Except for the historical information contained herein, this Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that involve substantial risks and uncertainties. Words such as "may," "should," "could," "would," "expect," "plan," "anticipate," "believe," "estimate," "predict," "continue," or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Our 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 "Item 1A-Risk Factors" as disclosed in our Form 10-K filed on March 6, 2009 with the Securities and Exchange Commission. 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 Report on Form 10-Q.

Background

We provide weight management products and services. Our pre-packaged foods are sold to weight loss program participants directly primarily via the Internet and telephone, referred to as the direct channel and through QVC, a television shopping network.

Revenue consists primarily of food sales. For the nine months ended September 30, 2009, the direct channel accounted for 93% of total revenue compared to 6% for QVC and 1% for the other channels. We incur significant marketing expenditures to support our brand. We believe that our brand is continuing to gain awareness as we continue to increase our purchases of media in certain media channels. New media channels are tested on a continual basis and we consider our media mix to be diverse. We market our weight management system through television, print, direct mail, Internet and public relations. We review and analyze a number of key operating and financial metrics to manage our business, including the number of new customers, revenue per customer, total revenues, marketing per new customer, operating margins and reactivation revenue.

While we are enduring a very challenging environment from an economic perspective, we are continuing to focus on expanding our capabilities and strengthening our business. During 2008, we enhanced our ecommerce platform and redesigned our website, entered into the retail channel with our national launch in Costco and extended our business across borders into Canada. We initiated a concerted effort to improve lifetime customer economics, length of stay and overall customer satisfaction. In the face of weakening new customer demand, it was crucial to improve each and every customer interaction with an eye toward customer success and business profitability, and in 2008 and 2009 we have seen improvement in the key metrics of customer satisfaction, length of stay and revenue per customer. We enhanced the customer experience with newly designed packaging, on-boarding efforts and customer service. We initiated new standards for order fulfillment and new operating procedures that delivered significant improvements in our overall order accuracy, which, we believe is a key driver of future customer satisfaction and re-order rates. In the face of increased food costs and margin pressure, we undertook a complete review of our entire supply chain management function. That comprehensive review entailed detailed studies on product cost improvements, vendor productivity, warehouse efficiencies and key cost center opportunities. The results contributed to a reduction in costs and improvement in our inventory management.

We also expanded our product offerings in 2008 and in early 2009. We introduced Nutrisystem Select, our first program to incorporate a new, fresh-frozen line of menu items and Nutrisystem Flex, our "weekends off" program, which provides a less restrictive option to meet the needs and lifestyle of an important segment of dieting consumers. In addition, we have included fresh food delivery in selected markets with our acquisition of NuKitchen in 2008, and have launched our marketing campaign for Nutrisystem D, our program for overweight people with Type 2 diabetes. We also recently announced a licensing agreement with House Foods in Japan for the launch of the Nutrisystem J Diet in the Japanese market. House Foods will market its diet plan under the brand name Nutrisystem J Diet. Additionally, we announced an expanded retail channel with our alignment with Walmart.

Our key focus in 2009 is to continue to leverage our direct-to-consumer model and improve our efficiency. We have already taken steps to reduce our overall operating costs, improve gross margins and limit capital spending to optimize cash generation in 2009.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are described in Note 2 of the consolidated financial statements included in Item 8 of our Form 10-K for the year ended December 31, 2008.

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 revenue 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. The accounting estimates we consider critical include reserves for returns, vendor rebates, excess and obsolete inventory and income taxes. These critical accounting estimates are discussed with our audit committee quarterly.

During the nine months ended September 30, 2009, we did not make any material change to our critical accounting policies.

Results of Operations

Revenue and expenses consist of the following components:

Revenue. Revenue consists primarily of food sales. Food sales include sales of food, supplements, shipping and handling charges billed to customers and sales credits and adjustments, including product returns. No revenue is recorded for food products provided to customers at no charge as part of promotions.

