NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, in thousands except share and per share amounts)
Nature of the Business
Nutrisystem, Inc. (the Company or Nutrisystem), a provider of weight management products and
services, offers nutritionally balanced weight loss programs designed for women, men, and seniors, as well as the
Nutrisystem
®
D
®
program specifically designed to help people with type 2 diabetes who want to lose weight and manage their diabetes. The Nutrisystem programs are based on 40 years of
nutrition research and on the science of the low glycemic index. The Companys pre-packaged foods are sold directly to weight loss program participants primarily through the Internet and telephone (including the redemption of prepaid program
cards), referred to as the direct channel, and through QVC, a television shopping network. In May 2012, the Company introduced a new in-store retail line, Nutrisystem
®
Everyday products, comprised of nutritionally balanced bars, smoothies and bakery and breakfast items targeted to consumers who aspire to eat healthier.
2.
|
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|
Presentation of Financial Statements
The
Companys consolidated financial statements include 100% of the assets and liabilities of Nutrisystem, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Interim Financial Statements
The
Companys consolidated financial statements as of and for the three and nine months ended September 30, 2012 and 2011 are unaudited and, in the opinion of management, include all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the Companys financial position and results of operations for these interim periods. Accordingly, readers of these consolidated financial statements should refer to the Companys audited
consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP), and the related notes thereto, for the year ended December 31, 2011, which are included in the Companys Annual
Report on Form 10-K for the fiscal year ended December 31, 2011 as certain footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted from this report pursuant to the rules of
the Securities and Exchange Commission (the SEC). The results of operations for the three and nine months ended September 30, 2012 are not necessarily indicative of the results to be expected for the year ending December 31,
2012.
Cash, Cash Equivalents and Short Term Investments
Cash equivalents include only securities having a maturity of three months or less at the time of purchase. At September 30, 2012 and December 31, 2011, demand accounts and money market accounts
comprised all of the Companys cash equivalents.
Short term investments consist of investments in municipal securities of the U.S.,
corporate debt securities and time deposits with original maturities of greater than three months at the time of purchase. The Company classifies these as available-for-sale securities. These investments were reported at fair value with the related
unrealized gains and losses included in accumulated other comprehensive loss, a component of stockholders equity, net of related tax effects.
6
At September 30, 2012, cash, cash equivalents and short term investments consisted of the following:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
|
|
|
Gross
Unrealized
Gains
|
|
|
Gross
Unrealized
Losses
|
|
|
Estimated
Fair Value
|
|
Cash
|
|
$
|
23,429
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
23,429
|
|
Money market account
|
|
|
25,245
|
|
|
|
0
|
|
|
|
0
|
|
|
|
25,245
|
|
Municipal income fund
|
|
|
10,080
|
|
|
|
42
|
|
|
|
0
|
|
|
|
10,122
|
|
Corporate debt securities
|
|
|
1,703
|
|
|
|
17
|
|
|
|
(10
|
)
|
|
|
1,710
|
|
Time deposits
|
|
|
8,294
|
|
|
|
11
|
|
|
|
(2
|
)
|
|
|
8,303
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
68,751
|
|
|
$
|
70
|
|
|
$
|
(12
|
)
|
|
$
|
68,809
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
At December 31, 2011, cash, cash equivalents and short term investments consisted of the following:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
|
|
|
Gross
Unrealized
Gains
|
|
|
Gross
Unrealized
Losses
|
|
|
Estimated
Fair Value
|
|
Cash
|
|
$
|
12,465
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
12,465
|
|
Money market account
|
|
|
35,129
|
|
|
|
0
|
|
|
|
0
|
|
|
|
35,129
|
|
Municipal income fund
|
|
|
10,013
|
|
|
|
0
|
|
|
|
0
|
|
|
|
10,013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
57,607
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
57,607
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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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 two to seven years. Leasehold
improvements are amortized on a straight-line basis over the lesser of the estimated useful life of the asset or the related lease term. Expenditures for repairs and maintenance are charged to expense as incurred, while major renewals and
improvements are capitalized.
Included in fixed assets is the capitalized cost of internal-use software and website development incurred
during the application development stage. Capitalized costs are amortized using the straight-line method over the estimated useful life of the asset, which is generally two to five years. Costs incurred related to planning or maintenance of
internal-use software and website development are charged to expense as incurred. The net book value of capitalized software was $10,964 and $10,285 at September 30, 2012 and December 31, 2011, respectively.
Revenue Recognition
Revenue from
product sales is recognized when the earnings process is complete, which is upon transfer of title to the product. Recognition of revenue upon shipment meets the revenue recognition criteria in that persuasive evidence of an arrangement exists,
delivery has occurred, the selling price is fixed and determinable and collection is reasonably assured. The Company also sells prepaid program cards to wholesalers and retailers. Revenue from these cards is recognized after the card is redeemed
online at the Companys website by the customer and the product is shipped to the customer.
