10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the fiscal year ended December 31, 2004

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the transition period from              to             

Commission File Number 0-28551

NutriSystem, Inc.

(Exact name of Registrant as specified in its charter)

Delaware	23-3012204
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
200 Welsh Road, Horsham, Pennsylvania	19044
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (215) 706-5300

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $.001 par value

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x    No  ¨.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes  ¨    No  x.

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2004, was $29,686,639. Such aggregate market value was computed by reference to the closing price of the common stock as reported on the American Stock Exchange on June 30, 2004.

Number of shares outstanding of the Registrant’s Common Stock, $0.001 par value, as of March 24, 2005: 30,725,184 shares

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be filed with the Securities and Exchange Commission for NutriSystem, Inc.’s Annual Meeting of Stockholders to be held on May 24, 2005, are incorporated by reference into Part III of this Form 10-K.

NutriSystem, Inc.

Table of Contents

		Page
	PART I
Item 1.	Business	3
Item 2.	Properties	11
Item 3.	Legal Proceedings	11
Item 4.	Submission of Matters to a Vote of Security Holders	11
	PART II
Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	11
Item 6.	Selected Consolidated Financial Data	12
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 7A.	Quantitative and Qualitative Disclosure about Market Risk	23
Item 8.	Financial Statements and Supplementary Data	23
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	23
Item 9A.	Controls and Procedures	23
Item 9B.	Other Information	23
	PART III
Item 10.	Directors and Executive Officers of the Registrant	24
Item 11.	Executive Compensation	24
Item 12.	Securities Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	24
Item 13.	Certain Relationships and Related Transactions	24
Item 14.	Principal Accountant Fees and Services	24
	PART IV
Item 15.	Exhibits and Financial Statement Schedules	25

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PART I

ITEM 1. BUSINESS

Background

NutriSystem, Inc., (a Delaware corporation), together with its subsidiaries (“NutriSystem” or the “Company”), provides weight management and fitness products and services. The NutriSystem diet program was originally developed by the Company’s predecessor businesses that operated through company-owned and franchised weight loss centers. Currently, there are no Company-operated centers and the Company terminated its last franchise agreements in 2003. There are 15 independent center-based distributors who operate without franchise agreements (“Case Distributors”). In 1998, the Company initiated a marketing program using independent commissioned representatives. In late 1999, the Company began selling directly to the consumer through the Internet and by telephone. In 2001, the Company began selling foods through QVC, a television shopping network. The Company’s pre-packaged foods are now sold to weight loss program participants directly via the Internet and telephone (the “Direct” channel) and through independent commissioned representatives (the “Field Sales” channel), Case Distributor weight loss centers (the “Case Distributor” channel) and QVC. On December 2, 2004, NutriSystem Inc. acquired Slim and Tone LLC, a franchisor of women’s express fitness centers. Slim and Tone franchisees now sell the NutriSystem diet program in their centers as independent commissioned representatives.

Since the NutriSystem businesses began in 1972, the businesses have operated in various organizational and legal structures, and were subject to a bankruptcy proceeding in 1993, which was discharged in 1994. NutriSystem became a publicly traded company in October 1999. In September 2000, the Company changed its name from nutrisystem.com inc. to Nutri/System, Inc. and in 2003, the Company changed its name to NutriSystem, Inc.

In 2001, the Company discontinued sales of the Sweet Success line of diet meal replacement products it had acquired the year before. In December 2002, the Company sold the intellectual property associated with Sweet Success. Sweet Success is reflected in the Consolidated Financial Statements as a discontinued operation.

In December 2002, HJM Holdings LLC and NewSpring Ventures, L.P. collectively acquired 58.4% of the outstanding shares of common stock from existing stockholders effecting a change in control of the Company. The Company was not a party to the transaction. In 2004, HJM Holdings LLC distributed its NutriSystem shares to its partners and dissolved. Currently, no affiliated group owns more than 15% of the common stock of the Company.

Industry

Weight loss is a challenge for a significant portion of the American population. According to a study published in the October 2002 Journal of the American Medical Association, approximately 127 million Americans are overweight. Furthermore, according to the National Center for Health Statistics, the incidence of obesity in the United States, as defined by federal guidelines, increased between 1980 and 2000 from 15% to 31% of the adult population. Many medical studies have documented a link between obesity and a variety of health concerns. With obesity rates escalating, Americans are increasingly at risk for diseases such as diabetes, certain cancers and various forms of heart disease that may be linked to obesity.

The weight loss industry consists of a wide variety of diet foods and meal replacement bars and shakes, appetite suppressants, nutritional supplements, pharmaceutical products and weight loss programs. The domestic market for weight loss programs, diet foods and diet related books and other information, excluding vitamins, supplements and minerals, was estimated by Market Data Enterprises, Inc. to be in excess of $7 billion in 2000.

Products and Services

For 30 years, the NutriSystem name has been recognized as a leader in the weight loss industry. By telephone and through its web site, www.nutrisystem.com, NutriSystem provides a comprehensive weight management program, consisting of support for dieters and a pre-packaged food program. Online support for dieters includes individualized diet and exercise plans, online counseling, support groups, bulletin boards, online classes and chat rooms. Trained counselors are available 126 hours a week to answer questions and custom-design and recommend an exercise program to help each member achieve his or her weight loss and fitness goals. Members share information and encouragement with each other through hosted chat rooms and bulletin boards. These services are complemented with relevant information on diet, nutrition, exercise and well-being provided on the web site. NutriSystem provides free membership and access to telephone and online support.

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In December 2003, the Company introduced NutriSystem Nourish, a new line of pre-packaged, portion-controlled food sold under the NutriSystem brand. The NutriSystem Nourish program consists of a menu of over 140 food selections with a low glycemic index that provide dieters with a balanced intake of “good” carbohydrates. NutriSystem Nourish also features new, easy-to-use exercise and behavior modification programs.

Typically, our customers purchase monthly food packages containing 28 breakfasts, lunches, dinners and snacks, which they supplement with fresh milk, fruit and vegetables. Most customers order on an auto delivery basis in which the Company sends food to the customer on an ongoing monthly basis until notified by the customer to cease shipments. With the auto delivery program, a full day’s supply of entrees and snacks currently are priced at less than $10.00 a day. The food is shelf stable at room temperature, making it relatively inexpensive to ship and store. On the web site, members can order food 24 hours a day, seven days a week.

The Company’s telephone and online support addresses many of the most common limitations of traditional weight loss programs, including high initiation and recurring membership fees, the inconvenience of traveling to weight loss centers for scheduled appointments and lack of privacy. In addition, the Company’s program allows members to participate conveniently and privately from their own homes or offices.

The Company’s pre-packaged foods are also sold to weight loss program participants through QVC, as well as through the Field Sales and Case Distributor channels.

On December 2, 2004, NutriSystem Inc. acquired Slim and Tone LLC, a franchisor of women’s express fitness centers. Slim and Tone franchisees provide women with an exercise facility that is safe, quick, comfortable, supportive and one that meets their unique needs. Customers obtain a 30 minute workout using hydraulic resistance training equipment. Franchise operators now offer the NutriSystem Nourish program to their clients, providing a comprehensive weight loss program that brings together diet and exercise.

Marketing

The Company’s primary marketing objective is to leverage NutriSystem’s established brand cost effectively to build sales of its food program through its Direct channel. The Company uses a combination of online and traditional offline advertising and promotional strategies.

Offline advertising. Offline advertising is used to encourage qualified customers to call or visit the Company’s web site and increase awareness of the online program. Offline, NutriSystem reaches its target audience primarily through a combination of television, print, and direct mail advertising. On television and in print, direct response-focused advertisements capitalize on the NutriSystem brand name and focus on “before and after” comparison and/or the program’s simplicity, convenience and “good carb” features. Direct mail is a companion to the media advertising and consists of mailings to Direct members who have purchased or signed up for membership.

Online advertising. The Company’s online advertising strategy includes the use of keyword search terms, affiliate programs, email newsletters and targeted direct email programs, primarily to its own email database of current and prior members. The Company currently places the bulk of its online banner advertising through affiliate programs that compensate advertisers on a cost per customer acquired (CPA) basis.

Promotion. Starting in the fourth quarter of 2003, the Company expanded its efforts to generate visibility in various press, television and radio outlets and improve public awareness of the brand. For example, the Company had promotional success through Zora Andrich, a spokesperson who was the winner of the Joe Millionaire reality TV show, as a featured dieter in a television reality makeover show, and as a subject of various magazine articles on dieting.

Fulfillment

The Company currently leases approximately 97,600 square feet of office and warehouse space in Horsham, Pennsylvania pursuant to a lease expiring in 2009 at an annual rent of $667,248. In December 2003, the Company obtained additional fulfillment capacity in central Pennsylvania and Sparks, Nevada through an outsourced provider. Management believes the Horsham facility combined with the outsourced fulfillment capacity are adequate for the Company’s needs for the foreseeable future. The Company also maintains 1,400 square feet of office space in Yardley, Pennsylvania in connection with the Slim and Tone acquisition. This lease expires in 2006 at an annual rent of $24,615.

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The Company operates an integrated order receipt, billing, picking, shipping and delivery tracking system comprised of proprietary and third party components. This system integrates the front end, or web site customer interface, with order processing and shipping, and allows Internet customers to access shippers’ order tracking numbers online. The Company’s computer-assisted picking system allows for virtually paperless order picking in all warehouse facilities. Management believes the integration of its shipping systems with the operations of its outsourced fulfillment operations is satisfactory.

Except in periods of unusually high demand, management believes that virtually all Direct customer orders received by 2:00 p.m. weekdays are shipped on the day received. Direct customers are not charged for their orders until the ordered product is shipped. Management estimates that it can ship to 90% of the domestic population from its owned or outsourced warehouse facilities within four business days using standard ground transportation. The Company ships to its customers using either Federal Express, United Parcel Service or US Mail. It does not currently charge customers for shipping and handling on auto delivery food orders.

Technology

The Company’s web site is hosted at a remote third party hosting facility with a backup at the Company’s headquarters in Horsham, PA. The hosting facility provides technologically advanced physical and fire security and electric power back up for the equipment on which the Company’s web site operates. The Company’s servers and its network are monitored 24 hours a day, seven days a week. Servers at both sites are connected on a continuous, real-time basis, which allows the Company to move the website from primary to backup without any loss of data.

Competition

The weight loss industry consists of pharmaceutical products and weight loss programs, as well as a wide variety of diet foods and meal replacement bars and shakes, appetite suppressants and nutritional supplements. The weight loss market is served by a diverse array of competitors. Potential customers seeking to manage their weight can turn to traditional center-based competitors, medically supervised programs, online diet-oriented sites or other self-administered products and programs.

The principal competitive factors in the weight loss market are:

• the ability to attract and retain customers through promotion and personal referral;

• the availability, convenience and effectiveness of the weight reduction program;

• brand recognition and trustworthiness; and

• program pricing.

Management believes it can compete effectively on these factors. However, it has no control over how successful competitors will be in addressing these factors. By providing a well-recognized food-based program using the Direct channel, management believes it has gained a competitive advantage in that market.

The women’s express workout market is dominated by Curves, which operates in approximately 8,000 locations. To succeed as a franchisor, Slim and Tone must have a successful network of franchisees and it must attract new franchisees to the business.

The principal competitive factors in the women’s express workout market are:

• the ability to attract and retain customers through effective site selection, center operator-led advertising and promotional efforts and an appealing and differentiated program offering;

• the ability to attract capable franchise operators by promoting the franchise opportunity, offering a compelling business model and providing support to the existing franchise network; and

• pricing to both the end consumer and the franchise operator.

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Management believes it can compete effectively on these factors. It believes the addition of the NutriSystem diet program enhances Slim and Tone’s market position and provides additional brand recognition.

In both the diet and workout markets, many current and potential competitors have larger customer bases, similar or greater brand recognition and significantly greater financial, marketing and other resources than the Company’s. Competitors have and are expected to continue to adopt aggressive pricing schemes and innovative product and service offerings. Increased competition may result in reduced operating margins, an inability to increase market share and a diminished brand franchise for NutriSystem and Slim and Tone.

Seasonality

Typically, revenues of weight loss business are lowest in the fourth calendar quarter and during the summer months. As a franchisor in the women’s express workout market, Slim and Tone experiences relatively little seasonality.

Employees

As of March 15, 2005, the Company had 102 administrative employees including counselors and customer service personnel, 40 employees dedicated to fulfillment and 13 employees in marketing. None of the Company’s employees are represented by a labor union and the Company considers its relations with its employees to be good.

Available Information

All periodic and current reports, registration statements, code of conduct, code of ethics and other material that the Company is required to file with the Securities and Exchange Commission (“SEC”), including the Company’s annual report on Form 10-K, quarterly reports on Form10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 (the “1934 Act Reports”), are available free of charge through the Company’s investor relations page at www.nutrisystem.com. Such documents are available as soon as reasonably practicable after electronic filing of the material with the SEC. The Company’s Internet web site and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.

The public may also read and copy any materials filed by the Company with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site, www.sec.gov, which contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

Executive Officers of the Company

The Company’s executive officers and their respective ages and positions as of December 31, 2004 are as follows:

Name	Age	Position
Michael J. Hagan	42	Chairman, Chief Executive Officer and Director
George Jankovic	37	President, Chief Operating Officer and Director
James D. Brown	47	Chief Financial Officer, Secretary & Treasurer
Brendon Perero	28	Chief Information Officer

Michael J. Hagan was appointed Chairman of the Board of Directors and Chief Executive Officer of the Company on December 20, 2002. Prior to joining the Company, Mr. Hagan was the co-founder of Verticalnet, Inc., a business-to-business internet and software company, and held a number of executive positions at Verticalnet since its founding in 1995, including Chairman of the Board from February 2002 to the present, president and Chief Executive Officer from January 2001 to February 2002, Executive Vice President and Chief Operating Officer from January 2000 to January 2001 and Senior Vice President prior to that time. Prior to founding Verticalnet, Mr. Hagan was a Vice President and

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Senior Manager at Merrill Lynch Asset Management from 1990 to 1995, and worked for Bristol Meyers Squibb from 1988 to 1990. Mr. Hagan is a director of Verticalnet, Inc. and American Financial Realty Trust. Mr. Hagan is also a trustee of Saint Joseph’s University. Mr. Hagan was a CPA in the State of Pennsylvania (license lapsed).

George Jankovic was appointed President and Chief Operating Officer of the Company on December 20, 2002. Prior to joining the Company, Mr. Jankovic was the founder, Chairman and Chief Executive Officer of beMany, Inc., a provider of residential telecom and energy services, from September 1999 to November 2002. Mr. Jankovic was Vice President of Product Development of Verticalnet, Inc. from September 1998 to September 1999. Mr. Jankovic was co-founder and Chief Executive Officer of RF Globalnet, Inc. from March 1996 until it was acquired by Verticalnet in September 1998.

James D. Brown has been the Company’s Chief Financial Officer since December 1999 and its Treasurer since February 2000. Prior to joining NutriSystem, Mr. Brown was Chief Financial Officer of ImageMax, Inc., a document management company, from 1997 to 1999, and Chief Financial Officer of LMR Holdings, a holding company for textile component manufacturers, from 1996 to 1997. During 1995, Mr. Brown was President of Main Line Management, a management consulting firm, and from 1990 to 1994 he was Chief Financial Officer of Liberty Broadcasting Group, a consolidator of radio broadcasting properties, and Controller of Lancer Industries, Inc., a diversified manufacturer. Mr. Brown was a CPA in the State of New York (license lapsed).

Brendon R. Perero has been NutriSystem’s Chief Information Officer since August 1999. From 1997 to 1999, Mr. Perero was a Vice President and Senior Programmer/Developer of INetU, Inc., a firm engaged in Internet hosting and consulting. From 1997 to 1998, Mr. Perero was also a member of the Design Council for IBM Net.Commerce and collaborated with IBM for third party development of e-commerce software.

RISK FACTORS

You should consider carefully the following risks and uncertainties when reading this Annual Report on Form 10-K. If any of the events described below actually occur, the Company’s business, financial condition and operating results could be materially adversely affected.

If consumers do not widely accept an online or telephonic source for weight loss products and services, the Company will be unable to increase its customer base.

The Company’s success depends on attracting and retaining a high volume of online or telephonic customers. Factors that could impair consumer acceptance of purchasing weight loss products and services online or by telephone include problems with or customer concerns about:

• the security of online or telephonic transactions;

• the loss of privacy with respect to personal weight and health information;

• delays in responses to inquiries;

• delivery time associated with telephone or online orders, compared to the immediate receipt of products at a store or weight loss center;

• shipping charges, which do not apply to shopping at stores or traditional weight loss centers;

• concern about the ability to return or exchange orders;

• the absence of face-to-face contact with counselors and other dieters; and

• the loss of the discipline, accountability and support associated with group sessions.

If the Company does not receive adequate supply from its food and other manufacturers, revenues and earnings could suffer.

The Company relies solely on contract manufacturers to supply all of the food and other products it sells. The Company does not have written contracts with any suppliers and it is subject to numerous risks associated with these suppliers’ businesses, including labor disruptions, delivery problems, shortages of ingredients and equipment failure. If the Company cannot supply a sufficient quantity, quality and variety of products to its customers on acceptable commercial terms, it would lose revenues and market share, or incur higher costs.

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The Company is dependent on its Chief Executive Officer and other key managers for future success, and these persons are not obligated to stay with the Company.

The Company’s future success depends to a significant degree on the skills, experience and efforts of Michael J. Hagan, its Chief Executive Officer, and other key managerial personnel. The loss of the services of any of these individuals could harm the business. The Company does not have an employment agreement with Mr. Hagan or certain other key personnel. In addition, the Company has not obtained key person life insurance on any key employees. If any key employees left NutriSystem or were seriously injured and became unable to work, the business could be harmed.

The Company may be subject to health-related claims from members or customers.

The Company’s weight loss program does not include medical treatment or medical advice, and the Company does not engage physicians or nurses to monitor the progress of its members. A registered dietician is available to our diet counselors continuously. Many persons who are overweight suffer from other physical conditions, and NutriSystem’s target consumers could be considered a high-risk population in some respects. A member who experiences health problems could bring a lawsuit against the Company alleging that such problems were caused by participation in the weight loss program because certain side effects can be associated with weight loss. For example, the Company’s Predecessor Businesses suffered substantial losses due to allegations that their weight loss programs led to gall bladder disease, even though no medical link was proven. Persons who suffer side effects while participating in the program may assert claims against the Company whether or not the program was responsible for causing the effects. Although the Company carries general liability insurance, its insurance does not cover claims of these types.

The weight loss industry is subject to adverse publicity, which could harm the business.

The weight loss industry receives adverse publicity from time to time, and the occurrence of such publicity could harm the Company, even if the adverse publicity is not directly related to NutriSystem. In the early 1990s, the Company’s predecessor businesses were subject to extremely damaging adverse publicity relating to a large number of lawsuits alleging that the NutriSystem weight loss program led to gall bladder disease. This publicity was a factor that contributed to the bankruptcy of our predecessor businesses in 1993. More recently, predecessors to the Company were severely impacted by significant litigation and damaging publicity related to the use by members of the weight loss program of fen-phen as an appetite suppressant, which the Food and Drug Administration (the “FDA”) ordered withdrawn from the market in September 1997. The significant decline in business resulting from the fen-phen problems caused the predecessor businesses to close all of their company-owned weight loss centers. Congressional hearings about certain practices in the weight loss industry have also resulted in adverse publicity and a consequent decline in the revenues of weight loss businesses. Future research reports or publicity that are perceived as unfavorable or that question certain weight loss programs, products or methods could result in a decline in the Company’s revenues. Because of the Company’s dependence on consumer perceptions, adverse publicity associated with illness or other undesirable effects resulting from the consumption of the Company’s products or competitors’ similar products, whether or not accurate, could also damage customer confidence in the NutriSystem weight loss program and result in a decline in revenues. Adverse publicity could arise even if the unfavorable effects associated with weight loss products or services resulted from the user’s failure to use such products or services appropriately.

New weight loss products or services may put the Company at a competitive disadvantage.

On an ongoing basis, many existing and potential providers of weight loss solutions, including many pharmaceutical firms with significantly greater financial and operating resources than NutriSystem, are developing new products and services. The creation of a weight loss solution, such as a drug therapy, that was perceived to be safe, effective and “easier” than a portioned controlled meal plan, would put the Company at a disadvantage in the marketplace and results of operations could be negatively affected.

The weight loss industry is subject to governmental regulation that could increase in severity and hurt results of operations.

Certain advertising practices in the weight loss industry have led to investigations from time to time by the Federal Trade Commission (the “FTC”) and other governmental agencies. Many companies in the weight loss industry, including the Company’s predecessor businesses, have entered into consent decrees with the FTC relating to weight loss claims and other advertising practices. The Company continues to be subject to such consent decrees. These consent decrees restrict the manner in which the Company’s advertising describes the success members have achieved in losing weight through the program and require the Company to include the phrase “results not typical” in such advertisements.