Cost of Revenue. Cost of revenue consists primarily of the cost of the products sold, including the compensation related to fulfillment, the costs of outside fulfillment, incoming and outgoing shipping costs, charge card fees and packing material. Cost of products sold includes products provided at no charge as part of promotions and the non-food materials provided with customer orders.

Marketing Expense. Marketing expense includes media, advertising production, marketing and promotional expenses and payroll-related expenses for personnel engaged in these activities. Internet advertising expense is recorded based on either the rate of delivery of a guaranteed number of impressions over the advertising contract term or on a cost per customer acquired, depending upon the terms. Direct-mail advertising costs are capitalized if the primary purpose was to elicit sales to customers who could be shown to have responded specifically to the advertising and results in probable future economic benefits. The capitalized costs are amortized to expense over the period during which the future benefits are expected to be received. All other advertising costs are charged to expense as incurred.

General and Administrative Expenses. General and administrative expenses consist of compensation for administrative, information technology, counselors and customer service personnel, share-based payment arrangements, facility expenses, website development costs, professional service fees and other general corporate expenses.

Equity and Impairment Loss. Equity and impairment loss consists of our share of the earnings or losses of our equity interests including any amortization expense for the difference between the cost and the underlying equity in net assets of the equity interest at the date of investment and any estimated impairment losses of those interests. In June 2009, we abandoned our interest in Zero Water as management determined that the business was no longer aligned with our current strategic direction and wrote off the remaining equity investment.

Interest (Expense) Income, Net. Interest (expense) income, net consists of the net amount of interest expense and interest income earned on cash balances and marketable securities.

Income Taxes. We are subject to corporate level income taxes and record a provision for income taxes based on an estimated annual effective income tax rate for the year.

Overview of the Direct Channel

In both the nine months ended September 30, 2009 and 2008, the direct channel represented 93% of our revenue. Net sales through the direct channel were $118.6 million and $392.4 million in the three and nine months ended September 30, 2009, respectively, compared to $149.5 million and $531.1 million in the comparable periods of 2008. The decrease in 2009 is primarily attributable to the decline in customer starts due to the weakening economy. Revenue is primarily generated through customer starts, reactivation of former customers and the customer ordering behavior, including length of time on our program and the diet program selection. Critical to increasing customer starts is our ability to deploy marketing dollars while maintaining marketing effectiveness. Factors influencing our marketing effectiveness include the quality of the advertisements, promotional activity by our competitors, as well as the price and availability of appropriate media.

Overview of Distribution via a Television Home Shopping Network

We distribute our proprietary prepackaged food through QVC, a television home shopping network. In both the nine months ended September 30, 2009 and 2008, this channel represented 6% of our revenue. On the QVC network, we reach a large audience in a 50 minute infomercial format that enables us to fully convey the benefits of the Nutrisystem diet programs. Under the terms of our agreement, QVC viewers purchase Nutrisystem products directly from QVC and are not directed to the Nutrisystem website. Retail prices (including shipping and handling) offered on QVC to consumers are similar to prices offered on the website. We generate a lower gross margin (as a percent of revenue) on sales through QVC relative to the direct channel, 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 QVC were $7.6 million and $26.1 million for the three and nine months ended September 30, 2009, respectively, compared to $11.0 million and $36.6 million in the comparable periods of 2008. QVC sales are a function of the number of shows and the sales per minute on each show.

Three Months Ended September 30, 2009 Compared to Three Months Ended
September 30, 2008



                                                       Three Months Ended September 30,
                                            2009             2008           $ Change         % Change
                                                                (in thousands)
REVENUE                                   $ 127,031        $ 162,681        $ (35,650 )           (22 )%


COSTS AND EXPENSES:
Cost of revenue                              57,776           76,341          (18,565 )           (24 )%
Marketing                                    36,293           39,165           (2,872 )            (7 )%
General and administrative                   16,684           22,577           (5,893 )           (26 )%
Depreciation and amortization                 3,002            2,484              518              21 %


