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.

Cash Equivalents and Marketable Securities

Cash equivalents include only securities having a maturity of three months or less at the time of purchase. At December 31, 2011 and December 31, 2010, demand accounts and money market accounts comprised all of the Company's cash and cash equivalents.

Marketable securities at December 31, 2011 consist of investments in an income fund that principally holds short-term municipal securities of the U.S. and at December 31, 2010 consisted of investments in a bond fund that held short-term U.S. government securities with original maturities of greater than three months. The Company classifies these as available-for-sale securities. The marketable securities 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.

The Company evaluates its investments for other-than-temporary impairment by reviewing factors such as the length of time and extent to which fair value has been below cost basis and the Company's ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery of the market value. There were no other-than-temporary impairments in 2011 or 2010.

Inventories

Inventories consist principally of packaged food held in outside fulfillment locations. Inventories are valued at the lower of cost or market, with cost determined using the first-in, first-out (FIFO) method. Quantities of inventory on hand are continually assessed to identify excess or obsolete inventory and a provision is recorded for any estimated loss. The reserve is estimated for excess and obsolete inventory based primarily on forecasted demand and/or the Company's ability to sell the products, introduction of new products, future production requirements and changes in customers' behavior. The reserve for excess and obsolete inventory was $769 and $419 at December 31, 2011 and 2010, respectively.

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 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 $10,285 and $12,845 at December 31, 2011 and 2010, respectively.

Long-Lived Assets

The Company continually evaluates whether events or circumstances have occurred that would indicate that the remaining estimated useful lives of long-lived assets may warrant revision or that the remaining balance may not be recoverable. Long-lived assets are evaluated for indicators of impairment. When factors indicate that long-lived assets should be evaluated for possible impairment, an estimate of the related undiscounted cash flows over the remaining life of the long-lived assets is used to measure recoverability. If any impairment is indicated, measurement of the impairment will be based on the difference between the carrying value and fair value of the asset, generally determined based on the present value of expected future cash flows associated with the use of the asset. As of December 31, 2011, management believes that no reductions to the remaining useful lives or write-downs of long-lived assets are required.

Foreign Currency Translation

The functional currency of the Company's Canadian subsidiary, which has been legally dissolved, was the Canadian dollar. Assets and liabilities were translated into U.S. dollars at exchange rates as of the financial statement date and revenues and expenses were translated at average exchange rates prevailing during the respective periods. Translation adjustments were included as a separate component of accumulated other comprehensive loss in stockholders' equity in the accompanying consolidated balance sheets. Gains and losses from foreign currency transactions were recognized as other (expense) income in the accompanying consolidated statements of operations and were $0 in 2011, $32 of expense in 2010 and $407 of income in 2009.

Derivative Instruments

Interest rate swap agreements, a type of financial derivative instrument, are utilized by the Company to reduce interest rate risk on credit facility borrowings. The Company recognizes the interest rate swaps in the accompanying consolidated balance sheets at fair value. The Company has designated and accounted for its interest rate swaps as cash flow hedges of variable-rate debt. The effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (loss) in stockholders' equity in the accompanying consolidated balance sheets, net of tax, and reclassified into earnings in the periods during which the hedged transactions affect earnings. To the extent that the change in value of the derivative does not perfectly offset the change in value of the items being hedged, that ineffective portion is immediately recognized in earnings.

Revenue Recognition

Revenue from product sales is recognized when the earnings process is complete, which is upon transfer of title to the product. Recognition of revenue upon shipment meets the revenue recognition criteria in that persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed and determinable and collection is reasonably assured. The Company also sells prepaid program cards to wholesalers and retailers. Revenue from these cards is recognized after the card is redeemed online at the Company's website by the customer and the product is shipped to the customer.

