Nutrisystem 2005 Annual Report Download - page 28

Public Accountants Statement of Position 93-7, “Reporting for 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,
facility expenses, website development costs, professional service fees and other general corporate expenses.
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 tax rate for the year.
Reclassifications
Beginning with the second quarter of 2004, we reclassified compensation related to fulfillment, the costs of
outside fulfillment and commissions paid on direct sales from general and administrative expenses to cost of
revenue. At the same time, we reclassified the cost of non-food materials provided with customer purchases from
marketing to cost of revenue. Prior year amounts have been reclassified to conform to the current period
presentation.
Overview of the Direct Channel
Our revenue and profitability have increased substantially from 2004 to 2005 driven primarily by profitable
growth in the direct channel. In the years ended 2005 and 2004, the direct channel represented 89% and 81%,
respectively, of our revenue. We have increased direct channel revenue largely by increasing the number of new
customers. New customer growth is dependent on our ability to increase purchases of marketing media in a cost
effective manner. Factors influencing the cost effectiveness of our advertising include the perceived value
proposition offered to our target consumers, the quality of the advertisements and the cost and availability of
various forms of media. We also generate new customers by referrals made by existing customers. We anticipate
that we will generate an increasing amount of revenue from returning customers in the future as the number of
former customers accumulates.
For the direct channel, our primary financial objectives are to generate growth while maintaining profit
margins. We measure growth in terms of the number of new customers, revenue per new customer and total
revenue. A new customer is defined as a first time purchaser through the direct channel. We define a customer
with an initial purchase of $100 or more to be a “program” new customer. These customers tend to stay on a
weight loss program longer and spend substantially more than customers that make an initial purchase of less
than $100. Profit margins are measured in terms of gross margin (revenue less cost of revenue) and total
marketing expense as a percentage of revenue. We evaluate the cost effectiveness of our marketing programs
based on the marketing cost per new customer acquired.
To be consistent with the presentation of our consolidated financial statements, we began including
commissions in cost of revenue in our overview of the direct channel in 2005. Prior year amounts have been
adjusted to conform to the current period presentation.
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