Total costs and expenses                    113,755          140,567          (26,812 )           (19 )%


Operating income from continuing
operations                                   13,276           22,114           (8,838 )           (40 )%

OTHER INCOME (EXPENSE)                          149              (40 )            189            (473 )%

EQUITY AND IMPAIRMENT LOSS                       -              (552 )            552            (100 )%

INTEREST (EXPENSE) INCOME, net                   80              216             (136 )           (63 )%

Income from continuing operations
before income taxes                          13,505           21,738           (8,233 )           (38 )%
INCOME TAXES                                  4,994            8,043           (3,049 )           (38 )%

Income from continuing operations             8,511           13,695           (5,184 )           (38 )%
LOSS ON DISCONTINUED OPERATION, net             (60 )           (164 )            104             (63 )%

Net income                                $   8,451        $  13,531        $  (5,080 )           (38 )%


% of revenue
Gross margin                                   54.5 %           53.1 %
Marketing                                      28.6 %           24.1 %
General and administrative                     13.1 %           13.9 %
Operating income from continuing
operations                                     10.5 %           13.6 %

Revenue. Revenue decreased to $127.0 million in the third quarter of 2009 from $162.7 million for the third quarter of 2008. The revenue decrease resulted primarily from a decrease in customer starts as we are still seeing lower consumer spending in the commercial weight loss sector due to the economy. Reactivation revenue during the third quarter of 2009 remained relatively flat compared to the amount recorded in the third quarter of 2008. In the three months ended September 30, 2009, the direct channel accounted for 93% of total revenue compared to 6% for QVC and 1% for other channels. In the three months ended September 30, 2008, the direct channel accounted for 92% of total revenue compared to 7% for QVC and 1% for other channels.

Costs and Expenses. Cost of revenue decreased to $57.8 million in the third quarter of 2009 from $76.3 million in the third quarter of 2008. Gross margin as a percent of revenue increased to 54.5% in the third quarter of 2009 from 53.1% for the third quarter of 2008. The increase in gross margin was primarily attributable to decreased freight costs. We have focused on these costs and have been working in partnership with our vendors to apply cost saving measures.

Marketing expense decreased to $36.3 million in the third quarter of 2009 from $39.2 million in the third quarter of 2008, yet marketing expense as a percent of revenue increased to 28.6% in 2009 from 24.1% in 2008. The increase as a percent of revenue is due to increased spending to promote the launch of Nutrisystem D. We are expecting the revenue growth from this launch to be reflected over the remaining months of 2009. Substantially all marketing spending during the quarter promoted the direct business, and the decrease in marketing is primarily attributable to decreased spending for advertising media ($3.8 million) partially offset by increased production of television advertising ($697,000). In total, media spending was $30.9 million in the third quarter of 2009 and $34.7 million in the third quarter of 2008.

General and administrative expenses decreased to $16.7 million in the three months ended September 30, 2009 compared to $22.6 million in the comparable period of 2008. General and administrative expense as a percent of revenue decreased to 13.1% in the three months ended September 30, 2009 from 13.9% for the comparable period of 2008. In the third quarter of 2009, compensation, benefits costs and temporary help decreased ($3.1 million) and outside and computer services decreased ($2.2 million) due to our focus on cost containment. Internet and telephone also decreased ($332,000) due to lower rates.

Depreciation and amortization expense increased to $3.0 million in the third quarter of 2009 compared to $2.5 million in the third quarter of 2008 due to the increased capital expenditures during 2008 and 2009 on our website.

Other Income (Expense). Other income (expense) primarily represents the favorable impact of changes in the Canadian dollar during 2009 as compared to 2008.

Equity and Impairment Loss. In June 2009, we abandoned our interest in Zero Water as management determined that the business was no longer aligned with our current strategic direction and wrote-off the remaining investment. Estimated losses of $552,000 were recorded in the third quarter of 2008 for our share of Zero Water's loss and the amortization expense for the difference between cost and the underlying equity in net assets of Zero Water.