Deferred revenue consists primarily of unredeemed prepaid program cards and unshipped frozen foods. When a customer orders the Nutrisystem^® Select^® program, two separate shipments are delivered. The first shipment contains Nutrisystem's standard shelf-stable food. The second shipment contains the fresh-frozen foods and is generally delivered within two weeks of a customer's order. Both shipments qualify as separate units of accounting and the fair value is based on the estimated selling price of both units.

Customers may return unopened product within 30 days of purchase in order to receive a refund or credit. Fresh-frozen products are non-returnable and non-refundable unless the order is canceled within seven days of delivery. Estimated returns are accrued at the time the sale is recognized and actual returns are tracked monthly. The Company reviews its history of actual versus estimated returns to ensure reserves are appropriate.

Revenue from product sales includes amounts billed for shipping and handling and is presented net of returns and billed sales tax. Revenue from shipping and handling charges was $2,867, $5,763 and $5,193 in 2011, 2010 and 2009, respectively. Shipping-related costs are included in cost of revenue in the accompanying consolidated statements of operations.

Dependence on Suppliers

In 2011, approximately 16% and 15%, respectively, of inventory purchases were from two suppliers. The Company has a supply arrangement with one of these vendors that requires the Company to make minimum purchases. In 2010, these vendors supplied approximately 17% and 18%, respectively, of inventory purchases and in 2009, approximately 19% and 18%, respectively, of total purchases (see Note 9). Additionally, the Company was dependent on one frozen food supplier for less than 20% of its food costs in 2011. The amount provided from this supplier in 2010 was negligible. The Company had a supply agreement with this supplier that expired in November 2011 and the Company has found other frozen food supply options to replace this supplier.

During 2011 and 2010, the Company outsourced 100% of its fulfillment operations to third party providers. During 2009, more than 85% of its fulfillment operations were handled by third party providers.

Vendor Rebates

One of the Company's suppliers provides for rebates based on purchasing levels. The Company accounts for this rebate on an accrual basis as purchases are made at a rebate percent determined based upon the estimated total purchases from the vendor. The estimated rebate is recorded as a reduction in the carrying value of purchased inventory and is reflected in the consolidated statements of operations when the associated inventory is sold. A receivable is recorded for the estimate of the rebate earned. The rebate period is June 1 through May 31 of each year. For the years ended December 31, 2011, 2010 and 2009, the Company reduced cost of revenue by $1,401, $1,912 and $2,316, respectively, for these rebates. A receivable of $686 and $541 at December 31, 2011 and 2010, respectively, has been recorded in receivables in the accompanying consolidated balance sheets. Historically, the actual rebate received from the vendor has closely matched the estimated rebate recorded. An adjustment is made to the estimate upon determination of the final rebate.

Marketing Expense

Marketing expense includes media, advertising production, marketing and promotional expenses and payroll-related expenses, including share-based payment arrangements, for personnel engaged in these activities. Media expense was $88,828, $127,597 and $126,117 in 2011, 2010 and 2009, respectively. Direct-mail advertising costs are capitalized if the primary purpose was to elicit sales to customers who could be shown to have responded specifically to the direct mailing 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. Typically, this period falls within 40 days of the initial direct mailing. All other advertising costs are charged to expense as incurred or the first time the advertising takes place. At December 31, 2011 and 2010, $4,800 and $7,152, respectively, of costs have been prepaid for future advertisements and promotions.

Lease Related Expenses

Certain of the Company's lease contracts contain rent holidays, various escalation clauses, or landlord/tenant incentives. The Company records rental costs, including costs related to fixed rent escalation clauses and rent holidays, on a straight-line basis over the lease term. Lease allowances utilized for space improvement are recorded as leasehold improvement assets and amortized over the shorter of the economic useful life of the asset or the lease term. Tenant lease incentive allowances received are recorded as deferred rent and amortized as reductions to rent expense over the lease term. Included in the accompanying consolidated balance sheets is $3,646 of a tenant improvement allowance at December 31, 2011, of which $345 is included in other accrued expenses and current liabilities and $3,301 in non-current liabilities. At December 31, 2010, the tenant improvement allowance was $3,991, of which $345 is included in other accrued expenses and current liabilities and $3,646 in non-current liabilities.

