  |   |        |  
|Net income                                                                                  |  | $                      | 812    |   |      | $ | 2,411 |      |  | $ | 1,249  |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities- |  |                        |        |   |      |   |       |      |  |   |        |  
|Discontinued operation net (income) loss                                                    |  |                        |       |   |      |   | (200  | )    |  |   | (813   | )
|Net cash from discontinued operation                                                        |  |                        |       |   |      |   | 45    |      |  |   | 541    |  
|Equity in losses of affiliate                                                               |  |                        | 157    |   |      |   | 143   |      |  |   |       |  
|Depreciation and amortization                                                               |  |                        | 223    |   |      |   | 336   |      |  |   | 418    |  
|Deferred tax benefit                                                                        |  |                        | (3,397 | ) |      |   |      |      |  |   |       |  
|Loss on disposal of fixed assets                                                            |  |                        | 152    |   |      |   |      |      |  |   | 16     |  
|Stockbased costs                                                                           |  |                        | 220    |   |      |   | 37    |      |  |   | 61     |  
|Changes in operating assets and liabilities-                                                |  |                        |        |   |      |   |       |      |  |   |        |  
|Restricted cash                                                                             |  |                        | 75     |   |      |   | 203   |      |  |   | (3     | )
|Trade receivables                                                                           |  |                        | (47    | ) |      |   | (129  | )    |  |   | 62     |  
|Inventories                                                                                 |  |                        | (1,639 | ) |      |   | (127  | )    |  |   | (1,323 | )
|Other assets                                                                                |  |                        | 198    |   |      |   | (140  | )    |  |   | (42    | )
|Accounts payable                                                                            |  |                        | 1,946  |   |      |   | (761  | )    |  |   | 454    |  
|Accrued payroll and related benefits                                                        |  |                        | 47     |   |      |   | 29    |      |  |   | (18    | )
|Deferred revenue                                                                            |  |                        | (493   | ) |      |   | 506   |      |  |   |       |  
|Other liabilities                                                                           |  |                        | (174   | ) |      |   | 560   |      |  |   | (260   | )
|                                                                                            |  |                        |        |   |      |   |       |      |  |   |        |  
|Net cash provided by (used in) operating activities                                         |  |                        | (1,920 | ) |      |   | 2,913 |      |  |   | 342    |  
|                                                                                            |  |                        |        |   |      |   |       |      |  |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                       |  |                        |        |   |      |   |       |      |  |   |        |  
|Capital additions, net of proceeds from dispositions                                        |  |                        | (528   | ) |      |   | (84   | )    |  |   | (139   | )
|Investment in affiliate                                                                     |  |                        | (93    | ) |      |   | (155  | )    |  |   |       |  
|                                                                                            |  |                        |        |   |      |   |       |      |  |   |        |  
|Net cash used in investing activities                                                       |  |                        | (621   | ) |      |   | (239  | )    |  |   | (139   | )
|                                                                                            |  |                        |        |   |      |   |       |      |  |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                       |  |                        |        |   |      |   |       |      |  |   |        |  
|Exercise of stock options                                                                   |  |                        | 25     |   |      |   | 8     |      |  |   |       |  
|Repayment of non-current liabilities                                                        |  |                        |       |   |      |   | (100  | )    |  |   |       |  
|Sale of common stock                                                                        |  |                        | 2,300  |   |      |   |      |      |  |   |       |  
|Treasury stock purchases, at cost                                                           |  |                        | (105   | ) |      |   | (695  | )    |  |   | (723   | )
|                                                                                            |  |                        |        |   |      |   |       |      |  |   |        |  
|Net cash provided by (used in) financing activities                                         |  |                        | 2,220  |   |      |   | (787  | )    |  |   | (723   | )
|                                                                                            |  |                        |        |   |      |   |       |      |  |   |        |  
|NET CHANGE IN CASH AND CASH EQUIVALENTS                                                     |  |                        | (321   | ) |      |   | 1,887 |      |  |   | (520   | )
|CASH AND CASH EQUIVALENTS, beginning of year                                                |  |                        | 3,005  |   |      |   | 1,118 |      |  |   | 1,638  |  
|                                                                                            |  |                        |        |   |      |   |       |      |  |   |        |  
|CASH AND CASH EQUIVALENTS, end of year                                                      |  | $                      | 2,684  |   |      | $ | 3,005 |      |  | $ | 1,118  |  
|                                                                                            |  |                        |        |   |      |   |       |      |  |   |        |  



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)



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, 24 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.



Cash and Cash Equivalents



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



Restricted Cash



Restricted cash
represents minimum cash deposited in banks required under certain vendor arrangements. The restrictions were eliminated on January 30, 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.



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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.



Goodwill



Goodwill represented the excess of the consideration
paid over the fair value of net assets acquired. As of December 31, 2002 goodwill was $527 and accumulated amortization was $237. Consistent with the Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets (SFAS 142), effective January 1, 2002, the Company no longer amortized goodwill. Amortization of goodwill in 2001 was $93 and, had SFAS No. 142 been in effect in 2001 net income would have been increased by this
amount and net income per share would have increased by $0.01. In June 2003, the Company eliminated goodwill in connection with the recognition of deferred tax assets (see Note 8).