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The Company cannot be sure that this regulation will not increase in scope or severity in the future, which could have a material adverse impact on its business. Remedies available in administrative actions may include requiring the Company to refund amounts paid by all affected customers or pay other damages, which could be substantial.

The Company may be subject to health-related claims or other liabilities by customers of certain predecessor businesses, and such claims or liabilities could adversely affect results of operations.

Certain of the Company’s predecessor businesses were subject to numerous claims based on various health-related concerns during their 30-year operating history, including most recently, claims related to the use of fen-phen. Wyeth (f/k/a American Home Products) has agreed to indemnify a predecessor business against the fen-phen claims. The Company has not been named in any such litigation, however, if it were, it would need to defend itself against such claims. Such litigation, regardless of its merit and ultimate outcome, is often lengthy and costly. Therefore, if the Company becomes involved in any such litigation, results of operations could be negatively affected.

The sale of ingested products involves product liability and other risks.

Like any other distributor of products that are ingested, the Company faces an inherent risk of exposure to product liability claims if the use of its products results in illness or injury. The food that the Company resells is subject to certain laws and regulations of the FDA, which establishes manufacturing practices and quality standards for food products. If the Company does not have adequate insurance or contractual indemnification from its suppliers, product liability claims could have a material adverse effect on the business. Distributors of weight loss food products, vitamins, nutritional supplements and minerals, including certain predecessor businesses, have been named as defendants in product liability lawsuits from time to time. The successful assertion or settlement of an uninsured claim, a significant number of insured claims or a claim exceeding the limits of the Company’s insurance coverage would harm it by adding costs to the business and by diverting the attention of senior management from the operation of the business. The Company may also be subject to claims that its products contain contaminants, are improperly labeled, include inadequate instructions as to use or inadequate warnings covering interactions with other substances. Product liability litigation, even if not meritorious, is very expensive and could also entail adverse publicity for the Company and reduce its revenues.

The Company may be subject to claims that its personnel are unqualified to provide proper weight loss advice.

Most of the Company’s counselors for our diet program do not have extensive training or certification in nutrition, diet or health fields and have only undergone the training they receive from the Company. NutriSystem may be subject to claims from its members alleging that its personnel do not have the qualifications necessary to provide proper advice regarding weight loss. The Company may also be subject to claims that its personnel have provided inappropriate advice or have inappropriately referred or failed to refer members for matters other than weight loss. Although the Company carries relevant liability insurance, such claims could result in damage to the Company’s reputation.

NutriSystem has a history of operating losses and an accumulated deficit and it may become unprofitable.

The Company incurred an operating loss in two of the last five years. As of December 31, 2004, the Company had an accumulated deficit of $21 million. The Company needs to continue to generate significant revenues to maintain profitability, and it may not be able to do so.

The Company’s stock price has been volatile and, in the past, its trading volume was low. These conditions may continue or worsen.

The Company’s common stock has, at times, traded at very low volumes. The Company cannot be assured of a consistently liquid trading market. In addition, the Company’s share price may decline for reasons related, or unrelated, to future operating results. For example, in October 2000, the Company’s share price declined substantially for reasons it believes are unrelated to operating performance. There are many factors, including the risk factors described in this Annual Report on Form 10-K, that may cause operating results to fluctuate or have a significant adverse effect on the market price of the Company’s common stock.

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Certain anti-takeover provisions in the Company’s certificate of incorporation and Delaware law may deter or prevent a change in control of the Company, even if that change would be beneficial to its stockholders.

Provisions of the Company’s certificate of incorporation, bylaws and Delaware law may have the effect of deterring unsolicited takeovers or delaying or preventing changes in control of the Company, including transactions in which its stockholders might otherwise receive a premium for their shares over then current market prices. In addition, these provisions may limit the ability of stockholders to approve transactions that they may deem to be in their best interests.

The Company’s certificate of incorporation permits its Board of Directors to issue preferred stock without stockholder approval upon such terms as its Board of Directors may determine. The rights of the holders of its common stock will be junior to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, a majority of the Company’s outstanding common stock. The issuance of a substantial number of preferred shares could adversely affect the price of the Company’s common stock.

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ITEM 2. PROPERTIES

The Company currently leases approximately 97,600 square feet of office and warehouse space in Horsham, Pennsylvania pursuant to a lease expiring in 2009 at an annual rent of $667,248. As discussed in Item 1, the Company also outsources some of its fulfillment operations. Management believes the Horsham facility, combined with its outsourced fulfillment capacity, is adequate for the Company’s needs for the foreseeable future. The Company also maintains 1,400 square feet of office space in Yardley, Pennsylvania as a result of the Slim and Tone LLC acquisition. This lease expires in 2006 at an annual rent of $24,615.

ITEM 3. LEGAL PROCEEDINGS

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None submitted.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s common stock traded on the NASDAQ OTC Bulletin Board from May 26, 2001 to May 11, 2004 and currently trades on the American Stock Exchange. The Company’s common stock trades under the symbol “NSI.” The following table sets forth, for the periods indicated, the high and low closing prices for the Company’s common stock as reported on the NASDAQ OTC Bulletin Board and American Stock Exchange.

	High		Low
2003 First Quarter	$	0.95	$	0.61
2003 Second Quarter		0.82		0.51
2003 Third Quarter		1.50		0.57
2003 Fourth Quarter		2.14		1.16
2004 First Quarter	$	4.01	$	1.69
2004 Second Quarter		4.00		1.65
2004 Third Quarter		1.98		1.09
2004 Fourth Quarter		3.14		1.42

On March 24, 2005, the closing price of the Company’s common stock on the American Stock Exchange was $6.21. As of March 24, 2005, the Company had approximately 383 record holders of its common stock.

The Company has not paid any dividends since its inception and currently does not foresee any future dividend payments. The declaration and payment of dividends in the future will be determined by the Company’s Board of Directors in light of conditions then existing, including the Company’s earnings, financial condition, capital requirements and other factors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources and other Financial Data.”

Recent Sales of Unregistered Securities

On February 12, 2004, the Company issued 10,000 and 1,000 shares of common stock to Zora Andrich and Ray Manzella, respectively, in consideration for marketing services. In granting the shares, the Company relied upon the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.

On June 28,2004, the Company issued 22,500 shares of common stock to CEOcast Inc., in consideration for Investor Relations services. In granting the shares, the Company relied upon the exemption from registration set forth in Section 4(2) of the Securities Act of 1933.

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ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data presented below have been derived from the Company’s Consolidated Financial Statements for each of the periods indicated. The data set forth below is qualified by reference to and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s Consolidated Financial Statements included as Items 7 and 8 in this Annual Report on Form 10-K.

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Selected Consolidated Financial Data

(in thousands, except per share data)

	Year Ended December 31,
	2004		2003			2002			2001			2000
Statement of Operations Data:
Revenues:
Total revenues	$	37,996	$	22,575		$	27,569		$	23,798		$	20,202
Costs and expenses:
Cost of revenues		21,612		14,870			17,655			14,385			11,711
Marketing		7,548		3,539			1,263			3,565			8,432
General and administrative		7,039		5,829			5,902			5,169			5,432
New program development		—		599			—			—			—
Depreciation and amortization		268		223			336			418			307
Operating income (loss) from continuing operations		1,529		(2,485	)		2,413			261			(5,680	)
Other income (loss)		134		—			(100	)		77			84
Equity in losses of affiliate		—		(157	)		(143	)		—			—
Interest income, net		36		57			41			98			198
Income tax provision (benefit)		680		(3,397	)(a)		—			—			—
Discontinued operation		—		—			200	(b)		813	(b)		(8,586	)(b)
Net income (loss)	$	1,019	$	812		$	2,411		$	1,249		$	(13,984	)
Basic and diluted earnings (loss) per share:
Continuing operations	$	0.03	$	0.03		$	0.08		$	0.01		$	(0.19	)
Discontinued operation		—		—			—			0.03			(0.03	)
Disposal of discontinued operation		—		—			0.01			—			(0.28	)
Basic and diluted	$	0.03	$	0.03		$	0.09		$	0.04		$	(0.50	)
Weighted average shares outstanding
Basic		29,206		26,733			26,475			28,156			28,006
Diluted		31,842		27,064			26,917			28,201			28,006
	December 31,
	2004		2003			2002			2001			2000
Balance Sheet Data:
Cash, cash equivalents and short-term investments	$	4,201	$	2,684		$	3,005		$	1,118		$	1,638
Working capital		5,100		5,664			4,445			2,310			1,434
Total assets		17,825		13,688			8,277			6,387			5,908
Non-current liabilities		272		2			255			123			145
Stockholders’ equity		12,175		9,291			5,249			3,488			2,901

(a) In the second quarter of 2003, management determined that recognition of the benefits related to deferred tax assets was more likely than not based on an analysis of the cumulative level of pretax profits over the prior three years, projected levels of profits, schedule of reversal of deferred taxes, and tax strategies. As a result, the valuation allowance was eliminated, a deferred tax asset and liability were recorded on the consolidated balance sheet and an income tax benefit was recorded in the statement of operations.

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(b) In 2000 and 2001, the Company recorded a loss from discontinued operation of $713 and an operating profit of $813, respectively. Also in 2000, the Company recorded a loss on disposal of $7,873 consisting of a write off of intangibles of $7,650 and $223 of other shutdown related costs. In 2002, the Company recorded a gain of $200 upon the sale of the intellectual property associated with Sweet Success. See discussion relating thereto in Note 4 of the Notes to the Consolidated Financial Statements.

The Company has not paid any dividends since its inception and currently has no plans to begin paying dividends.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Except for the historical information contained herein, this Annual Report on Form 10-K contains certain forward-looking statements that involve substantial risks and uncertainties. When used in this AnnualReport, the words “anticipate,” “believe,” “estimate,” “expect” and similar expressions, as they relate to NutriSystem, Inc. or its management, are intended to identify such forward-looking statements. The Company’s actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute to such differences include those set forth in “Business—Risk Factors.” Accordingly, there is no assurance that the results in the forward-looking statements will be achieved.

The following discussion should be read in conjunction with the financial information included elsewhere in this Annual Report on Form 10-K. Dollar amounts are stated in thousands, except share and per share data.

Background

NutriSystem provides weight management and fitness products and services. The NutriSystem diet program was originally developed by the Company’s predecessor businesses that operated through company-owned and franchised weight loss centers. Currently, there are no Company-operated centers and the Company terminated its last franchise agreements in 2003. There are 15 independent center-based distributors who operate without franchise agreements (“Case Distributors”). In 1998, the Company initiated a marketing program using independent commissioned representatives. In late 1999, the Company began selling directly to the consumer through the Internet and by telephone. In 2001, the Company began selling foods through QVC, a television shopping network. The Company’s pre-packaged foods are now sold to weight loss program participants directly via the Internet and telephone (the “Direct” channel) and through independent commissioned representatives (the “Field Sales” channel), Case Distributor weight loss centers (the “Case Distributor” channel) and QVC.

On December 2, 2004, NutriSystem Inc. acquired Slim and Tone LLC, a franchisor of women’s express fitness centers. Slim and Tone franchisees now sell the NutriSystem diet program in their centers as independent commissioned representatives. NutriSystem purchased Slim and Tone for $1,000 in cash at closing, $450 paid into escrow and a seller note for $450 payable over 36 months. As of February 28, 2004, there are 120 Slim and Tone franchise centers opened and operating.

Since the NutriSystem businesses began in 1972, the businesses have operated in various organizational and legal structures, and were subject to a bankruptcy proceeding in 1993, which was discharged in 1994. NutriSystem became a publicly traded company in October 1999. In September 2000, the Company changed its name from nutrisystem.com inc. to Nutri/System, Inc. and in 2003, the Company changed its name to NutriSystem, Inc.

In 2001, the Company discontinued sales of the Sweet Success line of diet meal replacement products it had acquired the year before.

In December 2002, HJM Holdings LLC and NewSpring Ventures, L.P. collectively acquired 58.4% of the outstanding shares of common stock from existing stockholders effecting a change in control of the Company. The Company was not a party to the transaction. In 2004, HJM Holdings LLC distributed its NutriSystem shares to its partners and dissolved. Currently, no affiliated group owns more than 15% of the common stock of the Company.

Discontinued Operation

On August 25, 2000, the Company acquired certain assets of the Sweet Success product line from Nestle USA, Inc. (the “Seller”) in return for 900,000 shares of the Company’s common stock, representing 3.1% of the shares outstanding after the transaction. The shares of common stock issued to the Seller were included in a registration statement that became effective in December 2003.

As a result of a determination made in December 2000, the Company discontinued sales of the Sweet Success product line in June 2001. In December 2002, the Company sold the intellectual property associated with Sweet Success. The sale of the Sweet Success intellectual property is reflected in the Consolidated Financial Statements as a discontinued operation.

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Critical Accounting Policies and Estimates

The Company’s Consolidated Financial Statements are prepared in accordance with United States generally accepted accounting principles. The Company’s significant accounting policies are described in Note 2 of the Consolidated Financial Statements included in Item 8.

The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Management develops, and changes periodically, these estimates and assumptions based on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Management considers the following accounting estimates to be the most critical in preparing the consolidated financial statements. These critical accounting estimates have been discussed with the Company’s audit committee.

Reserves for Returns. Management reviews the reserves for customer returns at each reporting period and adjusts them to reflect data available at that time. To estimate a return for reserves, management considers return rates in preceding periods and changes in product offerings or marketing methods that might impact returns going forward. To the extent the estimate of returns is inaccurate, management will adjust the reserve, which will impact the amount of product sales revenue recognized in the period of the adjustment.

Impairment of Fixed Assets and Intangibles. Management continually assesses the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operating performance of the Company. Future events could cause management to conclude that impairment indicators exist and the carrying values of fixed and intangible assets may be impaired. Any resulting impairment loss would be limited to the value of net fixed and intangible assets.

Income Taxes. NutriSystem experienced losses in 1999 and 2000. As a result, the Company has federal and state tax net operating loss (NOL) carryforwards of approximately $8,700 as of December 31, 2004. As a result of a change of control transaction which occurred in December 2002, approximately $2,000 of the NOL’s are subject to usage limitations pursuant to the rules of Internal Revenue Code section 382. Through March 2003, a valuation allowance had been maintained for the deferred tax asset based on management’s assessment that the deferred tax asset would not be realized given the historical taxable levels of income (loss), the uncertainty of future operating results, tax planning strategies, and the expiration date of net operating loss carryforwards. In the second quarter of 2003, management determined that recognition of the benefits related to deferred tax assets was more likely than not based on an analysis of the cumulative level of pretax profits over the past three years, projected levels of profits, schedule of reversal of deferred taxes, and tax strategies. As a result, the valuation allowance was eliminated, a deferred tax asset was recorded on the consolidated balance sheet and an income tax benefit was recorded in the statement of operations.

Currently, the Company is recording income taxes at a rate equal to the combined federal and state effective rates. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause the Company’s provision for income taxes to vary significantly from period to period. For the year ended December 31, 2003, the Company recorded an income tax benefit of $3,397 reflecting the elimination of the tax valuation allowance. For the year ended December 31, 2004, the Company recorded income tax expense of $680, which reflects an estimated annual effective tax rate of 40%.

Results of Operations

Revenues and expenses consist of the following components:

Revenues. Revenues consist 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. Revenues for Slim and Tone consist primarily of franchise fees and royalties. Revenues for franchise fees are recognized when a franchise center opens for business. Royalties are paid monthly and recognized in the month the royalty is earned.

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Cost of Revenues. Cost of revenues consists primarily of the cost of the products sold, including the write-off of obsolete packaging and product, incoming and outgoing shipping costs, charge card discounts, packing material, compensation related to fulfillment and the costs of outside fulfillment. 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 revenues also includes the fees paid to independent distributors and sales commissions. Cost of revenues for Slim and Tone consist of the costs incurred associated with the opening of a franchise center, including the cost of the exercise equipment, training costs, and promotional materials provided to the operators.

Marketing Expense. Marketing expense includes advertising, marketing and promotional expenses and payroll related expenses for personnel engaged in these activities. The Company follows the American Institute of Certified Public Accountants (“AICPA”) Statement of Position 93-7, “Reporting for Advertising Costs.” Internet advertising expense is recognized 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 payment terms. Direct-response 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 and customer service personnel, facility expenses, web site development costs, professional service fees and other general corporate expenses.

New Program Development. New program development includes various costs charged by third parties associated with the creation of the Company’s NutriSystem Nourish diet program, including new package design costs and development of program specifications.

Interest Income/Expense. Interest consists of interest income earned on cash balances, net of interest expense.

Income Taxes. The Company is subject to corporate level income taxes. No income tax benefit on the excess of the tax basis of assets over the financial reporting carrying amount was recorded from September 1999 to March 2003 in light of the historical taxable levels of income (loss), the uncertainty of future operating results, tax planning strategies, and the expiration date of net operating loss carryforwards. In the second quarter of 2003, management determined that recognition of the benefits related to deferred tax assets was more likely than not based on an analysis of the cumulative level of pretax profits over the past three years, projected levels of profits, schedule of reversal of deferred taxes, and tax strategies. As a result, the valuation allowance was eliminated, a deferred tax asset was recorded on the consolidated balance sheet and an income tax benefit was recorded in the statement of operations.

Reclassifications. Beginning with the second quarter of 2004, the Company reclassified compensation related to fulfillment, the costs of outside fulfillment and commissions paid on Direct sales from general and administrative expenses to cost of revenues. At the same time, the Company reclassified the cost of non-food materials provided with customer purchases from marketing to cost of revenues. Prior year amounts have been reclassified to conform to the current period presentation.

Overview of the Direct Channel

The Company began selling directly to consumers when it launched its web site on October 15, 1999. In 2004, the Direct channel represented 81% of the Company’s net revenues. For the Direct channel of distribution, the Company’s primary financial objectives are to generate growth while maintaining profit margins. The Company measures growth in terms of the number of new customers, revenues per customer and total revenues. A new customer is defined as a first time purchaser through the Direct channel. Profit margins are measured in terms of gross margin (revenues less cost of revenues as a percentage of revenues) and total advertising and marketing expense as a percentage of revenues.

In January 2004 the Company merged duplicate customer profiles that had been created over time. This reduced new customer counts by approximately 10% in 2003 and by a smaller amount in prior years, and it increased the sales per customer, as cumulative customer purchases were also aggregated. Merging duplicate profiles also raised the amount of sales that were attributed by customers acquired in prior periods. The changes affected customer counts and had no impact on the Company’s audited financial statements.

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FINANCIAL AND OPERATING STATISTICS FOR THE DIRECT CHANNEL

(in thousands, except customer data)

	2004			2003			2002
Revenues	$	30,798		$	14,712		$	16,127
Cost of revenues		15,414			7,642			8,028
Gross margin	$	15,384		$	7,070		$	8,099
% of revenue		49.9	%		48.1	%		50.2	%
Marketing	$	7,537		$	3,539		$	1,263
% of revenue		24.5	%		24.1	%		7.8	%
New customers
Program		48,377			16,744			19,579
Total		51,783			22,960			25,066
Marketing/new customer
Program	$	156		$	211		$	65
Total	$	146		$	154		$	50
New customer revenue/new customer
Program	$	482		$	467		$	483
Total	$	460		$	381		$	428

Direct revenues increased 109.3% from 2003 to 2004. Direct revenues are largely a function of the number of new customers acquired, the revenues generated from each new customer and the revenues generated from returning customers (customers that initially purchased food in a prior year). From 2003 to 2004, the number of new customers acquired increased by 28,823 or 125.5%. The increase in new customers is primarily attributable to higher marketing spending; marketing increased 113.6% from 2003 to 2004. In terms of spending per new customer acquired, the effectiveness of the marketing spending also improved; overall marketing per new customer was $154 in 2003 and $146 in 2004. The Company increased marketing spending in 2004 as the spending became more effective.

From 2003 to 2004, revenues per new customer increased $79 or 20.7%. The increase is primarily a function of an increased emphasis on obtaining program new customers. For analytic purposes, the Company defines 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. In 2004, program new customers represented 93% of all new customers, while in 2003, these customers represented 73% of all new customers. In addition, program new customers acquired in 2004 generated more revenue in 2004 than the same customer group did in 2003. Finally, in 2004 a higher percentage of new customers were obtained in December, which implies more revenues from 2004 new customers will fall into the subsequent year than was the case in 2003.

Customers that initially purchased in a prior year contributed approximately $7,000 and $6,000 to revenues in 2004 and 2003, respectively.

