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 as of and for the three months ended March 31, 2012 and 2011 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, for the year ended December 31, 2011, which are included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011 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 months ended March 31, 2012 are not necessarily indicative of the results to be expected for the year ending December 31, 2012.

Cash Equivalents and Marketable Securities

Cash equivalents include only securities having a maturity of three months or less at the time of purchase. At March 31, 2012 and December 31, 2011, demand accounts and money market accounts comprised all of the Company's cash equivalents.

Marketable securities consist of investments in an income fund that principally holds short-term municipal securities of the U.S. with original maturities of greater than three months at the time of purchase. The Company classifies these as available-for-sale securities. The marketable securities were reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive (loss) income, a component of stockholders' equity, net of related tax effects.

At March 31, 2012, cash, cash equivalents and marketable securities consisted of the following:


	Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Cash	$	20,918	$	0	$	0	$	20,918
Money market account		35,197		0		0		35,197
Municipal income fund		10,041		20		0		10,061

	$	66,156	$	20	$	0	$	66,176

At December 31, 2011, cash, cash equivalents and marketable securities consisted of the following:


	Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Cash	$	12,465	$	0	$	0	$	12,465
Money market account		35,129		0		0		35,129
Municipal income fund		10,013		0		0		10,013

	$	57,607	$	0	$	0	$	57,607

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 $10,483 and $10,285 at March 31, 2012 and December 31, 2011, respectively.

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 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 14 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.

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 product sales revenue recognized in the period of the adjustment. The provision for estimated returns for the three months ended March 31, 2012 and 2011 was $3,101 and $5,434, respectively. The reserve for estimated returns incurred but not received and processed was $1,314 and $726 at March 31, 2012 and December 31, 2011, respectively, and has been included in other accrued expenses and current liabilities in the accompanying consolidated balance sheets.

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 were $969 and $1,001 for the three months ended March 31, 2012 and 2011, respectively. Shipping-related costs are included in cost of revenue in the accompanying consolidated statements of operations.

Dependence on Suppliers

Approximately 16% and 14% of inventory purchases for the three months ended March 31, 2012 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 three months ended March 31, 2011, these suppliers supplied approximately 19% and 14% of inventory purchases (see Note 6).

For the three months ended March 31, 2012 and 2011, the Company outsourced 100% of its fulfillment operations to a third-party provider.

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 percentage 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 three months ended March 31, 2012 and 2011, the Company reduced cost of revenue by $506 and $344, respectively, for these rebates. A receivable of $1,134 and $686 at March 31, 2012 and December 31, 2011, 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.

Fair Value of Financial Instruments

A three-tier fair value hierarchy has been established by the Financial Accounting Standards Board 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 cash equivalents and marketable securities are based on quoted prices in active markets for identical assets. The fair values of the Company's derivative instruments are determined using pricing models that take into account contract terms and certain observable current market information such as London Inter-Bank Offered Rate ("LIBOR") interest rates.

The following table summarizes the Company's financial assets and liabilities measured at fair value at March 31, 2012:


	Total Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)
Money market account	$	35,197		$	35,197	$	0
Municipal income fund		10,061			10,061		0

Total assets	$	45,258		$	45,258	$	0


Interest rate swaps	$	(48	)	$	0	$	(48	)

The following table summarizes the Company's financial assets and liabilities measured at fair value at December 31, 2011:


	Total Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)
Money market account	$	35,129		$	35,129	$	0
Municipal income fund		10,013			10,013		0

Total assets	$	45,142		$	45,142	$	0


Interest rate swaps	$	(22	)	$	0	$	(22	)

Earnings Per Share

The Company uses the two-class method to calculate earnings (loss) 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 (loss) per common share are computed by dividing the sum of distributed earnings (loss) to common stockholders and undistributed earnings (loss) allocated to common stockholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings (loss) 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:


	Three Months Ended March 31,
	2012			2011

Net loss	$	(4,481	)	$	(3,424	)
Net loss allocated to unvested restricted stock		0			147

Net loss allocated to common shares	$	(4,481	)	$	(3,277	)


Weighted average shares outstanding:
Basic		27,321			26,802
Effect of dilutive securities		0			0

Diluted		27,321			26,802


Basic loss per common share	$	(0.16	)	$	(0.12	)

Diluted loss per common share	$	(0.16	)	$	(0.12	)

In both the three months ended March 31, 2012 and 2011, diluted loss per common share is identical to basic loss per common share as the Company is in a net loss position and the impact of including common stock equivalents is anti-dilutive.

Cash Flow Information

The Company made no payments for income taxes in the three months ended March 31, 2012 and $8 in the three months ended March 31, 2011. Interest payments in the three months ended March 31, 2012 and 2011 were $238 and $126, respectively. For the three months ended March 31, 2012, the Company had non-cash capital additions of $2,298 of unpaid invoices in accounts payable and accrued expenses. For the three months ended March 31, 2011, the Company had non-cash capital additions of $569 of unpaid invoices in accounts payable and accrued expenses.

Use of Estimates

The preparation of financial statements in accordance with U.S. 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.