Investment Carried Under the Equity Method



The Company has invested $93 in 2003 and $155 in 2002 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 at
December 31, 2003. For the years ended December 31, 2003 and 2002, the Company recorded losses of $157 and $143, respectively, in the statement of operations under the caption Equity in losses of affiliate, representing the
Companys portion of the losses incurred by Imagine. As of December 31, 2003, the Company had no commitment to make further investments in Imagine. A liability of $52 at December 31, 2003 is included in Other current liabilities and
the net investment of $13 at December 31, 2002 is included in Other assets in the accompanying consolidated balance sheets.



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 December 31, 2003 and 2002, 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 franchise or Case Distributors. Revenues for products distributed by QVC are recognized when QVC ships the products from their distribution center to the end-consumer.
Product inventory held by QVC is carried in the Companys inventories and payments received from QVC in advance of shipments to the end-consumer are recorded as deferred revenue in the consolidated balance sheet. Prior to 2003, the Company
shipped products sold through QVC directly to the consumer.



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 franchisees and
independent distributors, as well as franchise royalty fees. Revenues from shipping and handling charges were $359, $361, and $491 in 2003, 2002 and 2001, respectively.



Marketing Expense



Marketing expense includes advertising, marketing and promotional expenses and payroll related expenses for personnel engaged in these activities. The Company follows the
American Institute of Certified Public Accountants (AICPA) Statement of Position 93-7, Reporting for Advertising Costs 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



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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 December 31, 2003 and 2002, $90 and $283, respectively, of prepaid advertising was included in
prepaid expenses. Advertising expense was $3,182, $1,270 and $3,443 in 2003, 2002 and 2001, 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 and a deferred tax asset and a deferred tax liability were recorded on the consolidated balance sheet and an income tax benefit was recorded in the statement of operations (see Note 8).



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 2003, 2002 and 2001,
diluted net income per common share reflects the potential dilution from the exercise of outstanding options and warrants into common stock. In 2003, 2002 and 2001, common stock equivalents representing 750,666, 1,270,500 and 2,262,834 shares of
common stock, respectively, were excluded from weighted average shares for diluted net loss per share purposes since the effect of including would be anti-dilutive. In addition, outstanding warrants to purchase 698,740 shares of common stock in 2002
and 2001, respectively, were also excluded as the effect of including would be anti-dilutive.



Stock Options



The Company applies the
intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, to account for its fixed-plan stock options. Under this
method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS 123 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, the Company has elected to continue to apply the intrinsic-value-based method of accounting has adopted only the disclosure requirements.



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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:



|                                                                                                                      |  |                        |      |   |      |   |       |      |  |   |       |  
|--------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ---- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                                                                                      |  | Year Ended December 31 |     
|                                                                                                                      |  | 2003                   |      |   | 2002 |   |       | 2001 | 
|Net income:                                                                                                           |  |                        |      |   |      |   |       |      |  |   |       |  
|As reported                                                                                                           |  | $                      | 812  |   |      | $ | 2,411 |      |  | $ | 1,249 |  
|Add stock-based employee compensation expense included in reported net income, net of tax                             |  |                        |     |   |      |   | 20    |      |  |   | 20    |  
|Impact of total stock-based compensation expense determined under fair-value based method for all rewards, net of tax |  |                        | (493 | ) |      |   | (446  | )    |  |   | (787  | )
|                                                                                                                      |  |                        |      |   |      |   |       |      |  |   |       |  
|Pro forma                                                                                                             |  | $                      | 319  |   |      | $ | 1,985 |      |  | $ | 482   |  
|                                                                                                                      |  |                        |      |   |      |   |       |      |  |   |       |  
|Basic net income per share:                                                                                           |  |                        |      |   |      |   |       |      |  |   |       |  
|As reported                                                                                                           |  | $                      | 0.03 |   |      | $ | 0.09  |      |  | $ | 0.04  |  
|                                                                                                                      |  |                        |      |   |      |   |       |      |  |   |       |  
|Pro forma                                                                                                             |  | $                      | 0.01 |   |      | $ | 0.08  |      |  | $ | 0.02  |  
|                                                                                                                      |  |                        |      |   |      |   |       |      |  |   |       |  
|Diluted net income per share:                                                                                         |  |                        |      |   |      |   |       |      |  |   |       |  
|As reported                                                                                                           |  | $                      | 0.03 |   |      | $ | 0.09  |      |  | $ | 0.04  |  
|                                                                                                                      |  |                        |      |   |      |   |       |      |  |   |       |  
|Pro forma                                                                                                             |  | $                      | 0.01 |   |      | $ | 0.07  |      |  | $ | 0.02  |  
|                                                                                                                      |  |                        |      |   |      |   |       |      |  |   |       |  



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:



|                         |  |       |   |  |      |   |  |       |  
|------------------------ |  | ----- | - |  | ---- | - |  | ----- | -
|                         |  | 2003  |   |  | 2002 |   |  | 2001  |  
|Dividend yield           |  | None  |   |  | None |   |  | None  |  
|Expected volatility      |  | 103.9 | % |  | 94.7 | % |  | 101.9 | %
|Risk-free interest rate  |  | 2.29  | % |  | 4.80 | % |  | 4.58  | %
|Expected life (in years) |  | 6.2   |   |  | 5.3  |   |  | 4.3   |  



The weighted average fair value of the
options issued in 2003, 2002 and 2001 was $0.54, $0.33 and $0.28, 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 December 31, 2003 and 2002 consist of $0 and $200, respectively, in
certificates of deposit.