Deferred revenue
consists primarily of unredeemed prepaid program cards and unshipped frozen foods. When a customer orders the
Nutrisystem
®
Select
®
program, two separate shipments are delivered. The first shipment contains Nutrisystems standard shelf-stable food. The second shipment contains the
fresh-frozen foods and is generally delivered within a week of a customers order. Both shipments qualify as separate units of accounting and the fair value is based on estimated selling price of both units.
Customers may return unopened product within 30 days of purchase in order to receive a refund or credit. Fresh-frozen products are non-returnable and
non-refundable unless the order is canceled within 14 days of delivery. Estimated returns are accrued at the time the sale is recognized and actual returns are tracked monthly. The Company reviews its history of actual versus estimated returns to
ensure reserves are appropriate.
The Company reviews the reserves for customer returns at each reporting period and adjusts them to reflect
data available at that time. To estimate reserves for returns, the Company considers actual return rates in preceding periods
7
and changes in product offerings or marketing methods that might impact returns going forward. To the extent the estimate of returns changes, the Company will adjust the reserve, which will
impact the amount of product sales revenue recognized in the period of the adjustment. The provision for estimated returns for the three and nine months ended September 30, 2012 was $2,511 and $8,668, respectively, and $2,593 and $11,301 for
the three and nine months ended September 30, 2011, respectively. The reserve for estimated returns incurred but not received and processed was $957 and $726 at September 30, 2012 and December 31, 2011, respectively, and has been
included in other accrued expenses and current liabilities in the accompanying consolidated balance sheets.
Revenue from product sales
includes amounts billed for shipping and handling and is presented net of returns and billed sales tax. Revenue from shipping and handling charges were $355 and $2,075 for the three and nine months ended September 30, 2012, respectively, and
$691 and $2,498 for the three and nine months ended September 30, 2011, respectively. Shipping-related costs are included in cost of revenue in the accompanying consolidated statements of operations.
Dependence on Suppliers
Approximately
16% and 13% of inventory purchases for both the nine months ended September 30, 2012 and 2011 were from two suppliers. The Company has a supply arrangement with one of these suppliers that requires the Company to make minimum purchases (see
Note 6).
For the nine months ended September 30, 2012 and 2011, the Company outsourced 100% of its fulfillment operations to a
third-party provider.
Vendor Rebates
One of the Companys suppliers provides for rebates based on purchasing levels. The Company accounts for this rebate on an accrual basis as purchases are made at a rebate percentage determined based
upon the estimated total purchases from the vendor. The estimated rebate is recorded as a reduction in the carrying value of purchased inventory and is reflected in the consolidated statements of operations when the associated inventory is sold. A
receivable is recorded for the estimate of the rebate earned. The rebate period is June 1 through May 31 of each year. For the three and nine months ended September 30, 2012, the Company reduced cost of revenue by $310 and $1,257,
respectively, for these rebates. For the comparable periods of 2011, cost of revenue was reduced by $302 and $1,177, respectively. A receivable of $339 and $686 at September 30, 2012 and December 31, 2011, respectively, has been recorded
in receivables in the accompanying consolidated balance sheets. Historically, the actual rebate received from the vendor has closely matched the estimated rebate recorded. An adjustment is made to the estimate upon determination of the final rebate.
Fair Value of Financial Instruments
A three-tier fair value hierarchy has been established by the Financial Accounting Standards Board to prioritize the inputs used in measuring fair value. These tiers are as follows:
Level 1Valuations based on quoted prices for identical assets and liabilities in active markets.
Level 2Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and
liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3Valuations based on unobservable inputs reflecting the Companys own assumptions, consistent with reasonably available assumptions
made by other market participants. These valuations require significant judgment.
The fair values of the Companys Level 1 instruments
are based on quoted prices in active exchange markets for identical assets. The fair values of the Companys Level 2 instruments are based on quoted prices in less active markets. The fair values of the Companys derivative instruments are
determined using pricing models that take into account contract terms and certain observable current market information such as London Inter-Bank Offered Rate (LIBOR) interest rates. The Company had no Level 3 instruments at
September 30, 2012 and December 31, 2011.