Direct revenues decreased 8.8% from 2002 to 2003. From 2002 to 2003, the number of new customers acquired dropped by 2,106 or 8.4%. Low spending for advertising media over the course of 2002 and through August 2003 was the primary reason for a declining new customer count throughout this period. In September and October 2003, the Company increased spending for marketing media in selected markets, resulting in increased new customer counts in these markets. Overall, the new customer counts in the fourth quarter of 2003 were 48.7% higher than the same quarter of 2002.

From 2002 to 2003, revenues from each new customer acquired declined by $47 or 11.0%. The decline in revenues per new customer obtained in each year was triggered by two factors: a) market testing for a portion of 2003 that attracted more new customers that made an initial purchase of less than $100, and b) in 2003 a higher portion of the

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new customers were acquired later in the year. Customers with an initial purchase of less than $100 comprised 27.2% of all new customers in 2003 but only 21.9% of new customers in 2002; individuals that spend less than $100 tend to purchase “trials”, though the Company has had some success in converting these “trial size” customers into sustained program participants. The Company generated $467 and $484 per program new customer in 2003 and 2002, respectively. The Company had 16,744 and 19,579 program new customers in 2003 and 2002, respectively. Timing also affected sales per new customer. In 2003, a higher proportion of customers were generated late in the year. Customers acquired later in a calendar year have less time to contribute revenues within the calendar year.

Customers that initially purchased in a prior year contributed $6,000 and $5,400 to revenues in 2003 and 2002, respectively.

Direct gross margin increased from 48.1% in 2003 to 49.9% in 2004 primarily due to a charge in 2003 of $529 related to the write-off of obsolete old program product and packaging. The write-off also explains the decline in gross margins from 2002 to 2003.

Overview of Television Infomercial Distribution

In the second quarter of 2001, the Company began distribution of its proprietary prepackaged food through QVC, the shopping television network. In 2004, this channel represented 11% of the Company’s net revenue. On the QVC network, the Company reaches a large, incremental audience in a 50 minute, infomercial format that enables the Company to convey fully the benefits of the NutriSystem diet foods. QVC viewers purchase NutriSystem products directly from QVC and are not directed to the NutriSystem web site. Retail prices (including shipping and handling) offered on QVC to consumers are similar to prices offered on the web site. The Company generates a lower gross margin (as a percent of sales) on sales to QVC relative to direct sales, but QVC sales require no incremental advertising and marketing expense and, management believes, exposure on QVC raises consumer awareness of the NutriSystem brand. Net sales through the television infomercial distribution channel were $4,167, $4,617 and $7,376 for the years ended December 31, 2004, 2003 and 2002, respectively. Sales declined year over year because the Company aired fewer shows on QVC and sales per minute of air-time declined. During 2004, the Company and QVC did business without a contractual agreement.

Year Ended December 31, 2004 Compared to Year Ended December 31, 2003

Revenues. Revenues increased from $22,575 for the year ended December 31, 2003 to $37,996 for the year ended December 31, 2004. The revenue increase of $15,421, or 68.3%, resulted from increased Direct sales ($16,086) and the Field Sales channel ($129) plus the addition of the Slim and Tone division ($84), offset by decreased sales to QVC ($450) and Case Distributor ($428). In the year ended December 31, 2004, Direct accounted for 81% of total revenues, while QVC, Field Sales and Case Distributor revenues accounted for 11%, 5% and 3% of total revenues, respectively. In 2003, the comparable percents were 65%, 21%, 8% and 6%, respectively.

Costs and Expenses. Cost of revenues increased $6,742 from $14,870 to $21,612 for the years ended December 31, 2003 and 2004, respectively. Gross margin as a percent of revenues increased from 34.1% in 2003 to 43.1% in 2004. The increase in gross margin is primarily due to a mix shift toward the higher margin Direct channel, to higher pricing for the new NutriSystem Nourish program and to a $529 write-off of old program inventory and packaging recorded in cost of sales in 2003. Marketing expenses increased $4,009 from $3,539 to $7,548 for 2003 to 2004. Almost all marketing spending promoted the Direct business, and the increase in marketing is attributable to increased spending for advertising media ($3,175), public relations ($436), production of television advertising ($419) and payroll related to marketing and advertising ($231) offset by a decrease in market research and consulting ($252). Fourth quarter 2004 marketing expenses included about $800 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. Fourth quarter 2003 results included $751 in marketing expenses associated with the launch of the NutriSystem Nourish program.

General and administrative expenses ($5,829 and $7,039 in 2003 and 2004, respectively) increased $1,210 attributable to higher costs associated with the increase in revenues, especially compensation ($973) and rent ($177). In general and administrative expenses in 2003, the Company recorded litigation expense related to the franchise lawsuit of $238, and $198 expense related to the Reno warehouse closing costs. Primarily in the fourth quarter of 2003, the Company incurred $599 in expenses associated with new program development in order to create the NutriSystem Nourish program. New program expenses include the new package design costs and development of program

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specifications. For the year ended December 31, 2003, the Company recorded a loss of $157, respectively, under the caption “Equity in losses of affiliate,” representing the Company’s investment in an affiliate. In 2004, the Company made no additional investments in the affiliate.

Interest Income. Interest income net of interest expense decreased $21 from $57 in 2003 to $36 in 2004 primarily due to lower interest rates on invested funds.

Income taxes. In 2004, the Company recorded $680 of income taxes due to the income for the reporting period. The effective tax rate in 2004 is 40%. In 2003, the Company recorded a $3,397 income tax benefit related to the recognition of deferred tax assets (see Note 11 of the Consolidated Financial Statements).

Net Income. From 2003 to 2004, net income increased by $207 from net income of $812 to net income of $1,019. The increase in net income in 2004 is primarily due to higher gross profit in 2004 versus 2003 resulting from increased revenue offset by a $3,397 income tax benefit recorded in 2003 versus income tax expense of $680 recorded in 2004.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Revenues. Revenues decreased from $27,569 for the year ended December 31, 2002 to $22,575 for the year ended December 31, 2003. The revenue decrease of $4,994, or 18.1%, resulted from decreased sales to QVC ($2,759), Direct ($1,415), Case Distributor ($553) and the Field Sales channel ($267). In the year ended December 31, 2003, Direct accounted for 65% of total revenues, while QVC, Field Sales and Case Distributor revenues accounted for 21%, 8% and 6% of total revenues, respectively. In 2002, the comparable percents were 58%, 27%, 8% and 7%, respectively.

Costs and Expenses. Cost of revenues decreased $2,785 from $17,655 to $14,870 for the years ended December 31, 2002 and 2003, respectively. Gross margin as a percent of revenues decreased from 36.0% in 2002 as compared to 34.1% in 2003. The decrease in gross margin is attributable to $529 write-off of old program inventory and packaging recorded in cost of sales. Marketing expenses increased $2,276 from $1,263 to $3,539 from 2002 to 2003. All marketing spending promoted the Direct, and the increase in marketing is attributable to increased spending for advertising media ($898), market research and consulting ($529), payroll related to marketing and advertising ($364), production of television advertising ($299) and Internet advertising ($186). Fourth quarter 2003 results included $751 in marketing expenses associated with the launch of the NutriSystem Nourish program.

General and administrative expenses ($5,902 and $5,829 in 2002 and 2003, respectively) decreased $73 attributable to lower costs associated with the decline in revenues, especially compensation, and reduced costs associated with the closing of the Reno warehouse in the first quarter of 2003, offset by increased professional fees and consulting fees. In general and administrative expenses, the Company recorded litigation expense related to the franchise lawsuit of $302 and $238 in 2002 and 2003, respectively, and $198 expense related to the Reno warehouse closing costs. Included in general and administrative costs in 2002 are $481 in severance relating to the Company’s former Chief Executive Officer and $175 in charges relating to discontinued packaging and products. Primarily in the fourth quarter of 2003, the Company incurred $599 in expenses associated with new program development in order to create the NutriSystem Nourish program. New program expenses include the new package design costs and development of program specifications. Other expense in 2002 of $100 represents the cost of settling an employment-related complaint filed by certain employees of the Company’s former facility in Reno. For the year ended December 31, 2002 and 2003, the Company recorded a loss of $143 and $157, respectively, under the caption “Equity in losses of affiliate,” representing the Company’s investment in an affiliate.

Interest Income. Interest income net of interest expense increased $16 from $41 in 2002 to $57 in 2003 primarily due to interest earned on higher cash balances.

Income taxes. In 2003, the Company recorded a $3,397 income tax benefit related to the recognition of deferred tax assets (see Note 11 of the Consolidated Financial Statements).

Net Income. From 2002 to 2003, net income decreased by $1,599 from net income of $2,411 to net income of $812. The decrease in net income in 2003 is primarily due to lower revenues, increased marketing expense and costs associated with the development of a new program. These high costs were fully offset by an income tax benefit recorded in 2003.

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Contractual Obligations and Commercial Commitments

Following is a summary of contractual obligations of the Company. The Company has no other commercial commitments.

	Payments Due by Period
Contractual obligations	Total		Less Than 1 Year		1 – 3 Years		4 – 5 Years		After 5 Years
Note payable	$	450	$	150	$	300	$	—	$	—
Operating leases	$	4,077	$	794	$	1,646	$	1,637	$	—
	$	4,527	$	944	$	1,946	$	1,637	$	—

In 2004, the Company entered into two employment agreements. The agreements have terms ranging from one to two years, with automatic one-year renewal terms. These agreements provide for base compensation of $225 for each employee per year and other fringe benefits and payments upon termination.

Liquidity, Capital Resources and Other Financial Data

At December 31, 2004, the Company had net working capital of $5,100, a decrease of $564 from the $5,664 net working capital balance at December 31, 2003. Cash and cash equivalents at December 31, 2004 were $4,201, an increase of $1,517 from the balance of $2,684 at December 31, 2003. The Company’s principal source of liquidity during this period was cash flow from operations. At December 31, 2004, the Company had no bank debt or term or revolving credit facilities to fund operations or investment opportunities. In connection with the acquisition of Slim and Tone, the Company has a seller note obligation of $408 at the end of 2004. The Company currently has no off-balance sheet arrangements.

In the year ended December 31, 2004, the Company generated a cash flow of $2,795 from operations, an increase of $4,715 from the negative cash flow from operations of $1,920 at December 31, 2003. The increase in cash flow from operations is attributable to net income adjusted for non-cash charges, which provides most of the operating cash flow. Net income adjusted for non-cash items was $2,291 in 2004 versus a negative $1,833 in 2003. Net changes in operating assets and liabilities also increased cash flow from operations by $504 in 2004; in 2003, net changes in operating assets and liabilities reduced cash flow from operations by $87.

In the year ended December 31, 2004, net cash used in investing activities was $2,250, which primarily consisted of the acquisition of Slim and Tone, LLC ($1,562) (see Note 3 of the Consolidated Financial Statements) and net capital expenditures ($688) incurred to increase web site capacity, fulfillment operations, leasehold improvements related to the relocation of home office.

In the year ended December 31, 2004, net cash provided by financing activities was $972, representing proceeds from the exercise of stock options and warrants.

The Board of Directors has authorized the repurchase of up to 5,000,000 shares of the Company’s common stock. Through December 31, 2004, the Company had repurchased a total of 2,760,291 shares under the repurchase program, with the last purchase occurring in June of 2003.

As of December 31, 2004, the Company’s principal commitments consisted of obligations under operating leases. Although the Company has no material commitments for capital expenditures, it anticipates continuing requirements for capital expenditures consistent with anticipated growth in operations, infrastructure and personnel approximately consistent with prior periods.

In pursuing its business strategy, the Company may require additional cash for operating and investing activities. The Company expects future cash requirements, if any, to be funded from operating cash flow and financing activities, which may include additional offerings of equity securities or debt financing. Based on the Company’s ability to generate earnings in 2004, the variable nature of a portion of the Company’s expenditures, the cash balance at December 31, 2004 and management’s belief that additional equity financing, if required, can be raised, management

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believes that the Company has the ability to continue operations into 2006. However, there can be no assurance that the Company will be able to sustain profitability or, if necessary, obtain the capital to fund operating and investment needs in the future. Currently, there is no credit facility in place to fund working capital or investment needs.

There are no current plans or discussions in process relating to any material acquisition that is probable in the foreseeable future.

Factors Affecting Business and Prospects

The Company expects to experience significant fluctuations in future quarterly operating results due to a variety of factors, many of which are outside its control.

Inflation

The Company’s Consolidated Financial Statements are presented on a historical cost basis and do not fully reflect the impact of prior years’ inflation. While the U.S. inflation rate has been modest for several years, inflation issues may impact business in the future. The ability to pass on inflation costs is an uncertainty due to general economic conditions and competitive situations.

Recently Issued Accounting Pronouncements

In December 2004, the FASB issued Statement No. 123 (Revised 2004) Share-Based Payment. Statement No. 123R addresses all forms of share-based payment awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. It will require companies to recognize in the statement of earnings the grant-date fair value of stock options and other equity-based compensation issued to employees; but expresses no preference for a type of valuation model. The statement eliminates the intrinsic value-based method prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretation, that the Company currently uses. The Company is required to adopt Statement No. 123R beginning in the third quarter of 2005. The Company has not yet determined the impact of applying the various provisions of the statement; however, adoption of the statement is expected to significantly increase the amount the Company records as compensation expense in 2005.

In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities,” (“FIN 46R”) which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” which was issued January 2003. The Company is required to apply FIN 46R to variable interests in variable interest entities (“VIEs”) created after December 31, 2003. For variable interests in VIEs created before January 1, 2004, the Interpretation will be applied beginning on January 1, 2005. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. The adoption of FIN 46R did not have an impact on the Company’s Consolidated Financial Statements.

22

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company does not hold any investments in market risk sensitive instruments. Accordingly, management believes that it is not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk instruments. The Company does not have any funded debt outstanding at December 31, 2004, and its cash and cash equivalents of $4,201 are maintained in bank accounts. As such, a change in interest rates of 1 percentage point would not have a material impact on the Company’s operating results and cash flows.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by this Item is set forth on pages 26 through 43 hereto and is incorporated by reference herein.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2004. Based upon this evaluation, they concluded that, as of the date of the evaluation, the Company’s disclosure controls and procedures as of December 31, 2004 have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Management believes that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instance of fraud, if any, within a company have been detected. Since the date of this evaluation, there have been no significant changes in the Company’s internal controls or in other factors that could significantly affect those controls.

ITEM 9B. OTHER INFORMATION

None.

23

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information concerning directors and compliance with Section 16(a) of the Securities Exchange Act of 1934 and our Statement of Corporate Ethics and Code of Business Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer or controller called for by Item 10 of Form 10-K will be set forth under the captions “Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Statement of Corporate Ethics and Code of Business Conduct” in our definitive proxy statement, to be filed within 120 days after the end of the fiscal year covered by this annual report on Form 10-K, and is incorporated herein by reference.

The required information as to executive officers is set forth in Part I hereof and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated by reference to the information contained in our definitive proxy statement for the 2005 annual meeting of stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by Item 12 is incorporated by reference to the information contained in our definitive proxy statement for the 2005 annual meeting of stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is incorporated by reference to the information contained in our definitive proxy statement for the 2005 annual meeting of stockholders.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by Item 14 is incorporated by reference to the information contained in our definitive proxy statement for the 2005 annual meeting of stockholders.

24

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) 1. Financial Statements

See Index to the Consolidated Financial Statements which begins on page 26 of this Annual Report

2. Financial Statement Schedules

None, as all information required in these schedules is included in the Notes to the Consolidated Financial Statements.

3. Exhibits

Reference is made to the Exhibit Index on page 45 of this Annual Report for a list of exhibits required by Item 601 of Registration S-K to be filed as part of this Annual Report.

25

NUTRISYSTEM, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Registered Public Accounting Firm	27
Consolidated Balance Sheets	28
Consolidated Statements of Operations	29
Consolidated Statements of Stockholders’ Equity	30
Consolidated Statements of Cash Flows	31
Notes to Consolidated Financial Statements	32

26

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

NutriSystem, Inc.:

We have audited the 2004 and 2003 consolidated financial statements of NutriSystem, Inc. and subsidiaries as listed in the accompanying index. These consolidated financial statements are the responsibility of the management of NutriSystem, Inc. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the 2004 and 2003 consolidated financial statements referred to above present fairly, in all material respects, the financial position of NutriSystem, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with United States generally accepted accounting principles.

As discussed in Note 2 to the consolidated financial statements, effective January 1, 2002, the Company adopted the provisions of Statements of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets.”

/S/ KPMG LLP

Philadelphia, Pennsylvania

February 16, 2005

27

NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

	December 31
	2004			2003
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	4,201		$	2,684
Restricted cash		—			250
Trade receivables		1,028			448
Inventories		3,679			4,524
Deferred income taxes		421			1,716
Other current assets		1,149			437
Total current assets		10,478			10,059
FIXED ASSETS, net		1,197			753
IDENTIFIABLE INTANGIBLE ASSETS		1,615			—
GOODWILL		465			—
DEFERRED INCOME TAXES		3,938			2,753
OTHER ASSETS		132			123
	$	17,825		$	13,688
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current portion of note payable	$	136		$	—
Accounts payable		4,359			3,531
Accrued payroll and related benefits		368			189
Deferred revenue		311			13
Other current liabilities		204			662
Total current liabilities		5,378			4,395
NOTE PAYABLE AND OTHER		272			2
Total liabilities		5,650			4,397
COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS’ EQUITY:
Preferred stock, $.001 par value (5,000,000 shares authorized, no shares outstanding)		—			—
Common stock, $.001 par value (100,000,000 shares authorized; shares issued and outstanding– 30,132,860 at December 31, 2004 and 28,511,021 at December 31, 2003)		30			28
Additional paid-in capital		33,378			31,238
Warrants		—			277
Accumulated deficit		(21,233	)		(22,252	)
Total stockholders’ equity		12,175			9,291
	$	17,825		$	13,688

The accompanying notes are an integral part of these consolidated financial statements.

28

NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share amounts)

	Year Ended December 31
	2004		2003			2002
NET REVENUES	$	37,996	$	22,575		$	27,569
COSTS AND EXPENSES:
Cost of revenues		21,612		14,870			17,655
Marketing		7,548		3,539			1,263
General and administrative		7,039		5,829			5,902
New program development		—		599			—
Depreciation and amortization		268		223			336
Total costs and expenses		36,467		25,060			25,156
Operating income (loss) from continuing operations		1,529		(2,485	)		2,413
OTHER INCOME (LOSS)		134		—			(100	)
EQUITY IN LOSSES OF AFFILIATE		—		(157	)		(143	)
INTEREST INCOME, net		36		57			41
Income (loss) before income taxes and discontinued operation		1,699		(2,585	)		2,211
INCOME TAXES		680		(3,397	)		—
Income before discontinued operation		1,019		812			2,211
DISCONTINUED OPERATION (Note 4):
Gain on disposal		—		—			200
Net income	$	1,019	$	812		$	2,411
BASIC AND DILUTED INCOME PER SHARE:
Continuing operations	$	0.03	$	0.03		$	0.08
Disposal of discontinued operation		—		—			0.01
	$	0.03	$	0.03		$	0.09
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic		29,206		26,733			26,475
Diluted		31,842		27,064			26,917

The accompanying notes are an integral part of these consolidated financial statements.

29

NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except share amounts)

	Common Shares		Common Stock			Additional Paid-in Capital			Common Stock Warrants			Accumulated Deficit			Treasury Stock			Total
BALANCE, January 1, 2002	27,065,394		$	29		$	29,333		$	324		$	(25,475	)	$	(723	)	$	3,488
Net income	—			—			—			—			2,411			—			2,411
Stock-based costs	—			—			37			—			—			—			37
Exercise of stock options	23,334			—			8			—			—			—			8
Purchase of treasury stock	(869,791	)		—			—			—			—			(695	)		(695	)
Retirement of treasury stock	—			(3	)		(1,415	)		—			—			1,418			—
BALANCE, December 31, 2002	26,218,937			26			27,963			324			(23,064	)		—			5,249
Net income	—			—			—			—			812			—			812
Stock-based costs	41,000			—			220			—			—			—			220
Exercise of stock options	127,666			—			43			—			—			—			43
Exercise of warrants	43,518			—			47			(47	)		—			—			—
Sale of common stock	2,300,000			2			2,298			—			—			—			2,300
Purchase of treasury stock	(220,100	)		—			—			—			—			(123	)		(123	)
Retirement of treasury stock	—			—			(123	)		—			—			123			—
Recognition of previously reserved deferred tax asset	—			—			790			—			—			—			790
BALANCE, December 31, 2003	28,511,021			28			31,238			277			(22,252	)		—			9,291
Net income	—			—			—			—			1,019			—			1,019
Stock-based costs	108,500			—			322			—			—			—			322
Exercise of stock options	982,159			1			586			—			—			—			587
Exercise of warrants	531,180			1			661			(277	)		—			—			385
Tax benefit from stock option exercises	—			—			571			—			—			—			571
BALANCE, December 31, 2004	30,132,860		$	30		$	33,378		$	—		$	(21,233	)	$	—		$	12,175

The accompanying notes are an integral part of these consolidated financial statements.