The Company made payments for income taxes of $35 and
$6 in 2003 and 2002, respectively; no such payments were made in 2001. Payments for interest were $1, $37, and $4 in 2003, 2002 and 2001, respectively.



Recently Issued Accounting Pronouncements



In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, Accounting for Stock-Based Compensation  an Amendment to
FASB Statement No. 123, which amends SFAS 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. Management



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has elected to continue to apply the intrinsic-value based method of accounting under Accounting Principals Board (APB)
Opinion No. 25,  Accounting for Stock Issued to Employees, and related interpretations. The disclosure requirements of SFAS No. 148 are included in Note 2.



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.



In November 2002, FASB Interpretation No.
45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34,
was issued. This Interpretation enhances the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation were applicable to guarantees issued or modified after December 31, 2002
and the disclosure requirements were effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of this recently issued accounting standard did 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 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. DISCONTINUED OPERATION



On August 25, 2000, the Company acquired certain assets of the Sweet
Success product line from Nestle USA, Inc. (the Seller) in return for 900,000 shares of the Companys common stock, representing 3.1% of the shares outstanding after the transaction. The acquisition was recorded using the purchase
method of accounting. In the transaction, the Company acquired certain assets directly related to the Sweet Success product line, including inventory, books and records, contracts and intellectual property such as trademarks and product
specifications. The Company did not acquire any customer receivables or fixed assets, and the Company did not assume any liabilities beyond those obligations associated with certain contracts, in connection with the acquisition. The shares of common
stock issued to the Seller were included in a registration statement that became effective in December 2003.



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As a result of a determination made in December 2000, the Company discontinued sales of the Sweet Success product line by
June 30, 2001. The results of the Sweet Success product line have been reported separately as a discontinued operation in the Companys consolidated financial statements. Under the Companys ownership in 2000, Sweet Success generated sales
of $4,215 and incurred an operating loss of $713. The Company recorded a loss on disposal of $7,873, of which $7,650 related to the write down of intangible assets and the remaining $223 related to various shut down costs. In 2001, Sweet Success
generated sales of $3,350 and operating income of $813. Except for the sale of intellectual property (see below), Sweet Success was inactive in 2002.



In December 2002, the Company sold the intellectual property associated with Sweet Success for $150 cash, a $50 promissory note due, deferred payments based on sales
achieved by the buyer and a warrant to purchase equity of the buyer. The Company recorded a gain of $200 from the transaction. The deferred payments and value of the warrant are not expected to provide significant economic benefit to the Company, if
any.



4. FIXED ASSETS



Fixed assets consist of the following:



|                         |  |             |        |   |      |   |        |  
|------------------------ |  | ----------- | ------ | - | ---- | - | ------ | -
|                         |  | December 31 |       
|                         |  | 2003        |        |   | 2002 |  
|Furniture and fixtures   |  | $           | 162    |   |      | $ | 172    |  
|Equipment                |  |             | 1,220  |   |      |   | 1,316  |  
|Leasehold improvements   |  |             | 384    |   |      |   | 124    |  
|                         |  |             |        |   |      |   |        |  
|                         |  |             | 1,766  |   |      |   | 1,612  |  
|Accumulated depreciation |  |             | (1,013 | ) |      |   | (1,012 | )
|                         |  |             |        |   |      |   |        |  
|                         |  | $           | 753    |   |      | $ | 600    |  
|                         |  |             |        |   |      |   |        |  



Depreciation expense was $223, $336
and $325 in 2003, 2002 and 2001, respectively.



5. OTHER CURRENT LIABILITIES



Other current liabilities consist of the following:



|                                               |  |             |     |      |   |    
|---------------------------------------------- |  | ----------- | --- | ---- | - | ---
|                                               |  | December 31
|                                               |  | 2003        |     | 2002
|Accrued packaging costs                        |  | $           | 274 |      | $ |   
|Severance accrual                              |  |             | 246 |      |   | 241
|Legal accrual                                  |  |             |    |      |   | 235
|Compensation                                   |  |             | 85  |      |   |   
|Liabilities of discontinued operation          |  |             |    |      |   | 56 
|Indemnifications of Imagine Weight Loss Center |  |             | 52  |      |   |   
|Other                                          |  |             | 5   |      |   | 8  
|                                               |  |             |     |      |   |    
|                                               |  | $           | 662 |      | $ | 540
|                                               |  |             |     |      |   |    



