Medartis
Annual Report 2004

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2 0 0 4 A n n u a l R e p o r t M A K I N G P E O P L E H E A LT H Y 25 years strong FINANCIAL HIGHLIGHTS FISCAL YEAR 2004 2003 2002 INCOME STATEMENT Revenue Operating Income $27,340,000 $25,379,000 $12,345,000 $3,004,000 $3,598,000 $1,752,000 Net Income Attributed to Common Shareholders $1,729,000 $2,352,000 $2,405,000 BALANCE SHEET Total Assets Stockholders Equity WEIGHTED AVG. SHARES OUTSTANDING Basic Diluted SHARE DATA Basic EPS Diluted EPS $25,968,000 $24,232,000 $9,888,000 $19,206,000 $17,077,000 $5,578,000 $10,832,360 $9,305,731 $6,722,505 $12,413,424 $10,952,367 $8,737,292 $0.16 $0.14 $0.25 $0.22 $0.36 $0.30 Medifast, Inc. (the “Company” or “Medifast” ) is a Delaware corporation, incorporated in 1980. The Company’s operations are primarily conducted through five of its wholly owned subsidiaries, Jason Pharmaceuticals, Inc. (“Jason”), Take Shape for Life, Inc. (“TSFL”), Jason Enterprises, Inc., Jason Properties, LLC and Seven Crondall, LLC. The Company is engaged in the production, distribution, sale and support of weight management and disease management products and other consumable health and diet products manufactured in a modern, FDA-approved facility in Owings Mills, MD. FORWARD LOOKING STATEMENTS This document contains forward-looking statements which may involve known and unknown risks, uncertainties and other factors that may cause Medifast, Inc. actual results and performance in future periods to be materially different from any future results or performance suggested by these statements. Medifast, Inc. cautions investors not to place undue reliance on forward-looking statements, which speak only to management’s expectations on this date. About Medifast is committed to making people healthy through nutritional intervention. With restaurants offering huge meal portions, and with the high fat and caloric content of many foods on the market today, it is no wonder that 64.5% of American adults are overweight or obese. This alarming health trend has led to increased incidences of diabetes, heart disease, arthritis, and other health problems. Medifast is in a unique position to address these issues. Our products and programs have been clinically proven, recommended by over 15,000 physicians, and used by more than 1 million people for 25 years. Medifast, Inc. 2004 Annual Report 1 To Our Shareholders 2004 proved to be yet another year of significant growth and success for the Company. Medifast revenues grew 8% in 2004, despite a significant drop in our international sales. Every Medifast brand showed positive growth in 2004. The Medifast Direct and Physicians businesses continue their impressive growth due to highly-focused, effective marketing. Take Shape for Life was accepted into the prestigious Direct Selling Association and developed a party plan model, which we expect will fuel its growth in 2005. Our Hi-Energy Weight Control Centers have grown to more than 100 clinics, making us one of the largest weight control center companies in the country. Consumers Choice Systems has expanded its retail penetration in the U.S. and is expanding into Canada. Finally, Sunrise Distributing has become a valuable distribution and printing facility for our core businesses, and is now a revenue generator, serving external customers. A great deal of credit for our growth must go to the talented, energetic Medifast team. These dedicated individuals share my passion for making people healthy and have helped drive our growth to new levels. Medifast possesses three unique attributes which give us a competitive edge in the marketplace: • Manufacturing - Jason Pharmaceuticals, Inc., the Company’s wholly-owned manufacturing subsidiary, produces over 95% of the Medifast products in our state-of-the-art, FDA-approved food and pharmaceutical-grade facility in Owings Mills, Maryland. Being both a manufacturer and a distributor allows us favorable margins and the flexibility to compete aggressively. As our business continues to grow, our manufacturing facility has the capacity to significantly increase production with minimal capital expenditures. • Diverse Products - The Medifast soy-based formulas have been on the leading edge of nutrition technology for the last 25 years. In 2004 alone, we created 23 new products, thanks to our dynamic Research and Development team. Our diverse meal replacement menu makes the Medifast program easy for people to stay on and helps to attract and maintain customers. 2 Medifast Inc. 2004 Annual Report • Clinical Studies - Over the years, Medifast has earned an impressive reputation with customers and within the medical community. Clinical data from some of the most respected institutions in the world, including Johns Hopkins University and the National Institutes of Health, have proven Medifast's effectiveness. In 2005, Johns Hopkins University made an important addition to our already prestigious library of clinical claims. Lawrence Cheskin, M.D., Johns Hopkins Bloomberg School of Public Health, announced results of a two-year study of diabetic patients comparing Medifast products with a food diet recommended by the American Diabetic Association. In addition to impressive health improvements, after 86 weeks, the Medifast group lost twice as much weight and were twice as compliant as the group following a diet based on the American Diabetes Association’s dietary guidelines. Additionally, 24% of the Medifast users decreased or eliminated their diabetes medication, compared to 0% on the standard ADA diet. Medifast’s growth over the last five years has been outstanding by any standard. Our goal is to continue to make people healthy and to further penetrate the $39 billion weight loss market. Rest assured that everyone at Medifast is working hard to turn our opportunities into results. Medifast programs and products have been clinically proven, recommended by over 15,000 physicians, and used by more than 1 million people for 25 years. Sincerely, Bradley T. MacDonald Executive Chairman Medifast Inc. 2004 Annual Report 3 The Medifast Direct business, through its Lifestyles Program, is a medically supported program wherein consumers order products directly from Medifast’s website www.medifastdiet.com or toll- free numbers. Customers also have access to qualified medical and nutritional practitioners for program support and information. During 2004, Medifast utilized print ads, TV ads, direct mail and web marketing to drive business. As a result of targeting our core demographic base, Medifast’s advertising expenditures have resulted in a much higher return for each advertising dollar spent. In mid-2004, the Medifast website, www.medifastdiet.com, was redesigned to improve functionality and enhance the shopping experience, as well as to create an engaging support environment for customers. Medifast is now among the leaders in the online weight loss arena. include the Many physicians and clinics Medifast program within their practice while providing appropriate testing, medical support and evaluations for patients on the program. Medifast has grown its Physician business through direct mail and promotion at national conferences of the American Society of Bariatric Physicians, American Academy of Family Physicians, American Academy of Nurse Practitioners, and American Diabetes Association. 4 Medifast Inc. 2004 Annual Report In 2004, Medifast continued to target our core demographic customers and improve the effectiveness of our marketing efforts. In its second year of existence, Take Shape for Life continued to expand its direct sales Health Advisor network. The Health Advisor network is a system of independent businesspeople providing tools, education and support along with Medifast products to improve the health of their clients. In September 2004, Take Shape for Life received acceptance as a full member of the prestigious Direct Sales Association (DSA). The DSA is the premiere trade organization for the direct sales industry. With exclusive membership, the DSA selects only member companies that meet their high standards for product excellence, fair distributor policies, and demonstrated ethics in business. Each DSA member company is bound by a strict code of ethics in all business dealings. 2004 achievements also include introduction of the TSFL Tasting Program, which utilizes a party plan model. Robust training and marketing materials also energized our Health Advisor network. Tsfl healTh advisors at the annual 2004 tsfl conference. Medifast Inc. 2004 Annual Report 5 Hi-Energy Weight Control Centers specialize in clinically-supervised weight management programs to promote both weight loss and improved health. As a physical clinic that offers support and its own private label products, Hi-Energy is one of the industry’s most dynamic businesses. During 2004, the number of Hi-Energy Weight Control Centers grew to over 100. Most of the current centers are licensees. Additionally, the Company is operating 11 corporately-owned clinics that serve as models to attract qualified licensees. Hi-Energy provides its customers with a wide variety of products, programs, and services that make it one of the industry’s most dynamic businesses. 6 Medifast Inc. 2004 Annual Report (cid:35)(cid:47)(cid:46)(cid:51)(cid:53)(cid:45)(cid:37)(cid:50)(cid:51)(cid:0)(cid:35)(cid:40)(cid:47)(cid:41)(cid:35)(cid:37)(cid:0)(cid:51)(cid:57)(cid:51)(cid:52)(cid:37)(cid:45)(cid:51) Founded in March 1996, and acquired by Medifast in 2003, Consumers Choice Systems™ is a retail distribution company focusing on high quality, innovative products for women and people with diabetes. The Woman’s Wellbeing brand includes supplements for urinary tract infections and menopause relief. CCS products are currently distributed in retail outlets nationwide. In 2005, the Company will launch Maintain by Medifast, a clinically proven line of foods formulated to help people with Type 2 (adult-onset) diabetes control their weight and the adverse effects of their condition. DISTRIBUTION The Sunrise Distributing 119,000 square foot distribution operation uses over 1,000 feet of conveyor systems, state-of-the-art shipping technologies and tracking software to ensure accurate and timely processing. In addition to providing the daily fulfillment services for all Medifast subsidiaries, Sunrise Distributing also services multiple external customers. Services include specialty packing, product assembly, inventory management, and fulfillment with e-processing and advanced reporting. PRINTING Today, the company produces most of its own marketing and advertising materials at Sunrise Distributing through an expanded print shop and mail house. Its state of the art technology helps reduce costs of materials for our business segments. In December 2004, the Company acquired a Xerox iGen3 digital production press, becoming one of only 150 companies who have obtained this top-of-the-line machine. Our capabilities, which include a full-service print house, warehouse and distribution facility, allow Sunrise Distributing to service a complete range of business needs for internal and external clients. Medifast Inc. 2004 Annual Report 7 The Medifast Family of Products • medifast 55 shakes • • medifast 70 shakes • • plus for appetite suppression shakes • • bars • soups • • oatmeal • pudding • drinks • • plus for diabetics • • plus for women’s health • • plus for joint health • • plus for coronary health • • fit! for kids • 8 Medifast Inc. 2004 Annual Report BOARD OF DIRECTORS Rev. Joseph D. Calderone, OSA Michael C. MacDonald Michael J. McDevitt Rev. Donald F. Reilly, OSA Mary T. Travis R. Scott Zion PRESIDENT EXECUTIVE CHAIRMAN Michael S. McDevitt Bradley T. MacDonald ADDITIONAL INFORMATION Headquarters Medifast, Inc. 11445 Cronhill Drive Owings Mills, MD 21117 800.223.1809 www.medifastdiet.com Investor Relations Contact Jeremy Hunt Stock Exchange Listing American Stock Exchange Trading Symbol: MED Independent Public Accountants Bagell, Josephs & Company, LLC Gibbsboro, New Jersey BDO Seidman Affiliate Transfer Agent and Register American Stock Transfer and Trust Company 59 Maiden Lane Plaza Level New York City, NY 10038 800-937-5449 Annual Meeting September 16, 2005 BOARD OF DIRECTORS Bradley T. MacDonald Executive Chairman, Medifast, Inc. Reverend Donald F. Reilly, OSA Provincial, Augustinian Order of Villanova, PA Michael C. MacDonald President of Global Accounts and Marketing Operations, Xerox Corporation R. Scott Zion Principal, Resources Development, Inc. Mary T. Travis Senior Vice President of Wholesale Operations, Sunset Mortgage Company, LP Michael J. McDevitt Senior Executive (retired), Federal Bureau of Investigation Reverend Joseph D. Calderone, OSA Associate Director of Campus Ministry, Villanova University CORPORATE OFFICERS Michael S. McDevitt President Leo V. Williams, III Executive Vice President Richard J. Law Vice President Brendan N. Connors, CPA Vice President of Finance Quick, Easy, Clinically Proven Medifast, Inc. 11445 Cronhill Drive Owings Mills, Maryland 21117 800 • 223 • 1809 medifastdiet.com Medifast Inc. 2004 Annual Report V.7.28.5a SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ---------- FORM 10-KSB/A ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004 Commission File No. 000-23016 ---------- MEDIFAST, INC. ---------------------------------------------------- DELAWARE ------------------------------- Incorporation State 13-3714405 ------------------- Tax Identification number 11445 CRONHILL DRIVE, OWINGS MILLS, MD --------------------------------------------------------------- Principal Office Address 21117 ---------- Phone (410) 581-8042 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, PAR VALUE $.001 PER SHARE --------------------------------------- Check 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 past 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorpo- rated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ] The