Interest (Expense) Income, Net. Interest income, net, was $80,000 in the third quarter of 2009 compared to interest income, net of $216,000 in the third quarter of 2008. The change is due to lower interest rates.

Income Taxes. In the third quarter of 2009, we recorded income tax expense of $5.0 million, which reflects an estimated annual effective income tax rate of 37.0% compared to income tax expense of $8.0 million in the third quarter of 2008 at an estimated annual effective income tax rate of 37.0%.

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008

                                                        Nine Months Ended September 30,
                                                                                               %
                                              2009            2008           $ Change        Change
                                                                (in thousands)
REVENUE                                     $ 421,534       $ 573,178       $ (151,644 )        (26 )%


COSTS AND EXPENSES:
Cost of revenue                               195,000         272,914          (77,914 )        (29 )%
Marketing                                     118,986         148,449          (29,463 )        (20 )%
General and administrative                     59,780          64,391           (4,611 )         (7 )%
Depreciation and amortization                   8,385           6,170            2,215           36 %


Total costs and expenses                      382,151         491,924         (109,773 )        (22 )%


Operating income from continuing
operations                                     39,383          81,254          (41,871 )        (52 )%

OTHER INCOME (EXPENSE)                            339             (84 )            423         (504 )%

EQUITY AND IMPAIRMENT LOSS                     (4,000 )        (2,660 )         (1,340 )         50 %

INTEREST (EXPENSE) INCOME, net                    (14 )           508             (522 )       (103 )%

Income from continuing operations before
income taxes                                   35,708          79,018          (43,310 )        (55 )%

INCOME TAXES                                    9,549          29,234          (19,685 )        (67 )%

Income from continuing operations              26,159          49,784          (23,625 )        (47 )%
LOSS ON DISCONTINUED OPERATION, net               (87 )          (202 )            115          (57 )%

Net income                                  $  26,072       $  49,582       $  (23,510 )        (47 )%


% of revenue
Gross margin                                     53.7 %          52.4 %
Marketing                                        28.2 %          25.9 %
General and administrative                       14.2 %          11.2 %
Operating income from continuing
operations                                        9.3 %          14.2 %

Revenue. Revenue decreased to $421.5 million in the nine months ended September 30, 2009 from $573.2 million for the comparable period of 2008. The revenue decrease resulted primarily from a decrease in customer starts as we are still seeing lower consumer spending in the commercial weight loss sector due to the economy. Reactivation revenue during 2009 remained relatively flat compared to the amount recorded in 2008. In both the nine months ended September 30, 2009 and 2008, the direct channel accounted for 93% of total revenue compared to 6% for QVC and 1% for other channels.

Costs and Expenses. Cost of revenue decreased to $195.0 million in the nine months ended September 30, 2009 from $272.9 million in the comparable period of 2008. Gross margin as a percent of revenue increased to 53.7% in the nine months ended September 30, 2009 from 52.4% for the comparable period of 2008. The increase in gross margin as a percent of revenue was primarily attributable to decreased freight costs and a reduction in the use of food-based promotions. We have focused on these costs and have been working in partnership with our vendors to apply cost saving measures.

Marketing expense decreased to $119.0 million in the nine months ended September 30, 2009 from $148.4 million in the comparable period of 2008, yet marketing expense as a percent of revenue increased to 28.2% in 2009 from 25.9% for 2008. The increase as a percent of revenue is due to increased spending to promote the launch of Nutrisystem D. We are expecting the revenue growth from this launch to be reflected over the remaining months of 2009. Substantially all marketing spending during the nine months ended September 30, 2009 promoted the direct business, and the decrease in marketing is primarily attributable to decreased spending for advertising media ($29.9 million) partially offset by increased production of television advertising ($830,000). In total, media spending was $103.9 million in the nine months ended September 30, 2009 and $133.8 million in the comparable period of 2008.