30

NUTRISYSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Year Ended December 31
	2004			2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	1,019		$	812		$	2,411
Adjustments to reconcile net income to net cash provided by (used in) operating activities-
Gain on disposal of discontinued operation		—			—			(200	)
Net cash from discontinued operation		—			—			45
Equity in losses of affiliate		—			157			143
Depreciation and amortization		268			223			336
Deferred tax benefit		110			(3,397	)		—
Loss on disposal of fixed assets		—			152			—
Stock–based costs		322			220			37
Tax benefit from stock option exercises		571			—			—
Imputed interest expense		1			—			—
Changes in operating assets and liabilities excluding effects of acquisition-
Restricted cash		250			75			203
Trade receivables		(580	)		(47	)		(129	)
Inventories		845			(1,639	)		(127	)
Other assets		(585	)		198			(140	)
Accounts payable		828			1,946			(761	)
Accrued payroll and related benefits		179			47			29
Deferred revenue		27			(493	)		506
Other liabilities		(460	)		(174	)		560
Net cash provided by (used in) operating activities		2,795			(1,920	)		2,913
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital additions		(688	)		(528	)		(84	)
Cash paid for acquisition of a business		(1,562	)		—			—
Investment in affiliates		—			(93	)		(155	)
Net cash used in investing activities		(2,250	)		(621	)		(239	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of common stock		—			2,300			—
Exercise of stock options and warrants		972			25			8
Treasury stock purchases, at cost		—			(105	)		(695	)
Repayment of non-current liabilities		—			—			(100	)
Net cash provided by (used in) financing activities		972			2,220			(787	)
NET CHANGE IN CASH AND CASH EQUIVALENTS		1,517			(321	)		1,887
CASH AND CASH EQUIVALENTS, beginning of year		2,684			3,005			1,118
CASH AND CASH EQUIVALENTS, end of year	$	4,201		$	2,684		$	3,005

The accompanying notes are an integral part of these consolidated financial statements.

31

NUTRISYSTEM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share amounts)

1. BACKGROUND

Nature of the Business

NutriSystem, Inc. (The “Company” or “NutriSystem”) provides weight management and fitness products and services. The Company’s pre-packaged foods are now sold to weight loss program participants directly via the Internet and telephone (the “Direct” channel) and through independent commissioned representatives (the “Field Sales” channel), through 15 independent center-based distributors (the “Case Distributor” channel) and through QVC, a television shopping network.

On December 2, 2004, the Company acquired Slim and Tone LLC (“Slim and Tone”), a franchisor of women’s express fitness centers (see Note 3). Slim and Tone franchisees now sell the NutriSystem diet program in their centers as independent commissioned representatives. As of February 28, 2004, there are approximately 120 Slim and Tone franchise centers currently open and operating.

In December 2002, HJM Holdings LLC and NewSpring Ventures, L.P. collectively acquired 58.4% of the outstanding shares of common stock from existing stockholders effecting a change in control of the Company. The Company was not a party to the transaction. In 2004, HJM Holdings LLC distributed its NutriSystem shares to its partners and dissolved. Currently, no affiliated group owns more than 15% of the common stock of the Company.

Since the NutriSystem businesses began in 1972, the businesses have operated in various organizational and legal structures, and were subject to a bankruptcy proceeding in 1993, which was discharged in 1994. NutriSystem became a publicly traded company in October 1999. In September 2000, the Company changed its name from nutrisystem.com inc. to Nutri/System, Inc. and in 2003, the Company changed its name to NutriSystem, Inc.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Presentation of Financial Statements

The Company’s consolidated financial statements include the accounts of NutriSystem, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months of less when purchased to be cash equivalents for the purpose of determining cash flow. Cash and cash equivalents include cash on hand, cash in bank, money market investments and a certificate of deposit.

Restricted Cash

In 2003, restricted cash represents minimum cash deposited in banks required under certain vendor arrangements. The restrictions were eliminated in 2004.

Inventories

Inventories consist principally of packaged food held in the Company’s warehouse, outside fulfillment locations or in a QVC distribution center (see Revenue Recognition below). Inventories are valued at the lower of cost or market, with cost determined using the first-in, first-out (FIFO) method.

32

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 three to seven years. Leasehold improvements are amortized on a straight-line basis over the lesser of the estimated useful life of the asset or lease term. Expenditures for repairs and maintenance are charged to expense as incurred, while major renewals and improvements are capitalized.

Identifiable Intangible Assets and Goodwill

Identifiable intangible assets and goodwill arose from the acquisition of Slim and Tone in December 2004. Identifiable intangible assets represent trade names and trademarks, customer relationships, procedural manuals and covenants not to compete acquired in the transaction. Goodwill represents the excess of the purchase price over the net tangible and identifiable intangible assets of Slim and Tone. The Company does not amortize trade names, trademarks and goodwill due to their indefinite life, but management reviews these assets at least annually for impairment. The other identifiable intangible assets are presented at cost, net of accumulated amortization, and are amortized over their estimated useful lives (see Note 6).

Investment Carried Under the Equity Method

The Company has invested $93 in 2003 and $155 in 2002 for a 25% interest in Imagine Weight Loss Center, LLC (“Imagine”), a start up company formed to provide diet and fitness programs in center locations. There were no additional investments made in 2004. In addition to the cash investments, the Company has provided indemnifications to certain affiliates of Imagine amounting to $52 at December 31, 2003 and 2004. For the years ended December 31, 2003 and 2002, the Company recorded losses of $157 and $143, respectively, in the statement of operations under the caption “Equity in losses of affiliate”, representing the Company’s portion of the losses incurred by Imagine. As of December 31, 2004, the Company had no commitment to make further investments in Imagine. A liability of $52 at December 31, 2004 and 2003 is included in “Other current liabilities” in the accompanying consolidated balance sheets.

Valuation of Long-Lived Assets

Management continually evaluates whether events or circumstances have occurred that indicate that the remaining useful lives of the Company’s long-lived assets, primarily fixed assets and purchased identifiable intangibles subject to amortization should be revised or that the remaining balance of such assets may not be recoverable using objective methodologies. Such methodologies include evaluations based on the undiscounted cash flows generated by the underlying assets or other determinants of fair value. As of December 31, 2004 and 2003, respectively, management believes that no reductions to the remaining useful lives or write-downs of long-lived assets are required.

Revenue Recognition

Revenues for food sales are recognized when the related products are shipped to the end-consumer or to Case Distributors. In 2003, QVC distributed the Company’s products to QVC customers. In other periods, the Company shipped products sold through QVC directly to the consumer. Revenues for products distributed through QVC are recognized when the products are shipped to the end-consumer. Product inventory held by QVC were carried in the Company’s inventories and payments received from QVC in advance of shipments to the end-consumer were recorded as deferred revenue in the 2003 consolidated balance sheet.

Revenues for Slim and Tone consist primarily of franchise fees and royalties. Revenues for franchise fees are recognized when a franchise center opens for business. Slim and Tone franchise fee payments received prior to a franchise center opening are recorded as deferred revenue in the 2004 consolidated balance sheet. Royalties are paid monthly and recognized in the month the royalty was earned.

Revenues from pre-packaged food sales include amounts billed for shipping and handling, and are presented net of returns (see Note 17) and free food products provided to consumers. Revenues from shipping and handling charges were $401, $359, and $361 in 2004, 2003 and 2002, respectively.

33

Marketing Expense

Marketing expense includes advertising, marketing and promotional expenses and payroll related expenses for personnel engaged in these activities. The Company follows the American Institute of Certified Public Accountants (“AICPA”) Statement of Position 93-7, “Reporting for Advertising Costs.” Internet advertising expense is recognized 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 payment terms. Direct-response 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. At December 31, 2004 and 2003, $253 and $90, respectively, of prepaid advertising is included in prepaid expenses. Media expense was $5,274, $2,099 and $1,014 in 2004, 2003 and 2002, respectively.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of operations in the period that includes the enactment date.

At December 31, 2002, deferred tax assets were offset by a full valuation allowance. In the second quarter of 2003, management determined based on an analysis of the cumulative level of pretax profits over the past three years and projected level of profits that recognition of deferred tax assets was more likely than not. As a result, the valuation allowance was eliminated and a deferred tax asset and a deferred tax liability were recorded on the consolidated balance sheet and an income tax benefit was recorded in the statement of operations (see Note 11).

Fair Value of Financial Instruments

The carrying values of the Company’s financial instruments, including cash, cash equivalents, trade receivables and accounts payable, approximate the fair values due to the short-term nature of these instruments. The carrying amount of the note payable approximates the fair value as the Company recently issued the note on December 2, 2004.

Net Income Per Common Share

Basic net income per common share is computed by dividing net income by the weighted average number of shares of common stock outstanding. Diluted net income per common share reflects the potential dilution from the exercise of outstanding options and warrants into common stock.

Stock Options

The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS 123 established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS 123, as amended in SFAS 148, the Company has elected to continue to apply the intrinsic-value-based method of accounting and has adopted only the disclosure requirements.

34

Had compensation cost for the Company’s common stock options been determined based upon the fair value of the options at the date of grant, as prescribed under SFAS 123, as amended by SFAS 148, the Company’s net income and net income per share would have been changed to the following pro forma amounts:

	Year Ended December 31
	2004			2003			2002
Net income:
As reported	$	1,019		$	812		$	2,411
Add stock-based employee compensation expense included in reported net income, net of tax		—			—			20
Impact of total stock-based compensation expense determined under fair-value based method for all rewards, net of tax		(728	)		(493	)		(446	)
Pro forma	$	291		$	319		$	1,985
Basic net income per share:
As reported	$	0.03		$	0.03		$	0.09
Pro forma	$	0.01		$	0.01		$	0.08
Diluted net income per share:
As reported	$	0.03		$	0.03		$	0.09
Pro forma	$	0.01		$	0.01		$	0.07

In calculating pro forma compensation, the fair value of each stock option is estimated on the date of grant using the Black-Scholes option pricing model and the following weighted average assumptions:

	2004		2003		2002
Dividend yield	None		None		None
Expected volatility	122.2	%	103.9	%	94.7	%
Risk-free interest rate	3.86	%	2.29	%	4.80	%
Expected life (in years)	5.6		6.2		5.3

The weighted average fair value of the options issued in 2004, 2003 and 2002 was $2.08, $0.54 and $0.33, respectively.

Cash Flow Information

The Company made payments for income taxes of $40, $35 and $6 in 2004, 2003 and 2002, respectively. Payments for interest were $2, $1, and $37 in 2004, 2003 and 2002, respectively.

In connection with the acquisition of Slim and Tone (see Notes 1 and 3), the Company issued a $450 note payable to the seller.

Recently Issued Accounting Pronouncements

In December 2004, the FASB issued Statement No. 123 (Revised 2004) Share-Based Payment. Statement No. 123R addresses all forms of share-based payment awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. It will require companies to recognize in the statement of earnings the grant-date fair value of stock options and other equity-based compensation issued to employees; but expresses no preference for a type of valuation model. The statement eliminates the intrinsic value-based method prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretation, that the Company currently uses. The Company is required to adopt Statement No. 123R beginning in the third quarter of 2005. The Company has not yet determined the impact of applying the various provisions of the statement; however, adoption of the statement is expected to significantly increase the amount the Company records as compensation expense in 2005.

35

In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities,” (“FIN 46R”) which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” which was issued January 2003. The Company is required to apply FIN 46R to variable interests in variable interest entities (“VIEs”) created after December 31, 2003. For variable interests in VIEs created before January 1, 2004, the Interpretation will be applied beginning on January 1, 2005. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. The adoption of FIN 46R did not have an impact on the Company’s Consolidated Financial Statements.

Use of Estimates

The preparation of financial statements in accordance with United States generally accepted accounting principles 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 revenues and operating expenses during the reporting period. Actual results could differ from these estimates.

Reclassifications

Beginning with the second quarter of 2004, the Company reclassified compensation related to fulfillment, the costs of outside fulfillment and commissions paid on Direct sales from general and administrative expenses to cost of revenues. At the same time, the Company reclassified the cost of non-food materials provided with customer purchases from marketing to cost of revenues. Prior year and interim quarter amounts have been reclassified to conform to the current period presentation.

3. ACQUISITION

On December 2, 2004, the Company acquired Slim and Tone to unite diet and exercise for successful weight loss. The purchase price consists of $1,000 cash payment to the seller at closing, a $450 deposit into an escrow account for the benefit of the seller and a seller note for $450 (see Note 8). The acquisition was accounted for under the purchase method of accounting and the operating results of the acquired business have been included in the consolidated statements of operations and cash flows from the acquisition date through December 31, 2004. Revenues and operating costs of Slim and Tone for this period were $84 and $125, respectively.

A summary of the allocation of the purchase price to the net assets acquired is as follows:

Purchase price:
Cash paid for acquisition, net of cash acquired of $38	$	1,412
Note payable to seller, net of discount		407
Transaction costs		150
	$	1,969
Purchase price allocation:
Prepaid expenses	$	134
Fixed assets		15
Identifiable intangible assets		1,624
Goodwill		465
Security deposit		2
Deferred revenue		(271	)
	$	1,969

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4. DISCONTINUED OPERATION

As a result of a determination made in December 2000, the Company discontinued sales of the Sweet Success product line by June 30, 2001. The results of the Sweet Success product line have been reported separately as a discontinued operation in the Company’s Consolidated Financial Statements. In December 2002, the Company sold the intellectual property associated with Sweet Success for $150 cash, a $50 promissory note due, deferred payments based on sales achieved by the buyer and a warrant to purchase equity of the buyer. The Company recorded a gain of $200 from the transaction. The deferred payments and value of the warrant are not expected to provide significant economic benefit to the Company.

5. FIXED ASSETS

Fixed assets consist of the following:

	December 31
	2004			2003
Furniture and fixtures	$	225		$	162
Equipment		1,632			1,220
Leasehold improvements		594			384
		2,451			1,766
Accumulated depreciation		(1,254	)		(1,013	)
	$	1,197		$	753

Depreciation expense was $259, $223 and $336 in 2004, 2003 and 2002, respectively.

6. IDENTIFIABLE INTANTIBLE ASSETS

The Company recorded the following identifiable intangible assets in connection with the acquisition of Slim and Tone (see Note 3).

	Weighted Average Amortization Period	Cost		Accumulated Amortization		Net Book Value
Amortizable intangible assets
Customer relationships	10.0 years	$	580	$	6	$	574
Procedures manuals	1.5 years		120		3		117
Covenant not to compete	2.0 years		4		—		4
			704		9		695
Non-amortizable intangible assets
Trade Name/ Trademark			920		—		920
		$	1,624	$	9	$	1,615

The identifiable intangible assets are amortized over the above noted periods on a straight line basis other than customer relationships, which is amortized based on the estimated timing of the value obtained (under which the majority of the amortization expense will be recognized in the first two years of service). Amortization expense for the period from the acquisition date through December 31, 2004 is $9. Estimated amortization expense for the amortizable intangible assets for the next five years is $253 in 2005, $166 in 2006, $96 in 2007, $65 in 2008 and $44 in 2009.

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7. OTHER CURRENT LIABILITIES

Other current liabilities consist of the following:

	December 31
	2004		2003
Accrued packaging costs	$	50	$	274
Severance accrual		—		246
Compensation (see Note 12)		100		85
Indemnifications of Imagine Weight Loss Center		52		52
Other		2		5
	$	204	$	662

The accrued packaging costs represents remaining payments related to the costs associated with the development of new packaging as well as any remaining packaging that has been discontinued due to the introduction of the new product line. The severance accrual represents the current portion of future payments to a former executive of the Company, while the compensation liability represents the value of common stock granted to the Board of Directors at December 31, 2004 and 2003 but the stock was not yet issued. The Company has provided indemnifications to certain affiliates of Imagine Weight Loss Center amounting to $52 at December 31, 2004 and 2003 (see Note 2).

8. NOTE PAYABLE

In connection with the acquisition of Slim and Tone (see Notes 1 and 3), the Company issued a $450 note payable to the seller. The seller note bears no interest and, as such, has been recorded net of a discount of $43 computed at a 5.2% interest rate. Amortization of the note discount was $1 from the acquisition date through December 31, 2004. Under the terms of the note agreement, the Company will make a payment of $150 on December 31, 2005, 2006 and 2007. The seller is now an employee of the Company.

9. COMMITMENTS AND CONTINGENCIES

The Company leases its warehouse, corporate headquarters and certain equipment. These leases generally have initial terms of three to six years. The corporate headquarters has an option to renew for an additional two year period Certain of the leases also contain escalation clauses based upon increases in costs related to the properties. Lease obligations, with initial or remaining terms of one year or more years, consist of the following at December 31, 2004:

2005	$	794
2006		829
2007		817
2008		842
2009		795
	$	4,077

Total rent expense for 2004, 2003 and 2002 was $663, $485 and $624, respectively.

The Company is involved in certain various claims and routine litigation matters. In the opinion of management, after consultation with legal counsel, the outcome of such matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows in future years.

In 2004, the Company entered into two employment agreements. The agreements have terms ranging from one to two years, with automatic one-year renewal terms. These agreements provide for base compensation of $225 for each employee per year and other fringe benefits and payments upon termination.

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10. CAPITAL STOCK

Common Stock

In 2002, the Company issued 23,334 shares of common stock upon the exercise of stock options. In 2003, the Company issued 2,512,184 shares of common stock, 2,300,000 shares of common stock in a private placement and 127,666 shares upon the exercise of stock options and received proceeds of $2,300 and $25, respectively. The Company also issued 41,000 shares of common stock as compensation to certain consultants and spokespersons per their contract and 43,518 shares upon the cashless exercise of warrants. In 2004, the Company issued 982,159 shares of common stock upon the exercise of stock options and received proceeds of $587 and 108,500 shares of common stock as compensation to certain consultants and spokespersons per their contract. The Company also issued 531,180 shares of common stock upon exercise of common stock warrants and received proceeds of $385.

Treasury stock is accounted for using the cost method. During 2002, the Company repurchased 869,791 shares of common stock for an aggregate cost of $695 (an average price of $0.80 per share). In 2003, the Company purchased 220,100 shares of common stock for an aggregate cost of $123 (an average price of $0.56 per share). To date, all treasury stock has been retired. Management has been authorized to repurchase up to 5,000,000 shares of common stock, and through December 31, 2004 a total of 2,760,291 shares have been repurchased.

Preferred Stock

The Company has authorized 5,000,000 shares of preferred stock issuable in series upon resolution of the Board of Directors. Unless otherwise required by law, the Board of Directors can, 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.

11. INCOME TAXES

Income taxes consist of the following:

	Year Ended December 31
	2004		2003			2002
Current	$	—	$	—		$	—
Deferred		680		(1,173	)		966
Change in deferred valuation allowance		—		(2,224	)		(966	)
	$	680	$	(3,397	)	$	—

A reconciliation of the statutory federal income tax rate to the Company’s effective tax rate is as follows:

	Year Ended December 31
	2004		2003		2002
Statutory federal income tax rate	34.0	%	(34.0	)%	34.0	%
State income taxes, net of federal benefit	6.0		(6.0	)	6.0
Change in deferred tax valuation allowance	—		(91.4	)	(40.0	)
	40.0	%	(131.4	)%	—	%

The Company recognized a deferred tax asset of $571 in 2004 from the exercise of non-qualified stock options and exercise of certain incentive stock options and disposition of shares.

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The significant items comprising the Company’s deferred income tax assets and liabilities are as follows:

	December 31
	2004			2003
Deferred tax asset-
Reserves and accruals	$	129		$	364
Goodwill		428			472
Net operating loss carryforward		3,486			3,279
Other		339			377
		4,382			4,492
Deferred tax liability-
Property and equipment		(23	)		(23	)
	$	4,359		$	4,469

At December 31, 2004, the Company had net operating loss carryforwards of approximately $8,700 for federal and state tax purposes. As a result of a change of control transaction which occurred in December 2002, approximately $2,000 of the net operating loss carryforwards are subject to usage limitations pursuant to the rules of Internal Revenue Code section 382. Net operating losses will begin to expire in 2014. Through March 2003, a valuation allowance had been maintained for the deferred tax asset based on management’s assessment that the deferred tax asset would not be realized given the historical taxable levels of income (loss), the uncertainty of future operating results, tax planning strategies, and the expiration date of net operating loss carryforwards. In the second quarter of 2003, management determined based on an analysis of the cumulative level of pretax profits over the past three years, projected levels of profits, schedule of reversal of deferred taxes, and tax strategies that recognition of the benefits related to deferred tax assets was more likely than not. As a result, the valuation allowance was eliminated, a deferred tax asset was recorded on the consolidated balance sheet and an income tax benefit was recorded. A portion of the deferred tax asset recognized arose prior to a 1999 merger transaction; in order to reflect the recognition of the deferred tax asset on the previously recorded merger transaction the Company eliminated $290 of goodwill and credited equity by $790. Management continues to believe that the deferred tax assets are realizable at December 31, 2004 and 2003 based on the projected operating results of the Company.