issuer’s revenues for the fiscal year ended December 31, 2004 were $27,340,000 Aggregate market value of voting stock held by non-affiliates of registrant (deemed by registrant for this pur- pose to be neither a director nor a person known to registrant to beneficially own, exclusive of shares subject to outstanding options, less than 5% of the outstanding shares of registrant’s Common Stock) computed by refer- ence to the closing sales price as reported on the American Stock Exchange on December 31, 2004: $3.52. Number of shares outstanding of registrant’s Common Stock, as of December 31, 2004: 11,001,070 shares Documents incorporated by reference: None Transitional Small Business Disclosure Format (check one) Yes No X --- --- Explanatory Note This Form 10-KSB/A is being filed for the purpose of adding to or clarifying disclosures to our Controls and Procedures, Significant Accounting Policies, and footnotes previously included in our Form 10-KSB for the fis- cal year-ended December 31, 2004. The addition to our Controls and Procedures includes a report on manage- ment’s internal control over financial reporting required by Item 308(c) of Regulation SB. With respect to our Significant Accounting Policies, we have added greater detail about our revenue recognition policy. The Trade- mark footnote has been revised to clarify and supplement disclosures that might be useful to the readers of our financial statements. In addition, we have added updated certifications at Exhibits 31.1, 31.2 & 32.1 to conform to Item 601(b)(31) and (32) of Regulation SB. Except as described above we have not amended or modified the financial information or other disclosures on Form 10-KSB as originally filed. This Form 10-KSB/A does not reflect events occurring after the filing of the original Form 10-KSB, nor does it modify or update the disclosures therein in any way other than as required to reflect the amendments described above and set forth below. A former consultant continues to claim that he transferred his personal Medifast stock to a third party organization in 2000, in an attempt to keep these assets out of his bankrupt estate and therefore outside the jurisdiction of the Bankruptcy Court. The Company contests, and will vigorously defend, all such claims made by him. The Trustee in Bank- ruptcy for the former consultant’s bankruptcy estate has determined that he had no authority to transfer these shares from his estate, and has concluded that the attempted transfer was therefore invalid. The Trustee has demanded that he produce the shares, and plans to file a petition with the Bankruptcy Court requesting that the Court order him to do so. These assets will be made a part of the bankrupt estate and will be used to pay creditors. NOTE Q – SUBSEQUENT EVENTS In January 2005, the remainder of the Series “B” Convertible Preferred Stock was converted to Common Stock in accordance with the terms and conditions of the original offering statement, dated January 19, 2000. The offering stated that the holders, at the time of conversion, are to receive a dividend at a rate of 10% per annum and that “interest” will be paid in Common Stock. F-22 Medifast Inc. 2004 Annual Report PART I ITEM 1. BUSINESS. SUMMARY Medifast, Inc. (the “Company”, or “Medifast”) is a Dela- ware corporation, incorporated in 1980. The Company’s operations are primarily conducted through five of its wholly owned subsidiaries, Jason Pharmaceuticals, Inc. (“Jason”), Take Shape for Life, Inc. (“TSFL”), Jason En- terprises, Inc., Jason Properties, LLC and Seven Crondall, LLC. The Company is engaged in the production, distribution, and sale of weight management and disease management products and other consumable health and diet products. Medifast, Inc.’s product lines include weight and disease management, meal replacement and sports nutrition products manufactured in a modern, FDA approved facility in Owings Mills, Maryland. MARKETS Over the past 20 years the obesity rates in the United States have increases dramatically. The Centers for Disease Control (CDC) estimate that 64% of the U.S. adult population is overweight or obese. The amount of overweight adolescents and children ages 6-19 years have more than tripled since 1980. Currently, the CDC estimates that over 30% of adolescents and children are overweight. Distribution Channels The Medifast Lifestyles Program- The Medifast Life- styles Program is a medically supported network of health care professionals who support patients on the Medifast program. Patients order products directly from Medifast’s website or toll-free number. The Lifestyles medical practitioner ensures that each patient receives personalized attention throughout the weight loss pro- gram. Management estimates that more than 15,000 physicians nationwide have prescribed Medifast as a treatment for their overweight patients since 1980, and an estimated 1 million patients have used its’ products to lose and maintain their weight. The Company maintains an in-house Lifestyles support program for customers who have a Medifast physician, who does not have the time to provide counseling sup- port. These in-house qualified medical practitioners coordinate supervision of the Medifast program with the patient’s primary care physician. Customers have access to qualified medical practitioners for program support and advice by calling a toll free telephone help line or by e-mail. The in-house medical and marketing staff have developed extensive program support materials on Medifast products and programs, which are placed free of charge in customer orders, in addition to being available on the Company’s website. The CDC estimates that in the U.S. the associated costs with overweight and obesity reached $117 billion in 2000. The most common health problems associated with obesity are type II diabetes, coronary heart disease, hypertension and stroke, depression and certain forms of cancer. It’s also estimated that poor nutrition and physi- cal inactivity account for more than 300,000 premature deaths per year in the U.S. Take Shape for Life™ - The Take Shape for Life program is a comprehensive, medically supervised health network designed to assist in long-term weight loss, health management, or nutritional supplementation. The program features Medifast weight and disease manage- ment products, along with a team of personal and professional Health Advisors, to support the individual through their weight and or health management program. A 2003 market research study concluded consumers spend about $39 billion per year trying to lose weight or prevent weight gain. This includes consumer spend- ing on diet foods, medically supervised and commercial weight loss programs, diet books, appetite suppressants, fitness clubs, diet sodas, and videos and cassettes. Program entrants are encouraged to consult with their primary care physician and a Take Shape for Life Health Advisor to determine the Medifast program that is right for them. Physician directed Health Advisors are sup- ported, educated and qualified by The Health Institute, a training group staffed by Medifast professionals. Health Advisors obtain Medifast qualification based upon testing of their knowledge on Medifast products and programs. Medifast Inc. 2004 Annual Report 1 The Company has developed a Tasting program, which is similar to a home-based Party Plan model for introduc- ing new customers to the Medifast products and program. Physician directed Health Advisors recruit program entrants and provide them with program information, Medifast product samples and the opportunity to order products. Medifast Physicians and Clinics – Many Medifast physicians have chosen to implement the Medifast pro- gram within their practice. These physicians carry an in- ventory of Medifast products and resell them to patients. They also provide appropriate testing, medical support and evaluations for patients on the program. Physi- cians can also direct their patients to order directly from Medifast, if they do not have space to stock inventory. Hi-Energy Weight Control Centers - In 2003, the Company acquired Hi-Energy Weight Control Centers, a national company specializing in weight management programs, with weight loss centers in over 50 locations. During 2004 the number of Hi-Energy Weight Control Centers grew to over 100 nationally. Hi-Energy Weight Control Centers offer a competitive marketing edge through a regional advertising program, exclusive territo- ries and marketing support. The Company continues to seek out qualified licensees to add to its growing number of weight control clinics nationwide. Additionally, the Company is operating 11 corporately owned clinics that serve as models to attract qualified licensees. Consumers Choice System™ - Founded in March 1996, and acquired by Medifast in 2003, CCS is a retail distribution company focusing on high quality, innovative products for women. CCS products, under the Woman’s Wellbeing brand include supplements addressing meno- pause relief, coronary health and joint health. Products under the UTI brand address the detection, relief and prevention of urinary tract and bladder infections. CCS products are currently distributed in retail outlets nation- wide. The Company is currently launching Medifast’s “Maintain,” a pharmacist-directed Diabetic line of products. The CCS business is supported by a website and toll-free customer service line where customers can inquire about product information and retail availability. THE MEDIFAST® BRAND Medifast is a medically supervised weight management program, which specializes in multidisciplinary patient education programs using the highest quality meal re- placement supplements. In recent years Medifast’s core products and programs have continued to expand over a wellness spectrum to include disease management prod- ucts. Medifast offers products specially formulated for Diabetics as well as products for women’s health, joint health and coronary health. In 2003, Medifast began a two-year study with The Johns Hopkins Bloomberg School of Public Health to evaluate the efficacy of its Medifast Plus for Diabetics compared to basic nutrition recommendations by the American Diabetes Association (ADA). Preliminary results showed that participants using Medifast Plus for Diabetics lost twice as much weight as those following the ADA’s guidelines. Additionally, two-thirds of those on the Medifast program lost at least 5% of their weight, which is a standard measure of the Food and Drug Administra- tion’s (FDA) threshold to indicate clinically significant weight loss, versus one-quarter of those on the ADA diet. In addition to weight loss, the initial study results indi- cate that Medifast participants sustained an average 9% decrease in blood fasting glucose and an average 19% decrease in insulin levels. The final study results are expected to be released in 2005. Many Medifast Plus for Diabetics products have earned the coveted Seal of Approval from the Glycemic Re- search Institute. The line, designated as Low Glycemic, does not overly stimulate blood glucose and insulin and does not stimulate fat-storing enzymes. Products includ- ed in the Medifast Plus for Diabetics line consist of three delicious patented shakes, home style chili, apple cin- namon, French vanilla berry oatmeal, maple and brown sugar oatmeal, creamy chicken soup, creamy broccoli soup, chicken noodle soup, minestrone soup and two snack bars. The Company expanded the product line of its cutting edge adolescent weight management program, Fit!™ in 2003. The line, which formerly consisted of only one ready-to-drink and two chocolate bars, now consists of 2 Medifast Inc. 2004 Annual Report Throughout the year of 2004, 67,000 shares of Series “C” Preferred Convertible Stock were converted into 134,000 shares of Common Stock. As of December 31, 2004 there were 200,000 shares of Series “C” Preferred Convertible Stock remaining. NOTE N - WARRANTS During 2003, the Company issued 200,000 warrants to James Paradis and Anthony Burrascono, both affiliated with Villanova University and 200,000 warrants to Mr. David Scheffler, an investment banker, for advisory and consulting services provided to the Company. The warrants vest in five equal installments of 40,000 warrants per year over a five- year period. These are five-year warrants to purchase com- mon shares at an exercise price of $4.80 per share. These warrants may be cancelled, with a 90-day notice, if the con- sultants fail to perform to the satisfaction of the Company. During 2003, the Company issued 50,000 warrants to Con- sumer Choices Systems, Inc. (“CCS”) as part of the pay- ment for the purchase of the assets of CCS. These warrants are three-year warrants to purchase common shares at an exercise price of $10.00 per share. Of this amount, 25,000 warrants were exercised in 2003. During 2003, the Company issued 63,750 warrants and 18,750 warrants to Mainfield Enterprises, Inc. and Portside Growth & Opportunity Fund. These warrants are five-year warrants to purchase common shares at exercise prices of $16.78 per share, which was equal to one hundred fifteen percent (115%) of the five-day volume weighted average price, all pursuant to the terms of that certain Securities Pur- chase Agreement by and between the Company and Main- field Enterprises, Inc. and Portside Growth & Opportunity Fund dated as of July 24, 2003. During 2004, there were 40,000 warrants exercised at $4.80 and 6,700 warrants exercised at $0.35. The fair value of these warrants were estimated using the Black-Scholes pricing model with the following assump- tions: interest rate 4.5%, dividend yield 0%, volatility 0.40 and expected life of five years. The Company has the following warrants outstanding for the purchase of its common stock: Exercise Price $ 0.35 $ 0.35 $ 0.625 $ 4.80 $10.00 $16.78 Year Ended December 31, Expiration Date 2004 2003 August, 2004 March, 2005 