8
The following table summarizes the Companys financial assets and liabilities measured at fair value at
September 30, 2012:
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Total Fair Value
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Quoted Prices in Active
Markets for Identical
Assets (Level 1)
|
|
|
Significant Other
Observable Inputs
(Level 2)
|
|
Money market account
|
|
$
|
25,245
|
|
|
$
|
25,245
|
|
|
$
|
0
|
|
Municipal income fund
|
|
|
10,122
|
|
|
|
10,122
|
|
|
|
0
|
|
Corporate debt securities
|
|
|
1,710
|
|
|
|
0
|
|
|
|
1,710
|
|
Time deposits
|
|
|
8,303
|
|
|
|
0
|
|
|
|
8,303
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
45,380
|
|
|
$
|
35,367
|
|
|
$
|
10,013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps
|
|
$
|
(137
|
)
|
|
$
|
0
|
|
|
$
|
(137
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes the Companys financial assets and liabilities measured at fair value at
December 31, 2011:
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|
|
|
|
|
|
|
|
|
|
|
|
|
Total Fair Value
|
|
|
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
|
|
|
Significant Other
Observable Inputs
(Level 2)
|
|
Money market account
|
|
$
|
35,129
|
|
|
$
|
35,129
|
|
|
$
|
0
|
|
Municipal income fund
|
|
|
10,013
|
|
|
|
10,013
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
45,142
|
|
|
$
|
45,142
|
|
|
$
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps
|
|
$
|
(22
|
)
|
|
$
|
0
|
|
|
$
|
(22
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment Information
The Company is managed and operated as one business. The entire business is managed by a single management team that reports to the chief executive officer. Revenue consists primarily of food sales.
Earnings Per Share
The
Company uses the two-class method to calculate earnings per share (EPS) as the unvested restricted stock issued under the Companys equity incentive plans are participating shares with nonforfeitable rights to dividends. Under the
two-class method, earnings per common share are computed by dividing the sum of distributed earnings to common stockholders and undistributed earnings allocated to common stockholders by the weighted average number of common shares outstanding for
the period. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities based on the number of weighted average shares outstanding during the period.
9
The following table sets forth the computation of basic and diluted EPS:
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|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2012
|
|
|
2011
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
Net income
|
|
$
|
2,590
|
|
|
$
|
6,068
|
|
|
$
|
2,224
|
|
|
$
|
13,411
|
|
Net income allocated to unvested restricted stock
|
|
|
(91
|
)
|
|
|
(225
|
)
|
|
|
(235
|
)
|
|
|
(460
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income allocated to common shares
|
|
$
|
2,499
|
|
|
$
|
5,843
|
|
|
$
|
1,989
|
|
|
$
|
12,951
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
27,562
|
|
|
|
27,092
|
|
|
|
27,442
|
|
|
|
26,948
|
|
Effect of dilutive securities
|
|
|
239
|
|
|
|
243
|
|
|
|
200
|
|
|
|
324
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
27,801
|
|
|
|
27,335
|
|
|
|
27,642
|
|
|
|
27,272
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic income per common share
|
|
$
|
0.09
|
|
|
$
|
0.22
|
|
|
$
|
0.07
|
|
|
$
|
0.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted income per common share
|
|
$
|
0.09
|
|
|
$
|
0.21
|
|
|
$
|
0.07
|
|
|
$
|
0.47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In the three and nine months ended September 30, 2012, common stock equivalents representing 953,515 and 854,158
shares of common stock, respectively, were excluded from weighted average shares outstanding for diluted income per common share purposes because the effect would be anti-dilutive. In the three and nine months ended September 30, 2011, common
stock equivalents representing 979,563 and 610,168 shares of common stock, respectively, were excluded from weighted average shares outstanding for diluted income per common share purposes because the effect would be anti-dilutive.
Cash Flow Information
The Company made
payments for income taxes of $50 and $1,549 in the nine months ended September 30, 2012 and 2011, respectively. Interest payments in the nine months ended September 30, 2012 and 2011 were $700 and $487, respectively. For the nine months
ended September 30, 2012, the Company had non-cash capital additions of $404 of unpaid invoices in accounts payable and accrued expenses. For the nine months ended September 30, 2011, the Company had non-cash capital additions of $700 of
unpaid invoices in accounts payable and accrued expenses.
Use of Estimates
The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenue and operating expenses during the reporting period. Actual results could differ from these estimates.
Recently Issued Accounting Pronouncements
In June 2011, the Financial Accounting
Standards Board issued Accounting Standards Update (ASU) No. 2011-05 for the presentation of comprehensive income thereby amending ASC 220,
Comprehensive Income.
The amendment requires that all non-owner changes in stockholders
equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendment is effective for fiscal years beginning after December 15, 2011 and should be applied
retrospectively. The Company has added separate consolidated statements of comprehensive income to the accompanying financial statements.
