Nutrisystem 2008 Annual Report Download - page 32

We estimate the annual effective income tax rate at the beginning of each year and revise the estimate at
each reporting period based on a number of factors including operating results, level of tax exempt interest
income and sales by state, among other items.
Results of Operations
Revenue and expenses consist of the following components:
Revenue. Revenue consists primarily of food sales. Food sales include sales of food, supplements, shipping
and handling charges billed to customers and sales credits and adjustments, including product returns. No
revenue is recorded for food products provided at no charge as part of promotions.
Cost of Revenue. Cost of revenue consists primarily of the cost of the products sold, including compensation
related to fulfillment, the costs of outside fulfillment, incoming and outgoing shipping costs, charge card fees and
packing material. Cost of products sold includes products provided at no charge as part of promotions and the
non-food materials provided with customer orders. Cost of revenue also includes the fees paid to independent
distributors and sales commissions.
Marketing Expenses. Marketing expense includes media, advertising production, marketing and promotional
expenses and payroll-related expenses for personnel engaged in these activities. We follow the American
Institute of Certified Public Accountants Statement of Position 93-7, “Reporting on Advertising Costs.” Internet
advertising expense is recorded based on either the rate of delivery of a guaranteed number of impressions over
the advertising contract term or on a cost per customer acquired, depending upon the terms. Direct-mail
advertising costs are capitalized if the primary purpose was to elicit sales to customers who could be shown to
have responded specifically to the advertising and results in probable future economic benefits. The capitalized
costs are amortized to expense over the period during which the future benefits are expected to be received. All
other advertising costs are charged to expense as incurred.
General and Administrative Expenses. General and administrative expenses consist of compensation for
administrative, information technology, counselors (excluding commissions) and customer service personnel,
share-based payment arrangements, facility expenses, website development costs, professional service fees and
other general corporate expenses.
Equity and Impairment Loss. Equity and impairment loss consists of our share of the earnings or losses and
estimated impairment losses of our equity interests. We hold an approximate 27% fully diluted interest in Zero
Water and have the ability to participate in the operations of Zero Water. The investment in Zero Water is
accounted for using the equity method of accounting.
Interest Income, Net. Interest income, net consists of interest income earned on cash balances and
marketable securities, net of interest expense.
Income Taxes. We are subject to corporate level income taxes and record a provision for income taxes based
on an estimated effective income tax rate for the year.
Overview of the Direct Channel
In the years ended 2008, 2007 and 2006, the direct channel represented 93%, 94% and 93%, respectively, of
our revenue. Net sales through the direct channel were $639.0 million in 2008 compared to $727.6 million in
2007 and $526.7 million in 2006. The decrease in 2008 is primarily attributable to the decline in customer starts
due to the weakening economy. Revenue is primarily generated through customer starts and the customer
ordering behavior, including length of time on our program and the diet program selection. Critical to increasing
customer starts is our ability to deploy marketing dollars while maintaining marketing effectiveness. Factors
influencing our marketing effectiveness include the quality of the advertisements, promotional activity by our
competitors, as well as the price and availability of appropriate media.
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