September, 2004 April, 2008 June, 2006 July, 2008 - 2,000 - 360,000 25,000 82,500 469,500 40,100 - 2,500 400,000 25,000 82,500 550,100 Weighted average exercise price $7.16 $6.49 As of December 31, 2004, 229,500 of the warrants were exercisable. NOTE O - COMMITMENTS, CONTINGENCIES AND OTHER MATTERS The Company, like other manufacturers and distribu- tors of products that are ingested, faces an inherent risk of exposure to product liability claims in the event that, among other things, the use of its products results in injury. NOTE P – LITIGATION On December 16, 2003 John Donavin, on behalf of the General Public, filed suit, against Jason Pharma- ceuticals, Inc. in the Superior Court of the State of California, City and County of San Francisco. The suit alleges that Medifast bars contain Vitamin D3 or Vitamin D in violation of Federal laws and regula- tions, and asks for equitable relief and damages. The Company’s general council believes that the Compa- ny’s formulation used in its “meal replacement” bars for over 20 years has been and is in conformity with current and past FDA regulations. The Company believes that the plaintiff’s claim lacks merit and may even be considered frivolous. The suit has been stayed upon appeal to the FDA to clarify its regulations. Medifast Inc. 2004 Annual Report F-21 NOTE J - EMPLOYMENT AGREEMENTS The CEO of Medifast, Inc., Bradley T. MacDonald, has a two-year employment agreement for an aggregate annual base salary of $225,000 with a bonus potential of 50% of base salary provided the Company makes its profit plan per the Board approved forecast. This contract has been extended to December 31, 2007. Due to the inequities of funding a retirement plan in the 401K, and in recognition of the performance responsible for the turnaround of the Com- pany, the Board of Directors approved a Selective Execu- tive Retirement Compensation Plan funded by the form of deferred compensation. The Deferred Compensation Plan will be funded up to $350,000 by a dollar for dollar match program, having Mr. MacDonald defer $175,000, followed by a Company match of $175,000. In June 2004 The Board of Directors authorized an additional $50,000 to be de- ferred by Mr. MacDonald followed by a Company match of $50,000. This brought the Selective Executive Retirement Compensation Plan total funded value to $450,000. Mr. MacDonald exercised 100,000 options at $.25 in January 2003 and 15,000 options at $.75 in March 2003. He has no options remaining available to exercise. NOTE K - REDEEMABLE PREFERRED STOCK In August 1996, the Company sold 432,500 shares of Series “A” nonvoting preferred stock that generated gross proceeds of $865,000, or $2.00 per share. Each share was entitled to a dividend of 8% ($.16) per share. The shares were con- vertible into the Company’s common stock on the basis of one share of common stock for each share of convertible preferred stock. In 2001, 157,000 shares opted to convert to Series “C” Preferred Convertible Stock and 85,000 shares were redeemed under the partial settlement and conver- sion to Series “C” preferred convertible stock offered to Series “A” preferred stockholders as approved by the Board of Directors. In 2002 the remaining 75,000 shares were redeemed. NOTE L - SERIES “B” CONVERTIBLE PREFERRED STOCK In January 2000, the Company was authorized to issue 600,000 Series “B” Convertible Preferred Stock (“Preferred Stock B”) par value $1.00 per share. Each share is entitled F-20 Medifast Inc. 2004 Annual Report to a dividend of 10% of liquidation value $1.00 ($.10) per share and is to be converted on January 15, 2005 unless converted prior thereto. Each holder of Preferred Series “B” stock is entitled to four votes per share in all matters in which holders of the Company’s common stock are entitled to vote. These shares were converted to common stock in January 2005. (See note Q). Each share of Preferred Series “B” stock is convertible, at the option of the holder after one year from the issuance date into common stock of the Company. The initial con- version price will be 75% of the market value of the Com- pany’s common stock on the day prior to conversion with a maximum conversion price of $.50 per share subject to ad- justment as defined. In March 2002, the Board amended the Series “B” convertible preferred stock terms and conditions as follows (1) a dividend of 10% paid in preferred stock, or (2) cash at the option of the holder. The Board also fixed the conversions of Series “B” preferred at $0.50 per share in common stock and eliminated the spiral conversion provi- sion and reduced voting to 2 votes per share. Throughout the year of 2004, 103,120 shares of Series “B” Convertible Preferred Stock were converted into 206,240 shares of Common Stock. As of December 31, 2004 there were 300,614 shares of Series “B” Convertible Preferred Stock remaining. NOTE M - SERIES “C” PREFERRED CONVERTIBLE STOCK In the Fall of 2001, the Company was authorized to issue 1,015,000 shares of Series “C” Preferred Convertible Stock par value (.001), market value $1.00 per share. Each share is entitled to a dividend of 10% of liquidation value $1.00 ($.10) per share and is to be converted on December 31, 2006 unless converted prior thereto. Each Holder of Pre- ferred Series “C” Stock is entitled to one (1) vote per share in all matters in which holders of the Company’s Common Stock are entitled to vote. Each share of Preferred Series “C” Stock is convertible, at the option of the holder, after one year from the issuance date into Common Stock of the Company. The conversion price will be $.50 a share. In 2002, 11,500 warrants issued at $0.35 per share were dis- tributed proportionately to Series “C’ preferred holders. three delicious powdered shakes, vanilla berry oatmeal, chicken noodle soup, hot cocoa with marshmallows, chocolate pudding, 3 power-packed bars and one ready- to-drink. Medifast has commissioned another study at Johns Hop- kins that began in 2004 to evaluate the effectiveness of Medifast Fit! meal replacements in a weight loss program for overweight children. The study aims to prove that the Medifast program will generate greater initial weight loss, greater reductions in body fat and greater improve- ments in overall health than a standard reference diet. The study will also evaluate the weight loss outcomes in a joint parent-child approach versus children dieting without parental support. Most Medifast® products qualify to make the FDA’s heart healthy claim, “May Reduce the Risk of Heart Disease.” In order to make this claim, a product must contain at least 6.25 grams of soy protein per serving and be low in fat, saturated fat, and cholesterol. Unlike popu- lar fad diets and herbal supplements, Medifast® products are a safe, nutritionally balanced choice, offering gender specific formulas containing high protein and low carbo- hydrates, a soy protein source rather than animal protein source, and vitamin and mineral fortification. It is very difficult to meet the minimum recommended nutritional requirements on a low-calorie diet, but a dieter can eas- ily meet these requirements using the nutrient dense Medifast® brand of meal replacement food supplements. Medically supervised, low calorie diets are continuing to gain popularity, as consumers search for a safe and effective solution that provides balanced nutrition, quick weight loss and valuable behavior modification educa- tion. In addition, consumers are becoming more aware of chronic diseases such as diabetes and coronary health. COMPETITION There are many different kinds of diet products and programs within the weight loss industry. These include a wide variety of commercial weight loss programs, phar- maceutical products, weight loss books, self-help diets, dietary supplements, appetite suppressants and meal replacement shakes and bars. The Company has proven it can compete in this com- petitive market because its products have been clinically tested and proven at Johns Hopkins University and have been safely and effectively used by customers for over 20 years. Medifast has been on the cutting edge of product development with soy based nutritional and weight man- agement products since 1989. These products are formu- lated with high-quality, low-calorie, low-fat ingredients that provide alternatives to fad diets or medicinal weight loss remedies. PRODUCTS The Company offers a variety of weight and disease management products under the Medifast® brand and for select private label customers. The Medifast® line includes Medifast® 55, Medifast® 70, Medifast® Plus for Appetite Suppression, Medifast® Plus for Diabet- ics, Medifast® Plus for Joint Health, Medifast® Plus for Women’s Health, Medifast® Plus for Coronary Health, Medifast® Fit!, Medifast® Take ShapeTM, Medifast® Supplement Bars, Medifast® Creamy Soups, Medifast® Minestrone Soup, Medifast® Hot Cocoa, Medifast® Oat- meals, Medifast® Pro Teas, Medifast® Chicken Noodle Soup, Medifast® Fast Soups, Medifast® Homestyle Chili and Medifast® Multigrain Crackers. Medifast nutritional products are formulated with high- quality, low-calorie, low-fat ingredients. Many Medifast products are soy based and contain 24 vitamins and min- erals, as well as other nutrients essential for good health. The Company uses DuPont Protein Technologies’ Su- pro® brand soy protein, which is a high-quality complete protein derived from soybeans. The Consumers Choice Systems subsidiary sells prod- ucts under the private label Woman’s Wellbeing. These products include Menopause Relief Pills, Personal Cream Lubricant, a UTI Home Screening Test Stick, UTI Cleansing Wipes, UTI Cranberry-Plus-Blueberry, Women’s Wellbeing Meal Replacements and all-natural weight loss pills. Medifast® brand awareness continues to expand through product development, line extensions, and the Company’s emphasis on quality customer service, technical support Medifast Inc. 2004 Annual Report 3 and publications developed by the Company’s market- ing staff. Medifast® products have been proven to be effective for weight and disease management in clinical studies conducted by the U.S. government and Johns Hopkins University. The Company has contin- ued to develop its sales and marketing operations with qualified management and innovative programs. The Company’s facility in Owings Mills, MD manufac- tures powders and supplement bars and subcontracts the production of its Ready-to-Drink products. NEW PRODUCTS The Company expanded the Medifast product line with twenty-three new products in 2004. Medifast intro- duced Medifast® Cappuccino, Medifast® Chai Latte, Medifast® Hot Cocoa with Marshmallows, Medifast® Maple and Brown Sugar Oatmeal, Medifast® Banana Cream Pudding, Medifast® Chicken and Wild Rice Soup, Medifast® Cranberry Mango Fruit Drink, Medifast® Tropical Fruit Punch Drink and Medifast® Garden Veg- etable Crackers. Medifast also introduced a line of salad dressings and three new meal replacement bars. Last, the Company introduced a line called Essential 1 Meals that includes grilled chicken breasts, grilled beef patties, tuna salad and chicken salad. Consumers Choice Systems reformulated its existing Menopause Relief capsules, adding a new type of soy and developing the product into an extended time-release formula, branded as Menopause Relief 24. Menopause Relief 24 is the only time release formula for relieving the symptoms of menopause in the market today. The Company also introduced two new all natural weight loss pills in 2004 under the private label Woman’s Wellbeing called Active Trim and Always Trim. These two new diet formulas are all-natural capsules that help burn fat, boost energy and suppress appetite. MARKETING The Company continued to build and leverage its core Medifast brand through multiple marketing strategies to its target audiences. Print advertising, television, and radio were all used to target new customers by stressing Medifast’s quick, easy and safe approach to weight man- 4 Medifast Inc. 2004 Annual Report agement. Also, direct mail has been utilized to encourage and support existing customers. Online advertising began to be used in 2004 and it includ- ed keyword search, banner ads, affiliate programs, and targeted direct email campaigns. The online advertising has been supported by Medifast’s well designed, user- friendly website, which provides a wealth of information and customer support for easy ordering functionality. The Company has expanded its public relations efforts in order to gain exposure in the media to promote greater consumer awareness of the Medifast brand. Mr. Dick Vitale, the famous basketball commentator, continues to be the Company’s spokesperson, particularly support- ing the Company’s Take Shape for Life programs and its Diabetic products and programs. SALES The Company’s Sales division handles three primary areas: Physician and Clinic Sales— The sales team is respon- sible for prospecting larger medical accounts, clinics, hospitals, and HMOs. During 2004, the sales team attended a number of medical professional trade shows, which expanded Medifast’s penetration of the clinical business segment. Hi-Energy Weight Control Centers— During 2004 Hi- Energy provided ongoing support to its licensees as well as to the Company’s 11 corporately owned centers which opened at the end of 2004. This support included mar- keting materials, ads, on-site trainings, fitness programs, nutritional programs and clinical operation materials and forms. Employees attended professional trade shows, prospected new licensees, and partnered with area phy- sicians to provide Hi-Energy programs and services to local hospitals and private practices. Take Shape for Life— Provides a sales force of Health Advisors who support patients and their primary care physicians with a defined support program. NOTE I - LONG-TERM DEBT AND LINE OF CREDIT Long-term debt as of December 31, 2004 and 2003, consist of the following: 2004 2003 $2,850,000 fifteen year term loan secured by the building and land at a variable rate which was 5.14% at December 31, 2004 $1,760,000 ten-year reducing revolver line of credit rate at LIBOR plus 220 bps , which was 4.59% on December 31, 2004 $186,976 three-year term loan secured by 20,000 restricted common shares variable rate which was 8.25% at December 31, 2004 $200,000 five-year term loan secured by equipment fixed rate was 3% at December 31, 2004 $475,000 seven-year loan secured by the building and land at a variable rate at LIBOR plus 250 bps, which was 4.91% on December 31, 2004 $220,000 two-year term loan secured by equipment at a floating rate which was 6% at December 31, 2003 $100,000 unsecured note payable at a fixed rate of 3%, discounted to an incremental borrowing rate of 12% Note payable over 3 years secured by vehicle at a fixed rate of 12.25% $550,000 agreement three years secured by certain assets of the Company variable rate, which was prime floating at December 31, 2003. $ 2,391,000 1,623,000 111,000 130,000 459,000 - - - $ 2,581,000 1,740,000 151,000 172,000 - 73,000 59,000 2,000 - 550,000 Less current portion 4,714,000 458,000 $ 4,256,000 5,328,000 764,000 $ 4,564,000 Future principal payments on long-term debt for the next 5 years are as follows: 2005 ...................................... $ 458,000 2006 ...................................... 