Starting in 2001, the Company offset taxable income for federal tax purposes with net operating loss carryforwards. 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. However, the state taxable income in 2004, 2003 and 2002 is below the annual limitation.

12. STOCK OPTIONS AND WARRANTS

Stock Option Plan

The Company has two stock option plans, the 1999 Equity Incentive Plan and 2000 Equity Incentive Plan, under which options to purchase shares of the Company’s common stock can be granted to key employees. Currently, 1,000,000 and 5,100,000 shares of common stock may be issued pursuant to the 1999 Equity Incentive Plan and the 2000 Equity Incentive Plan, respectively. At December 31, 2004, options to purchase 651,001 shares were available for grant under these plans. These options could be either incentive stock options or nonqualified stock options.

In June 2000, the Company also adopted the 2000 Equity Incentive Plan for Outside Directors and Consultants (the “Director Plan”) under which a variety of equity investments are offered including nonqualified stock options to purchase shares of the Company’s common stock or shares of common stock can be granted to non-employee directors and consultants to the Company. A maximum of 1,500,000 shares of common stock may be issued pursuant to the Director Plan. At December 31, 2004, 659,500 shares were available for grant under this plan.

Under each of the plans, the Board of Directors determines the term of each option, but no option can be exercisable more than ten years from the date the option was granted. To date, all of the options issued under the Equity Incentive Plans expire ten years from the issue date and all of the options issued under the Director Plan expire between three months and ten years from the issue date. The Board also determines the option exercise price per share and vesting provisions. Options issued to employees generally vest over a three year period.

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The following table summarizes the options granted, exercised and cancelled in 2002, 2003 and 2004:

	Number of Shares		Average Exercise Price
Outstanding, January 1, 2001	2,679,834		2.01
Granted	210,000		0.44
Exercised	(23,334	)	0.38
Cancelled	(410,000	)	1.90
Outstanding, December 31, 2002	2,456,500		1.91
Granted	2,866,000		0.74
Exercised	(127,666	)	0.46
Cancelled	(357,667	)	3.72
Outstanding, December 31, 2003	4,837,167		1.12
Granted	1,481,834		2.39
Exercised	(982,159	)	0.60
Cancelled	(198,666	)	1.81
Outstanding, December 31, 2004	5,138,176		1.56

The following table summarizes information about stock options outstanding as of December 31, 2004:

Range of Exercise Prices	Number of Shares	Average Remaining Life (Years)	Average Exercise Price
$0.33 - $0.49	567,921	6.7	$	0.37
$0.50 - $0.99	2,035,755	8.3	$	0.61
$1.00 - $1.99	1,018,166	6.8	$	1.54
$2.00 - $2.99	1,304,334	9.3	$	2.58
$3.00 - $6.99	155,000	5.3	$	5.52
$7.00 - $13.99	57,000	5.5	$	13.50
	5,138,176

At December 31, 2004, 2003 and 2002, options to purchase 2,324,755, 2,186,742, and 1,445,889 shares were exercisable with a weighted-average exercise price of $1.64, $1.65 and $2.20 per share, respectively.

In 1999, the Company issued 200,000 options to an employee which have an exercise price below the fair value on the date of grant. Compensation expense was recognized over the vesting period of the options and $20 of expense associated with these options was recorded in 2002. At December 31, 2002, compensation costs related to these options was fully amortized to expense.

In 2003, an employee exercised options to purchase 50,000 shares of common stock ($18,500 total exercise price) by tending 28,462 shares of common stock previously held.

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The Company issued 33,333 and 330,666 stock options to non-employees in 2004 and 2003, respectively, in addition to stock options granted in prior years. These options vest over various periods and resulted in compensation expense of $102, $159 and $17 in 2004, 2003 and 2002, respectively. Compensation costs for these stock options relate to general and administrative expenses. The fair value of the stock options issued to non-employees was determined using the Black-Scholes option pricing model and the following weighted average assumptions:

	2004		2003
Dividend yield	None		None
Expected volatility	70.0	%	70.0	%
Risk-free interest rate	1.7%-3.2	%	4.80	%
Contract life (in years)	0.25-2.5		0.5-10.0

In 2004 and 2003, the Company authorized the issuance of 35,000 and 50,000 shares of common stock as compensation to the Board of Directors resulting in a $100 and $85 stock-based compensation expense, respectively. These shares were charged to expense in 2004 and 2003 when authorized, but issued in the subsequent year. In addition, in 2004 and 2003 the Company issued a total of 58,500 and 41,000 shares of common stock, respectively, to non-employees for services. The value of the shares issued is $135 and $79 in 2004 and 2003, respectively. The stock-based compensation costs were recorded in general and administrative expenses in the accompanying consolidated statements of operations.

At December 31, 2004, 6,448,677 shares of common stock are reserved for the exercise of stock options.

Common Stock Warrants

In return for services provided in connection with a private placement completed in 1999, the placement agent received warrants to purchase 743,740 common shares at $1.00 per share. The fair value of the warrants of $344, computed using the Black-Scholes option pricing model, was recorded as a reduction of the proceeds from the offering. In 2003, 43,518 common shares were issued upon the cashless exercise of 100,000 warrants. In 2004, 531,180 common shares were issued upon the cashless exercise of 208,790 warrants and $385 proceeds were received for the remaining warrants exercised. All remaining warrants expired on September 30, 2004.

13. RELATED PARTY TRANSACTIONS

In connection with the acquisition of Slim and Tone (see Note 3), the Company issued a note payable of $450 to the seller (see Note 8). The seller is now an employee of the Company.

During 2002, the Company purchased $478 of food from a vendor that is an affiliate of a former member of the Board of Directors.

14. EMPLOYEE BENEFIT PLAN

The Company maintains a qualified tax deferred defined contribution retirement plan (the “Plan”). Under the provisions of the Plan, substantially all employees meeting minimum age and service requirements are entitled to contribute on a before and after-tax basis a certain percentage of their compensation. The Company matches 100% of an employee’s contribution, up to a maximum Company match of 4% for 2004 and 2003 of the employee’s annual salary and 3% in 2002. Employees vest immediately in their contributions and the Company contribution. The Company’s contributions in 2004, 2003 and 2002 were $137, $106 and $63, respectively.

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15. EARNINGS PER SHARE

The following table presents the amounts used in computing earnings per share and the effect on weighted average number of shares for dilutive common stock equivalents.

	Year Ended December 31
	2004	2003	2002
Weighted average number of shares used in computing basic earnings per share	29,206	26,733	26,475
Dilutive effect of stock options and warrants	2,636	331	442
Weighted average number of shares used in computing diluted earnings per share	31,842	27,064	26,917

In 2004, 2003 and 2002, common stock equivalents from stock options representing 1,290,334, 750,666 and 1,270,500 shares of common stock, respectively, were excluded from weighted average shares for diluted income per share purposes since the effect of including would be anti-dilutive. In addition, outstanding warrants to purchase 698,740 shares of common stock in 2002 were also excluded as the effect of including would be anti-dilutive.

16. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL DATA

	Quarter
(In thousands, except per share amounts)	First		Second		Third			Fourth			Year
2004:
Revenues	$	13,282	$	9,179	$	7,655		$	7,880		$	37,996
Income (loss) before income taxes	$	1,242	$	1,263	$	201		$	(1,007	)	$	1,699
Net income (loss)	$	745	$	758	$	121		$	(605	)	$	1,019
Income (loss) per basic share	$	0.03	$	0.03	$	0.00		$	(0.02	)	$	0.03
Income (loss) per diluted share	$	0.02	$	0.02	$	0.00		$	(0.02	)	$	0.03
2003:
Revenues	$	7,196	$	6,315	$	4,866		$	4,198		$	22,575
Income (loss) before income taxes	$	651	$	211	$	(376	)	$	(3,071	)	$	(2,585	)
Net income (loss)	$	651	$	2,098	$	(225	)	$	(1,712	)	$	812
Income (loss) per basic and diluted share	$	0.02	$	0.08	$	(0.01	)	$	(0.06	)	$	0.03

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17. RETURNS RESERVE

Following is an analysis for the returns reserve for 2004, 2003 and 2002:

	Year Ended December 31
	2004			2003			2002
Balance at beginning of year	$	71		$	26		$	22
Provision for estimated returns		2,164			822			1,037
Actual returns		(2,096	)		(777	)		(1,033	)
Balance at end of year	$	139		$	71		$	26

The provision for estimated returns and actual returns increased in 2004 due to the higher level of new customers.

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INDEX TO EXHIBITS

No.	Description
*2.1	Agreement and Plan of Merger dated August 19, 1999 between nutrisystem.com inc. and Ansama Corp.
*2.2	Asset Purchase Agreement dated August 16, 1999 between Ansama Corp. and Nutri/System L.P.
*2.3	Stock Exchange and Purchase Agreement dated August 16, 1999 among Ansama Corp., HPF Holdings, Inc., Brian D. Haveson and NutriSystem Direct, L.L.C. management (comprised of Joseph Boileau, Kathleen Simone, Deborah Gallen and Frederick C. Tecce)
*2.4	Assignments of NutriSystem Direct, L.L.C. Membership Interests dated September 30, 1999 to nutrisystem.com inc. by each of HPF Holdings, Inc., Brian D. Haveson, Joseph Boileau, Kathleen Simone, Deborah Gallen and Frederick C. Tecce
*2.5	Operating Agreement of NutriSystem Direct, L.L.C. dated September 30, 1999
*2.6	Intellectual Property Assignment from Nutri/System L.P. to nutrisystem.com inc. dated September 30, 1999
*2.7	Assignment of Franchise Agreements from Nutri/System L.P. to nutrisystem.com inc. dated September 30, 1999
*3.1	Certificate of Incorporation of nutrisystem.com inc.
*3.2	By-laws of nutrisystem.com inc.
*4.1	Form of Common Stock certificate of nutrisystem.com inc.
*4.2	Form of warrant to purchase Common Stock of nutrisystem.com inc.
*10.1	Joint Defense and Indemnification Agreement dated September 27, 1999 between Wyeth Ayerst Laboratories Division of American Home Products Corporation and Nutri/System L.P.
*10.2	Lease, dated December 11, 1997, between Teachers Insurance and Annuity Association and nutrisystem.com inc. as amended by First Amendment to Lease dated October 28, 1999
*10.3	Form of Nutri/System L.P. Franchise Agreement
*10.4	Form of NutriSystem Direct, L.L.C. Distributor Agreement
*10.5	1999 Equity Incentive Plan of nutrisystem.com inc.

45

	No.	Description
**	10.14	Asset Purchase Agreement dated as of August 25, 2000 between nutrisystem.com inc. and Nestle USA, Inc. and related agreements.
##	10.15	Agreement dated as of September 6, 2001 between Nutri/System, Inc. and QVC, Inc. and related exhibit.
###	10.16	Agreement dated as of October 21, 2003 between NutriSystem, Inc. and GT Merchandising & Licensing LLC.
#	10.17	2000 Equity Incentive Plan for Outside Directors and Consultants of the Company
#	10.18	2000 Equity Incentive Plan of the Company
****	10.19	Second Amendment, dated September 23, 2003 to the Lease, dated December 11, 1997, between Teachers Insurance and Annuity Association and nutrisystem.com inc. as amended by First Amendment to Lease dated October 28, 1999
	10.20	Membership Interest Purchase Agreement dated as of December 2, 2004 between NutriSystem Inc. and Slim and Tone, LLC. and related agreements.
####	10.21	Employment Agreement dated December 22, 2004 between George Jankovic, the Company’s President and Chief Operating Officer and NutriSystem Inc.
***	21.1	Subsidiaries of nutrisystem.com inc.
	23.1	Consent of KPMG LLP
	31.1	Certifying Statement of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2	Certifying Statement of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32.1	Certifying Statement of the Chief Executive Officer pursuant to Section 1350 of Title 18 of the United States Code
	32.2	Certifying Statement of the Chief Financial Officer pursuant to Section 1350 of Title 18 of the United States Code

* Incorporated by reference to the designated exhibit of the Company’s Registration Statement on Form 10 filed on December 17, 1999 (file number 000-28551).

** Incorporated by reference to the designated exhibit of the Company’s Report on Form 8-K filed on October 24, 2000 (file number 000-28551).

*** Incorporated by reference to the designated exhibit of Amendment No. 2 of the Company’s Registration Statement on Form 10 filed on March 8, 2000 (file number 000-28551).

**** Incorporated by reference to the designated exhibit of the Company’s Report on Form 10-K filed on March 29, 2004 (file number 0-28551).

# Incorporated by reference to the designated exhibit of the Company’s Form PRE 14A filed on May 12, 2000 (file number 0-28551).

## Incorporated by reference to the designated exhibit of the Company’s Report on Form 8-K filed on September 18, 2001 (file number 000-28551).

### Incorporated by reference to the designated exhibit of the Company’s Report on Form 10-Q filed on November 4, 2003 (file number 0-28551).

#### Incorporated by reference to the designated exhibit of the Company’s Report on Form 8-K filed on December 22, 2004 (file number 000-28551).

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

NutriSystem, Inc.
By:	/S/ Michael J. Hagan
	Michael J. Hagan, Chairman
	of the Board and Chief Executive Officer

Dated: March 28, 2005

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capabilities indicated.

BY:	/S/ MICHAEL J. HAGAN	March 28, 2005
	Michael J. Hagan
	Chairman of the Board and Chief Executive Officer
BY:	/S/ JAMES D. BROWN	March 28, 2005
	James D. Brown
	Chief Financial Officer and Principal Accounting Officer
BY:	/S/ DJORDJE (GEORGE) JANKOVIC	March 28, 2005
	Djordje (George) Jankovic
	President, Chief Operating Officer and Director
BY:	/S/ IAN J. BERG	March 28, 2005
	Ian J. Berg
	Director
BY:	/S/ MICHAEL DIPIANO	March 28, 2005
	Michael DiPiano
	Director
BY:	/S/ WARREN V. (PETE) MUSSER	March 28, 2005
	Warren V. (Pete) Musser
	Director
BY:	/S/ BRIAN P. TIERNEY	March 28, 2005
	Brian P. Tierney
	Director
BY:	/S/ STEPHEN T. ZARRILLI	March 28, 2005
	Stephen T. Zarrilli
	Director

47

EX-10.20

Exhibit 10.20

MEMBERSHIP INTEREST PURCHASE AGREEMENT

between

NUTRISYSTEM, INC.

(a Delaware corporation),

and

ELIZABETH LUDLOW

the sole member of

SLIM AND TONE, LLC

MEMBERSHIP INTEREST PURCHASE AGREEMENT

INTRODUCTION

This MEMBERSHIP INTEREST PURCHASE AGREEMENT is dated as of December 2, 2004. The parties are NUTRISYSTEM, INC., a Delaware corporation (the “Buyer”) and ELIZABETH LUDLOW, an individual and a resident of the Commonwealth of Pennsylvania (the “Seller”). Seller is the sole member and President of SLIM AND TONE, LLC, a Pennsylvania limited liability company (the “Company”).

BACKGROUND

Seller owns all of the issued and outstanding membership interests (the “Shares”) of the Company. The Buyer desires to purchase from the Seller, and the Seller desires to sell to the Buyer, the Shares on the terms and conditions set forth herein.

NOW, THEREFORE, in consideration of the respective covenants, representations and warranties herein contained, and intending to be legally bound hereby, the parties hereto agree as follows:

1. Definitions.

For convenience, certain terms used in more than one part of this Agreement are listed in alphabetical order and defined or referred to below (such terms as well as any other terms defined elsewhere in this Agreement shall be equally applicable to both the singular and plural forms of the terms defined).

“Action” is defined in Section 7.5.

“Affiliates” means, with respect to a particular party, Persons controlling, controlled by or under common control with that party, as well as any officers, directors and majority-owned entities of that party and of its other Affiliates. For the purposes of the foregoing, ownership, directly or indirectly, of 20% or more of the voting membership interest or other equity interest shall be deemed to constitute control.

“Agreement” means this Membership Interest Purchase Agreement, including all schedules and exhibits hereto.

“Assets” means, with respect to the Company as the context may require, all assets, properties, business, goodwill and rights of every kind and description, real and personal, tangible and intangible, wherever situated and whether or not reflected on the Current Balance Sheet.

“Balance Sheet Date” means September 30, 2004.

“Business” means the existing and prospective business, operations, facilities and other Assets, financial condition, results of operations, finances, markets, products, competitive position, raw materials and other supplies, customers and customer relations and personnel of the Company.

“Business Day” means any calendar day which is not a Saturday, Sunday or public holiday under the laws of the Commonwealth of Pennsylvania.

“Buyer” is defined in the Introduction.

“Cap” is defined in Section 7.3(d).

“CERCLA” means the Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. §§ 9601 et seq.

“Change of Control Event” means (i) any sale, lease, exchange, or other transfer of all or substantially all of the assets of the Buyer to any other Person (in one transaction or a series of related transactions), (ii) dissolution or liquidation of the Buyer, or (iii) when any Person, including a “group” as contemplated by Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, acquires or gains ownership or control (including, without limitation, power to vote) of more than 50% of the outstanding shares of the Buyer’s voting securities (based upon voting power).

“Charter Documents” means an entity’s certificate or articles of incorporation or formation, certificate defining the rights and preferences of securities, articles of organization, general or limited partnership agreement, operating agreement, certificate of limited partnership, joint venture agreement or similar document governing the entity.

“Claim Notice” is defined in Section 7.3(a).

“Claim Response” is defined in Section 7.3(a).

“Closing” is defined in Section 3.1.

“Closing Date” is defined in Section 3.1.

“Code” means the US Internal Revenue Code of 1986, as amended, and the rules and regulations thereunder.

“Company” is defined in the Introduction.

“Company Intellectual Property” means all Intellectual Property Rights owned or licensed by the Company or used by the Company.

“Company Plan” means (x) any pension plan, 401(k) plan, profit-sharing plan, health or welfare plan, and any other employee benefit plan (within the meaning of Section 3(3) of ERISA) that is maintained or sponsored by the Company or to which the Company contributes or for which the Company otherwise has or may have any liability, contingent or otherwise, either directly or as a result of an ERISA Affiliate, and (y) any other benefit arrangement, obligation, or practice, whether or not legally enforceable, to provide benefits, other than salary, as compensation for services rendered, to one or more present or former employees, directors, agents, or independent contractors, that is maintained or sponsored by the Company or to which the Company contributes or for which the Company otherwise has or may have any liability, contingent or otherwise, either directly or as a result of an ERISA Affiliate.

“Company Software” means all Software owned or licensed by the Company or used by the Company.

“Company Trade Secrets” means all Trade Secrets owned by the Company or used by the Company.

“Confidential Information” means any information of a party, including a formula, pattern, list, compilation, device, method, technique or process that derives independent economic value, actual or potential, from not being generally known to the public or to other Persons who can obtain economic value from its disclosure or use.

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“Contract” means any written or oral contract, agreement, lease, plan, instrument or other document, commitment, arrangement, undertaking, practice or authorization that is or may be binding on any Person or its property under applicable Law.

“Copyrights” mean all copyrights in both published and unpublished form and all registrations and applications for registration for copyrights in any jurisdiction, and any renewals, modifications and extensions thereof.

“Court Order” means any judgment, decree, injunction, order or ruling of any federal, state, local or foreign court or governmental or regulatory body or authority that is binding on any Person or its property under applicable Law.

“Current Balance Sheet” means the Company’s unaudited balance sheet as of September 30, 2004.

“Damages” is defined in Section 7.1(a).

“Default” means (i) a breach, default or violation, (ii) the occurrence of an event that with or without the passage of time or the giving of notice, or both, would constitute a breach, default or violation or (iii) with respect to any Contract, the occurrence of an event that with or without the passage of time or the giving of notice, or both, would give rise to a right of termination, renegotiation or acceleration.

“Elizabeth Ludlow Employment Agreement” means the Employment Agreement between the Buyer and the Seller, in a form substantially similar to that attached hereto as Exhibit A.

“Encumbrance” means any lien, mortgage, easement, security interest, pledge, charge, claim, community property interest, condition, equitable interest, option, right of first refusal, restriction on transferability, defect of title or other restriction of any nature whatsoever, including any restriction on use, voting, transfer, receipt of income, or exercise of any other attribute of ownership.

“Environmental Law” means all Laws and Court Orders as well as any principles under common law in existence as of the Closing Date relating to pollution or protection of the environment or occupational health under which a Person may be held liable for the Release of any Hazardous Substance into the environment.