The accrued packaging costs represents
remaining payments related to the costs associated with the development of new packaging as well as any remaining packaging that has been discontinued due to the introduction of the new product line. The severance accrual represents the current
portion of future payments to a former executive of the Company, while the compensation liability represents the value of common stock granted to the Board of Directors at December 31, 2003 but the stock was not yet issued. The legal accrual
represents the estimated attorney fees and settlement costs associated with



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##### Table of Contents

legal actions discussed in Note 6. It is the Companys policy to accrue for estimated defense costs at the time a
matter becomes known. The Company has provided indemnifications to certain affiliates of Imagine Weight Loss Center amounting to $52 at December 31, 2003



6. COMMITMENTS AND CONTINGENCIES



The Company leases its warehouse, corporate headquarters and certain equipment. These leases generally have initial terms of three to six years. Certain of the leases
also contain escalation clauses based upon increases in costs related to the properties. Lease obligations, with initial or remaining terms of one year or more years, consist of the following at December 31, 2003:



|     |  |   |      
|---- |  | - | -----
|2004 |  | $ | 614  
|2005 |  |   | 645  
|2006 |  |   | 656  
|2007 |  |   | 673  
|2008 |  |   | 678  
|2009 |  |   | 629  
|     |  |   |      
|     |  | $ | 3,895
|     |  |   |      



Total rent expense for 2003, 2002 and
2001 was $485, $624 and $613, respectively.



In December 2002, the Company
entered into a contract with its former Chief Executive Officer that requires payments totaling approximately $517 over the course of 2003 and 2004. As of December 31, 2003, the remaining liability is $246.



In September 1997, Nutri/System L.P., one of the Predecessor Businesses, removed a drug
combination from its weight loss program after it was shown to cause health problems. Numerous suits were subsequently filed against Nutri/System L.P. Also, in 1997, the Company obtained a settlement from its insurance carrier for coverage
associated with this matter. In September 1999, the supplier of the drug combination agreed to indemnify Nutri/System L.P. with respect to any further liability with respect to this matter. In the opinion of management, the Company has no liability
with respect to this matter.



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 and $238 in 2002 reflecting the incremental costs of the settlement and defense costs, net of insurance
proceeds of $75. These amounts are included in general and administrative expenses in the accompanying statements of operations. Under the terms of the settlement, the plaintiffs have terminated their franchise agreements and now operate as Case
Distributors.



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



|7. | CAPITAL STOCK
|-- | -------------



Common Stock



The Company did not issue
any shares of common stock in 2001 and issued 23,334 shares in 2002 upon the exercise of common stock options. In 2003, the Company issued 2,512,184 shares of common stock, 2,300,000 shares of common stock in a private placement and 127,666 shares
upon the exercise of common stock options and received proceeds of $2,300 and $25, respectively. The Company also issued 41,000 shares of common stock as compensation to certain consultants and spokespersons per their contract and 43,518 shares upon
the cashless exercise of common stock warrants.



Treasury stock is accounted
for using the cost method. During 2001, the Company repurchased 1,670,400 shares of common stock for an aggregate cost of $723 (an average price of $0.43 per share) and in 2002 the Company repurchased 869,791 shares of common stock for an aggregate
cost of $695 (an average price of $0.80 per share). In 2003, the



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Company purchased 220,100 shares of common stock for an aggregate cost of $123 (an average price of $0.56 per share). 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 December 31, 2003 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.



8. INCOME TAXES



Income taxes consist
of the following:



|                                       |  |                        |        |   |      |   |      |      |  |   |      |  
|-------------------------------------- |  | ---------------------- | ------ | - | ---- | - | ---- | ---- |  | - | ---- | -
|                                       |  | Year Ended December 31 |       
|                                       |  | 2003                   |        |   | 2002 |   |      | 2001 | 
|Current                                |  | $                      |       |   |      | $ |     |      |  | $ |     |  
|Deferred                               |  |                        | (1,173 | ) |      |   | 966  |      |  |   | 501  |  
|Change in deferred valuation allowance |  |                        | (2,224 | ) |      |   | (966 | )    |  |   | (501 | )
|                                       |  |                        |        |   |      |   |      |      |  |   |      |  
|                                       |  | $                      | (3,397 | ) |      | $ |     |      |  | $ |     |  
|                                       |  |                        |        |   |      |   |      |      |  |   |      |  



A reconciliation of the statutory
federal income tax rate to the Companys effective tax rate is as follows:



|                                                               |  |                        |    |  |       |   |  |       |  
|-------------------------------------------------------------- |  | ---------------------- | -- |  | ----- | - |  | ----- | -
|                                                               |  | Year Ended December 31 |   
|                                                               |  | 2003                   |    |  | 2002  |   |  | 2001  |  
|Statutory federal income tax rate                              |  | (34.0                  | )% |  | 34.0  | % |  | 34.0  | %
|State income taxes, net of federal benefit                     |  | (6.0                   | )  |  | 6.0   |   |  | 6.0   |  
|Basis difference in loss in disposal of discontinued operation |  |                       |    |  |      |   |  |      |  
|Change in deferred tax valuation allowance                     |  | 131.4                  |    |  | (40.0 | ) |  | (40.0 | )
|                                                               |  |                        |    |  |       |   |  |       |  
|                                                               |  | 91.4                   | %  |  |      | % |  |      | %
|                                                               |  |                        |    |  |       |   |  |       |  