475,000 2007 ...................................... 421,000 2008 ……………………….. 376,000 2009……………………….. 379,000 Thereafter…………………... 2,605,000 $4,714,000 The Company has established a $5 Million revolving line of credit at the LIBOR rate plus 2% with Mercantile Safe Deposit and Trust Company secured by substantially all of the assets of Jason Pharmaceuticals, Inc. The outstanding balance on this line was $369,000 and $55,000 at December 31, 2004 and 2003, respectively. Ef- fective January 17, 2004, $366,000 of the line of credit was converted to a note payable secured by all assets of Jason Pharmaceuticals excluding trade marks at a variable rate at libor plus 250 basis points which was 4.4% on December 31, 2004. Medifast Inc. 2004 Annual Report F-19 NOTE H - INCOME TAXES At December 31, 2004 and 2003, the principal components of the net deferred tax assets are as follows: Net operating loss carry forwards Accounts receivable Inventory overhead and write downs Trademarks and intangibles Total deferred tax assets Current benefit 2004 $ - 19,000 - 91,000 110,000 19,000 $91,000 2003 $290,000 32,000 274,000 - 596,000 596,000 A reconciliation of the federal statutory rate to income tax expense is as follows: Year Ended December 31, Income tax based on federal statutory rate State and local tax, net of federal benefit Deferred income tax expense Income tax expense 2004 $600,000 90,000 469,000 $1,159,000 2003 $973,000 175,000 - $1,148,000 F-18 Medifast Inc. 2004 Annual Report MANUFACTURING Jason Pharmaceuticals, Inc., the Company’s wholly owned manufacturing subsidiary, produces over 95% of the Medifast products in a state-of-the-art food and pharmaceutical-grade facility in Owings Mills, Maryland. Management purchased the plant in July 2002 for $3.4 million. The Company purchased additional lines for the internal production of its growing nutritional meal replacement bar product line in 2003. The manufacturing facility has the capacity for significant increases to its production output with minimal capital expenditures. It is presently operating on a single shift. Adding an additional shift, along with diminutive ma- chinery expenses would enable the Company to produce enough products to generate over $200 million in sales. Manufacturing processes, product labeling, quality control and equipment are subject to regulations and inspections mandated by the Food & Drug Administra- tion (FDA), the Maryland State Department of Health and Hygiene, and the Baltimore County Department of Health. The plant strictly adheres to all GMP practices and has maintained its status as an “OU” (Orthodox Union) Kosher-approved facility since 1982. FINANCING AND STRATEGIC ALTERNATIVES Management desires to develop strategic marketing relationships with other third parties having existing relationships with the medical professional community, specifically to reach the diabetic population in the United States and to secure international distribution in Europe and Asia. GOVERNMENTAL REGULATION HISTORY The formulation, processing, packaging, labeling and advertising of the Company’s products are subject to regulation by several federal agencies, but principally by the Food and Drug Administration (the “FDA”). The Company must comply with the standards, labeling and packaging requirements imposed by the FDA for the marketing and sale of medical foods, vitamins, and nutritional products. Applicable regulations prevent the Company from representing in its literature and labeling that its products produce or create medicinal effects or possess drug-related characteristics. The FDA could, in certain circumstances, require the reformulation of cer- tain products to meet new standards, require the recall or discontinuation of certain products not capable of refor- mulation, or require additional record keeping, expanded documentation of the properties of certain products, expanded or different labeling, and scientific substantia- tion. If the FDA believes the products are unapproved drugs or food additives, the FDA may initiate similar enforcement proceedings. Any or all such requirements could adversely affect the Company’s operations and its financial condition. The FDA also requires “medical food” labeling to list the name and quantity of each ingredient and identify the product as a “weight management/modified fasting or fasting supplement” in the labeling. To the extent that sales of vitamins, diet, or nutritional supplements may constitute improper trade practices or endanger the safety of consumers, the operations of the Company may also be subject to the regulations and enforcement powers of the Federal Trade Commission (“FTC”), and the Consumer Product Safety Commission. The Company’s activities are also regulated by various agencies of the states and localities in which the Com- pany’s products are sold. The Company’s products are manufactured and packaged in accordance with custom- ers’ specifications and sold under their private labels both domestically and in foreign countries through indepen- dent distribution channels. PRODUCT LIABILITY AND INSURANCE The Company, like other producers and distributors of ingested products, faces an inherent risk of exposure to product liability claims in the event that, among other things, the use of its products results in injury. The Company maintains insurance against product liability claims with respect to the products it manufactures. With respect to the retail and direct marketing distribution of products produced by others, the Company’s principal form of insurance consists of arrangements with each of its suppliers of those products to name the Company Medifast Inc. 2004 Annual Report 5 as beneficiary on each of such vendor’s product liability insurance policies. The Company does not buy products from suppliers who do not maintain such coverage. upon appeal to the FDA to clarify its regulations. The Company believes recent legislation restricting the ability of plaintiff’s lawyers from filing local class action suits should favor the Company’s legal position in this case. EMPLOYEES At December 31, 2004, the Company employed 130 full-time and contracted employees, of whom 46 were engaged in manufacturing, warehouse management, and shipping, and 84 in marketing, administrative, call center and corporate support functions. None of the employees are subject to a collective bargaining agreement with the Company. ITEM 2. DESCRIPTION OF PROPERTY The Company owns a 49,000 square-foot facility in Ow- ings Mills, Maryland, which contains its Corporate Head- quarters and manufacturing plant. In 2003, the Company purchased a state-of-the-art 119,000 square-foot distribu- tion facility in Ridgely, Maryland. The facility gives the Company the ability to distribute over $200 million of Medifast product sales per year. In 2004, the Company purchased a 3,000 square foot conference and training fa- cility in Ocean City, Maryland. The facility will be used to conduct corporate training meetings, Board of Director Meetings and employee morale and wellness programs. The Company has 11 leases for its corporately owned Hi-Energy Weight Control clinics throughout Florida, Ar- kansas, Mississippi and Texas. The leases range in terms from one to five years. ITEM 3. LEGAL PROCEEDINGS. On December 16, 2003, John Donavin, on behalf of the General Public, filed suit, against Jason Pharmaceuti- cals, Inc. in the Superior Court of the State of California, City and County of San Francisco. The suit alleges that Medifast bars contain Vitamin D3 or Vitamin D in viola- tion of Federal laws and regulations, and asks for equitable relief and damages. The Company’s General counsel believes that the Company’s formulation used in its “meal replacement” bars for over 20 years has been and is in con- formity with current and past FDA regulations. The Com- pany believes that the plaintiff’s claim lacks merit and may even be considered frivolous. The suit has been stayed 6 Medifast Inc. 2004 Annual Report A former counsel continues to claim that he transferred his personal Medifast stock to a third party organiza- tion in 2000, in an attempt to keep these assets out of his bankrupt estate and therefore outside the jurisdiction of the Bankruptcy Court. The Company contests, and will vigorously defend, all such claims made by him. The Trustee in Bankruptcy for his bankruptcy estate has determined that he has no authority to transfer these shares, and has concluded that the attempted transfer was therefore invalid. The trustee has demanded that he produce the shares, and plans to file a petition with the Bankruptcy Court requesting that the Court order him to do so. These assets will be made a part of the bankrupt estate and will be used to pay creditors. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Medifast Annual Shareholder Meeting was held on September 3, 2004 at Sunrise Distributing, the Compa- ny’s distribution headquarters. The shareholders voted Bradley T. MacDonald (98%) and Rev. Donald F. Reilly, O.S.A.* (98%) as Class I Directors that will hold office until 2007, Scott Zion* (98%) and Michael C. MacDon- ald (98%) as Class II Directors, and Mary T. Travis* (98%), Michael J. McDevitt (98%), and Rev. Joseph Calderone, O.S.A.* (98%) as Class III Directors. Class II and III Directors will hold office until the next Annual Shareholders Meeting at which time their respective class term expires and their respective successors will be duly elected and qualified. Additionally, the shareholders approved the appointment of Bagell, Josephs & Com- pany, LLC, an independent member of the BDO Seidman Alliance, as the Company’s independent auditors for the fiscal year ending December 31, 2004. Additionally the Board of Directors elected Mr. Bradley T. MacDonald as Chairman of the Board and CEO and Mr. Conrad Sump, Esq. as Secretary of the Corporation. * Independent Director NOTE G – OPERATING LEASES The Company leases office space for its eleven corporately owned Hi-Energy Weight Control Clinics under lease terms ranging from one to five year leases commencing 2004. Monthly payments under the leases range in price from $1,120 to $2,695. The Company is required to pay property taxes, utilities, insurance and other costs relating to the leased facilities. The following is a schedule by years of future minimum rental payments required under operating lease that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2004: For the Years Ending December 31, 2005 2006 2007 2008 2009 $238,737 208,605 166,355 121,871 117,038 Total minimum payments required $852,606 Medifast Inc. 2004 Annual Report F-17 NOTE E – TRADEMARKS As of December 31, 2004 As of December 31, 2003 Gross Carrying Amount Accumulated Amortization Gross Carrying Amount Accumulated Amortization Customer lists Non-compete agreements Trademarks and patents Goodwill $ 4,355,000 840,000 1,703,000 894,000 $ 394,000 248,000 12,000 $ 1,724,000 840,000 1,541,000 894,000 $ 150,000 86,000 14,000 Total $ 7,792,000 $ 654,000 $ 4,999,000 $250,000 Amortization expense for the year ended December 31, 2004 and 2003 was as follows: Customer lists Non-compete agreements Trademarks and patents 2004 $ 244,000 162,000 Total Trademarks and Intangible $ 406,000 2003 127,000 86,000 14,000 $ 227,000 Amortization expense is included in selling, general and administrative expenses. NOTE F - ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses as of December 31, 2004 and 2003 consist of the following: Trade payables Accrued expenses and other Accrued payroll and related taxes Sales commissions payable Deferred revenue Total 2004 $ 343,000 2003 $ 969,000 116,000 121,000 215,000 266,000 96,000 360,000 - 168,000 $ 940,000 $1,714,000 F-16 Medifast Inc. 2004 Annual Report PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. (a) The Company’s Common Stock has been quoted under the symbol MED since December 20, 2002. The old symbol, MDFT, had been traded since February 5, 2001. The common stock is traded on the American Stock Exchange. The following is a list of the low and high closing prices by fiscal quarters for 2004 and 2003: 2004 ----------------- Low High ----- ------ 8.60 14.05 Quarter ended March 31, 2004 ................... Quarter ended June 30, 2004 .................... 4.78 9.33 Quarter ended September 30, 2004 ............... 3.05 5.09 3.20 5.24 Quarter ended December 31, 2004 ................ 2003 ----------------- Low High ----- ------ 3.79 6.10 Quarter ended March 31, 2003 .................. Quarter ended June 30, 2003 .................... 4.80 14.95 Quarter ended September 30, 2003 ............... 