“Escrow Agent” means Sovereign Bank, a federal savings bank duly qualified to carry on business in Philadelphia, Pennsylvania.

“Escrow Agreement” means the Escrow Agreement between Buyer, Seller and the Escrow Agent in a form substantially similar to that attached hereto as Exhibit B.

“Escrow Funds” is defined in Section 2.3(e).

“ERISA” means the Employee Retirement Income Security Act of 1974, as amended, and all regulations and rules issued thereunder, or any successor law.

“Exchange Act” means the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder.

“Financial Statements” means (a) the audited consolidated balance sheets of the Company for the two year period ended December 31, 2003 and the related consolidated statements of operations, changes in Seller’s equity and cash flows for each of the years then ended together with the unqualified audit opinion thereon of the Company’s independent accountants, (b) the unaudited consolidated balance sheet

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of the Company for the nine months ended September 30, 2004 and the related statements of operations and cash flows for the nine months ended September 30, 2003 and 2004, which has been compiled by the Company’s independent accountants, and (c) the notes thereto.

“Franchise Agreement” means all franchise agreements and license agreements for Outlets, along with any sublease, collateral assignment of lease, security interest or personal guaranty granted in connection with the foregoing.

“GAAP” means generally accepted accounting principles.

“Governmental Authorization” means any permits, licenses, franchises, registrations, certificates, variances, exemptions, waivers, consents, approvals and other authorizations granted or otherwise made available by or under the authority of any governmental or regulatory body or authority, including, but not limited to, the US Federal Trade Commission.

“Hazardous Substances” means any hazardous, toxic or radioactive substance, material or waste which is regulated as of the Closing Date by any state or local governmental authority or the United States of America.

“Indemnified Party” is defined in Section 7.3(a).

“Indemnified Buyer Party” is defined in Section 7.1.

“Indemnified Seller Party” is defined in Section 7.2.

“Indemnitor” is defined in Section 7.3(a).

“Initial Payment” is defined in Section 2.3(a).

“Intellectual Property Rights” means Patents, Trademarks, Copyrights, Trade Secrets, Software and all other tangible or intangible proprietary information, materials or data.

“IRS” means the US Internal Revenue Service.

“Knowledge” of a particular fact or matter means actual knowledge of such fact or other matter after having completed a reasonable level of inquiry concerning the existence of such fact or other matter.

“Law” means any statute, law, ordinance, regulation, order or rule of any federal, state, local or, foreign governmental or regulatory body or authority.

“Lease” is defined in Section 4.13.

“Liability” means any direct or indirect liability, indebtedness, obligation, expense, claim, loss, damage, deficiency, guaranty or endorsement of or by any Person, absolute or contingent, accrued or unaccrued, due or to become due, liquidated or unliquidated.

“Liquidated Claim Notice” is defined in Section 7.3(a).

“Litigation” means any lawsuit, action, arbitration, administrative or other proceeding, criminal prosecution or governmental investigation or inquiry.

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“Material Adverse Effect” means a material adverse effect on the Company or the Business, Assets, financial condition, results of operations, prospects, liquidity, products, competitive position, customers and customer relations of the Company or the Business.

“Ordinary course” or “ordinary course of business” means the ordinary course of business that is consistent with past practices.

“Outlet” shall mean one Slim and Tone fitness center that is the subject of an executed Franchise Agreement between the Company and a franchisee.

“Patents” mean all patents, together with any extensions, reexaminations, reissues, patents of additions, patent applications, divisions, continuations, continuations-in-part, improvements and any subsequent filings in any country of jurisdiction claiming priority therefrom.

“Person” means any natural person, corporation, partnership, proprietorship, association, joint venture, trust or other legal entity.

“Prime Rate” means the prime lending rate as reported in The Wall Street Journal from time to time as the base rate on corporate loans.

“Purchase Price” is defined in Section 2.2.

“Release” means any release, spill, emission, leaching, leaking, pumping, injection, deposit, disposal, discharge or dispersal into the indoor or outdoor environment, or into or out of any property.

“Required Consents” is defined in Section 4.4.

“Response Period” is defined in Section 7.3(a).

“Restricted Party” is defined in Section 6.1.

“Restricted Period” is defined in Section 6.1.

“Restricted Territory” is defined in Section 6.1.

“Securities Act” means the Securities Act of 1933, as amended, and the rules and regulations thereunder.

“Shares” is defined in the Introduction.

“Software” means any computer software, of any nature whatsoever, and all middleware and firmware, and any and all documentation and object and source code related thereto.

“Seller” is defined in the Introduction.

“Taxes” shall mean all taxes, duties, charges, fees, levies or other assessment imposed by any taxing authority (including any interest, penalties or additions attributable to or imposed on or with respect to any such assessment).

“Tax Returns” means all reports, returns, statements (including estimated reports, returns or statements) and other similar filings required to be filed by a party with respect to any Taxes.

“Threshold Amount” is defined in Section 7.3(d).

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“Trademarks” mean trademarks, services marks, trademark and service mark applications, brand names, certification marks, trade dress, Internet domain names and Internet domain name applications, goodwill associated with the foregoing and all registrations in any jurisdictions of, and all applications in any jurisdiction to register, the foregoing, including any extension, modification, renewal of any such registration or application thereof.

“Trade Secrets” mean all know-know, trade secrets, customer lists, personnel information, sales and profit figures, distribution and sales methods, supplier lists, technology rights and licenses, specifications and other technical information, data, blue prints, process technology, processes, plans, formulae, rights in research and development, franchises, drawings (including engineering and auto-cad drawings), innovations, inventions, discoveries, ideas, databases and all other proprietary information.

“Transaction Documents” means this Agreement and any other certificate, instrument, agreement or document required to be delivered pursuant to the terms hereof.

“Transactions” means the sale of the Shares by the Seller to Buyer and the purchase of the Shares by the Buyer from the Seller as described herein and the other transactions contemplated by the Transaction Documents.

“Unliquidated Claim” is defined in Section 7.3(a).

“US” means the United States of America.

2. Sale and Purchase of the Shares; Purchase Price.

2.1 Sale and Purchase of the Shares. Subject to the terms and conditions of this Agreement and on the basis of and in reliance upon the representations, warranties, covenants and agreements set forth herein, at the Closing the Seller shall sell to the Buyer and the Buyer shall purchase from the Seller all of the Shares.

2.2 Purchase Price. The purchase price for the Shares (the “Purchase Price”), which shall be paid in accordance with Section 2.3, shall be an amount equal to $1,900,000.

2.3 Payment of Purchase Price. The Purchase Price shall be payable to the Seller as follows:

(a) At the Closing, Buyer shall deliver to the Seller a payment in the amount of $1,000,000 in cash (the “Initial Payment”) by wire transfer of immediately available funds to accounts designated by the Seller in writing to Buyer at least two days prior to the Closing Date.

(b) On or before December 31, 2005, Buyer shall deliver to the Seller a payment in the amount of $150,000 in cash (the “2005 Payment”) by wire transfer of immediately available funds to accounts designated by the Seller in writing to Buyer at least two days prior to the 2005 Payment.

(c) On or before December 31, 2006, Buyer shall deliver to the Seller a payment in the amount of $150,000 in cash (the “2006 Payment”) by wire transfer of immediately available funds to accounts designated by the Seller in writing to Buyer at least two days prior to the 2006 Payment.

(d) On or before December 31, 2007, Buyer shall deliver to the Seller a payment in the amount of $150,000 in cash (the “2007 Payment”) by wire transfer of immediately available funds to accounts designated by the Seller in writing to Buyer at least two days prior to the 2007 Payment.

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(e) At the Closing, Buyer shall deliver an aggregate amount of $450,000 to the Escrow Agent (the “Escrow Funds”) to be held in escrow and distributed by the Escrow Agent in accordance with the Escrow Agreement.

(f) Upon a Change of Control Event, the parties agree that any outstanding amounts owed to Seller from the 2005 Payment, the 2006 Payment and the 2007 Payment shall be delivered to the Escrow Agent to be deposited with the Escrow Funds. Buyer and Seller agree to jointly instruct the Escrow Agent to accept such funds and to add, as determined by the date of each Payment, the appropriate amount to the corresponding scheduled disbursement as provided by Section 4 of the Escrow Agreement.

3. Closing.

3.1 Location; Date. The closing for the Transactions (the “Closing”) shall be held at the offices of Morgan Lewis & Bockius LLP in Philadelphia on December 2, 2004 or at such other date and place as may be mutually agreed by the parties (the “Closing Date”).

3.2 Deliveries. At the Closing and as a condition to Closing:

(a) The Seller shall deliver to Buyer:

(i) The certificates, if any, and other instruments evidencing the Shares in negotiable form (free and clear of all pledges, liens, transfer tax obligations, Encumbrances, claims and other charges thereon of every kind), duly endorsed in blank, or with separate membership interest transfer powers attached thereto and signed in blank;

(ii) All of the Required Consents;

(iii) An executed copy of each Transaction Document to which the Seller is a party;

(iv) The Elizabeth Ludlow Employment Agreement;

(v) The Escrow Agreement;

(vi) Evidence that the Escrow Funds were delivered to the Escrow Agent;

(vii) The Financial Statements; and

(viii) Such other documents, instruments, certificates and agreements as may be reasonably required by Buyer to consummate and give effect to the transactions contemplated by this Agreement.

(b) Buyer shall deliver to the Seller:

(i) The Initial Payment;

(ii) An executed copy of each Transaction Document to which a Buyer is a party;

(iii) The Escrow Agreement;

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(iv) The Elizabeth Ludlow Employment Agreement; and

(v) Such other documents, instruments, certificates and agreements as may be reasonably required by the Seller to consummate and give effect to the transactions contemplated by this Agreement.

4. Representations and Warranties of Seller. Seller hereby represents and warrants to Buyer as follows:

4.1 Organization and Standing.

(a) The Company is a limited liability company, duly organized and validly existing and in good standing under the laws of the Commonwealth of Pennsylvania having full power and authority to carry on the Business as it has been and is now being conducted and to own, lease and operate the Assets. The Company is duly qualified to do business and is in good standing in every jurisdiction in which the Business or the character of the Assets requires such qualification, all of which jurisdictions are disclosed in Schedule 4.1(a).

4.2 Capitalization and Ownership.

(a) The authorized membership interests of the Company consist of one membership interest, all of which is issued and outstanding, and all of which is owned by Seller. Seller is the record and beneficial holder of the Shares, free and clear of any Encumbrance. All of the Shares have been duly authorized and validly issued, are fully paid and nonassessable, were not issued in violation of the terms of any Contract binding upon the Company or Seller, and were issued in compliance with all applicable Charter Documents of the Company and all applicable federal and state securities or “blue sky” Laws. There are no outstanding options, warrants, convertible securities, Contracts or rights of any kind to purchase or otherwise acquire or receive from the Company any membership interests of, or any securities convertible into, the Common Membership interest or other securities of the Company. No membership interests or other securities of the Company are reserved or authorized for issuance. Seller is not a party to any voting trust, proxy, Contract or other agreement or understanding with respect to the voting or transfer of any capital membership interest of the Company.

(b) The Company owns no equity security of any Person and has no other ownership or other investment interest, either of record, beneficially or equitably, in any Person, except for bank, checking and money market accounts and other cash equivalent investments.

4.3 Authority and Binding Effect. Seller has the full power, authority, capacity and legal right to execute and deliver this Agreement and the other Transaction Documents, to perform the Transactions to be performed by her hereunder and thereunder, and has taken all actions necessary to secure all approvals required in connection therewith. The execution and delivery of this Agreement and the performance of the Transactions by her will not constitute a Default under the Charter Documents of the Company or any Contract binding upon the Company or Seller. This Agreement constitutes, and the other Transaction Documents will constitute, the legal, valid and binding obligation of Seller, enforceable against her in accordance with their respective terms.

4.4 Validity of the Transactions. Except for any consents specified in Schedule 4.4 (the “Required Consents”), neither the execution and delivery of this Agreement by Seller nor the performance of the Transactions (i) will cause a Default under any Law or Court Order which is applicable to the Company or Seller, (ii) require the consent or approval of, or notice to, any party to, any Contract relating to the Business or the Assets or by which the Company or Seller is a party or otherwise bound or affected, or (iii) require the Company or Seller to notify, or obtain any Governmental Authorization from, any governmental or regulatory body or authority.

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4.5 Financial Statements; Books of Account.

(a) The Financial Statements are complete, were prepared in accordance with GAAP, consistently applied throughout the periods covered thereby and, subject to any qualifications set forth in the applicable notes and schedules, fairly and accurately present the financial position and results of operations of the Company at the dates and for the periods covered.

(b) The books and accounting records of the Company fairly reflect in all material respects (i) all transactions relating to the Company and (ii) all items of income and expense, assets and liabilities and accruals relating to the Company. The Company has not engaged in any material transaction, maintained any bank account or used any corporate funds except for transactions, bank accounts and funds which have been and are reflected in the normally maintained books and records of the Company.

4.6 Taxes.

(a) All Tax Returns required to be filed by the Company or with respect to the Business, its income or Assets have been timely filed and all such Tax Returns were true, correct and complete in all material respects.

(b) Except for Taxes not yet due, all Taxes owed with respect to the Company or with respect to the Business, its income or Assets have been paid on a timely basis, whether or not shown on any Tax Return.

(c) The amount of the Company’s liability for unpaid Taxes as of the Balance Sheet Date did not exceed the amount of the current liability accruals for Taxes (excluding reserves for deferred Taxes) shown on the Current Balance Sheet, and the amount of the Company’s liability for unpaid Taxes for all periods or portions thereof ending on or before the Closing Date will not exceed the amount of the current liability accruals for Taxes (excluding reserves for deferred Taxes) as such accruals are reflected on the books and records of the Company on the Closing Date.

(d) There are no ongoing examinations or claims against the Company for Taxes, and no written notice of any audit, examination or claim for Taxes, whether pending or threatened, has ever been received.

(e) The Company is not the beneficiary of any extension of time within which to file any Tax Return, nor has the Company made any requests for such extensions. No claim has ever been made by an authority in a jurisdiction where the Company does not file Tax Returns that it is or may be subject to taxation by that jurisdiction.

(f) The Company has a taxable year ended on December 31.

(g) The Company currently utilizes the cash method of accounting for income Tax purposes and such method of accounting has not changed since the founding of the Company. The Company has not agreed to and is not required to make by reason of a change in accounting method or otherwise, and could not be required to make by reason of a proposed or threatened change in accounting method or otherwise, any adjustment under Section 481(a) of the Code.

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(h) The Company has not received (and is not subject to) any ruling from any taxing authority and has not entered into (and is not subject to) any agreement with a taxing authority.

(i) The Company has withheld and paid over to the proper taxing authorities all Taxes required to have been withheld and paid over, and complied with all information reporting and backup withholding requirements, including maintenance of required records with respect thereto.

(j) Copies of (i) any Tax examinations, (ii) extensions of statutory limitations for the collection or assessment of Taxes and (iii) the Tax Returns of the Company for the last three fiscal years have been made available to Buyer.

(k) There are (and as of immediately following the Closing there will be) no Encumbrances on the Assets or Shares of the Company relating to or attributable to Taxes.

(l) The Company is not a party to any Tax allocation or sharing agreement. The Company does not have any liability for the Taxes of any person (i) as a transferee or successor, (ii) by contract, or (iii) otherwise.

(m) The Company will not be required to include any item of income in, or exclude any item of deduction from, taxable income for any taxable period (or portion thereof) ending after the Closing Date as a result of any (i) installment sale or open transaction disposition made on or prior to the Closing Date or (ii) prepaid amount received on or prior to the Closing Date.

(n) The Company has, at all times since its inception, properly been treated as a disregarded entity for federal income tax purposes.

4.7 Undisclosed Liabilities. Except as set forth on Schedule 4.7, the Company does not have any Liabilities except for:

(a) those Liabilities adequately and specifically set forth or reserved for on the Current Balance Sheet and not heretofore paid or discharged; and

(b) those Liabilities incurred in the ordinary course of business since the Balance Sheet Date and not heretofore paid or discharged.

4.8 No Manufacturing. The Company does not manufacture and has not manufactured any product for sale.

4.9 Trade Receivables. The trade receivables reflected on the Current Balance Sheet, and all trade receivables arising since the Balance Sheet Date, represent valid obligations arising from sales actually made in the ordinary course of business and are good and collectible in full at the recorded amounts thereof, net of reserves for doubtful accounts, in each case, computed in accordance with GAAP and past practices consistently applied. In the case of the reserve, as of the Closing Date, it does not represent a greater percentage of the trades receivable than the reserve reflected on the Current Balance Sheet represented the trade receivables reflected therein.

4.10 Franchise Matters.

(a) Disclosure Documents. The Company’s past and present franchise disclosure documents and/or franchise offering circulars (collectively “FOCs”) for any type of franchise the Company offers, and/or, if applicable, any licenses: (A) materially comply with all applicable Federal

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Trade Commission (“FTC”) franchise disclosure regulations, any other applicable foreign or federal laws and regulations, state franchise and business opportunity sales laws and regulations, and local laws and regulations; (B) include and accurately state all material information (including but not limited to the discussion of litigation matters) set forth in them; (C) do not omit any required material information; (D) accurately state the Company’s position that it does not provide to prospective area or individual franchisees “earnings claims” information (as that term is defined in the FTC’s franchise disclosure regulations and the North American Securities Administrators Association’s current Uniform Franchise Offering Circular Guidelines); (E) have been timely revised to reflect any material changes or developments in the Company’s franchise system, agreements, operations, financial condition, litigation matters, or other matters requiring disclosure under any applicable foreign, federal, state, and/or local law; and (F) include all material documents (including but not limited to audited financial statements for the Company) required by any applicable foreign, federal, state, and/or local law to be provided to prospective franchisees and/or, if applicable, any licensees.

(b) Franchise and License Agreements. The Company’s past and present agreements with its franchisees and licensees: (A) materially comply with applicable foreign, federal, state, and/or local laws and regulations; (B) do not include provisions that would prevent or otherwise impair the Company’s ability to undergo a change in ownership or control or require the Company to notify any franchisees and/or licensees of such a change in ownership or control; (C) do not obligate the Company to buy back or otherwise acquire the stock, assets, or contractual rights of franchisees, and/or licensees; (D) do not impose on the Company an obligation to guarantee the lease obligations, third party financing obligations, or other material obligations to third parties of the franchisees, and/or licensees; (E) impose on franchisees, and licensees an obligation to comply with all applicable federal, state, and local laws and regulations; and (F) impose on franchisees, and licensees an obligation to maintain commercially reasonable insurance that names the Company as an additional insured, requires the insurer to notify the Company before it terminates any such insurance policy for nonpayment, and permits the Company to make such payments to maintain such insurance coverage on behalf of any non-paying franchisee, or licensee.

(c) Registration and Disclosure Compliance. All of the franchises, and licenses of the Company have been sold in material compliance with applicable foreign, federal, state, and/or local franchise disclosure and registration requirements, except those set forth on Schedule 4.10(c). As a result,

(i) each prospective franchisee, and, if applicable, licensee was provided with any required FOC at the earlier of (1) the first personal face-to-face meeting between the Company and the then prospect for the purposes of discussing the acquisition of a franchise, or, if applicable, license, (2) at least ten business days before the execution of any agreement with the Company or the payment of any funds to the Company by the prospective franchisee, or, if applicable, licensee, or (3) within any other minimum time period imposed by law;

(ii) at least five business days before execution of any agreements with the Company, each prospective franchisee, and, if applicable, licensee was provided with a completed execution copy of the Company’s franchise agreement, or, if applicable, license agreement, respectively, together with any related documents (e.g., spousal consent form, phone transfer agreement, software license, security agreement, equipment lease, national account agreement) with all pertinent specific information for such prospective franchisee, or, if applicable, licensee set forth in those agreements and documents;

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(iii) each FOC provided to a prospective franchisee, or, if applicable, licensee complied in all material respects at the time of the delivery of such FOC with applicable foreign, federal, state, and/or local laws regarding such franchise offering circulars;

(iv) each of the Company’s required FOCs were either properly registered with appropriate franchise regulatory authorities, covered by a proper notice filing with appropriate franchise regulatory authorities, or qualified for an exemption from such registration or notice filing requirements;

(v) each of the Company’s offerings were, where applicable, either properly registered with appropriate business opportunity sales authorities or qualified for an exemption from such registration requirements;

(vi) the Company obtained signed acknowledgments of receipt for the delivery of each FOC to prospective franchisees, and, if applicable, licensees;

(vii) to the extent that the Company may have experienced lapses in one or more jurisdictions for its registrations for franchise offerings, and/or, if applicable, license offerings, the Company did not offer or sell during the period of any such lapses any such franchises, or, if applicable, licenses for franchises (1) in those jurisdictions, (2) to be operated outside those jurisdictions by residents of those jurisdictions, or (3) the sale of which might otherwise have triggered the application of the franchise registration laws of those jurisdictions during the periods of any such lapse;

(viii) to the extent required by foreign, federal, state, and/or local law, the Company has complied with all applicable franchise advertising filing requirements;

(ix) to the best of its knowledge, the Company is not aware of any instances in which any of its employees, sales agents, or sales brokers for franchises, or, if applicable, licenses provided information to prospective franchisees, or, if applicable, licensees, that materially differed from the information contained in the FOCs provided to such prospects (including but not limited to “earnings claim” information);

(x) where required, the Company properly filed with appropriate franchise regulatory authorities amendments to its FOCs to reflect any material changes or developments in the Company’s franchise system, agreements, operations, financial condition, litigation or other matters requiring disclosure;

(xi) where required, the Company complied with foreign, federal, state, and/or local laws (including in particular those of California and North Dakota) requiring registration, disclosure, and/or other compliance activities associated with any “material modifications” made to the Company’s then current franchises, or, if applicable, licenses.