General and administrative expenses decreased to $59.8 million in the nine months ended September 30, 2009 compared to $64.4 million in the comparable period of 2008. General and administrative expense as a percent of revenue increased to 14.2% in the nine months ended September 30, 2009 from 11.2% for the comparable period of 2008. The decrease was primarily attributable to a decline in compensation and benefits costs and temporary help due to our focus on cost containment ($5.6 million) and telephone and internet expense due to lower rates ($958,000). These decreases were partially offset by increased non-cash expense for share-based payment arrangements ($1.2 million) due to an increased number of grants of restricted stock. Additionally, we recorded charges primarily related to our force reduction ($1.3 million) as we attempt to streamline work processes and right size our organization to improve our position for economic recovery and future growth.

Depreciation and amortization expense increased to $8.4 million in the nine months ended September, 30 2009 compared to $6.2 million in comparable period of 2008 due to the increased capital expenditures during 2008 and 2009 on our website and the amortization expense associated with NuKitchen acquisition in July 2008.

Other Income (Expense). Other income (expense) primarily represents the favorable impact of changes in the Canadian dollar during 2009 as compared to 2008.

Equity and Impairment Loss. In June 2009, the Company abandoned its interest in Zero Water as management determined that the business was no longer aligned with our current strategic direction. An equity and impairment loss of $4.0 million was recorded in the nine months ended September 30, 2009 to write-off the remaining investment. Estimated losses of $2.7 million were recorded in the nine months ended September 30, 2008 for our share of Zero Water's loss and the amortization expense for the difference between cost and the underlying equity in net assets of Zero Water.

Interest (Expense) Income, Net. Interest expense, net, was $14,000 in the nine months ended September 30, 2009 compared to interest income, net of $508,000 in the comparable period of 2008. The change is due to lower interest rates.

Income Taxes. In the nine months ended September 30, 2009, we recorded income tax expense of $9.5 million, which reflects an effective income tax rate of 26.7% compared to income tax expense of $29.2 million, which reflected an effective income tax rate of 37.0% in the comparable period of 2008. The decrease in the effective tax rate related to our abandonment of our investment in Zero Water which will provide a current year income tax deduction for the entire original $14.3 million tax basis investment in Zero Water and will reduce 2009 income tax payments by approximately $5.0 million. This reduction in income tax payments resulted in a similar decrease in income tax expense for the nine months ended September 30, 2009 including a reversal of a $3.7 million valuation allowance established in 2008 for deferred tax assets related to prior Zero Water losses and impairment charges not previously considered realizable.

Contractual Obligations and Commercial Commitments

As of September 30, 2009, our principal commitments consisted of obligations under supply agreements with food vendors, an agreement with our outside fulfillment provider, operating leases and employment contracts. Although we have no material commitments for capital expenditures, we anticipate continuing requirements for capital expenditures consistent with current operations.

During the nine months ended September 30, 2009, there were no items that significantly impacted our commitments and contingencies as disclosed in the notes to the consolidated financial statements for the year ended December 31, 2008, as included in our Form 10-K. In addition, we have no off-balance sheet financing arrangements.

Liquidity, Capital Resources and Other Financial Data

The capital and credit markets have become more volatile as a result of the recent global economic conditions. This has caused a general tightening in the credit markets, lower levels of liquidity and increased financing costs. Despite these factors, we believe that available capital resources are sufficient to fund our working capital requirements, capital expenditures, income tax obligations, dividends and share repurchases for the foreseeable future.

At September 30, 2009, we had net working capital of $101.3 million, compared to net working capital of $78.4 million at December 31, 2008. Cash and cash equivalents at September 30, 2009 were $67.5 million, an increase of $29.2 million from the balance of $38.3 million at December 31, 2008. Additionally, we had $30.1 million invested in marketable securities at September 30, 2009. Our principal sources of liquidity during this period were cash flows from operations. We have a $200.0 million unsecured revolving credit agreement with a group of lenders, which is committed until October 2, 2012 with an expansion . . .