3.
|
CREDIT FACILITY AND INTEREST RATE SWAPS
|
On November 8, 2012, the Company entered into a new $40,000 secured credit facility (the $40,000 Facility) with a new lender to replace the
existing amended and restated credit agreement that provided for a $100,000 unsecured revolving credit facility (the $100,000 Facility). The $40,000 Facility provides for interest at a floating rate equal to one month LIBOR or one month
LIBOR plus an applicable margin or a floating rate at the lenders prime rate plus an applicable margin, and is also subject to an unused fee payable quarterly. The $40,000 Facility contains financial and other covenants including a minimum
fixed charge ratio, a minimum tangible net worth and a minimum liquidity ratio,
10
and includes limitations on, among other things, capital expenditures, additional indebtedness, acquisitions and stock repurchases. The $40,000 Facility can be drawn upon through November 8,
2015, at which time all amounts must be repaid. The Company will incur approximately $1,245 in expense during the three months ended December 31, 2012 to write off the unamortized debt issuance costs and the interest rate swaps associated with
the $100,000 Facility.
As of September 30, 2012, the Company had $30,000 in borrowings outstanding under the $100,000 Facility at a
weighted average interest rate of 1.9%.
The $100,000 Facility provided for interest at either a floating rate, which was a base rate, or a
Eurocurrency rate equal to LIBOR for the relevant term, plus an applicable margin. The base rate was the higher of the lenders base rate or one-half of one percent above the Federal Funds Rate. The $100,000 Facility was also subject to an
unused fee payable quarterly. The unused fee was subject to adjustment based on the Companys consolidated leverage ratio and ranged from 0.25% to 0.45% per year. During the three and nine months ended September 30, 2012, the Company
incurred $234 and $557 in interest, respectively, and $53 and $159 in an unused line fee, respectively. In the comparable periods of 2011, the Company incurred $91 and $299 in interest, respectively, and $76 and $210 in unused line fees,
respectively. Interest payments and unused line fees are classified within interest expense, net in the accompanying consolidated statements of operations.
At September 30, 2012, the Company had $1,108 of unamortized debt issuance costs associated with the $100,000 Facility that were being amortized over the term of the $100,000 Facility.
The Company uses interest rate swaps, a type of derivative financial instrument, to manage interest costs and minimize the effects of interest rate
fluctuations on cash flows associated with its variable-rate debt. The Company does not use interest rate derivatives for trading or speculative purposes. While interest rate swaps are subject to fluctuations in value, these fluctuations are
generally offset by the value of the underlying exposures being hedged. The Company minimizes the risk of credit loss by entering into these agreements with financial institutions that have high credit ratings.
In January and June 2012, respectively, the Company entered into two separate $10,000 notional value forward-starting interest rate swaps. Both of these
swaps have effective dates of October 1, 2012 and mature on October 1, 2014. Under these swaps, the Company receives interest equivalent to the one-month LIBOR and pays a fixed rate of interest of 0.6825% and 0.535%, respectively, with
settlements occurring monthly. The objective of the hedges is to eliminate the variability of cash flows in interest payments for $20,000 of floating rate debt. The estimated fair value for these two swaps was a liability of $137 as of
September 30, 2012, and is included in non-current liabilities, net of tax in the accompanying consolidated balance sheets. The corresponding change in fair value is included in accumulated other comprehensive loss in the accompanying
consolidated balance sheets. There was no cash flow hedge ineffectiveness recorded during the three and nine months ended September 30, 2012 or 2011. The swaps will terminate and be expensed during the three months ended December 31, 2012
upon the inception of the new $40,000 Facility. In addition, the Company had two separate $10,000 notional values floating to fixed interest rate swap agreements that matured on August 3, 2012 and September 28, 2012, respectively.
Common Stock
The Company issued 6,768 and 20,001 shares of common stock upon the exercise of stock options in the nine months ended September 30,
2012 and 2011, respectively, and received proceeds of $10 and $128, respectively. During the nine months ended September 30, 2012 and 2011, employees surrendered to the Company 92,801 and 141,918 shares of common stock, respectively, valued at
$1,036 and $1,856, respectively, in satisfaction of minimum tax withholding obligations associated with the vesting of equity awards. In connection with the approval of the Amended and Restated 2008 Long-Term Incentive Plan in September 2012, these
shares will now be included in treasury stock. Previously, these shares were retired. Included in the 92,801 shares surrendered were 7,691 shares of common stock which are held in treasury. Also, in the nine months ended September 30, 2012 and
2011, the Company issued 64,508 and 37,648 shares of common stock, respectively, as compensation to board members and third-party marketing vendors pursuant to their respective contracts. Costs recognized for these stock grants issued were $552 and
$466 for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, 65,571 shares of common stock issued to third-party marketing vendors remain unvested. Additional expense for these shares will be
recognized upon vesting. During each of the quarters in the periods ended September 30, 2012 and 2011, the Company paid a dividend of $0.175 per share to all stockholders of record.