The significant items comprising the
Companys deferred income tax assets and liabilities are as follows:



|                                |  |             |       |   |      |   |        |  
|------------------------------- |  | ----------- | ----- | - | ---- | - | ------ | -
|                                |  | December 31 |      
|                                |  | 2003        |       |   | 2002 |  
|Deferred tax asset-             |  |             |       |   |      |   |        |  
|Reserves and accruals           |  | $           | 364   |   |      | $ | 508    |  
|Goodwill                        |  |             | 472   |   |      |   | 383    |  
|Net operating loss carryforward |  |             | 3,279 |   |      |   | 2,014  |  
|Other                           |  |             | 377   |   |      |   | 422    |  
|                                |  |             |       |   |      |   |        |  
|                                |  |             | 4,492 |   |      |   | 3,327  |  
|                                |  |             |       |   |      |   |        |  
|Deferred tax liability-         |  |             |       |   |      |   |        |  
|Property and equipment          |  |             | (23   | ) |      |   | (23    | )
|                                |  |             |       |   |      |   |        |  
|Net deferred tax asset          |  |             | 4,469 |   |      |   | 3,304  |  
|                                |  |             |       |   |      |   |        |  
|Valuation allowance             |  |             |      |   |      |   | (3,304 | )
|                                |  |             |       |   |      |   |        |  
|                                |  | $           | 4,469 |   |      | $ |       |  
|                                |  |             |       |   |      |   |        |  



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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 2002 and 2001 is below the annual limitation.



9. STOCK OPTIONS AND WARRANTS



Stock Option Plan



The Company has two stock option plans (the 1999 Equity Incentive Plan and 2000 Equity Incentive Plan) under which options to purchase shares of the Companys common stock can be granted to key employees.
Currently, 1,000,000 and 4,100,000 shares of common stock may be issued pursuant to the 1999 Equity Incentive Plan and the 2000 Equity Incentive Plan, respectively. At December 31, 2003, options to purchase 900,833 shares were available for grant
under these plans. These options could be either incentive stock options or nonqualified stock options.



In June 2000, the Company also adopted the 2000 Equity Incentive Plan for Outside Directors and Consultants (the Director Plan) under which nonqualified stock options to purchase shares of the
Companys common stock could be granted to non-employee directors and consultants to the Company. A maximum of 1,000,000 shares of common stock may be issued pursuant to the Director Plan. At December 31, 2003, options to purchase 209,334
shares were available for grant under this plan.



Under each of the plans, the
Board of Directors determines the term of each option, but no option can be exercisable more than ten years from the date the option was granted. To date, all of the options issued under the Equity Incentive Plans expire ten years from the issue
date and all of the options issued under the Director Plan expire between three months and ten years from the issue date. The Board also determines the option exercise price per share and vesting provisions. Options issued to employees generally
vest over a three year period. All of the options issued are incentive stock options.



40



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##### Table of Contents

The following table summarizes the options granted, exercised and cancelled in 2001, 2002 and 2003:



|                               |  |                  |  |                       |     
|------------------------------ |  | ---------------- |  | --------------------- | ----
|                               |  | Number of Shares |  | Average ExercisePrice
|Outstanding, January 1, 2001   |  | 1,716,134        |  | $                     | 1.30
|                               |  |                 
|Granted                        |  | 1,387,000        |  |                       | 0.40
|Exercised                      |  |                 |  |                       |    
|Cancelled                      |  | 423,300          |  |                       | 2.15
|                               |  |                  |  |                       |     
|Outstanding, December 31, 2001 |  | 2,679,834        |  |                       | 2.01
|                               |  |                 
|Granted                        |  | 210,000          |  |                       | 0.44
|Exercised                      |  | 23,334           |  |                       | 0.38
|Cancelled                      |  | 410,000          |  |                       | 1.90
|                               |  |                  |  |                       |     
|Outstanding, December 31, 2002 |  | 2,456,500        |  |                       | 1.91
|                               |  |                 
|Granted                        |  | 2,866,000        |  |                       | 0.74
|Exercised                      |  | 127,666          |  |                       | 0.46
|Cancelled                      |  | 357,667          |  |                       | 3.72
|                               |  |                  |  |                       |     
|Outstanding, December 31, 2003 |  | 4,837,167        |  |                       | 1.12
|                               |  |                  |  |                       |     



The following table summarizes
information about stock options outstanding as of December 31, 2003:



|                         |  |                 |  |                                |  |                        |      
|------------------------ |  | --------------- |  | ------------------------------ |  | ---------------------- | -----
|Range of Exercise Prices |  | Number ofShares |  | Average Remaining Life (Years) |  | Average Exercise Price
|$0.33 - $0.49            |  | 867,667         |  | 7.7                            |  | $                      | 0.37 
|$0.50 - $0.99            |  | 2,657,000       |  | 8.4                            |  |                        | 0.61 
|$1.00 - $1.99            |  | 930,500         |  | 5.0                            |  |                        | 1.49 
|$2.00 - $2.99            |  | 165,000         |  | 6.3                            |  |                        | 2.62 
|$3.00 - $6.99            |  | 157,000         |  | 6.2                            |  |                        | 5.52 
|$7.00 - $13.99           |  | 60,000          |  | 6.5                            |  |                        | 13.50
|                         |  |                 |  |                                |  |                        |      
|                         |  | 4,837,167       |  |                                |  |                        |      
|                         |  |                 |  |                                |  |                        |      