(d) Franchise and Related Litigation. The Company’s May 1, 2004 FOC for its standard franchise agreement sets forth accurate summary information about

(i) any governmental regulatory, criminal, and/or material civil actions pending against the Company alleging a violation of a foreign and/or United States franchise, antitrust or securities law, fraud, unfair or deceptive practices, or comparable allegations as well as actions other than ordinary routine litigation incidental to the Company’s business which are significant in the context of the number of the Company’s franchisees and the size, nature or financial condition of the franchise system or its business operations;

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(ii) any convictions of a felony, nolo contendre pleas to a felony charge, and adverse final judgments in a civil action in foreign countries and/or the United States for the period for which disclosure is required in the FOC as well as all material actions for the period for which disclosure is required in the FOC involving violation of a franchise, antitrust or securities law, fraud, unfair or deceptive practices, or comparable allegations; and

(iii) all currently effective injunctive or restrictive orders or decrees relating to the franchise area under a foreign, federal, state, or local franchise, securities, antitrust, trade regulation, or trade practices law resulting from a concluded or pending action or proceeding brought by a public agency.

In addition, the Company has not received notice of any threatened administrative, criminal and/or material civil action against it and/or any persons disclosed in Item 2 of the Company’s May 1, 2004 FOC for its standard franchise agreement where such threatened administrative, criminal and/or material civil action alleges a violation of a foreign and/or United States franchise, antitrust law, or securities law, fraud, unfair or deceptive practices, or comparable allegations as well as actions other than ordinary routine litigation incidental to the Company’s business which are significant in the context of the number of the Company’s franchisees and the size, nature, or financial condition of the franchise system or its business operations.

(iv) Franchisee Relations and Operations. In the Company’s communications with its franchisees, licensees, and representative groups of those franchisees, and/or licensees, the Company is not aware of any material misstatements regarding its operations, franchise system, agreements, financial condition, litigation matters, or plans that could be used as a basis for a successful fraud, misrepresentation, or franchise law violation claim against the Company. The Company has taken and continues to take commercially reasonable efforts to protect the confidentiality of its current Operations Manual.

(v) Franchise Terminations. The Company’s termination of or effort to terminate or refusal to renew any franchisee, or, if applicable, licensee, has complied with applicable federal, state, and/or local franchise termination laws and regulations including, in particular, but not limited to, having provided any such franchisee, or, if applicable, licensee involved in such a nonrenewal or termination any statutorily required notice and opportunity to cure. The Company has complied with all other applicable foreign, federal, state, and/or local laws and/or regulations relating to ongoing franchise relationships, the termination of such relationships, and/or the non-renewal of such relationships.

(e) Outlet Activity. Set forth on Schedule 4.10 is a true and correct report of Outlet activity by the Company identifying Outlet sales, sales leads, Outlet closures, Outlet openings on a monthly basis from January 2003 through October 2004.

4.11 Title to Assets. The Company owns outright all of the Assets it purports to own, including the assets and properties set forth on the Current Balance Sheet (except for such as may have been disposed of in the ordinary course of business since the Balance Sheet Date) together with any Assets acquired since the Balance Sheet Date, free and clear of all Encumbrances, except for property leased pursuant to leases disclosed on any Schedule hereto. Except pursuant to leases described on any Schedule hereto, no person other than the Company owns any vehicles, equipment or other tangible Assets situated on the facilities used by the Company in the Business (other than immaterial items of personal property owned by the Company’s employees) which are necessary to the operation of the Business.

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4.12 Condition of Assets. The equipment and all other tangible assets and properties which are part of the Assets are in good operating condition and repair and are usable in the ordinary course of the Business, except for failures that would not reasonably be likely to result in an Adverse Material Effect, and conform in all material respects to all applicable Laws relating to their use and operation as such Assets.

4.13 Real Property. All real property (including, all interests in and rights to real property) and improvements located thereon which are leased by the Company are listed on Schedule 4.13 (individually, a “Lease” and collectively, the “Leases”). The Company does not have an ownership interest of any kind in, or rights to, any real property or improvements, except solely for leasehold interests in the real property and improvements listed on Schedule 4.13 pursuant to the leases described on Schedule 4.13. Each of the Leases is in full force and effect in accordance with its respective terms and the Company is the holder of the lessee’s or tenant’s interest thereunder. There exists no Default under any Lease. There are no leases, subleases, licenses, concessions or any other contracts or agreements granting to any Person other than the Company any right to the possession, use, occupancy or enjoyment of any portion of real property leased by the Company, except for that certain sublease with LHBW, LLC, a Slim and Tone franchisee that operates a Slim and Tone club on the first floor of the real property housing Slim and Tone’s headquarters.

4.14 Non-Real Estate Leases. Schedule 4.14 lists all Assets used in the Business (other than Real Property) that are possessed by the Company under an existing lease, including all, automobiles, equipment, furniture and computers. Schedule 4.14 also lists the leases under which such Assets listed in Schedule 4.14 are possessed.

4.15 Intellectual Property.

(a) Intellectual Property of the Business.

(i) Schedule 4.15(a)(i) contains a complete and accurate list and summary description of all of the Company Intellectual Property, in the groupings and further information required by Sections 4.15(b), (c) and (d).

(ii) Schedule 4.15(a)(ii)(A) contains a complete and accurate list and summary description of all of the Intellectual Property Rights, which the Company licenses or uses, in the groupings and further information required by Sections 4.15(b), (c) and (d). Except as set forth in Schedule 4.15(a)(ii)(B), with respect to the Intellectual Property Rights listed in Schedule 4.15(a)(ii)(A), the Company has secured all necessary rights and licenses to such Intellectual Property Rights material to the conduct of the Business.

(iii) The Intellectual Property Rights listed in Schedules 4.15(a)(i) and 4.15(a)(ii)(A), constitutes all of the material Intellectual Property Rights material to the Business.

(iv) Except as described in Schedules 4.15(a)(ii)(A) and (B), the Company is the owner of all right, title and interest in and to all of the Intellectual Property Rights related to the Business, free and clear of any Encumbrances, and has the right to use without payment to a third party.

(v) To the Seller’s Knowledge, except as set forth in Schedule 4.15(a)(v), the operation of the Business does not (and will not) infringe or misappropriate any Intellectual Property Rights of any other Person. Except as set forth in Schedule 4.15(a)(v), Seller has not received written notice from any other Person and otherwise has no Knowledge that the operation of the Business infringes or misappropriates the Intellectual Property Rights of any other Person or constitutes unfair competition or trade practices under the Laws of any jurisdiction.

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(b) Patents. The Company has no Patents.

(c) Trademarks.

(i) Schedule 4.15(a)(i) contains a complete and accurate list and summary description of all registrations and applications for registration for Trademarks and all material unregistered Trademarks which are owned by the Company or an Affiliate, detailing the countries or jurisdictions in which such material registrations have been registered or such applications for registration have been filed. Except as disclosed in Schedule 4.15(c)(i), all applications to register any domestic Trademarks and all of such Trademarks that have been registered with the US Patent and Trademark Office, are currently in compliance with all formal requirements under any federal law and are valid and enforceable.

(ii) Except as listed in Schedule 4.15(c)(ii), no registration or applications for registration for a domestic Trademark listed in Schedule 4.15(a)(i) is now involved in any opposition, invalidation or cancellation and, to the Seller’s Knowledge, the Company has received no notice that any such action is threatened with respect to any of the registration or applications for registration for a Trademark.

(iii) Except as disclosed in Schedule 4.15(c)(iii), to the Seller’s Knowledge, no Trademark listed in Schedule 4.15(a)(i) is infringed or has been challenged or threatened in any way by any third party.

(d) Copyrights. Schedule 4.15(a)(i) contains a complete and accurate list and summary description of all registrations and applications for registration for Copyrights and all unregistered Copyrights which are owned by the Company, detailing for each the countries or jurisdictions in which such material registrations have been registered or such applications for registration have been filed. To the Seller’s Knowledge, no Copyright listed in Schedule 4.15(a)(i) is infringed or has been challenged or threatened in any way by any third party.

(e) Trade Secrets. The Company takes reasonable precautions to protect the secrecy, confidentiality and value of its Trade Secrets. To Seller’s Knowledge, and except as disclosed in Schedule 4.15(e), no such Trade Secrets owned by the Company or an Affiliate has been disclosed to a third party except under a confidentiality agreement. Except as disclosed in Schedule 4.15(e), to the Seller’s Knowledge, the Company has received no written notice or otherwise has no Knowledge that any Trade Secret of the Company is subject to any adverse claim or has been challenged or threatened in any way.

(f) Company Software. Schedule 4.15(f)(i)(A) contains a complete and accurate list and summary description of all of the Company Software. The Company owns or has secured all necessary rights and licenses to such Software material to the conduct of the Business. To Seller’s Knowledge, the Company’s use of the Company Software listed in Schedule 4.15(f)(i)(A) does not violate any agreement with a third party.

4.16 Contracts.

(a) Schedule 4.16 lists all current Contracts of the following types to which the Company is a party or by which it is bound:

(i) Any Franchise Agreement;

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(ii) Contracts with any present or former Seller, member, director, officer, employee, partner or consultant of the Company (other than Contracts where the sole remaining obligations relate to non-disclosure or other similar provision binding upon the parties other than the Company);

(iii) Contracts, other than purchase orders for food products, for the future purchase of, or payment for, goods or services by a third party obligating the Company to pay or by which they could be obligated to pay $25,000 or more (other than Contracts that are terminable upon not more than 30 days prior written notice without payment or penalty);

(iv) Contracts to sell or supply products or to perform services that involve an amount in excess of $25,000 in any individual case;

(v) Contract under which the Company is either lessor or lessee and pursuant to which the aggregate amount payable in any one year is greater than $25,000 or the aggregate amount payable during the current term of the lease is greater than $50,000;

(vi) Any license, franchise, distributorship, sales agency or other arrangements; provided, however, that for direct marketing distributorship agreements which are standard form agreements and identical other than the countersigning party, only a sample copy of such agreements need be provided;

(vii) Any notes, debentures, bonds, conditional sale agreements, letter of credit agreements, reimbursement agreements, loan agreements or other Contracts for the borrowing or lending of money (including loans to or from Affiliates of the Company or any members of their immediate families), agreements or arrangements for a line of credit or for a guarantee of, or other undertaking in connection with, the indebtedness of any other Person;

(viii) Any Contracts for any capital expenditure or leasehold improvements in excess of $25,000;

(ix) Any Contract with an officer, director or Affiliate thereof;

(x) Except as previously set forth or specifically excluded above, any other Contract under which any Liability in excess of $25,000 exists;

(xi) Contracts limiting or restraining the Company from engaging or competing in any business with any Person; and

(xii) Any other Contracts (other than those described in any of (i) through (xi) above) not made in the ordinary course of business.

(b) All of the Contracts to which the Company is a party or by which it or any of its Assets is bound or affected are valid, binding and enforceable in accordance with their terms against the Company and any other party thereto, except as such enforcement may be limited by applicable bankruptcy, insolvency, moratorium or similar laws affecting the rights of creditors generally and general equity principles (regardless of whether enforceability is considered a proceeding at law or in equity). To the best of Seller’s knowledge, the Company has fulfilled, and has taken all action necessary to enable it to fulfill when due, all of its obligations under each of such Contracts and all parties to such Contracts

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have complied with the provisions thereof. The Company is not in Default thereunder and no notice of any claim of Default has been given to the Company. With respect to any of such Contracts that are leases, the Company has not received any written notice of, nor is Seller aware of, cancellation or termination under any option or right reserved to the lessor, or any notice of Default, thereunder. There are no provisions of, or developments affecting, any such Contract which might prevent the Company from realizing the benefits thereof whether before or after the completion of the Transactions. Seller has no knowledge of any facts or circumstances that would indicate that the Company would be unable to perform under any Contract to which it is a party.

4.17 Governmental Authorizations. The Company has obtained and is in full compliance with all Governmental Authorizations relating to the Business that are required for the operation of any material aspect of the Business as currently operated. All of such Governmental Authorizations are currently valid and in full force. To the knowledge of Seller, no revocation, cancellation or withdrawal thereof has been threatened nor is there a reasonable basis for such.

4.18 Compliance with Law and Court Orders. The Company is not in Default of any Law where such Default has had or is reasonably likely to have a Material Adverse Effect, and its assets have not been used or operated by such entity or any other Person in violation of any Law. The Company is not a party or subject to any Court Order. The Company has made all filings or notifications required to be made under any Laws applicable to it or its businesses or Assets where such failure to file or notify has had or is reasonably likely to have a Material Adverse Effect.

4.19 Litigation. (a) There is no Litigation pending or, threatened against the Company, the Business or the Assets; (b) there is no dispute or disagreement pending or threatened in writing between the Company and any of its customers, other than consumer complaints arising in the ordinary course of business and none of which is reasonably likely to have a Material Adverse Effect, or suppliers; (c) no event has occurred, and no claim has been asserted, that might result in Litigation against the Company, the Business or the Assets; and (d) to the knowledge of Seller, there is no reasonable basis for any such claim.

4.20 Insurance. Schedule 4.20 hereto lists all policies of fire, liability, workmen’s compensation, life, property and casualty, director and officer liability and other insurance owned or held by the Company, copies of which have been made available to Buyer. All such policies are in full force and effect and, to the best of Seller’s knowledge, the Company has not committed any Default thereunder. No written notice of cancellation or non-renewal has been received by the Company with respect to such policies nor is Seller aware of any basis therefor.

4.21 Labor Matters.

(a) There are no complaints, charges or claims against the Company pending, threatened or anticipated relating to any labor, safety or discrimination matters involving any employee.

(b) The Company is in compliance with all Laws respecting employment and employment practices, terms and conditions of employment and wages and hours.

4.22 Employee Benefit Plans.

(a) Schedule 4.22(a) contains a complete and accurate list of all Company Plans. True, correct and complete copies of all of the following documents with respect to each Company Plan, to the extent applicable, have been delivered to Buyer: (i) all documents constituting the Company Plans; and (ii) all employee manuals or handbooks containing personnel or employee relations policies.

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(b) The Company has no Liability with respect to any benefit plans or arrangements other than the Company Plans listed on Schedule 4.22(a). To the best of Seller’s knowledge, all Company Plans are in compliance and conform (and at all times conformed) with all applicable provisions of ERISA, the Code and the regulations issued thereunder, as well as with all other applicable Laws, and have been administered, operated and maintained in accordance with their governing documents.

(c) All persons classified by the Company as independent contractors satisfy and have at all times satisfied the requirements of applicable Law to be so classified; the Company has fully and accurately reported their compensation on IRS Forms 1099 when required to do so; and the Company has no obligations to provide benefits with respect to such persons under the Company Plans or otherwise.

4.23 Transactions with Affiliates. Except as disclosed in Schedule 4.23, neither Seller, nor any Affiliate of the Company: (a) borrowed money or loaned money to the Company which remains outstanding; or (b) has any material contractual arrangements with the Company.

4.24 Absence of Certain Changes. Except as contemplated by this Agreement or as set forth on Schedule 4.24, since the Balance Sheet Date, the Company has conducted its Business in the ordinary course and there has not been with respect to the Company:

(a) any change that has had or is reasonably likely to have a Material Adverse Effect;

(b) any payment or increase of compensation to any Seller, director, officer, or (other than in the ordinary course of business) employee or enter into any employment, severance or similar Contract with any director, officer or employee or change to any Company Plan or adoption of any new employee benefit plan;

(c) any sale, assignment or transfer of Assets, or any additions to or transactions involving any Assets, other than those made in the ordinary course of business;

(d) any distributions or payments to any Affiliate, except as set forth on Schedule 4.23;

(e) any capital expenditures incurred or capital leases entered into that in the aggregate exceed $10,000;

(f) any amendment to the Charter Documents of the Company;

(g) any declaration, setting aside or payment of any dividend or the making of or agreement to make any other distribution or payment in respect of its equity securities or redeemed, purchased or otherwise acquired or agreed to redeem, purchase or acquire any of its equity securities;

(h) any incurrence, issuance, assumption or guarantee of any indebtedness for money borrowed or any other indebtedness of any type or subjected to or created any Encumbrance with respect to any of its Assets;

(i) any making or suffering of any amendment or termination of any material Contract, to which it is a party or by which it is or any of its Assets are bound, or canceled, modified or waived any material debts or claims held by it, other than in the ordinary course, or waived any right of material value, whether or not in the ordinary course; or

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(j) agreement, oral or written, to do any of the foregoing.

4.25 Environmental Matters. Without limiting the generality of Section 4.18, except as disclosed on Schedule 4.25, there has not been any Environmental Condition at any real property leased or operated at any time by the Company, nor has the Company received notice of any such Environmental Condition. “Environmental Condition” means any condition or circumstance, including a Release or the presence of Hazardous Substances, whether created by the Company or any third party, at or relating to any such real property that does or may reasonably be expected to (a) require abatement or correction under an Environmental Law, (b) give rise to any civil or criminal Liability on the part of the Company under an Environmental Law, or (c) create a public or private nuisance.

4.26 Broker’s or Finder’s Fee. No agent, broker, person or firm acting on behalf of the Company or the Seller is, or will be, entitled to any commission or broker’s or finder’s fees from any of the parties hereto, or from any person controlling, controlled by, or under common control with any of the parties hereto, in connection with this Agreement or any of the transactions contemplated herein.

4.27 Relationship With Customers/Suppliers. The Company has used its reasonable commercial efforts to maintain, and currently maintains, good working relationships with all of its customers and suppliers. Except as set forth on Schedule 4.27, the Company has not received notice of, and Seller has no knowledge of any basis for, any (a) material complaint by any customer of the Company or (b) desire or plan on the part of a supplier to terminate or cancel any relationship with the Company.

5. Representations and Warranties of Buyer. Buyer hereby represents and warrants to Seller as follows:

5.1 Organization and Standing. Buyer is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Delaware, having all requisite power and authority to perform its obligations under this Agreement.

5.2 Authority and Binding Effect. Buyer has the full corporate power and authority to execute, deliver and perform this Agreement and the other Transaction Documents to which it is a party and, except as set forth on Schedule 5.2, has taken all actions necessary to secure all approvals required in connection therewith. The execution and delivery of this Agreement and the consummation of the Transactions will not contravene or violate the Charter Documents of Buyer. This Agreement constitutes, and the other Transaction Documents will constitute, the legal, valid and binding obligation of Buyer, enforceable against it in accordance with their respective terms.

5.3 Validity of Contemplated Transactions. Neither the execution and delivery of this Agreement by Buyer nor the consummation of the Transactions by Buyer will contravene or violate any Court Order which is applicable to Buyer, or the Charter Documents of Buyer, or will result in a Default under any Contract to which Buyer is a party or by which it is otherwise bound.

6. Covenants.

6.1 Covenant Not to Compete. No Restricted Party (defined below) shall, at any time within the Restricted Period (defined below), directly or indirectly, engage in, or have any interest on behalf of itself or others in any Person (whether as an employee, officer, director, agent, security holder, creditor, partner, joint venturer, beneficiary under a trust, investor, consultant or otherwise) that engages within the Restricted Territory (defined below) in any of those business activities in which the Company is engaged or has been engaged in the last 12 months, including operating women’s only fitness centers, providing

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weight-loss programs or distributing pre-packaged food (that is marketed to consumers purchasing the product primarily for weight-loss purposes) or nutritional supplements or vitamins targeted primarily to weight-loss consumers. The term “Restricted Party” means the Seller and any Affiliates thereof. The term “Restricted Period” means the two-year period following the Closing Date. The term “Restricted Territory” means the area comprising all of North America. In the event of Litigation involving this Agreement, if a court of competent jurisdiction determines that the scope of this Section 6.1 is too broad in any respect, then the scope shall be deemed to be reduced or narrowed to such scope as is found lawful and reasonable by such court. The Seller acknowledges, however, that this Section 6.1 has been negotiated by the parties and that the geographical and time limitations, as well as the limitation on activities, are reasonable in light of the circumstances pertaining to the Company and the Business. Notwithstanding the foregoing, and provided that such activities do not interfere with the fulfillment of the Seller’s obligations, the Seller may acquire solely as an investment not more than 5% of any class of securities of any entity that has a class of securities registered pursuant to the Exchange Act so long as she remains a passive investor in such entity. Notwithstanding the above, this covenant shall not apply to Seller’s continued employment by Slim and Tone or by any successor to the Company nor to Seller’s ownership of shares in any successor to the Company.