11
In 2011, the Board of Directors of the Company authorized a stock repurchase program of up to $150,000 of
the Companys outstanding shares of common stock in open-market transactions on the NASDAQ National Market or through privately negotiated transactions, including block transactions. The timing and actual number of shares repurchased will
depend on a variety of factors including price, corporate and regulatory requirements, limitations under the credit facility, alternative investment opportunities and other market conditions. This stock repurchase program has an expiration date of
June 30, 2013 but may be limited or terminated at any time by the Board of Directors without prior notice. No shares of common stock were repurchased during the nine months ended September 30, 2012 or 2011.
Preferred Stock
The Company has
authorized 5,000,000 shares of preferred stock issuable in one or more series upon resolution of the Board of Directors. Unless otherwise required by law, the Board of Directors may, 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.
5.
|
SHARE-BASED COMPENSATION EXPENSE
|
The
following table summarizes the Companys stock option activity during the nine months ended September 30, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
|
Weighted-
Average
Exercise Price
Per Share
|
|
|
Weighted-
Average
Remaining
Contractual
Life (years)
|
|
|
Aggregate
Intrinsic Value
|
|
Outstanding, January 1, 2012
|
|
|
336,307
|
|
|
$
|
14.43
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
124,805
|
|
|
|
11.23
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(6,768
|
)
|
|
|
1.50
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, September 30, 2012
|
|
|
454,344
|
|
|
$
|
13.74
|
|
|
|
5.94
|
|
|
$
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable, September 30, 2012
|
|
|
89,035
|
|
|
$
|
15.56
|
|
|
|
5.50
|
|
|
$
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected to vest at September 30, 2012
|
|
|
436,081
|
|
|
$
|
13.76
|
|
|
|
5.93
|
|
|
$
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company recorded compensation expense of $41 and $1,109 in the accompanying consolidated statements of operations for
the three and nine months ended September 30, 2012, respectively, for stock option awards. During both the three and nine months ended September 30, 2011, the Company recorded compensation expense of $60. The total intrinsic value of stock
options exercised during the three and nine months ended September 30, 2012 was $21 and $64, respectively, and $0 and $144, respectively, for the comparable periods of 2011.
The Company has issued restricted stock to employees generally with vesting terms ranging from three to five years. The fair value is equal to the market price of the Companys common stock on the
date of grant. Expense for restricted stock is amortized ratably over the vesting period. The following table summarizes the restricted stock activity for the nine months ended September 30, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
|
Weighted-
Average
Grant-Date
Fair Value
|
|
|
Aggregate
Intrinsic Value
|
|
Nonvested, January 1, 2012
|
|
|
862,858
|
|
|
$
|
16.43
|
|
|
|
|
|
Granted
|
|
|
400,617
|
|
|
|
11.38
|
|
|
|
|
|
Vested
|
|
|
(305,435
|
)
|
|
|
14.57
|
|
|
|
|
|
Forfeited
|
|
|
(14,263
|
)
|
|
|
15.33
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested, September 30, 2012
|
|
|
943,777
|
|
|
$
|
14.90
|
|
|
$
|
9,938
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additionally, the Company grants restricted stock units. Prior to 2012, the restricted stock units were performance-based
units. The performance-based units have performance conditions and service-based vesting conditions. Each vesting tranche is treated as an individual award and the compensation expense is recognized on a straight-line basis over the
12
requisite service period for each tranche. The requisite service period is a combination of the performance period and the subsequent vesting period based on continued service. The level of
achievement of such goals may cause the actual amount of units that ultimately vest to range from 0% to 200% of the original units granted which is reflected as performance factor adjustment in the table below. The Company recognizes expense for
performance-based restricted stock units when it is probable that the performance criteria specified will be achieved. The fair value is equal to the market price of the Companys common stock on the date of grant. Expense is amortized ratably
over the vesting period. In 2012, grants of restricted stock units contained market-based conditions. Market-based awards entitle employees to vest in a number of units determined by the Companys stock price return as compared to a set of
comparator companies over a period and will range from 0% to 200% of the original units granted. The fair value is calculated using a Monte Carlo simulation model on the date of grant. Compensation expense is recognized over the requisite service
periods using the straight-line method regardless of the outcome of the market conditions so long as the award holder remains an employee through the requisite service period.