At December 31, 2003, 2002 and 2001,
options to purchase 2,186,742, 1,445,889, and 643,667 shares were exercisable with a weighted-average exercise price of $1.65, $2.20 and $2.97 per share, respectively.



41



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##### Table of Contents

In 1999, the Company issued 200,000 options to an employee which have an exercise price below the fair value on the date
of grant. Compensation expense of $20 per year associated with these options was recorded in 2002 and 2001. At December 31, 2002, compensation costs related to these options was fully amortized to expense.



In 2003, an employee exercised options to purchase 50,000 shares of common stock ($18,500
total exercise price) by tending 28,462 shares of common stock previously held.



The Company issued 330,666, 0 and 110,000 stock options to non-employees in 2003, 2002 and 2001, respectively. These options vest over various periods and resulted in compensation expense of $159, $17 and $41 in 2003, 2002 and 2001,
respectively. Compensation costs for these stock options relate to general and administrative expenses. The fair value of the stock options issued to non-employees was determined using the Black-Scholes option pricing model and the following
weighted average assumptions:



|                         |  |          |  |       |  |             
|------------------------ |  | -------- |  | ----- |  | ------------
|                         |  | 2003     |  | 2002  |  | 2001        
|Dividend yield           |  | None     |  | None  |  | None        
|Expected volatility      |  | 70.0%    |  | 70.0% |  | 70.0%       
|Risk-free interest rate  |  | 4.80%    |  | 4.80% |  | 4.27% -5.83%
|Contract life (in years) |  | 0.5-10.0 |  | 10.0  |  | 10.0        



Common Stock Warrants



In return for services provided in connection with a private placement
completed in 1999, the placement agent received warrants to purchase 743,740 common shares at $1.00 per share. The fair value of the warrants of $344, computed using the Black-Scholes option pricing model, was recorded as a reduction of the proceeds
from the offering. In 2000, warrants to purchase 45,000 common shares were exercised; with 42,391 net shares being issued. In 2003, 43,518 common shares were issued upon the cashless exercise of 100,000 warrants. The 598,740 remaining outstanding
warrants outstanding expire on September 30, 2004.



10. RELATED-PARTY
TRANSACTIONS



During 2002 and 2001, the Company purchased $478 and $466,
respectively, of food from a vendor that is an affiliate of a former member of the Board of Directors.



In 2002 and 2001, the Company purchased vitamins and supplements of $3 and $58, respectively, from a vendor that was owned by a former member of the Board of Directors.



11. EMPLOYEE BENEFIT PLAN



The Company maintains a qualified tax deferred defined contribution retirement plan (the
Plan). Under the provisions of the Plan, substantially all employees meeting minimum age and service requirements are entitled to contribute on a before and after-tax basis a certain percentage of their compensation. The Company matches
100% of an employees contribution, up to a maximum Company match of 4% for 2003 and 3% for 2002 of the employees annual salary. Employees vest immediately in their contributions and the Company contribution. The Companys expense in
2003, 2002 and 2001 was $106, $63 and $68, respectively.



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12. ALLOWANCE FOR DOUBTFUL ACCOUNTS



Valuation and qualifying accounts consist of trade receivables allowance for doubtful accounts. The changes in the allowance for doubtful
accounts for the years 2003, 2002 and 2001 consist of the following:



|            |  |                            |    |            |   |     |            |  |   |                   |   |  |   |  
|----------- |  | -------------------------- | -- | ---------- | - | --- | ---------- |  | - | ----------------- | - |  | - | -
|Fiscal Year |  | Balance atBeginning ofYear |    | Write-offs |   |     | Deductions |  |   | BalanceEnd ofYear
|2003        |  | $                          |   |            | $ |    |            |  | $ |                  |   |  | $ | 
|2002        |  | $                          |   |            | $ |    |            |  | $ |                  |   |  | $ | 
|2001        |  | $                          | 36 |            | $ | (33 | )          |  | $ | (3                | ) |  | $ | 