11.15 17.21 Quarter ended December 31, 2003 ................ 11.60 18.49 (b) The quotations reflect inter-dealer prices, without retail mark-up, markdown or commissions and may not represent actual transactions. (c) There were 6,366 record holders of the Company’s Common Stock, as of December 31, 2004. The Com- pany had 6 preferred holders of the Company’s stock as of December 31, 2004. (d) No dividends on common stock were declared by the Company during 2004 or 2003. ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. FORWARD LOOKING STATEMENTS This document contains forward-looking statements which may involve known and unknown risks, uncertainties and other factors that may cause Medifast, Inc. actual results and performance in future periods to be materially different from any future results or performance suggested by these statements. Medifast, Inc. cautions investors not to place undue reliance on forward-looking statements, which speak only to management’s expectations on this date. Medifast Inc. 2004 Annual Report 7 2004 COMPARISON WITH 2003 OPERATING Consolidated net sales for 2004 were $27,340,000 as compared to 2003 sales of $25,379,000, an increase of $1,961,000, or 8%. A major reason for the revenue increase for the Company is attributed to the contin- ued success from the Take Shape for Life division, national advertising, the Hi-Energy acquisition and the redesigned website. The Take Shape for Life division added a Take Shape for Life replicating website option for Health Advisors, an Internet distribution program for their customers, as well as the new Tasting Party Program. These have proven to be effective at generat- ing revenues and recruiting Health Advisors into the Take Shape for Life Network. The national advertising campaign included print, TV, radio, direct mail and web marketing. The Company increased its Internet sales in 2004 as compared to 2003, by redesigning its web- site and increasing its web marketing. The redesigned website created an easy to use shopping cart and a more user-friendly interface. The acquisition of Hi- Energy Weight Control Centers contributed to revenues throughout 2004. Cost of sales decreased from $6,825,000 in 2003 com- pared to $6,746,000 in 2004, a decrease of $79,000. The decrease is attributed to decreases in costs through economies of scale. Gross margins increased to 75% in 2004 from 73% in 2003. This was largely due to greater economies of scale as a result of the acquisition of the Company’s 119,000 square foot distribution facility thereby creat- ing higher margins of the Medifast® products through purchasing capabilities. The increase is also attributed to the increased margin of Medifast® direct and Inter- net sales directly to patients via the Lifestyles and Take Shape for Life programs. Selling, general and adminis- trative (SG&A) expenses of $17,590,000 for 2004 were $2,634,000 more than the $14,956,000 in 2003, due to increased advertising expenses to include television advertising, celebrity endorsements, expenses involved with starting and operating new corporately owned Hi- Energy Weight Control Clinic locations, the expansion 8 Medifast Inc. 2004 Annual Report of the Take Shape for Life commissioned sales orga- nization, and overall corporate infrastructure improve- ments. The Company experienced income from opera- tions for the year 2004 of $3,004,000. This compares with income from operations of $3,598,000 in 2003, a decrease of 17%. In 2004, the Company realized a tax expense of $1,159,000, as compared to a tax expense of $1,148,000 in 2003 as a result of the elimination of the deferred tax asset and the net operating loss for income tax purposes. Interest expense increased to $245,000 in 2004, as compared to $154,000 in 2003. This increase was due to a complete year of additional debt, which was acquired in 2003. A preferred stock dividend in the amount of $18,000 was expensed to shareholders in 2004. LIQUIDITY AND CAPITAL RESOURCES At December 31, 2005, the Company had net working capital of $7,465,000, a decrease of $1,933,000 from the $9,398,000 net working capital balance at Decem- ber 31, 2003. Cash and investment securities at Decem- ber 31, 2004 were $3,238,000. On November 7, 2003 Medifast, Inc.’s wholly owned subsidiary Jason Phar- maceuticals, Inc. increased its Secured Line of Credit from $1,000,000 to $5,000,000 from Mercantile Safe- Deposit and Trust of Baltimore, Maryland. The line of credit is at LIBOR plus two percent. The increased line may be used to finance equipment, inventory, and receivables of Medifast, Inc. The Company currently has no off-balance sheet arrangements. In the year ended December 31, 2004, the Company generated a negative cash flow of $2,332,000 from operations, primarily attributable to purchases of inventory and the pay down of accounts payable and accrued expenses. In the year ended December 31, 2004, net cash used in investing activities was $3,940,000, which primarily con- sisted of the purchase of intangible assets, purchase of property and equipment, and the purchase of a building. NOTE C - INVENTORY Inventory consists of the following at December 31, 2004 and 2003: 2004 Raw materials ....................…... $1,085,000 Packaging…………………….. 958,000 Finished goods .......................... 2,208,000 $4,251,000 2003 $ 813,000 694,000 1,481,000 $2,988,000 NOTE D - PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment as of December 31, 2004 and 2003, consist of the following: Land Building and building improvements Equipment and fixtures Vehicle 11,000 2004 $ 650,000 6,728,000 4,062,000 Less accumulated depreciation and amortization Property, plant and equipment - net 11,451,000 2,753,000 $ 8,698,000 2003 $ 565,000 5,937,000 2,876,000 20,000 9,398,000 1,949,000 $ 7,449,000 Substantially all of the Company’s property, plant and equipment are pledged as collateral for various loans (see Note I). Depreciation expense for the years ended December 31, 2004 and 2003 were $804,000 and $421,000, respectively. Medifast Inc. 2004 Annual Report F-15 Board (“APB”) Opinion No. 28, “Interim Financial Reporting”, to require disclosure about those effects in interim financial information. SFAS 148 is effec- tive for financial statements for fiscal years ending after December 15, 2002. The Company will continue to account for stock-based employee compensation using the intrinsic value method of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, but has adopted the enhanced disclosure requirements of SFAS 148. In May 2003, the FASB issued SFAS Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It re- quires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This statement is effective for finan- cial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of nonpublic entities, if applicable. It is to be implemented by reporting the cumula- tive effect of a change in an accounting principle for financial instruments created before the issuance date of the Statement and still existing at the beginning of the interim period of adoption. The adoption of this statement did not have a significant impact on the Company’s results of operations or financial position. In November 2002, the FASB issued Interpreta- tion No. 45 (“FIN 45”), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 requires a company, at the time it issues a guaran- tee, to recognize an initial liability for the fair value of obligations assumed under the guarantees and elaborates on existing disclosure requirements related to guarantees and warranties. The recognition require- ments are effective for guarantees issued or modified after December 31, 2002 for initial recognition and initial measurement provisions. The adoption of FIN F-14 Medifast Inc. 2004 Annual Report 45 did not have a significant impact on the Company’s results of operations or financial position. In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), Consolidation of Variable Inter- est Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consoli- dated by the primary beneficiary of the entity if the equity investors in the entity do not have the charac- teristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The adoption of FIN 46 did not have a significant impact on the Company’ results of operations or financial position. [16] INVESTMENTS In accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, securities are classified into three categories: held-to- maturity, available-for-sale and trading. The Compa- ny’s investments consist of debt and equity securities classified as available-for-sale securities. Accord- ingly, they are carried at fair value in accordance with SFAS No. 115. Further, SFAS No. 115 the unrealized holding gains and losses for available-for-sales securi- ties are excluded from earnings and reported, net of deferred income taxes, as a separate component of stockholders’ equity, unless the loss is classified as other than a temporary decline in market value. [17] RECLASSIFICATIONS Certain amounts for the year ended December 31, 2003 have been reclassified to conform to the presen- tation of the December 31, 2004 amounts. The reclas- sifications have no effect on net income for the year ended December 31, 2003. In the year ended December 31, 2004, net cash used in financing activities was $304,000, representing the principal repayments of long-term debt. Agreement by and between the Company and Mainfield Enterprises, Inc. and Portside Growth & Opportunity Fund dated as of July 24, 2003 (the “Securities Pur- chase Agreement”). In pursuing its business strategy, the Company may re- quire additional cash for operating and investing activi- ties. The Company expects future cash requirements, if any, to be funded from operating cash flow and cash flow from financing activities. There are no current plans or discussions in process relating to any material acquisition that is probable in the foreseeable future On June 11, 2003 Jason Enterprises, Inc. acquired the assets of Consumers Choice Systems, Inc., a Delaware Corporation. The Company obtained all the assets of the business that support their retail and international business including the distribution rights in 18,000 retail food and drug stores. Jason Enterprises, Inc. acquired the assets for 76,120 shares of Medifast, Inc. restricted common stock and 50,000 five-year warrants at a purchase price of $10.00 per share. The transac- tion will be accounted for as an asset purchase transac- tion. The Company is expecting to record limited and selected liabilities that amount to approximately $1.35 million. On July 24, 2003 the Company announced an agree- ment with Amazon.com. Through the agreement the Consumer Choice Systems, Women’s Wellbeing branded products will be offered on Amazon.com’s website in the women’s health section. On July 25, 2003, the Company announced that it had sold an aggregate of 550,000 shares of common stock and warrants to purchase 82,500 shares of common stock (the “PIPE Shares”) to Mainfield Enterprises, Inc. and Portside Growth & Opportunity Fund. The shares of common stock were sold for a cash consideration of $12.40 per share, or a total of $6,820,000, and the warrants, exercisable for a period of five years from the date of issuance, at an exercise price equal to one hundred fifteen percent (115%) of the five-day volume weighted average price (the “PIPE Transaction”), all pursuant to the terms of that certain Securities Purchase On September 12, 2003 Medifast, Inc.’s wholly owned subsidiary Seven Crondall, LLC purchased a 119,825 sq. foot distribution facility located at 601 Sunrise Ave., Ridgely, Maryland 21660 from New Roads, Inc. for $2,200,000. The Company financed $1,760,000 through Merrill Lynch Capital at the 30 day LIBOR interest rate plus 220 basis points over seven years. On November 7, 2003 Medifast, Inc.’s wholly owned subsidiary Jason Properties, LLC purchased the assets of Hi-Energy Weight Control Centers, located in Gulf Breeze, Florida. The acquisition includes equipment, inventory, trademarks, and licenses for fifty Hi-En- ergy clinics. The clinics are located primarily in the southeastern region of the United States. The assets were purchased for $1,500,000 in cash, which included selected liabilities, capital expenditures, costs of assets and miscellaneous fees. SEASONALITY The Company’s weight management/diet control is sub- ject to seasonality. Traditionally the holiday season in November/December of each year are considered poor sales for diet control products and services. January and February generally show increases in sales. INFLATION To date, inflation has not had a material effect on the Company’s business. INFORMATION SYSTEMS INFRASTRUCTURE Throughout 2004 the Company significantly enhanced the capacity and the functionality of its IT infrastruc- ture. The enhancements include a more robust email system and upgraded network operating system. The Company also added additional servers, as well as a higher capacity network switch. A Virtual Private Medifast Inc. 2004 Annual Report 9 Trading Policy In March 2003, the Company implemented a Trading Policy whereby if a director, officer or employee has material non-public information relating to the Compa- ny, neither that person nor any related person may buy or sell securities of the Company or engage in any other action to take advantage of, or pass on to others, that information. Additionally, insiders may purchase or sell MED securities if such purchase or sale is made within 30 days after an earnings or special announce- ment to include the 10-KSB, 10-QSB and 8-K in order to insure that investors have available the same informa- tion necessary to make investment decisions as insiders. ITEM 8. FINANCIAL STATEMENTS. See pages F-1 through F-20. ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES. There were no disagreements with the Company’s independent auditors, regarding accounting and financial disclosures for the fiscal year ending December 31, 2004. Network was implemented between the remote office sites. The Company continued its upgrades and service enhancements to its Navision (ERP) system to more effectively and efficiently manage inventory and sales growth. ITEM 7. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) of the Securi- ties Exchange Act of 1934, as amended (the “Exchange Act”). This term refers to the controls and procedures of a company that are designed to ensure that infor- mation required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized, and reported within the required time periods. Our Chief Executive Officer and our President have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this annual report. They have concluded that, as of that date, our disclosure controls and procedures were effective at ensuring that required information will be disclosed on a timely basis in our reports filed under the Exchange Act. (b) Changes in Internal Control over Financial Reporting No change in our internal control over financial report- ing (as defined in Rules 13a-15(f ) and 15d-15(f ) under the Exchange Act) occurred during the period covered by this report that has materially affected, or is reason- ably likely to materially affect, our internal control over financial reporting. Code of Ethics In September 2002, the Company implemented a Code of Ethics by which directors, officers and employees commit and undertake to personal and corporate growth, dedicate themselves to excellence, integrity and responsiveness to the marketplace, and work together to enhance the value of the Company for the shareholders, vendors, and customers. 10 Medifast Inc. 2004 Annual Report [14] SEGMENT INFORMATION In 2004 and 2003, the Company’s international joint venture arrangements for distribution of goods in the Asian market were responsible for the revenue recognition of approximately $488,000 and $2,000,000, respectively. In 2004 and 2003, the Company’s retail distribution through the division of Consumer Choice Systems recognized revenue of $2,134,000 and $979,000 re- spectively. [15] RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement No. 142 “Goodwill and Other Intangible Assets”. This statement addresses financial accounting and reporting for acquired good- will and other intangible assets and supersedes APB Opinion No. 17, “Intangible Assets”. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This State- ment also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The Company, in its acquisitions, recognized $893,850 of goodwill. The Company performs its annual impair- ment test for goodwill at year-end. As of December 31, 2004, the Company has determined that there is no impairment of its goodwill. In addition, the Company has acquired other intangi- ble assets, which include: customer lists, non-compete agreements, trademarks and patents. The non-com- pete agreements are being amortized over the legal life of the agreements ranging between 3 to 7 years. The customer lists are being amortized over a period ranging between 5 to 10 years based on management’s best estimate of the expected benefits to be consumed or otherwise used up. Trademarks and patents are regularly reviewed to determine whether the facts and circumstances exist to indicate that the useful life is shorter than originally estimated or the carry- ing amount of the assets may not be recoverable. The Company assesses the recoverability of its trademarks and patents by comparing the projected discounted net cash flows associated with the related asset, over their remaining lives, in comparison to their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. On July 20, 2000, the Emerging Issues Task Force issued EITF 00-14 “Accounting For Certain Sales In- centives” which establishes accounting and reporting requirements for sales incentives such as discounts, coupons, rebates and free products or services. Gener- ally, reductions in or refunds of a selling price should be classified as a reduction in revenue. For SEC reg- istrants, the implementation date is the beginning of the fourth quarter after the registrant’s fiscal year end December 15, 1999. EITF 00-14 has been consid- ered in the preparation of the consolidated financial statements. In December 1999, the Securities and Exchange Com- mission issued Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements.” SAB 101 provides guidance for revenue recognition under certain circumstances, and is effective during the first quarter of fiscal year 2001. SAB 101 has been considered in the preparation of the consolidated financial statements. In December 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based Compensation- Transition and Disclosure”, an amendment of FASB Statement No. 123”(“SFAS 148”). SFAS 148 amends FASB Statement No. 123, “Accounting for Stock- Based Compensation,” to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock- based employee compensation. It also amends the disclosure provisions of that Statement to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. Finally, this Statement amends Accounting Principles Medifast Inc. 2004 Annual Report F-13 The following table summarizes information about stock options outstanding and exercisable at December 31, 2004 Options Outstanding Options Exercisable Weighted Average Contractual Life Remaining Number Outstanding (in Years) Range of Exercise Prices Weighted Average Exercise Price Weighted Average Exercise Price Number Exercisable $0.25 150,000 $0.32 16,670 $0.50 100,000 $0.65 8,334 $0.80 16,666 $0.86 1,667 $1.23 6,668 $1.26 16,667 $1.60 8,334 $4.80 22,391 $8.26 2,000 $8.60 30,000 $11.15 10,000 1.0 2.5 1.6 3.6 3.3 3.3 3.5 3.5 3.6 4.1 4.2 4.8 4.3 $0.25 150,000 $0.32 16,670 $0.50 100,000 $0.65 8,334 $0.80 16,666 $0.86 1,667 $1.23 6,668 $1.26 16,667 $1.60 - $4.80 15,999 $8.26 1,000 $8.60 9,999 $11.15 6,666 $0.25 $0.32 $0.50 $0.65 $0.80 $0.86 $1.23 $1.26 $1.60 $4.80 $8.26 $8.60 $11.15 389,397 2.2 $1.51 350,336 $1.11 F-12 Medifast Inc. 2004 Annual Report PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. (a) The following are the Board of Directors: Name Age Position Date First Became Director Bradley T. MacDonald ....…...... 57 Chairman of the Board, 1996 Chief Executive Officer and Director Donald F. Reilly ........…….......... 57 Director 1998 Michael C. MacDonald …….... 51 Director 1998 Scott Zion...………..………..... 54 Director 1999 Michael J. McDevitt…………. 56 Director Mary T. Travis……………….... 54 Director Joseph D. Calderone………… 56 Director 2002 2002 2003 BRADLEY T. MACDONALD became Chairman of the Board and Chief Executive Officer of Medifast, Inc. on January 28, 1998. Prior to joining the Com- pany, he was appointed as Program Director of the U.S. Olympic Coin Program of the Atlanta Centen- nial Olympic Games. Mr. MacDonald was previously employed by the Company as its Chief Executive Officer from September 1996 to August 1997. From 1991 through 1994, Colonel MacDonald returned to active duty to be Deputy Director and Chief Fi- nancial Officer of the Retail, Food, Hospitality and Recreation Businesses for the United States Marine Corps. Prior thereto, Mr. MacDonald served as Chief Operating Officer of the Bonneau Sunglass Company, President of Pennsylvania Optical Co., Chairman and CEO of MacDonald and Associates, which had major financial interests in a retail drug, consumer candy, and pilot sunglass companies. Mr. MacDonald was national president of the Marine Corps Reserve Of- ficers Association and retired from the United States Marine Corps Reserve as a Colonel in 1997, after 27 years of service. He has been appointed to the De- fense Advisory Board for Employer Support of the Guard and Reserve (ESGR). Mr. MacDonald serves on the Board of Directors of the Wireless Accessories Group (OTCBB: WIRX). He is also on the Board of Directors of the Marine Corps Reserve Toys for Tots Foundation and is a Foundation Trustee of the Marine Reserve Association. REVEREND DONALD FRANCIS REILLY, O.S.A., a Director, holds a Doctorate in Ministry (Counseling) from New York Theological and an M.A. from Washington Theological Union as well as a B.A. from Villanova University. Reverend Don Reilly was ordained a priest in 1974. His assignments included Associate Pastor, pastor at St. Denis, Haver- town, Pennsylvania, Professor at Villanova University, Personnel Director of the Augustinian Province of St. Thomas of Villanova, Provincial Counselor, Founder Medifast Inc. 2004 Annual Report 11 FBI. He had attained Senior Executive status within the FBI’s Investigative Technology Branch and is cur- rently employed within the private sector as a physical security specialist. MARY T. TRAVIS, a Director, is currently em- ployed with Sunset Mortgage Company, L.P. in Penn- sylvania as the Senior Vice President of wholesale operations and was formerly the Vice President of operations for the Financial Mortgage Corporation. Mrs. Travis is an expert in mortgage banking with over 36 years of diversified experience. She is an approved instructor of the Mortgage Bankers Association Ac- credited School of Mortgage Banking. Mrs. Travis was also formally a delegate and 2nd Vice president of the Mortgage Bankers Association of Greater Phila- delphia and the Board of Governors of the State of Pennsylvania. She is the key financial executive on the Company’s Audit Committee providing oversight of the Company’s external auditors. REVEREND JOSEPH D. CALDERONE, O.S.A., a Director, is the Associate Director of Campus Min- istry at Villanova University. He formerly spent over eight years with the Loyola University Medical Center as the hospital Chaplain and taught multiple courses including Introduction to the Practice of Medicine and Business Ethics. Rev. Calderone is currently a Cap- tain in the US Navy Reserves and serves as the Wing Chaplain for the 4th Marine Aircraft Wing. of SILOAM Ministries where he ministers and coun- sels HIV/AIDS patients and caregivers. He is currently on the Board of Directors of Villanova University, is President of the board of “Bird Nest” in Philadelphia, Pennsylvania and is Board Member of Prayer Power. Fr. Reilly was recently elected Provincial of the Au- gustinian Order at Villanova, PA. He oversees more than 300 Augustinian Friars and their service to the Church, teaching at universities and high schools, min- istering to parishes, serving as chaplain in the Armed Forces and hospitals, ministering to AIDS victims, and serving missions in Japan and South America. MICHAEL C. MACDONALD, a Director, is a corporate officer and President of Global Accounts and Marketing Operations, for the Xerox Corporation. Mr. MacDonald’s former positions at Xerox Corporation include executive positions in the sales and market- ing areas. He is currently on the Board of Trustees of Rutgers University and a Director of the Jimmy V Foundation. Mr. MacDonald is the brother of Bradley T. MacDonald, the CEO of the Company. SCOTT ZION, is a Director and also Assistant Secretary for Medifast, Inc. He received a Bachelor of Arts Degree from Denison University, Granville, Ohio. Mr. Zion is currently a principal in Resources Development, Inc. a health care consulting company in Napa, California. Prior to forming Resources Development, he was Senior Vice President of Sales and Marketing for Santen, Inc. an ophthalmic phar- maceutical company. Before Santen, he was Senior Vice President and General Manager for Akorn, Inc., an ophthalmic manufacturing and distribution com- pany. Pilkington Barnes Hind, a worldwide contact lens company, as Head of North American Sales and Marketing, also employed him. Prior to that, he spent 20 years with the Mead Johnson Nutritional Division of Bristol Myers Squibb in various positions of in- creasing responsibility in sales management. He has extensive experience in nutritional products particu- larly in the areas of sales and marketing. MICHAEL J. MCDEVITT, a Director, is a retired FBI Special Agent with over 29 years of government service with the United States Marine Corps and the 12 Medifast Inc. 2004 Annual Report The following summarizes the stock option activity for the years ended December 31: 2004 2003 Outstanding at beginning of year Options granted Options reinstated Options exercised Options forfeited or expired 0 0.00 (47,221) (32,837) Weighted Average Exercise Price Shares 439,455 30,000 $1.76 8.60 Weighted Average Exercise Price Shares 891,669 163,500 $0.69 5.32 0 0.00 (1.19) (615,714) (7.01) (1.16) (0) 0.00 Outstanding at end of year 389,397 $1.51 439,455 $1.76 Options exercisable at year end 350,336 $1.11 302,668 $0.76 Options available for grant at end of year 860,603 810,545 Medifast Inc. 2004 Annual Report F-11 shares and 250,000 shares respectively. The Company has elected to continue to account for stock option grants in accordance with APB 25 and related interpretations. Under APB 25, where the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation is recognized. If compensation expense for the Company’s stock-based compensation plans had been determined consistent with SFAS 123, the Company’s net income and net income per share including pro forma results would have been the amounts indicated below: Year Ended December 31 2004 Net income: 2003 As reported Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects Pro forma Net income per share: $1,747,000 $2,410,000 (108,000) $1,639,000 (403,000) $2,007,000 as reported: Basic Diluted Pro forma: Basic Diluted $ 0.06 $ 0.14 $ 0.15 $ 0.13 $ 0.25 $ 0.22 $ 0.21 $ 0.18 The pro forma effect on net income may not be representative of the pro forma effect on net income of future years due to, among other things: (i) the vesting period of the stock options and the (ii) fair value of additional stock options in future years. For the purpose of the above table, the fair value of each option grant is estimated as of the date of grant using the Black-Scholes option-pricing model with the following assumptions: 2004 2003 Dividend yield ........................ Expected volatility .................. Risk-free interest rate ............. 4.50% Expected life in years ............. 0.0% 0.40 1-5 0.0% 0.40 3.00%-5.00% 1-5 The weighted average fair value at date of grant for options granted during the years 2004 and 2003 were $8.60 and $5.32, respectively, using the above assumptions. F-10 Medifast Inc. 2004 Annual Report ITEM 11. EXECUTIVE COMPENSATION. The following table sets forth information as to the compensation of the Chief Executive Officer of the Compa- ny and each other executive officer that received compensation in excess of $100,000 for 2004, 2003, and 2002. Annual Compensation Salary ($) Bonus ($) Name Bradley T. MacDonald Chairman of the Board & CEO Year 2004 2003 2002 225,000 225,000 145,000 0 112,000 75,000 Value of Common/ Preferred Stock Issued in Lieu of Cash 0 0 0 Option Awards Other Annual Compensation 0 0 100,000(1) 0 0 0 (1) The Board of Directors reinstated 100,000 options at $1.50 per share granted in 1997 and not exercised. Mr. MacDonald exercised those options in December 2002 per the Board’s direction. Annual Compensation Name Leo V. Williams, III Executive Vice President Year 2004 Salary ($) 118,000 Bonus ($) 0 Value of Common/ Preferred Stock Issued in Lieu of Cash 0 Option Awards 10,000 Other Annual Compensation 0 Medifast Inc. 2004 Annual Report 13 STOCK OPTIONS The Company’s 1993 Employee Stock Option Plan (the “Plan”), as amended in July 1995, December 1997, June 2002, and again in July 2003 authorizes the issuance of options for 1,250,000 shares of Common Stock. The Plan authorizes the Board of Directors or the Compensation Committee appointed by the Board to grant incentive stock options and non-incentive stock options to officers, key employees, directors, and independent consultants, with directors who are not employees and consultants eligible only to receive non-incentive stock options. Employee stock options are vested over 2 years. * The following tables set forth pertinent information as of December 31, 2004 with respect to options granted under the Plan since its inception to the persons set forth under the Summary Compensation Table, all current executive officers as a group and all current Directors who are not executive officers as a group of the Company. In addition, a chart listing option holders, grants made in FY 2004, and a list of aggregated options and the value of these options, is provided. BRADLEY T. MACDONALD (1) ALL CURRENT EXECUTIVE OFFICERS AS A GROUP ALL CURRENT INDEPENDENT DIRECTORS AS A GROUP Options granted………………………………………… 215,000 75,000 110,000 Average exercise price………………………………… $ 0.86 $ 1.98 $ 1.07 Options exercised……………………………………… 215,000 49,999 100,000 Average exercise price………………………………… $$ 0.86 $ 0.88 $ 0.70 Shares sold……………………………………………… Options unexercised as of 12/31/04…………………… * 0 * 11,667 * 10,000 FY 04 Grants @ Price & Expiration Month/Year Approximate 5 YR Potential Realizable Value at 10% Annual- Stock Appreciation Unexercised Options as of 12/31/04 Value of Unexercised Options as of 12/31/04 Current Executive Officers and Directors 10,000@$8.60 2009 $13.86 10,000 Employees 20,000@$8.60 2009 $13.86 20,000 Consultants 0 0 30,000 $0 0 0 $0 14 Medifast Inc. 2004 Annual Report (30 days). Because the period of payment generally approximates the period revenue was originally recog- nized, refunds are recorded as a reduction of revenue when paid. The Company’s estimate for returns is based upon its historical experience with actual re- turns. While such experience has allowed for reason- able estimation in the past, history may not always be an accurate indicator of future returns. The Company continually monitors its estimates for returns and makes adjustments when it believes that actual product returns may differ from the established accruals. [10] ESTIMATES: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the report- ed amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the finan- cial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. [11] FAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying amounts reported in the consolidated bal- ance sheets for cash, certificates of deposit, accounts receivable, accounts payable and accrued liabilities approximate fair value because of the immediate or short-term maturity of the financial instruments. The Company believes that its indebtedness ap- proximates fair value based on current yields for debt instruments with similar terms. [12] CONCENTRATION OF CREDIT RISK: ties at December 31, 2004 and 2003, include amounts deposited with multiple financial institutions that exceed the federal insurance coverage by $3,525,000 and $3,862,000, respectively. The Company markets its products primarily to medical professionals, clin- ics, and Internet medical sales and has no substantial concentrations of credit risk in its trade receivables. As of December 31, 2004 and 2003, the Company had two customers that individually represented over 10% of the accounts receivable and in the aggregate, ap- proximately 49% and 26% of the accounts receivable, respectively. [13] STOCK-BASED COMPENSATION: The Company has adopted Statement of Financial Ac- counting Standards No. 123, “Accounting for Stock- Based Compensation” (“SFAS 123”). The provisions of SFAS 123 allow companies to either expense the estimated fair value of stock options or to continue to follow the intrinsic value method set forth in Account- ing Principles Bulletin Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) but dis- close the pro forma effects on net income had the fair value of the options been expensed. The Company has elected to continue to apply APB 25 in accounting for its employee stock option incentive plans. MEDIFAST, INC. AND SUBSIDIARIES STOCK OPTION PLAN On October 9, 1993 and as amended in May 1995, the Company adopted a stock option plan (“Plan”) autho- rizing the grant of incentive and nonincentive options for an aggregate of 500,000 shares of the Company’s common stock to officers, employees, directors and consultants. Incentive options are to be granted at fair market value. Options are to be exercisable as deter- mined by the stock option committee. Financial instruments that potentially subject the Company to credit risk consist of cash, certificates of deposit, investment securities and trade receivables. Cash, certificates of deposit and investment securi- In November 1997, June 2002 and July 2003, the Company amended the Plan by increasing the number of shares of the Company’s common stock subject to the Plan by an aggregate of 200,000 shares, 300,000 Medifast Inc. 2004 Annual Report F-9 [4] INVENTORY: Inventory is stated at the lower of cost or market, uti- lizing the first-in, first-out method. The cost of finished goods includes the cost of raw materials, packaging supplies, direct and indirect labor and other indirect manufacturing costs. [5] ADVERTISING: Advertising costs such as preparation, layout, design and production of advertising are deferred. They are expensed when the advertisement is first used, except for the costs of executory contracts, which are amor- tized as performance under the contract is received. Advertising costs deferred at December 31, 2004 and 2003, were $478,000 and $295,000 respectively. Advertising expense for the years ended Decem- ber 31, 2004 and 2003 amounted to $1,055,000 and $2,233,000, respectively. [6] PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are stated at cost less accumulated depreciation and amortization. The Com- pany computes depreciation and amortization using the straight-line method over the estimated useful lives of the assets acquired as follows: Building and building improvements Equipment and fixtures Vehicles 3 - 15 years 5 years 39 years The carrying amount of all long-lived assets is evaluat- ed periodically to determine whether adjustment to the useful life or to the unamortized balance is warranted. Such evaluation is based principally on the expected utilization of the long-lived assets and the projected undiscounted cash flows of the operations in which the long-lived assets are used. [7] INCOME TAXES: The Company accounts for income taxes in accordance with Statements of Financial Accounting Standards F-8 Medifast Inc. 2004 Annual Report No. 109, “Accounting for Income Taxes,” which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income taxes and liabilities are computed annually for differences between the financial statement and the tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect tax- able income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. [8] EARNINGS PER COMMON SHARE: Basic earnings per share is calculated by dividing net profit attributable to common stockholders by the weighted average number of outstanding com- mon shares during the year. Basic earnings per share exclude any dilutive effects of options, warrants and other stock-based compensation, which are included in diluted earnings per share. [9] REVENUE: Revenue is recognized for product sales upon shipment and passing of risk to the customer and when estimates of discounts, rebates, promotional adjustments, price adjustments, returns, and other potential adjustments are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations. These estimates are presented in the financial statements as reductions to net revenues and accounts receiv- able. Estimated sales returns, allowances and discounts are provided for. Outbound shipping charges to customers and out- bound shipping-related costs are netted and included in “cost of sales.” Returns – Consistent with industry practice, the Company maintains a return policy that allows its customers to return product within a specified period Nutraceutical Group Industry Comparison of Stock Prices Company Medifast (MED) Natural Alternatives International, Inc. (NAII) Weider Nutrition (WNI) Pure World, Inc (PURW) Natures Sunshine Products, Inc. (NATR) Company Medifast (MED) Natural Alternatives International, Inc. (NAII) Weider Nutrition (WNI) Pure World, Inc (PURW) Natures Sunshine Products, Inc. (NATR) December 31, 2004 Stock Price December 31, 2003 Stock Price $3.52 9.23 4.35 1.56 20.36 $14.10 6.40 4.45 2.51 8.31 December 31, 2004 Stock Price December 31, 1999 Stock Price $3.52 9.23 4.35 1.56 20.36 $0.22 3.25 3.22 3.13 7.42 $ Change 10.58 2.83 (0.10) (0.95) 12.05 $ Change 3.30 5.98 1.13 (1.57) 12.94 % Change (75.0)% 44.22% (2.3)% (37.9)% 145.0% % Change 1500.0 % 184.0 % 35.1 % (50.2) % 174.4 % Index Comparison $100 invested in 1999 would return: Nutraceutical Group Index Medifast (MED) 1999 $100 $100 2004 $469 $1600 Factual material is obtained from sources believed to be reliable, but the publisher is not responsible for any errors or omissions contained herein. COMPENSATION OF DIRECTORS The Company is authorized to pay a fee of $300 for each meeting attended by its Directors who are not executive officers. It reimburses those who are not employees of the Company for their expenses incurred in attending meetings. Independent Directors claimed $17,500 in Director’s fees and/or expenses in 2004. See “Executive Compensation – Stock Options” for stock options granted under the 1993 Plan to the Directors. Medifast Inc. 2004 Annual Report 15 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth information with respect to the beneficial ownership of shares of Common Stock or voting Preferred Stock as of December 31, 2004 of the Chief Executive Officer, each Director, each nomi- nee for Director, each current executive officer named in the Summary Compensation Table under “Executive Compensation” and all executive officers and Directors as a group. The number of shares beneficially owned is determined under the rules of the Securities and Exchange Commission and the information is not necessar- ily indicative of beneficial ownership for any other person. Under such rules, “beneficial ownership” includes shares as to which the undersigned has sole or shared voting power or investment power and shares, which the undersigned has the right to acquire within 60 days of March 15, 2005 through the exercise of any stock option or other right. Unless otherwise indicated, the named person has sole investment and voting power with respect to the shares set forth in the table. NUMBER % OF NAME AND ADDRESS* OF SHARES OUTSTANDING 1,270,373 (1) Bradley T. MacDonald……….………………………………….... 65,452 Donald F. Reilly…………………………………………………... 39,354 Michael C. MacDonald………………………………………….. 192,000 Scott Zion………………………………………………………… Mary Travis……………………………………………………….. 5,340 Michael J. McDevitt…………………………………………….. .. 13,900 11.6% 0.6% 0.4% 1.8% 0.05% 0.1% Executive Officers and Directors as a group (8 persons) ……………………………………………………. 1,666,005 15.1% *The address is c/o Medifast, Inc., 11445 Cronhill Drive, Owings Mills, Maryland 21117 (1) Mr. MacDonald beneficially owns 1,090,373 shares of common stock and 90,000 shares of voting Series “C” Preferred Convertible Stock. Mrs. Shirley D. MacDonald and Ms. Margaret E. MacDonald, wife and daughter of Mr. MacDonald, individually or jointly own 442,625 shares of stock. 