The fair value of the market-based restricted stock units utilized the following inputs and assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 Year
|
|
|
2 Years
|
|
|
3 Years
|
|
Closing stock price on grant date
|
|
$
|
11.23
|
|
|
$
|
11.23
|
|
|
$
|
11.23
|
|
Performance period starting price
|
|
$
|
12.78
|
|
|
$
|
12.78
|
|
|
$
|
12.78
|
|
Term of award (in years)
|
|
|
1
|
|
|
|
2
|
|
|
|
3
|
|
Volatility
|
|
|
45.91
|
%
|
|
|
50.99
|
%
|
|
|
51.66
|
%
|
Risk-free interest rate
|
|
|
0.17
|
%
|
|
|
0.30
|
%
|
|
|
0.47
|
%
|
Expected dividend yield
|
|
|
6.05
|
%
|
|
|
6.05
|
%
|
|
|
6.05
|
%
|
Fair value
|
|
$
|
6.68
|
|
|
$
|
10.70
|
|
|
$
|
12.34
|
|
The performance period starting price is measured as the average closing price over the last 20 trading days prior to the
performance period start.
The following table summarizes the restricted stock unit activity for the nine months ended September 30,
2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Restricted
Stock Units
|
|
|
Weighted-
Average
Grant-Date
Fair Value
|
|
|
Aggregate
Intrinsic Value
|
|
Nonvested, January 1, 2012
|
|
|
36,316
|
|
|
$
|
17.53
|
|
|
|
|
|
Granted
|
|
|
105,786
|
|
|
|
9.36
|
|
|
|
|
|
Vested
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
Forfeited
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested, September 30, 2012
|
|
|
142,102
|
|
|
$
|
11.45
|
|
|
$
|
1,496
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company recorded compensation of $1,373 and $6,520 in the accompanying consolidated statements of operations for the
three and nine months ended September 30, 2012, respectively, and $1,901 and $6,976, respectively, for the comparable periods of 2011 in connection with the issuance of the restricted stock and restricted stock units. As of September 30,
2012, 903,193 shares of restricted stock and 135,622 restricted stock units were expected to vest.
As of September 30, 2012, there was
$10,058 of total unrecognized compensation expense related to unvested share-based compensation arrangements, including market-based units, which is expected to be recognized over a weighted-average period of 1.5 years. The total unrecognized
compensation expense will be fully expensed through the second quarter of 2016.
6.
|
COMMITMENTS AND CONTINGENCIES
|
Litigation
On August 5, 2011, a
lawsuit was filed by a stockholder in the United States District Court for the Eastern District of Pennsylvania naming Nutrisystem, Inc., certain of its officers and directors, and one of its former officers as defendants and alleging breaches by
defendants of their fiduciary duties of candor, good faith and loyalty, unjust enrichment, and aiding and abetting from 2010 to the present in connection with the award of allegedly excessive and unwarranted 2010 executive compensation. Plaintiff
specifically claims the action to be a failed say-on-pay shareholder derivative action
13
stemming from the advisory, non-binding vote of the Companys stockholders at its May 12, 2011 annual meeting in which the Companys stockholders did not approve the Companys
2010 executive compensation. The complaint is listed under docket number 2:11-cv-05036-PD and specifically alleges that (1) defendants breached their fiduciary duties in connection with the issuance of certain false and misleading statements
contained in Nutrisystems Proxy Statement; (2) defendants breached their fiduciary duties in connection with the Board of Directors compensation practices; (3) defendants breached their fiduciary duties in connection with the
Companys failure to respond to the negative say-on-pay vote; and (4) as a result of the foregoing defendants were unjustly enriched at the expense of the Company. Accordingly, the complaint asks the court to (1) award
judgment against defendants and in favor of the Company for an unspecified amount of damages sustained by the Company as a result of defendants violation of state law, (2) grant extraordinary equitable and/or injunctive relief as
necessary or permitted by law, equity and the statutory provisions cited in the complaint, including disgorgement, attachment, impoundment, imposition of a constructive trust on or otherwise restricting the disposition/exercise of improvidently
awarded executive compensation based upon false financial reporting and/or the proceeds of defendants trading activities or their other assets so as to ensure that plaintiff on behalf of the Company has an effective remedy; (3) order the
implementation and administration of internal controls and systems at the Company designed to prohibit and prevent excessive and/or unwarranted executive compensation payments to the Companys chief executive, chief financial, and other senior
executive officers; (4) award to plaintiff the costs and disbursements of the action, including reasonable attorneys fees, and accountants and expert fees, costs and expenses; and (5) grant such other and further relief as the
court deems just and proper. On October 21, 2011, defendants filed a motion to dismiss the complaint pursuant to Rules 12(b)(6) and 23.1 of the Federal Rules of Civil Procedure for failure to state a claim upon which relief can be granted and
for failure to adequately plead demand futility. On November 21, 2011, plaintiff filed his brief in opposition to defendants motion to dismiss the complaint and alleged that the directors issued false and misleading statements in the
Companys proxy statement by stating that the Company adhered to a pay-for-performance policy when in fact it did not. In its opposition brief, plaintiff abandoned the count contained in its complaint that defendants breached their fiduciary
duties in connection with the Companys failure to respond to the negative say-on-pay vote. On December 5, 2011, defendants filed their reply brief in support of their motion to dismiss the complaint. On March 8, 2012, the
court held a preliminary pretrial conference, and on May 16, 2012, the court held a settlement conference. Although the Company continues to believe that the claims are without merit, on September 5, 2012 plaintiff, defendants and the
plaintiff in the related state court lawsuit discussed in the following paragraph entered into a Stipulation and Agreement of Settlement with respect to all of the claims at issue under the respective lawsuits, and on September 13, 2012, the
court issued an order preliminarily approving the settlement. The court has scheduled a settlement hearing for November 15, 2012 to finally approve the settlement. If the settlement is not approved by the court, or if the settlement agreement
is terminated for any reason, the settlement will be vacated, plaintiff, defendants and the plaintiff in the related state court lawsuit will be restored to their respective positions as of September 5, 2012, and the Company will continue to
defend the litigation vigorously. The Companys entire exposure for these matters has been expensed through September 30, 2012.
