Nutrisystem 2007 Annual Report Download - page 32

Excess and Obsolete Inventory. We continually assess the quantities of inventory on hand to identify excess
or obsolete inventory and record a provision for the potential loss. We estimate the reserve for excess and
obsolete inventory based primarily on our forecasted demand and/or our ability to sell the products, future
production requirements and changes in our customers’ behavior. The reserve for excess and obsolete inventory
was $516,000 and $450,000 at December 31, 2007 and 2006, respectively.
Income Taxes. For the year ended December 31, 2007, we recorded income tax expense of $60.9 million,
which reflected an effective income tax rate of 36.7%. For the year ended December 31, 2006, we recorded $51.0
million of income taxes, which reflected an effective income tax rate of 37.3%. 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 Loss. Equity loss consists of our share of the earnings or losses of our equity interests. We hold an
approximate 27% interest in Zero Technologies, LLC (“Zero Water”) and have the ability to significantly
influence 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.
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