2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Presentation of Financial Statements

The Company’s consolidated financial statements include 100% of the assets and liabilities of Nutrisystem, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Interim Financial Statements

The Company’s consolidated financial statements included in this Quarterly Report on Form 10-Q are unaudited and, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the Company’s financial position and results of operations for these interim periods. Accordingly, readers of these consolidated financial statements should refer to the Company’s audited consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), and the related notes thereto, as of and for the year ended December 31, 2017, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (the “2017 Annual Report”) as certain footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted from this report pursuant to the rules of the Securities and Exchange Commission (the “SEC”). The results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results to be expected for the year ending December 31, 2018.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” (“ASU 2014-09”). ASU 2014-09 outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and superseded most revenue recognition guidance, including industry-specific guidance. This new revenue recognition model provides a five-step analysis in determining when and how revenue is recognized. The new model requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. It also requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. This guidance is effective for annual periods beginning on or after December 15, 2017, including interim reporting periods within that reporting period and should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application.

The Company adopted accounting standards codification (“ASC”) 606, “Revenue from Contracts with Customers,” on January 1, 2018 using the modified retrospective method by recognizing the cumulative effect as an adjustment to the opening balance of stockholders’ equity at January 1, 2018. Therefore, the comparative information for periods ended prior to January 1, 2018 were not restated. The Company applied the transition practical expedient to only assess contracts that were not completed contracts at the date of initial application when applying the cumulative effect method. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements and footnote disclosures. The cumulative impact of adopting ASC 606 on January 1, 2018 was an increase in stockholders’ equity of $1,135.

In February 2016, the FASB issued ASU No. 2016-02, “Leases,” which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. This standard is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. In July 2018, the FASB issued ASU No. 2018-11, “Targeted Improvements to ASC 842”, which includes an option to not restate comparative periods in transition and elect to use the effective date of ASC 842 as the date of initial application of transition. The Company plans to adopt the standard effective January 1, 2019 using the transition option provided under ASC No. 2018-11 and anticipates applying the package of practical expedients included therein. The Company is currently evaluating its population of leases and is continuing to assess all potential impacts of the standard, but currently believes the most significant impact relates to fulfillment warehouse agreements and its real estate operating lease. For the fulfillment warehouse agreements, the Company has identified the population and is currently assessing the impact. The Company does anticipate the recognition of additional assets and corresponding liabilities related to leases upon adoption but has not yet quantified these at this time. The Company is in the process of implementing changes to its systems, processes and controls to account for its leases in accordance with the new standard.

In August 2016, the FASB issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments,” which clarifies and provides guidance on eight cash flow classification issues and is intended to reduce existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This standard is effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years. The adoption of this new accounting standard did not have a material impact on the Company’s consolidated financial statements and footnote disclosures.

In May 2017, the FASB issued ASU No. 2017-09, “Scope of Modification Accounting,” which provides guidance about which changes to the terms or conditions of share-based payment awards require an entity to apply modification accounting. This standard is effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years. The adoption of this new accounting standard did not have a material impact on the Company’s consolidated financial statements and footnote disclosures.

In June 2018, the FASB issued ASU No. 2018-07, “Improvements to Nonemployee Share-Based Payment Accounting,” which eliminates the separate accounting model for nonemployee share-based payment awards and generally requires companies to account for share-based payment transactions with nonemployees in the same way as share-based payment transactions with employees. This standard is effective for annual periods beginning after December 15, 2018, and interim periods within those fiscal years. The adoption of this new accounting standard is not expected to have a material impact on the Company’s consolidated financial statements and footnote disclosures.

In August 2018, the FASB issued ASU No. 2018-15, “Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract,” which requires implementation costs incurred by customers in cloud computing arrangements to be deferred and recognized over the term of the arrangement, if those costs would be capitalized by the customer in a software licensing arrangement. This standard is effective for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. The adoption of this new accounting standard is not expected to have a material impact on the Company’s consolidated financial statements and footnote disclosures.

Cash, Cash Equivalents and Short Term Investments

Cash equivalents include only securities having a maturity of three months or less at the time of purchase. At September 30, 2018 and December 31, 2017, demand accounts, money market funds and treasury bills comprised all of the Company’s cash and cash equivalents.

Short term investments consist of investments in government and agency securities and corporate debt securities with original maturities between three months and three years. The Company classifies these investments as available-for-sale securities. These investments are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive loss, a component of stockholders’ equity, net of related tax effects.