On
September 1, 2011, a lawsuit was filed by another stockholder in the Court of Common Pleas of Montgomery County, Pennsylvania naming Nutrisystem, Inc., certain of its officers and directors, and one of its former officers as defendants and
alleging breaches by defendants of their fiduciary duties of care, candor, good faith and loyalty, unjust enrichment, and aiding and abetting from 2010 to the present in connection with the award of excessive and unwarranted 2010 executive
compensation. This action stems from the same failed say-on-pay advisory, non-binding vote of the Companys stockholders at its May 12, 2011 annual meeting in which the Companys stockholders did not approve the
Companys 2010 executive compensation. The complaint is listed under docket number 2011-24985-0 and specifically alleges that (1) defendants breached their fiduciary duties in connection with the issuance of certain materially false and
misleading statements and omissions of fact in Nutrisystems Proxy Statement; (2) defendants breached their fiduciary duties in connection with the Companys allegedly excessive 2010 executive compensation and the failure to rescind
such compensation in response to the negative say-on-pay vote; and (3) as a result of the foregoing the executive defendants were unjustly enriched at the expense of the Company. Accordingly, the complaint asks the court to
(1) determine that the action is a proper derivative action maintainable under the law and that demand is excused; (2) award judgment against defendants and in favor of the Company for an unspecified amount of damages sustained by the
Company as a result of defendants breaches of fiduciary duties; (3) grant injunctive and other equitable relief as necessary or permitted by law, equity and the statutory provisions cited in the complaint, including disgorgement,
attachment, impoundment, imposition of a constructive trust on or otherwise restricting the disposition/exercise of disloyally awarded 2010 executive compensation; (4) direct the Company to take all necessary actions to reform and improve its
corporate governance and internal procedures to comply with all applicable laws and to protect the Company and its stockholders from a repeat of the allegedly damaging events described in the Complaint; (5) award to plaintiff the costs and
disbursements of the action, including reasonable allowance of fees and costs for plaintiffs attorneys, experts and accountants; and (6) grant such other and further relief as the court deems just and proper. On November 10, 2011,
14
defendants filed preliminary objections to the complaint asserting (1) the court should decline to exercise subject matter jurisdiction over the action pursuant to Pennsylvania Rule of Civil
Procedure 1028(a)(1) and (a)(4) under Pennsylvanias internal affairs doctrine; (2) failure to state a claim upon which relief may be granted under Pennsylvania Rule of Civil Procedure 1028(a)(4); and (3) lack of capacity to sue under
Pennsylvania Rule of Civil Procedure 1028(a)(5) because plaintiff did not make a demand on the Companys directors and failed to adequately allege that such demand was excused. On November 21, 2011, defendants filed a praecipe for argument
in which they requested oral argument. On December 23, 2011, plaintiff filed his opposition to defendants preliminary objections and alleged that the directors issued false and misleading statements in the Companys proxy statement
by stating that the Company adhered to a pay-for-performance policy when in fact it did not. On January 23, 2012, defendants filed their reply brief in support of their preliminary objections to the complaint. Oral argument was heard by the
court on February 8, 2012, and on February 13, 2012, the court denied defendants preliminary objections. On March 14, 2012, defendants filed an answer and new matter in response to the complaint, and on April 10, 2012
plaintiff filed its reply to defendants new matter. Plaintiff participated in the settlement conference on May 16, 2012 in connection with the lawsuit described in the preceding paragraph that was filed by another stockholder in the
United States District Court for the Eastern District of Pennsylvania stemming from the same failed say-on-pay advisory, non-binding vote of the Companys stockholders at its May 12, 2011 annual meeting in which the
Companys stockholders did not approve the Companys 2010 executive compensation. Although the Company continues to believe that the claims are without merit, on September 5, 2012 plaintiff, defendants and the plaintiff in the related
federal court lawsuit discussed in the preceding paragraph entered into a Stipulation and Agreement of Settlement with respect to all of the claims at issue under the respective lawsuits, and on September 13, 2012, the federal court issued an
order preliminarily approving the settlement. The federal court has scheduled a settlement hearing for November 15, 2012 to finally approve the settlement. Additionally, the state court asked the parties to the state action to submit a proposed
order dismissing the state action for the state court to sign upon the federal courts dismissal of the federal action. The parties to the state action submitted the proposed order to settle, discontinue, and end on October 2, 2012, which
the parties expect the state court to enter upon final approval of the settlement by the federal court. If the settlement is not approved by the federal court, or if the settlement agreement is terminated for any reason, the settlement will be
vacated, plaintiff, defendants and the plaintiff in the related federal court lawsuit will be restored to their respective positions as of September 5, 2012, and the Company will continue to defend the litigation vigorously.