6.2 Hiring of Employees. During the Restricted Period, the Seller will not (directly or indirectly) solicit for employment, or hire or offer employment to any employee of the Company whose employment is continued by the Company (or one of its Affiliates) after the Closing Date unless the employment of such employee had been terminated by the Company without cause at least 60 days prior to such solicitation, hire or offer; provided, however, that as a point of clarification, the aforementioned exception from the prohibition on soliciting, hiring or offering employment shall not apply if the employee at issue resigned or otherwise ceased his or employment with the Company. Nothing contained in this Section 6.4 shall affect or be deemed to affect in any manner any other provision of this Agreement.

6.3 Affiliates. To the extent that any Restricted Party is not a party to this Agreement, the terms of this Section 6 shall apply to such Restricted Party as if he, she or it were a party hereto, and the Seller shall take whatever reasonable actions to cause any such Restricted Party to adhere to the terms of this Section 6.

6.4 Injunctive Relief. In the event of any breach or threatened breach by any Restricted Party of any of the provisions contained in Sections 6.1, 6.2 or 6.3, Buyer shall be entitled to injunctive or other equitable relief, restraining such party from using or disclosing any Confidential Information in whole or in part, or from engaging in conduct that would constitute a breach of the obligations of a Restricted Party contained in such Sections. Such relief shall be in addition to and not in lieu of any other remedies that may be available, including an action for the recovery of damages.

6.5 Tax Matters. All transfer, documentary, sales, use, stamp, registration and other such Taxes and fees (including any penalties and interest) incurred in connection with this Agreement shall be paid by the Seller when due, and the Seller will, at her own expense, file all necessary Tax Returns and other documentation with respect to all such transfer, documentary, sales, use, stamp, registration and other Taxes and fees, and, if required by applicable law, Buyer will, and will cause its affiliates to, join in the execution of any such Tax Returns and other documentation.

7. Indemnification.

7.1 By Seller. To the extent provided in this Section 7, Seller shall indemnify and hold the Buyer, and its respective successors and assigns, officers, directors, employees, members, agents,

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Affiliates and any Person who controls the Buyer within the meaning of the Securities Act or the Exchange Act (each, an “Indemnified Buyer Party”) harmless from and against:

(a) any Liabilities, claims, demands, judgments, losses, costs, damages (including punitive, special, direct and indirect and consequential damages and lost revenue and income) dimunition in value or expenses whatsoever (including reasonable attorneys’, consultants’ and other professional fees and disbursements of every kind, nature and description incurred by such Indemnified Buyer Party in connection therewith) (collectively, “Damages”) suffered, sustained or incurred by an Indemnified Buyer Party in connection with, resulting from, arising out of, or relating to, directly or indirectly:

(i) any inaccuracy of any representation or warranty of Seller in this Agreement, the Transaction Documents or any certificate or other writing delivered by or on behalf of Seller, in connection herewith or therewith; and

(ii) any failure to perform or fulfill fully any covenant or agreement on the part of Seller set forth in this Agreement, any Transaction Document or any certificate or other writing delivered by or on behalf of Seller, in connection herewith or therewith; and

(iii) any and all actions, suits, claims, proceedings, investigations, allegations, demands, assessments, audits, fines, judgments, costs and other expenses (including without limitation reasonable attorneys’ fees and expenses) incident to any of the foregoing or to the enforcement of this Section 7.1.

7.2 By Buyer. From and after the Closing Date, to the extent provided in this Section 7, Buyer shall indemnify and hold the Seller, her heirs, successors and assigns (each, an “Indemnified Seller Party”) harmless from and against:

(a) any Damages that such Indemnified Seller Party may sustain, suffer or incur and that result from, arise out of or relate to, directly or indirectly:

(i) any inaccuracy of any representation or warranty of Buyer contained in this Agreement, any Transaction Document or any certificate or other writing delivered by or on behalf of Buyer in connection herewith or therewith; and

(ii) any and all actions, suits, claims, proceedings, investigations, allegations, demands, assessments, audits, fines, judgments, costs and other expenses (including reasonable attorneys’ fees and expenses) incident to any of the foregoing or to the enforcement of this Section 7.2.

7.3 Procedure for Claims.

(a) An Indemnified Buyer Party or an Indemnified Seller Party that desires to seek indemnification under any part of this Section 7 (each, an “Indemnified Party”) shall give notice (a “Claim Notice”) to each party responsible or alleged to be responsible for indemnification hereunder (an “Indemnitor”) prior to any applicable Expiration Date. Such notice shall briefly explain the nature of the claim and the parties known to be involved, and shall specify the amount thereof. If the matter to which a claim relates shall not have been resolved as of the date of the Claim Notice, the Indemnified Party shall estimate the amount of the claim in the Claim Notice, but also specify therein that the claim has not yet been liquidated (an “Unliquidated Claim”). If an Indemnified Party gives a Claim Notice for an Unliquidated Claim, the Indemnified Party shall also give a second Claim Notice (the “Liquidated Claim Notice”) within 60 days after the matter giving rise to the claim becomes finally resolved, and the Liquidated Claim Notice shall specify the amount of the claim. Each Indemnitor to which a Claim Notice

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is given shall respond to any Indemnified Party that has given a Claim Notice (a “Claim Response”) within 20 days (the “Response Period”) after the later of (i) the date that the Claim Notice is given and (ii) if a Claim Notice is first given with respect to an Unliquidated Claim, the date on which the Liquidated Claim Notice is given. Any Claim Notice or Claim Response shall be given in accordance with the notice requirements hereunder, and any Claim Response shall specify whether or not the Indemnitor giving the Claim Response disputes the claim described in the Claim Notice. If any Indemnitor fails to give a Claim Response within the Response Period, such Indemnitor shall be deemed not to dispute the claim described in the related Claim Notice. If any Indemnitor elects not to dispute a claim described in a Claim Notice, whether by failing to give a timely Claim Response or otherwise, then the amount of such claim shall be conclusively deemed to be an obligation of such Indemnitor that shall give rise to Damages under this Section 7.

(b) If any Indemnitor shall be obligated to indemnify an Indemnified Party hereunder, such Indemnitor shall pay to such Indemnified Party within 30 days after the last day of the Response Period the amount to which such Indemnified Party shall be entitled. If the Indemnified Party shall be an Indemnified Buyer Party, it shall first seek payment of the Damages to which it is entitled under this Section 7 from the 2007 Payment, then from the 2006 Payment and then from the Escrow Funds, but only to the extent that the 2007 Payment, the 2006 Payment and the Escrow Funds are then being held by the Buyer and are not subject to other claims for indemnification; thereafter, if the amount of the 2007 Payment, the 2006 Payment and the Escrow Funds available for payment of Damages is less than the amount of Damages to which such Indemnified Buyer Party is entitled, such Indemnified Buyer Party shall seek indemnification directly from the Seller. Subject to Section 7.3(c), if there shall be a dispute as to the amount or manner of indemnification under this Section 7, the Indemnified Party may pursue whatever legal remedies may be available for recovery of the Damages claimed from any Indemnitor. If any Indemnitor fails to pay all or part of any indemnification obligation when due, then such Indemnitor shall also be obligated to pay to the applicable Indemnified Party interest on the unpaid amount for each day during which the obligation remains unpaid at an annual rate equal to the Prime Rate plus 5%, and the Prime Rate in effect on the first Business Day of each calendar quarter shall apply to the amount of the unpaid obligation during such calendar quarter.

(c) If, during the Response Period, an Indemnified Party receives a Claim Response from the Indemnitor, then for a period of 45 days (the “Resolution Period”) after the Indemnified Party’s receipt of such Claim Response, the Indemnified Party and the Indemnitor shall endeavor to resolve any dispute arising therefrom. If such dispute is resolved by the parties during the Resolution Period, the amount that the parties have specified as the amount to be paid by the Indemnitor, if any, as settlement for such dispute shall be conclusively deemed to be an obligation of such Indemnitor. If the parties are unable to agree upon a resolution to such dispute prior to the expiration of the Resolution Period (or any extension thereto to which the Indemnitor and the Indemnified Party agree in writing), the issue shall be presented to the American Arbitration Association in Philadelphia, Pennsylvania (the “AAA”) for determination. The parties shall have available to them all rights to conduct discovery available to opposing parties in federal district court litigation in the Eastern District of Pennsylvania. The written determination of the AAA shall be binding upon the parties.

(d) Notwithstanding any other provision of this Section 7, an Indemnified Party shall be entitled to indemnification with respect to any inaccuracy of any representation or warranty made hereunder only when the aggregate of all Damages to such Indemnified Party exceeds $20,000 (the “Threshold Amount”) and then such Indemnified Party shall be entitled to indemnification for all of its Damages, including the Damages counted in achieving the Threshold Amount; provided, however, that for purposes of the foregoing, Damages to the Indemnified Buyer Parties shall be aggregated. Except as otherwise set forth herein, Seller shall not be obligated to indemnify Buyer under Section 7.1(a) for an amount in excess of the actual amounts received from the 2005 Payment, 2006 Payment and 2007

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Payment (the “Cap”). Notwithstanding the foregoing, neither the Threshold Amount or the Cap shall apply to (A) any obligation to indemnify the Buyer for a breach or inaccuracy of a representation or warranty set forth in Sections 4.2 (“Capitalization and Ownership”), 4.3 (“Authority and Binding Effect”), 4.4 (“Validity of the Transactions”), 4.6 (“Taxes”), or 4.19 (“Litigation”). The calculation of the Threshold Amount shall include any Damages incurred by an Indemnified Party for which the Indemnified Party would have been entitled to claim indemnification under this Section 7 with respect to a breach of representation or warranty but for such representation or warranty being qualified by materiality, the knowledge of a particular party or related exceptions. Nothing herein shall be deemed to limit or restrict in any manner any rights or remedies that any party has, or might have, at law, in equity or otherwise, against any other party hereto, based on any willful misrepresentation, willful breach of warranty or willful failure to fulfill any agreement or covenant.

7.4 Claims Period. Any claim for indemnification under this Section 7 shall be made by giving a Claim Notice under Section 7.3 on or before the applicable “Expiration Date” specified in this Section 7.4, or the claim under this Section 7 shall be invalid. The following claims shall have the following respective “Expiration Dates”: (a) the 18 month anniversary of the Closing Date — any claims that are not specified in any of the succeeding clauses; and (b) 60 days after the date on which the applicable statute of limitations expires—any claim for Damages related to (i) a breach of any covenant or agreement, or (ii) a breach of any representations or warranties of a Party to this Agreement that were made with an intent to mislead or defraud or with a reckless disregard of the accuracy thereof, or (iii) a breach or inaccuracy of a representation or warranty set forth in Sections 4.2 (“Capitalization and Ownership”), 4.3 (“Authority and Binding Effect”), 4.4 (“Validity of the Transactions”), or 4.6 (“Taxes”). If more than one of such Expiration Dates applies to a particular claim, the latest of such Expiration Dates shall be the controlling Expiration Date for such claim. So long as an Indemnified Party gives a Claim Notice on or before the applicable Expiration Date, such Indemnified Party shall be entitled to pursue its rights to indemnification regardless of the date on which such Indemnified Party gives the related Liquidated Claim Notice.

7.5 Third Party Claims. An Indemnified Party that desires to seek indemnification under any part of this Section 7 with respect to any actions, suits or other administrative or judicial proceedings, other than those that are brought or lie in equity (each, an “Action”), that may be instituted by a third party shall give each Indemnitor prompt notice of a third party’s institution of such Action. After such notice, any Indemnitor may, or if so requested by such Indemnified Party, any Indemnitor shall, participate in such Action or assume the defense thereof, with counsel satisfactory to such Indemnified Party; provided, however, that such Indemnified Party shall have the right to participate at its own expense in the defense of such Action; and provided, further, that the Indemnitor shall not consent to the entry of any judgment or enter into any settlement (in whole or in part), except with the written consent of such Indemnified Party (which consent shall not be unreasonably withheld). Any failure to give prompt notice under this Section 7.5 shall not bar an Indemnified Party’s right to claim indemnification under this Section 7, except to the extent that an Indemnitor shall have been actually and materially harmed by such failure.

7.6 Right of Offset. An Indemnified Buyer Party shall be entitled, at its sole discretion, to recover any Damages payable by the Seller through a reduction of amounts due from Buyer to Seller to the extent any amounts are then or will in the future become payable by Buyer or Company to Seller. Neither the exercise of nor the failure to exercise such right of set-off will constitute an election of remedies or limit Buyer in any manner in the enforcement of any other remedies that may be available to it.

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7.7 Survival. All of the representations, warranties, covenants and agreements made by each party in this Agreement or in any attachment, exhibit, schedule, certificate, document or list delivered by any such party pursuant hereto or in connection with the Transactions shall survive the Closing.

7.8 Effect of Investigation or Knowledge. Any claim by Buyer for indemnification shall not be adversely affected by any investigation by or opportunity to investigate afforded to Buyer.

8. Public Announcements. The Seller and Buyer will consult with each other before issuing any press release or making any public statement with respect to this Agreement and the Transactions and, except as may be required by applicable Law or any applicable membership interest exchange regulations, the Seller will not issue any such press release or make any such public statement without the consent of Buyer.

9. Miscellaneous.

9.1 Contents of Agreement. This Agreement, together with the other Transaction Documents sets forth the entire understanding of the parties hereto with respect to the Transactions and supersedes all prior agreements or understandings among the parties regarding those matters.

9.2 Amendment, Parties in Interest, Assignment, Etc. This Agreement may be amended, modified or supplemented only by a written instrument duly executed by each of the parties hereto. If any provision of this Agreement shall for any reason be held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or unenforceability shall not affect any other provision hereof, and this Agreement shall be construed as if such invalid, illegal or unenforceable provision had never been contained herein. This Agreement shall be binding upon and inure to the benefit of and be enforceable by the respective heirs, legal representatives, successors and permitted assigns of the parties hereto. No party hereto shall assign this Agreement or any right, benefit or obligation hereunder. Any term or provision of this Agreement may be waived at any time by the party entitled to the benefit thereof by a written instrument duly executed by such party.

9.3 Interpretation. Unless the context of this Agreement clearly requires otherwise, (a) references to the plural include the singular, the singular the plural, the part the whole, (b) references to any gender include all genders, (c) “or” has the inclusive meaning frequently identified with the phrase “and/or,” (d) “including” has the inclusive meaning frequently identified with the phrase “but not limited to,” and (e) references to “hereunder” or “herein” relate to this Agreement. The section and other headings contained in this Agreement are for reference purposes only and shall not control or affect the construction of this Agreement or the interpretation thereof in any respect. Section, subsection, schedule and exhibit references are to this Agreement unless otherwise specified. Each accounting term used herein that is not specifically defined herein shall have the meaning given to it under GAAP.

9.4 Expenses. The parties hereto shall pay their own expenses incidental to the preparation of this Agreement, the carrying out of the provisions of this Agreement and the consummation of the Transactions. No expenses of the Seller, including, without limitation, the Seller’s legal fees and expenses or any finder’s fees, shall be paid by or out of any of the assets or properties of the Company.

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9.5 Notices. All notices that are required or permitted hereunder shall be in writing and shall be sufficient if personally delivered or sent by mail, facsimile message or by a nationally recognized overnight delivery courier. Any notices shall be deemed given upon the earlier of the date when received at, or the third day after the date when sent by registered or certified mail or the day after the date when sent by overnight delivery courier to, the address or fax number set forth below, unless such address or fax number is changed by notice to the other party hereto:

If to Buyer:

NutriSystem, Inc.

200 Welsh Road

Horsham, PA 19044

Attn: Michael J. Hagan

Facsimile: 215-706-5325

with a required copy to:

Morgan, Lewis & Bockius LLP

1701 Market Street

Philadelphia, PA 19103-2921

Attention: James W. McKenzie, Jr., Esq.

Facsimile: 215-963-5299

Telephone: 215-963-5134

If to Seller:

Elizabeth Ludlow

10 Alton Road

Yardley, PA. 19067

Telephone: 215.493.6172

with a required copy to:

Joel Rosen, Esq.

1000 Germantown Pike, Unit B4-B8

Plymouth Meeting, PA 19462

Facsimile: 610-277-9571

Telephone: 610-277-9570

9.6 Governing Law. This Agreement shall be construed and interpreted in accordance with the Laws of the Commonwealth of Pennsylvania without regard to its provisions concerning choice of laws, choice of forum or principles that might otherwise refer construction or interpretation of this Agreement to the substantive law of another jurisdiction. The parties hereby irrevocably (a) submit themselves to the non-exclusive jurisdiction of the state and federal courts sitting in the Commonwealth of Pennsylvania, (b) waive the right and hereby agree not to assert by way of motion, as a defense or otherwise in any action, suit or other legal proceeding brought in any such court, any claim that it, he or she is not subject to the jurisdiction of such court, that such action, suit or proceeding is brought in an inconvenient forum or that the venue of such action, suit or proceeding is improper and (c) agree and consent that services of process may be made upon it in any legal proceedings relating hereto in a manner permitted by the notice provisions in Section 9.5 hereof or by any means allowed under state or federal law.

9.7 Counterparts. This Agreement may be executed in two or more counterparts and delivered by facsimile, each of which shall be binding as of the date first written above, and all of which shall constitute one and the same instrument. Each such copy shall be deemed an original, and it shall not be necessary in making proof of this Agreement to produce or account for more than one such counterpart.

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IN WITNESS WHEREOF, this Agreement has been executed by the parties hereto as of the day and year first written above.

BUYER: NUTRISYSTEM, INC.
By:
Name:	Michael J. Hagan
Title:	Chairman and CEO
SELLER:
ELIZABETH LUDLOW

EXHIBIT A

ELIZABETH LUDLOW EMPLOYMENT AGREEMENT

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

The Board of Directors

NutriSystem, Inc.

We consent to the incorporation by reference in the registration statement (No. 333-44908) on Form S-8 of NutriSystem, Inc. of our report dated February 16, 2005, with respect to the consolidated balance sheets of NutriSystem, Inc and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operation, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2004, which report appears in the December 31, 2004 annual report on Form 10-K of NutriSystem, Inc.

Our report with respect to the consolidated financial statements refers to the adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” as of January 1, 2002.

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 28, 2005

EX-31.1

Exhibit 31.1

Statement of Chief Executive Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Michael J. Hagan, certify that:

1. I have reviewed this annual report on Form 10-K of NutriSystem, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b. Evaluated the effectiveness of the registrant’s disclosure controls and procedures, and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a. All significant deficiencies and material weakness in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 28, 2005

/S/ MICHAEL J. HAGAN

Michael J. Hagan

Chief Executive Officer

EX-31.2

Exhibit 31.2

Statement of Chief Financial Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, James D. Brown, certify that:

1. I have reviewed this annual report on Form 10-K of NutriSystem, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b. Evaluated the effectiveness of the registrant’s disclosure controls and procedures, and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a. All significant deficiencies and material weakness in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 28, 2005

/S/ JAMES D. BROWN

James D. Brown

Chief Financial Officer

EX-32.1

Exhibit 32.1

Statement of Chief Executive Officer

Pursuant to Section 1350 of Title 18 of the United States Code

Pursuant to Section 1350 of Title 18 of the United States Code as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, Michael J. Hagan, the Chief Executive Officer of NutriSystem, Inc. (the “Company”), hereby certifies that based on the undersigned’s knowledge:

1) The Company’s Form 10-K Annual Report for the period ended December 31, 2004 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 28, 2005	/S/ MICHAEL J. HAGAN
	Chief Executive Officer

EX-32.2

Exhibit 32.2

Statement of Chief Financial Officer

Pursuant to Section 1350 of Title 18 of the United States Code

Pursuant to Section 1350 of Title 18 of the United States Code as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, James D. Brown, the Chief Financial Officer of NutriSystem, Inc. (the “Company”), hereby certifies that based on the undersigned’s knowledge:

1) The Company’s Form 10-K Annual Report for the period ended December 31, 2004 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: March 28, 2005	/S/ JAMES D. BROWN
	Treasurer and Chief Financial Officer