At September 30, 2018, cash, cash equivalents and short term investments consisted of the following:

			Gross		Gross
			Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
Cash	$	23,948	$	0	$	0		$	23,948
Money market funds		5,227		0		0			5,227
Treasury bills		8,983		0		0			8,983
Government and agency securities		47,697		175		(515	)		47,357
Corporate debt securities		7,067		23		(53	)		7,037
	$	92,922	$	198	$	(568	)	$	92,552

At December 31, 2017, cash, cash equivalents and short term investments consisted of the following:

			Gross		Gross
			Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
Cash	$	24,454	$	0	$	0		$	24,454
Money market funds		200		0		0			200
Government and agency securities		42,220		135		(355	)		42,000
Corporate debt securities		5,577		28		(37	)		5,568
	$	72,451	$	163	$	(392	)	$	72,222

Fixed Assets

Fixed assets are stated at cost. Depreciation expense is calculated using the straight-line method over the estimated useful lives of the related assets, which are generally two to seven years. Leasehold improvements are amortized on a straight-line basis over the lesser of the estimated useful life of the asset or the related lease term. Expenditures for repairs and maintenance are charged to expense as incurred, while major renewals and improvements are capitalized.

Included in fixed assets is the capitalized cost of internal-use software and website development incurred during the application development stage. Capitalized costs are amortized using the straight-line method over the estimated useful life of the asset, which is generally two to five years. Costs incurred related to planning or maintenance of internal-use software and website development are charged to expense as incurred. The net book value of capitalized software was $14,423 and $16,419 at September 30, 2018 and December 31, 2017, respectively.

Revenue Recognition

On January 1, 2018, the Company adopted ASC 606 using the modified retrospective method by recognizing the cumulative effect as an adjustment to the opening balance of stockholders’ equity at January 1, 2018. While the adoption of this standard did not have a material impact on the Company’s consolidated financial statements and footnote disclosures it did have an impact on the timing of revenue recognized in accounting for gift cards as presented in the consolidated statement of operations for 2018. In accordance with the new standard, the Company is recognizing the estimated breakage of gift cards (estimated amount of unused gift cards) over the pattern of redemption of the gift cards. Prior to adopting ASC 606, the Company recognized gift card breakage when the likelihood of redemption became remote. The Company also is recognizing direct-mail advertising costs to expense as incurred. Prior to adopting ASC 606, the Company capitalized these costs and expensed over the period of benefit. Additionally, the Company is recognizing an asset for the carrying amount of product to be returned and for costs to obtain a contract if the amortization period is more than one year in duration. The Company is applying the practical expedient to expense costs to obtain a contract as incurred if the amortization period is less than one year. Prior to adopting ASC 606, the value of product expected to be returned was presented net as a reduction of the related reserve for returns and costs to obtain a contract were expensed as incurred.

Revenue is measured based on the consideration specified in a contract with a customer and excludes any sales incentives and amounts collected on behalf of third parties. The Company recognizes revenue when it satisfies a performance obligation by transferring control over a product to a customer.

Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue producing transaction, that are collected by the Company from a customer, are excluded from revenue and presented on a net basis.

Shipping and handling costs associated with outbound freight, after control over a product has transferred to a customer, are accounted for as a fulfillment cost and are included in revenue and cost of revenue in the accompanying consolidated statements of operations. Revenue from shipping and handling charges was $4,141 and $12,865 for the three and nine months ended September 30, 2018, respectively, and $1,890 and $5,772 for the three and nine months ended September 30, 2017, respectively. The increase in shipping and handling was due primarily to an increased handling charge paid by customers.

The Company’s pre-packaged foods are sold directly to weight loss program participants primarily through the Internet and telephone, referred to as the direct channel, through QVC, a television shopping network, and select retailers. Pre-packaged foods are comprised of both frozen and non-frozen (ready-to-go) products.

Products sold through the direct channel, both frozen and non-frozen, may be sold separately (a la carte) or as part of a packaged monthly meal plan for which customers pay for at the point of sale. Products sold through QVC are payable by QVC upon satisfaction of the performance obligation. Revenue is recognized at a point in time. Direct to consumer customers may return unopened ready-to-go products within 30 days of purchase in order to receive a refund or credit. Frozen products are nonreturnable and non-refundable unless the order is canceled within 14 days of delivery. The Company recognizes revenue at the shipping point.

Products sold to retailers include both frozen and non-frozen products and are payable by the retailer upon satisfaction of the performance obligation. Revenue is recognized at a point in time. Certain retailers have the right to return unsold products. The Company recognizes revenue when the retailers take possession of the product.