The Company is also involved in other various claims and routine litigation matters. In the opinion of management, after consultation with legal counsel,
the outcomes of such matters are not anticipated to have a material adverse effect on the Companys consolidated financial position, results of operations or cash flows in future years.
Contractual Commitments
The Company has entered into supply agreements with various food
vendors. The majority of these agreements provide for annual pricing and annual purchase obligations, as well as exclusivity in the production of certain products, with terms of five years or less. One agreement also provides rebates if certain
volume thresholds are exceeded. The Company anticipates it will meet all annual purchase obligations in 2012. Certain agreements with frozen food suppliers require advance payments to the supplier. As of September 30, 2012 and December 31,
2011, advances were $1,308 and $2,907, respectively. A portion of the supplier advances as of December 31, 2011 was classified as other assets in the accompanying consolidated balance sheets. Included in these amounts are advances to a frozen
food supplier whereby the Company has committed to purchase up to $10,000 of product through 2013. As of September 30, 2012 and December 31, 2011, advances to this frozen food supplier were $690 and $2,313, respectively. The Company
has been notified that this supplier is in default with its bank lender and is in the process of negotiating a work out plan and exploring other strategic alternatives. During the three months ended September 30, 2012, the Company recorded
an impairment charge of $2,100 related to this advance. The impairment was recorded in general and administrative expense in the accompanying statement of operations. If this supplier continues to be unsuccessful in negotiating a work out plan or
consummating a strategic alternative, its bank lender may take a number of actions, including foreclosing on the assets of this supplier, which may adversely impact the Companys ability to receive repayment of the remaining advance payments to
this supplier. The Company has a first priority security interest in certain equipment of the supplier and that interest has been consented to by the bank. The Company believes other frozen food supply options are available to replace this supplier
and has been actively exploring those options.
Generally accounting
standards require companies to provide for income taxes each quarter based on their estimate of the effective tax rate for the full year. The authoritative guidance for accounting for income taxes allows use of the discrete method when, in certain
situations, the actual interim period effective tax rate provides a better estimate of
15
income tax expense. As a small variation in expected income leads to wide variations in annual effective tax rates, the Company believes that the discrete method provides a more accurate estimate
of income tax expense and therefore income tax expense for the quarter ended September 30, 2012 has been presented using the discrete method. The Company recorded income taxes at an income tax rate applied to income before income taxes of
(54.3)% and (88.6)% in the three and nine months ended September 30, 2012, respectively, as compared to 36.7% and 36.5% in the comparable periods of 2011. The decrease in the income tax rate was due to the elimination of the limitation on
executive compensation deductions, lower income levels, reductions in tax reserves and increased food donations. The Company offsets taxable income for state tax purposes with net operating loss carryforwards. At December 31, 2011, the Company
had net operating loss carryforwards of approximately $12,832 for state tax purposes. For state tax purposes, there is a limitation on the amount of net operating loss carryforwards that can be utilized in a given year to offset state taxable income
and management believes that some of the net operating loss carryforwards will be subject to this annual limit in 2012. State net operating loss carryforwards will begin to expire in 2024. The total amount of gross unrecognized tax benefits as of
September 30, 2012 and December 31, 2011 was $1,761 and $1,919, respectively. The total amount of unrecognized tax benefits that, if recognized, would affect the effective income tax rate is approximately $1,145 and $1,247, respectively.
Based on the projected level of future taxable income over the periods in which the deferred tax assets are deductible, management believes
it is more likely than not that the Company will realize the net deferred tax assets.
16