Income Taxes

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 consolidated statements of operations in the period that includes the enactment date. In assessing the ability to realize deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.

A tax benefit from an uncertain tax position may be recognized only if it is "more likely than not" that the position is sustainable, based on its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with a taxing authority having full knowledge of all relevant information. The liability for unrecognized tax benefits is classified as noncurrent unless the liability is expected to be settled in cash within 12 months of the reporting date. The Company records accrued interest and penalties related to unrecognized tax benefits as part of interest expense.

Segment Information

The Company is managed and operated as one business. The entire business is managed by a single management team that reports to the chief executive officer. Revenue consists primarily of food sales.

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. The following table sets forth the computation of basic and diluted EPS:


	Year Ended December 31,
	2011			2010			2009
Income from continuing operations	$	12,261		$	33,879		$	32,873
Income allocated to unvested restricted stock		(460	)		(1,620	)		(1,436	)

Income from continuing operations allocated to common shares		11,801			32,259			31,437
Loss on discontinued operations allocated to common shares		0			(231	)		(3,924	)

Net income allocated to common shares	$	11,801		$	32,028		$	27,513

Weighted average shares outstanding:
Basic		27,033			28,312			29,458
Effect of dilutive securities		292			374			311

Diluted		27,325			28,686			29,769

Basic income per common share:
Income from continuing operations	$	0.44		$	1.14		$	1.07
Loss on discontinued operations		0.00			(0.01	)		(0.14	)

Net income	$	0.44		$	1.13		$	0.93

Diluted income per common share:
Income from continuing operations	$	0.43		$	1.13		$	1.06
Loss on discontinued operations		0.00			(0.01	)		(0.14	)

Net income	$	0 .43		$	1.12		$	0.92

In 2011, 2010 and 2009, common stock equivalents representing 656,871, 167,158 and 527,891 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.

Share-Based Payment Awards

The cost of all share-based awards to employees and non-employees, including grants of stock options, restricted stock and restricted stock units, is recognized in the financial statements based on the fair value of the awards at grant date. The fair value of stock option awards is determined using the Black-Scholes valuation model on the date of grant. The fair value of restricted stock and restricted stock unit awards is equal to the market price of the Company's common stock on the date of grant.

The fair value of share-based awards is recognized on a straight-line basis over the requisite service period, net of estimated forfeitures. The Company relies primarily upon historical experience to estimate expected forfeitures and recognizes compensation expense on a straight-line basis from the date of grant. The Company issues new shares upon exercise of stock options or vesting of restricted stock or restricted stock units.

Cash Flow Information

The Company made payments for income taxes of $6,049, $16,660 and $11,449 in 2011, 2010, and 2009, respectively. Interest payments in 2011, 2010 and 2009 were $655, $283 and $304, respectively. During 2011, the Company had non-cash capital additions of $1,198 of unpaid invoices in accounts payable and accrued expenses. During 2010, the Company had non-cash capital additions of $3,991 through a tenant improvement allowance and $1,664 of unpaid invoices in accounts payable and accrued expenses.

Recently Issued Accounting Pronouncements

Accounting Standards Update No. 2011-05 – "Comprehensive Income (Topic 220): Presentation of Comprehensive Income" ("ASU No. 2011-05") amends existing guidance by allowing only two options for presenting the components of net income and other comprehensive income: (1) in a single continuous financial statement, statement of comprehensive income or (2) in two separate but consecutive financial statements, consisting of an income statement followed by a separate statement of other comprehensive income. ASU No. 2011-05 requires retrospective application, and it is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The Company believes the adoption of this update will change the order in which certain financial statements are presented and provide additional detail on those financial statements when applicable, but will not have any other impact on its consolidated financial position or results of operations.

Use of Estimates

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

Reclassifications

Certain immaterial reclassifications have been made to prior year amounts to conform to the current year presentation.