The Company accounts for the shipment of frozen and non-frozen products as separate performance obligations. The consideration, including variable consideration for product returns, are allocated between frozen and non-frozen products based on their stand-alone selling prices. The amount of revenue recognized is adjusted for expected returns, which are estimated based on historical data.

In addition to its pre-packaged foods, the Company sells prepaid gift cards through a wholesaler that are redeemable through the Internet or telephone. Prepaid gift cards represent grants of rights to goods to be provided in the future to retail customers. The wholesaler has the right to return all unsold prepaid gift cards. The retail selling price of the gift cards is deferred in the balance sheets and recognized as revenue when the Company has satisfied its performance obligation when the retail customer redeems the gift card. The Company recognizes breakage amounts as revenue, in proportion to the actual gift card redemptions exercised by the retail customer in relation to the total expected redemptions of gift cards. The Company utilizes historical experience in estimating the total expected breakage and period over which the gift cards will be redeemed.

In the following table, revenue is disaggregated by the source of revenue:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Direct	$	146,778	$	147,020	$	519,617	$	522,690
Retail		8,323		8,363		27,411		28,964
QVC		4,065		2,651		14,189		13,762
Other		89		115		279		304
	$	159,255	$	158,149	$	561,496	$	565,720

The Company applied ASC 606 using the cumulative effect method and the comparative information for the prior year periods have not been adjusted and continue to be reported under ASC 605, “Revenue Recognition.”

The following table provides information about receivables, contract assets and contract liabilities from contracts with customers:

	September 30, 2018		January 1, 2018
			As Adjusted
Receivables	$	19,125	$	17,871
Contract assets	$	260	$	279
Contract liabilities	$	9,287	$	6,654

Receivables primarily relate to the timing of credit card receivables and sales to retailers. The contract assets primarily relate to unbilled accounts receivable and are included as other current assets in the accompanying consolidated balance sheet. The contract liabilities (deferred revenue) primarily relate to sale of prepaid gift cards and unshipped foods which are deferred until such time as the Company has satisfied its performance obligations.

Significant changes in the contract liabilities (deferred revenue) balance during the period is as follows:

Nine Months Ended

September 30, 2018

Revenue recognized that was included in the contract liability (def.

revenue) balance at beginning of period

(4,995

)

Increases due to cash received for prepaid gift cards sold or unshipped

food, excluding amounts recognized as revenue

7,628

The following table includes estimated revenue from the prepaid gift cards expected to be recognized in the future related to performance obligations that are unsatisfied (or partially unsatisfied) at the end of the reporting period:

Remaining 2018	$	5,559
2019		1,561
2020		59
	$	7,179

The Company applies the practical expedient in subtopic ASC 606-10-50-14 and does not disclose information about remaining performance obligations that have original expected durations of one year or less.

The following table summarizes the impacts of adopting ASC 606 on the Company’s consolidated financials for 2018:

	Three Months Ended September 30, 2018						Nine Months Ended September 30, 2018
	As Reported		Adjustments		Amounts without Adoption of ASC 606		As Reported		Adjustments		Amounts without Adoption of ASC 606
Statements of Operations
Revenue	$	159,255	$	111	$	159,144	$	561,496	$	319	$	561,177
Income tax expense	$	4,592	$	25	$	4,567	$	11,738	$	72	$	11,666
Net income	$	15,994	$	86	$	15,908	$	44,933	$	247	$	44,686

	September 30, 2018
	As Reported			Adjustments			Amounts without Adoption of ASC 606
Balance Sheet
ASSETS
Prepaid income taxes	$	693		$	404		$	1,097
Prepaid expenses and other current assets	$	8,237		$	(181	)	$	8,056

LIABILITIES
Deferred revenue	$	9,287		$	(1,676	)	$	10,963
Other accrued expenses and current liabilities	$	5,883		$	71		$	5,812

EQUITY
Retained earnings	$	106,436		$	1,382		$	105,054

	Nine Months Ended September 30, 2018
	As Reported			Adjustments			Amounts without Adoption of ASC 606
Statement of Cash Flows
Net income	$	44,933		$	247		$	44,686
Changes in operating assets and liabilities:
Prepaid expenses and other assets	$	3,602		$	(51	)	$	3,653
Deferred revenue	$	2,633		$	(339	)	$	2,972
Income taxes	$	5,794		$	72		$	5,722
Other accrued expenses and liabilities	$	(811	)	$	71		$	(882	)

The Company reviews the reserves for customer returns at each reporting period and adjusts them to reflect data available at that time. To estimate reserves for returns, the Company considers actual 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 changes, the Company will adjust the reserve, which will impact the amount of revenue recognized in the period of the adjustment. The provision for estimated returns for the three and nine months ended September 30, 2018 was $4,400 and $15,145, respectively, and $3,949 and $16,129 for the three and nine months ended September 30, 2017, respectively. The reserve for estimated returns incurred but not received and processed was $1,210 at September 30, 2018 and has been included in other accrued expenses and current liabilities in the accompanying consolidated balance sheet. At December 31, 2017, the reserve for estimated returns incurred but not received and processed was $868 and was recorded net of the carrying amount of product to be returned.