13. UNAUDITED QUARTERLY
CONSOLIDATED FINANCIAL DATA





|                                             |  |         |        |        |   |       |  |   |        |   |  |      |        |   |  |   |        |  
|-------------------------------------------- |  | ------- | ------ | ------ | - | ----- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                             |  | Quarter |       
|(In thousands, except per share amounts)     |  | First   |        | Second |   | Third |  |   | Fourth |   |  | Year |       
|2003:                                        |  |         |        |        |   |       |  |   |        |   |  |      |        |   |  |   |        |  
|Revenues                                     |  | $       | 7,196  |        | $ | 6,315 |  | $ | 4,866  |   |  | $    | 4,198  |   |  | $ | 22,575 |  
|Income (loss) before income taxes            |  | $       | 651    |        | $ | 211   |  | $ | (376   | ) |  | $    | (3,071 | ) |  | $ | (2,585 | )
|Net income (loss)                            |  | $       | 651    |        | $ | 2,098 |  | $ | (225   | ) |  | $    | (1,712 | ) |  | $ | 812    |  
|Income (loss) per basic and diluted share    |  | $       | 0.02   |        | $ | 0.08  |  | $ | (0.01  | ) |  | $    | (0.06  | ) |  | $ | 0.03   |  
|                                             |  |         |        |        |   |       |  |   |        |   |  |      |        |   |  |   |        |  
|2002:                                        |  |         |        |        |   |       |  |   |        |   |  |      |        |   |  |   |        |  
|Revenues                                     |  | $       | 10,439 |        | $ | 7,562 |  | $ | 5,458  |   |  | $    | 4,110  |   |  | $ | 27,569 |  
|Income (loss) from continuing operations     |  | $       | 1,736  |        | $ | 1,345 |  | $ | 365    |   |  | $    | (1,235 | ) |  | $ | 2,211  |  
|Discontinued operation                       |  | $       |       |        | $ |      |  | $ |       |   |  | $    | 200    |   |  | $ | 200    |  
|Net income (loss)                            |  | $       | 1,736  |        | $ | 1,345 |  | $ | 365    |   |  | $    | (1,035 | ) |  | $ | 2,411  |  
|Income (loss) per basic and diluted share:   |  |         |        |        |   |       |  |   |        |   |  |      |        |   |  |   |        |  
|Continuing operations                        |  | $       | 0.06   |        | $ | 0.05  |  | $ | 0.01   |   |  | $    | (0.04  | ) |  | $ | 0.08   |  
|Discontinued operation                       |  | $       |       |        | $ |      |  | $ |       |   |  | $    |       |   |  | $ |       |  
|Income on disposal of discontinued operation |  | $       |       |        | $ |      |  | $ |       |   |  | $    | 0.01   |   |  | $ | 0.01   |  
|                                             |  |         |        |        |   |       |  |   |        |   |  |      |        |   |  |   |        |  
|                                             |  | $       | 0.06   |        | $ | 0.05  |  | $ | 0.01   |   |  | $    | (0.03  | ) |  | $ | 0.09   |  
|                                             |  |         |        |        |   |       |  |   |        |   |  |      |        |   |  |   |        |  





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INDEX TO EXHIBITS



|      |  |                                                                                                                                                                                                                                                     
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|No.   |  | Description                                                                                                                                                                                                                                         
|*2.1  |  | Agreement and Plan of Merger dated August 19, 1999 between nutrisystem.com inc. and Ansama Corp.                                                                                                                                                    
|      | 
|*2.2  |  | Asset Purchase Agreement dated August 16, 1999 between Ansama Corp. and Nutri/System L.P.                                                                                                                                                           
|      | 
|*2.3  |  | Stock Exchange and Purchase Agreement dated August 16, 1999 among Ansama Corp., HPF Holdings, Inc., Brian D. Haveson and NutriSystem Direct, L.L.C. management (comprised of Joseph Boileau,
Kathleen Simone, Deborah Gallen and Frederick C. Tecce)
|      | 
|*2.4  |  | Assignments of NutriSystem Direct, L.L.C. Membership Interests dated September 30, 1999 to nutrisystem.com inc. by each of HPF Holdings, Inc., Brian D. Haveson, Joseph Boileau, Kathleen
Simone, Deborah Gallen and Frederick C. Tecce             
|      | 
|*2.5  |  | Operating Agreement of NutriSystem Direct, L.L.C. dated September 30, 1999                                                                                                                                                                          
|      | 
|*2.6  |  | Intellectual Property Assignment from Nutri/System L.P. to nutrisystem.com inc. dated September 30, 1999                                                                                                                                            
|      | 
|*2.7  |  | Assignment of Franchise Agreements from Nutri/System L.P. to nutrisystem.com inc. dated September 30, 1999                                                                                                                                          
|      | 
|*3.1  |  | Certificate of Incorporation of nutrisystem.com inc.                                                                                                                                                                                                
|      | 
|*3.2  |  | By-laws of nutrisystem.com inc.                                                                                                                                                                                                                     
|      | 
|*4.1  |  | Form of Common Stock certificate of nutrisystem.com inc.                                                                                                                                                                                            
|      | 
|*4.2  |  | Form of warrant to purchase Common Stock of nutrisystem.com inc.                                                                                                                                                                                    
|      | 
|*10.1 |  | Joint Defense and Indemnification Agreement dated September 27, 1999 between Wyeth Ayerst Laboratories Division of American Home Products Corporation and Nutri/System L.P.                                                                         
|      | 
|*10.2 |  | Lease, dated December 11, 1997, between Teachers Insurance and Annuity Association and nutrisystem.com inc. as amended by First Amendment to Lease dated October 28, 1999                                                                           
|      | 
|*10.3 |  | Form of Nutri/System L.P. Franchise Agreement                                                                                                                                                                                                       
|      | 
|*10.4 |  | Form of NutriSystem Direct, L.L.C. Distributor Agreement                                                                                                                                                                                            
|      | 
|*10.5 |  | 1999 Equity Incentive Plan of nutrisystem.com inc.                                                                                                                                                                                                  



