Nutrisystem 2005 Annual Report Download - page 31

the year ended December 31, 2005, direct accounted for 89% of total revenue, while QVC, field sales, case
distributor and Slim and Tone revenue accounted for 7%, 2%, 1% and 1% of revenue, respectively. In 2004, the
comparable percents were 81%, 11%, 5%, 3% and 0%, respectively.
Costs and Expenses. Cost of revenue increased $87.8 million to $109.4 million for the year ended
December 31, 2005 from $21.6 million for the year ended December 31, 2004. Gross margin as a percent of
revenue increased to 48.5% in 2005 from 43.1% in 2004. The increase in gross margin is primarily attributable to
a 3.4 percentage point increase in our direct channel gross margin (discussed above) and a greater proportion of
our revenue was represented by the higher margin direct channel (89% in 2005 versus 81% in 2004). The
remaining increase in gross margin is primarily attributable to the full year impact of Slim and Tone, which was
acquired in December 2004, and therefore had minimal impact on 2004 results.
Marketing expenses increased $40.3 million to $47.8 million in 2005 from $7.5 million in 2004. Almost all
marketing spending promoted the direct business, and the increase in marketing is attributable to increased
spending for advertising media ($38.8 million), payroll related to marketing and advertising ($764,000) and
production of television advertising ($510,000). In total, advertising media spending was $44.1 million in 2005
and $5.3 million in 2004. Fourth quarter 2005 marketing expenses included about $380,000 in production costs
for infomercial and short form television advertisements that were charged to expense when they first aired in
November and December 2005. This compares to the fourth quarter 2004 when marketing expenses included
about $800,000 in production and talent costs for an infomercial and short form television advertisements that
were charged to expense when they first aired in late December 2004.
General and administrative expenses increased $14.0 million to $21.0 million in 2005 from $7.0 million in 2004.
The increase is attributable to higher costs associated with the increase in revenue, especially compensation and
benefits costs ($7.4 million); professional, computer and temporary staffing services ($3.1 million); telephone
and internet expenses ($944,000); office related expenses including rent and supplies ($901,000); sales, use and
miscellaneous taxes ($540,000); travel and conference expenses ($427,000); new product and program
development and associated packaging expenses ($405,000); and insurance ($306,000). General and
administrative expenses in 2005 included approximately $965,000 in costs associated with our Sarbanes-Oxley
compliance initiatives including consulting and accounting fees, but excluding compensation expense for
additional internal staff.
Interest Income, Net. Interest income, net increased $824,000 to $860,000 in 2005 from $36,000 in 2004
primarily due to higher average balances in cash and marketable securities.
Income Taxes. In 2005, we recorded income tax expense of $13.1 million, which reflects an effective tax
rate of 38.5%. The effective tax rate in 2005 was less than the statutory rate due to reduction of a state tax
valuation allowance and tax-free interest income. In 2004, we recorded $680,000 of income tax expense for the
reporting period. The effective tax rate in 2004 was 40.0%.
Net Income. For the year ended December 31, 2005, net income increased by $20.0 million to $21.0
million from net income of $1.0 million in 2004. The increase in net income in 2005 is primarily due to higher
gross profit in 2005 versus 2004 resulting from increased revenue offset by higher advertising and marketing
spending, general and administrative expenses and income taxes.
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