Dependence on Suppliers

Approximately 10% and 9%, respectively, of inventory purchases for the nine months ended September 30, 2018 were from two suppliers. The Company has a supply arrangement with one of these suppliers that requires the Company to make minimum purchases. For the nine months ended September 30, 2017, these suppliers supplied approximately 7% and 11%, respectively, of inventory purchases.

The Company outsources 100% of its fulfillment operations to a third-party provider. Additionally, more than 97% of its direct to consumer orders are shipped by one third-party provider and more than 97% of its orders for the retail programs are shipped by another third-party provider.

Fair Value of Financial Instruments

A three-tier fair value hierarchy has been established by the FASB to prioritize the inputs used in measuring fair value. These tiers are as follows:

Level 1—Valuations based on quoted prices for identical assets and liabilities in active markets.

Level 2—Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3—Valuations based on unobservable inputs reflecting the Company’s own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

The fair values of the Company’s Level 1 instruments are based on quoted prices in active exchange markets for identical assets. The Company had no Level 2 or 3 instruments at September 30, 2018 and December 31, 2017.

The following table summarizes the Company’s financial assets measured at fair value at September 30, 2018:

	Total Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)
Money market funds	$	5,227	$	5,227
Treasury bills		8,983		8,983
Government and agency securities		47,357		47,357
Corporate debt securities		7,037		7,037
Total assets	$	68,604	$	68,604

The following table summarizes the Company’s financial assets measured at fair value at December 31, 2017:

	Total Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)
Money market funds	$	200	$	200
Government and agency securities		42,000		42,000
Corporate debt securities		5,568		5,568
Total assets	$	47,768	$	47,768

Earnings Per Share

The Company uses the two-class method to calculate earnings per share (“EPS”) as the unvested restricted stock issued under the Company’s equity incentive plans are participating shares with nonforfeitable rights to dividends. Under the two-class method, earnings per common share are computed by dividing the sum of distributed earnings to common stockholders and undistributed earnings allocated to common stockholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities based on the number of weighted average shares outstanding during the period. Undistributed losses are not allocated to unvested restricted stock as the restricted stockholders are not obligated to share in the losses. The following table sets forth the computation of basic and diluted EPS:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Net income	$	15,994		$	15,027		$	44,933		$	46,946
Net income allocated to unvested restricted stock		(125	)		(119	)		(361	)		(404	)
Net income allocated to common shares	$	15,869		$	14,908		$	44,572		$	46,542
Weighted average shares outstanding:
Basic		29,208			29,799			29,466			29,685
Effect of dilutive securities		365			500			331			479
Diluted		29,573			30,299			29,797			30,164

Basic income per common share	$	0.54		$	0.50		$	1.51		$	1.57
Diluted income per common share	$	0.54		$	0.49		$	1.50		$	1.54

In the three and nine months ended September 30, 2018, common stock equivalents representing 152 and 176 shares of common stock, respectively, were excluded from weighted average shares outstanding for diluted income per common share purposes because the effect would be anti-dilutive or the minimum performance requirements for such common stock equivalents had not yet been met.

In the three and nine months ended September 30, 2017, common stock equivalents representing 142 and 148 shares of common stock, respectively, were excluded from weighted average shares outstanding for diluted income per common share purposes because the effect would be anti-dilutive or the minimum performance requirements for such common stock equivalents had not yet been met.

Cash Flow Information

The Company made payments for income taxes of $6,267 and $22,705 in the nine months ended September 30, 2018 and 2017, respectively. Interest payments in the nine months ended September 30, 2018 and 2017 were $142 and $156, respectively. For the nine months ended September 30, 2018 and 2017, the Company had non-cash capital additions of $911 and $727, respectively, of unpaid invoices in accounts payable and other accrued expenses and current liabilities.

Use of Estimates

The preparation of financial statements in accordance with GAAP 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 revenue and operating expenses during the reporting period. Actual results could differ from these estimates.