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##### Table of Contents

|          |  |                                                                                                                                                                                                                            
|--------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|No.       |  | Description                                                                                                                                                                                                                
|** 10.14  |  | Asset Purchase Agreement dated as of August 25, 2000 between nutrisystem.com inc. and Nestle USA, Inc. and related agreements.                                                                                             
|          | 
|## 10.15  |  | Agreement dated as of September 6, 2001 between Nutri/System, Inc. and QVC, Inc. and related exhibit.                                                                                                                      
|          | 
|### 10.16 |  | Agreement dated as of October 21, 2003 between NutriSystem, Inc. and GT Merchandising & Licensing LLC.                                                                                                                     
|          | 
|# 10.17   |  | 2000 Equity Incentive Plan for Outside Directors and Consultants of the Company                                                                                                                                            
|          | 
|# 10.18   |  | 2000 Equity Incentive Plan of the Company                                                                                                                                                                                  
|          | 
|10.19     |  | Second Amendment, dated September 23, 2003 to the Lease, dated December 11, 1997, between Teachers Insurance and Annuity Association and nutrisystem.com inc. as amended by First Amendment to
Lease dated October 28, 1999
|          | 
|*** 21.1  |  | Subsidiaries of nutrisystem.com inc.                                                                                                                                                                                       
|          | 
|23.1      |  | Consent of KPMG LLP                                                                                                                                                                                                        
|          | 
|23.2      |  | Notice regarding consent of Arthur Andersen LLP                                                                                                                                                                            
|          | 
|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                                                                                                         

---

|* | Incorporated by reference to the designated exhibit of the Companys Registration Statement on Form 10 filed on December 17, 1999 (file number 000-28551).
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------

|** | Incorporated by reference to the designated exhibit of the Companys Report on Form 8-K filed on October 24, 2000 (file number 000-28551).
|-- | ------------------------------------------------------------------------------------------------------------------------------------------

|*** | Incorporated by reference to the designated exhibit of Amendment No. 2 of the Companys Registration Statement on Form 10 filed on March 8, 2000 (file number 000-28551).
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|# | Incorporated by reference to the designated exhibit of the Companys Form PRE 14A filed on May 12, 2000 (file number 0-28551).
|- | ------------------------------------------------------------------------------------------------------------------------------

|## | Incorporated by reference to the designated exhibit of the Companys Report on Form 8-K filed on September 18, 2001 (file number 000-28551).
|-- | --------------------------------------------------------------------------------------------------------------------------------------------

|### | Incorporated by reference to the designated exhibit of the Companys Report on Form 10-Q filed on November 4, 2003 (file number 0-28551).
|--- | -----------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) 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. HaganMichael J. Hagan, Chairmanof the Board and Chief Executive Officer




Dated: March 23, 2004



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.



|    |  |                                                          |  |               
|--- |  | -------------------------------------------------------- |  | --------------
|BY: |  | /S/ MICHAEL J. HAGAN                                     |  | March 23, 2004
|    |  | Michael J. Hagan                                         |  |               
|    |  | Chairman of the Board and Chief Executive Officer        |  |               
|    |  |                                                         
|BY: |  | /S/ JAMES D. BROWN                                       |  | March 23, 2004
|    |  | James D. Brown                                           |  |               
|    |  | Chief Financial Officer and Principal Accounting Officer |  |               
|    |  |                                                         
|BY: |  | /S/ DJORDJE (GEORGE) JANKOVIC                            |  | March 23, 2004
|    |  | Djordje (George) Jankovic                                |  |               
|    |  | President, Chief Operating Officer and Director          |  |               
|    |  |                                                         
|BY: |  | /S/ IAN J. BERG                                          |  | March 23, 2004
|    |  | Ian J. Berg                                              |  |               
|    |  | Director                                                 |  |               
|    |  |                                                         
|BY: |  | /S/ MICHAEL DIPIANO                                      |  | March 23, 2004
|    |  | Michael DiPiano                                          |  |               
|    |  | Director                                                 |  |               
|    |  |                                                         
|BY: |  | /S/ WARREN V. (PETE) MUSSER                              |  | March 23, 2004
|    |  | Warren V. (Pete) Musser                                  |  |               
|    |  | Director                                                 |  |               
|    |  |                                                         
|BY: |  | /S/ BRIAN P. TIERNEY                                     |  | March 23, 2004
|    |  | Brian P. Tierney                                         |  |               
|    |  | Director                                                 |  |               
|    |  |                                                         
|BY: |  | /S/ STEPHEN T. ZARRILLI                                  |  | March 23, 2004
|    |  | Stephen T. Zarrilli                                      |  |               
|    |  | Director                                                 |  |               



46