16 Medifast Inc. 2004 Annual Report MEDIFAST, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2004 AND 2003 NOTE A – BUSINESS Medifast, Inc. (the “Company”, or “Medifast”) is a Delaware corporation, incorporated in 1980. The Company’s operations are primarily conducted through five of its wholly owned subsidiaries, Jason Pharmaceuticals, Inc. (“Jason”), Take Shape for Life, Inc. (“TSFL”), Jason Enterprises, Inc., Jason Proper- ties, LLC and Seven Crondall, LLC. The Company is engaged in the production, distribution, and sale of weight management and disease management prod- ucts and other consumable health and diet products. Medifast, Inc.’s product lines include weight and disease management, meal replacement and sports nutrition products manufactured in a modern, FDA ap- proved facility in Owings Mills, Maryland. The Company is engaged in the manufacturing and distribution of Medifast‚ and Hi-Energy‚ branded and private label weight and disease management products. These products are sold through various channels of distribution, to include medical professionals, weight loss clinics, direct consumer marketing supported via the phone and the web, supported by licensed, quali- fied medical practitioners including qualified health advisors. The processing, formulation, packaging, labeling and advertising of the Company’s products are subject to regulation by one or more federal agen- cies, including the Food and Drug Administration, the Federal Trade Commission, the Consumer Product Safety Commission, the United States Department of Agriculture, and the United States Environmental Protection Agency. NOTE B - SIGNIFICANT ACCOUNTING POLICIES Significant accounting policies followed in the prepa- ration of the consolidated financial statements are as follows: [1] PRINCIPLES OF CONSOLIDATION AND BA- SIS OF PRESENTATION: The consolidated financial statements include the accounts of the Company and its wholly owned sub- sidiaries, Jason Pharmaceuticals, Inc., Take Shape For Life, Inc., Seven Crondall Associates, LLC, Jason Properties, LLC and Jason Enterprises, Inc. All inter- company accounts have been eliminated. [2] CASH AND CASH EQUIVALENTS: For the purposes of the consolidated statements of cash flow, the Company considers all highly liquid debt instruments purchased with maturity of three months or less to be cash equivalents. At December 31, 2004, the Company had invested in four $100,000 certificates of deposit, of which three are considered cash equivalents. At December 31, 2003, the Company had invested in four $100,000 certificates of deposit, which are con- sidered cash equivalents. The Company also invested $465,000 in miscellaneous investments through Mer- rill Lynch. These investments are considered cash equivalents due to terms of maturity. [3] ACCOUNTS RECEIVABLE: Accounts receivable are recorded net of reserves for sales returns and allowances, and net of provisions for doubtful accounts. Allowances for sales returns and discounts are based on an analysis of historical trends, and allowances for doubtful accounts are based primarily on an analysis of aging accounts receivable balances and on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history. Medifast Inc. 2004 Annual Report F-7 MEDIFAST, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW Cash flows from Operating Activities: Net income Adjustments to reconcile net income to net cash provided by operating activities from operations: Depreciation and amortization Realized (gain) loss on investment securities Common stock issued for services Net change in other comprehensive (loss) Deferred income taxes Changes in Assets and Liabilities: (Increase) in accounts receivable (Increase) in inventory (Increase) in prepaid expenses and other current assets (Increase) in deferred compensation (Increase) Decrease in other assets (Decrease) increase in accounts payable and accrued expenses Increase in income taxes payable Net cash provided by operating activities Cash Flow from Investing Activities: Maturities (purchase) of certificates of deposit Sale (purchase) of investment securities, net Purchase of building Purchase of property and equipment Purchase of intangible assets Net cash (used in) investing activities Cash Flow from Financing Activities: Issuance of common stock, options and warrants (Decrease) increase in line of credit, net Proceeds from long-term debt Principal repayments of long-term debt Dividends paid on preferred stock Net cash provided by (used in) financing activities NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS Cash and cash equivalents - beginning of the year Cash and cash equivalents - end of year Supplemental disclosure of cash flow information: Interest paid Income taxes Supplemental disclosure of non cash activity: Conversion of preferred stock B and C to common stock Common stock for services Common stock for intangibles and fixed assets Conversion of debt to equity Preferred Stock Dividends The accompanying notes are an integral part of these consolidated financial statements. Years Ended December 31, 2004 2003 $1,747,000 $2,410,000 1,310,000 19,000 93,000 (14,000) 486,000 (422,000) (1,263,000) (143,000) (100,000) (25,000) (460,000) 674,000 1,902,000 (112,000) 1,450,000 (566,000) (1,490,000) (2,792,000) (3,510,000) 7,000 314,000 475,000 (1,089,000) (11,000) (304,000) (1,912,000) 2,524,000 $612,000 $245,000 $- $170,000 $93,000 $- $307,000 $7,000 677,000 (1,000) 207,000 - 1,138,000 (357,000) (1,729,000) (687,000) (350,000) 44,000 525,000 - 1,877,000 418,000 (3,982,000) (1,823,000) (1,309,000) (2,458,000) (9,154,000) 6,722,000 (36,000) 2,669,000 (346,000) (45,000) 8,964,000 1,687,000 837,000 $2,524,000 $154,000 $- $835,000 $207,000 $1,949,000 $- $18,000 F-6 Medifast Inc. 2004 Annual Report PART IV ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 3.1 Certificate of Incorporation of the Company and amendments thereto* 3.2 By-Laws of the Company* 10.1 1993 Stock Option Plan of the Company as amended* 10.3 Lease relating to the Company’s Owings Mills, Maryland facility** 10.4 Employment agreement with Bradley T. MacDonald*** ________ * Filed as an exhibit to and incorporated by reference to the Registration Statement on Form SB-2 of the Company, File No. 33-71284-NY. ** Filed as an exhibit to and incorporated by reference to the Registration Statement on Form S-4 of the Company, File No. 33-81524. ***Filed as an exhibit to 10KSB, dated April 15, 1999 of the Company, file No. 000-23016. (b) Reports on Form 8-K March 23, 2004, to report the official 2004 financial guidance July 2, 2004, to report the Company had decreased 2004 guidance September 10, 2004 to report the Annual Meeting of Shareholders September 3, 2004 ITEM 14. ACCOUNTING FEES In 2004, the Company incurred $70,000 in accounting fees as compared to $60,000 in 2003. These fees include work performed on quarterly audits and the preparation of the Company’s 10-QSB’s and 10-KSB. Medifast Inc. 2004 Annual Report 17 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. MEDIFAST, INC. (Registrant) BRADLEY T. MACDONALD - --------------------------------------- Bradley T. MacDonald Chairman, CEO & CFO Dated: May 27, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the Registrant and in the capacities and on the dates indicated have signed this Report below. Name Title Date BRADLEY T. MACDONALD ------------------------------------------- Bradley T. MacDonald Chairman of the Board, May 27, 2005 Director, Chief Executive Officer and Chief Financial Officer SCOTT ZION ------------------------------------------ Scott Zion /s/ MICHAEL C. MACDONALD ------------------------------------------ Michael C. MacDonald /s/ MARY T. TRAVIS ------------------------------------------ Mary T. Travis /s/ REV. DONALD F. REILLY, OSA ------------------------------------------ Rev. Donald F. Reilly, OSA /s/ MICHAEL J. MCDEVITT ------------------------------------------ Michael J. McDevitt /s/ JOSEPH D. CALDERONE ------------------------------------------ Joseph D. Calderone Director May 27, 2005 Director May 27, 2005 Director May 27, 2005 Director May 27, 2005 Director May 27, 2005 Director May 27, 2005 18 Medifast Inc. 2004 Annual Report K C O T S N I S E G N A H C F O T N E M E T A T S D E T A D I L O S N O C S E R A D S B U S D N A I I I . C N I , T S A F D E M I 3 0 0 2 D N A 4 0 0 2 D E D N E S R A E Y E H T R O F S S O L E V S N E H E R P M O C D N A Y T U Q E I I ’ S R E D L O H y r u s a e r T k c o t S l a t o T s s o L t i c fi e D e v i s n e h e r p m o C d e t a l u m u c c A d e t a l u m u c c A l a n o i t i d d A n I - d i a P l a t i p a C e u l a V r a P 0 0 . 0 $ t n u o m A r e b m u N s e r a h S f o d e t a t S e u l a V t n u o m A r e b m u N s e r a h S f o d e t a t S e u l a V t n u o m A r e b m u N s e r a h S f o ) 0 0 0 , 7 6 1 $ ( 0 0 0 , 5 4 7 , 5 $ - $ ) 0 0 0 , 1 8 3 , 5 $ ( 0 0 0 , 3 1 6 , 9 $ 0 0 0 , 7 $ 3 9 6 , 4 0 2 , 7 0 0 0 , 5 8 9 $ 0 0 0 , 5 8 9 0 0 0 , 1 2 5 $ 0 9 2 , 1 2 5 2 0 0 2 , 1 3 r e b m e c e D , e c n a l a B 0 0 0 , 3 3 8 0 0 0 , 2 8 0 1 , 1 7 6 , 1 0 0 0 , 8 1 7 - 0 0 0 , 8 1 7 - 0 0 0 , 7 1 1 - 6 5 5 , 7 1 1 - k c o t S n o m m o C o t d e t r e v n o c d e r r e f e r P k c o t S n o m m o C k c o t S d e r r e f e r P k c o t S d e r r e f e r P C s e i r e S B s e i r e S 0 0 0 , 5 8 3 , 2 0 0 0 , 5 2 - 0 0 0 , 0 1 4 , 2 0 0 0 , 6 1 5 - 0 0 0 , 0 9 5 0 0 0 , 0 5 3 0 0 0 , 7 1 7 , 8 0 0 0 , 8 1 0 0 0 , 5 4 - 0 0 0 , 5 4 - 0 0 0 , 0 9 5 0 0 0 , 0 5 3 4 1 7 , 5 1 6 4 2 7 , 8 8 2 0 0 0 , 6 1 7 , 8 0 0 0 , 1 0 7 9 , 5 6 6 0 0 0 , 8 1 0 0 4 , 6 3 n o m m o C o t d e t r e v n o C s t n a r r a W n o m m o C o t d e s i c r e x e s n o i t p O k c o t S k c o t S - c e r i D o t d e u s s i k c o t S n o m m o C - i s i u q c a d n a s t n a t l u s n o c , s r o t s n o i t s e i r e S r o f d e u s s i k c o t S n o m m o C d n e d i v i d ” C “ k c o t s n i d i a p d n e d i v i D e m o c n I t e N 0 0 0 , 3 8 6 - 0 0 0 , 0 6 7 , 7 1 0 0 0 , 5 2 - 0 0 0 , 6 1 0 , 3 - 0 0 0 , 0 2 1 , 0 2 0 0 0 , 0 1 9 0 6 , 2 8 4 , 0 1 0 0 0 , 7 6 2 0 0 0 , 7 6 2 0 0 0 , 4 0 4 4 3 7 , 3 0 4 3 0 0 2 , 1 3 r e b m e c e D , e c n a l a B 0 0 0 , 0 7 1 0 4 2 , 0 4 3 0 0 0 , 7 6 - 0 0 0 , 7 6 - 0 0 0 , 3 0 1 - 0 2 1 , 3 0 1 - k c o t S n o m m o C o t d e t r e v n o c d e r r e f e r P 0 0 0 , 1 3 - 0 0 0 , 5 3 0 0 0 , 3 2 1 - 0 0 0 , 5 2 1 0 0 0 , 8 2 0 0 0 , 6 6 1 0 0 0 , 4 1 1 0 0 0 , 5 3 1 0 0 0 , 3 9 0 0 0 , 5 3 1 0 0 0 , 5 3 1 - 0 0 0 , 1 1 - 0 0 0 , 7 - 0 0 0 , 1 1 - 0 0 0 , 3 3 7 , 1 0 0 0 , 4 1 - 0 0 0 , 7 4 7 , 1 0 0 0 , 4 3 0 0 0 , 1 1 2 2 , 7 4 0 0 0 , 5 2 1 0 0 0 , 8 2 0 0 0 , 4 1 1 0 0 0 , 3 9 0 0 0 , 5 3 1 - 0 0 0 , 7 0 0 7 , 6 4 0 0 4 , 5 5 0 0 5 , 5 1 0 0 4 , 3 1 n o m m o C o t d e t r e v n o C s t n a r r a W n o m m o C o t d e s i c r e x e s n o i t p O k c o t S k c o t S t u o y t i u q e o t t b e d f o n o i s r e v n o C y t i u q e o t t b e d f o n o i s r e v n o C y r u s a e r T f o - n o C o t d e u s s i k c o t s n o m m o C s t n a t l u s s e i r e S r o f d e u s s i k c o t S n o m m o C d n e d i v i d ” C “ y r u s a e r T f o t u o d e u s s i s e r a h S k c o t s n i d i a p d n e d i v i D e m o c n I t e N ) 0 0 0 , 6 3 5 $ ( 0 0 0 , 2 4 7 , 9 1 $ ) 0 0 0 , 9 3 $ ( ) 0 0 0 , 7 8 2 , 1 $ ( 0 0 0 , 6 5 5 , 0 2 $ 0 0 0 , 1 1 $ 0 7 0 , 1 0 0 , 1 1 0 0 0 , 0 0 2 $ 0 0 0 , 0 0 2 0 0 0 , 1 0 3 $ 4 1 6 , 0 0 3 4 0 0 2 , 1 3 r e b m e c e D , e c n a l a B s t n e m e t a t s l a i c n a n fi d e t a d i l o s n o c e s e h t f o t r a p l a r g e t n i n a e r a s e t o n g n i y n a p m o c c a e Th Medifast Inc. 2004 Annual Report F-5 MEDIFAST, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Revenue Cost of sales Gross profit YEARS ENDED DECEMBER 31, 2004 2003 $27,340,000 (6,746,000) 20,594,000 $25,379,000 (6,825,000) 18,554,000 Selling, general, and administration (17,590,000) (14,956,000) Income from operations Other income (expense): Interest expense Interest income Other expense 3,004,000 3,598,000 (245,000) 154,000 (7,000) (98,000) (150,000) 110,000 - (40,000) Net income before provision for income taxes Provision for income taxes 2,906,000 (1,159,000) 3,558,000 (1,148,000) Net income 1,747,000 2,410,000 Less: Preferred stock dividend requirement (18,000) (58,000) Net income attributable to common shareholders $1,729,000 $2,352,000 Basic earnings per share Diluted earnings per share Weighted average shares outstanding - Basic Diluted $0.16 $0.14 $0.25 $0.22 10,832,360 12,413,424 9,305,731 10,952,367 The accompanying notes are an integral part of these consolidated financial statements F-4 Medifast Inc. 2004 Annual Report Index to Exhibits Exhibit Number Description of Exhibit 31.1 Certification of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursu- ant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sar- banes-Oxley Act of 2002 Medifast Inc. 2004 Annual Report 19 Exhibit 31.1 CEO Certification CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a) I, Bradley T. MacDonald, certify that: 1. I have reviewed this report on Form 10-KSB of Medifast, Inc.; Based on my knowledge, this report does not contain any untrue statement of a material fact or omit 2. 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the regis- trant as of, and for, the periods presented in this report; I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Ex- 4. change Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and proce- dures to be designed under our supervision, to ensure that material information relating to the registrant, includ- ing its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this 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 the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. I have disclosed, based on my most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control 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: May 27, 2005 /s/ Bradley T. MacDonald Bradley T. MacDonald Chairman Of the Board and Chief Executive Officer 20 Medifast Inc. 2004 Annual Report MEDIFAST, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 2004 December 31, 2003 ASSETS Current assets: Cash Accounts receivable-net of allowance for doubtful accounts of $87,000 and $55,000 Inventory Investment securities Deferred compensation Prepaid expenses and other current assets Current portion of deferred tax asset Total Current Assets Property, plant and equipment - net Trademarks and intangibles - net Deferred tax asset, net of current portion Other assets TOTAL ASSETS LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable and accrued expenses Income taxes payable Dividends payable Line of credit Current maturities of long-term debt Total current liabilities Long-term debt, net of current portion Total Liabilities Stockholders’ Equity: Series B Convertible Preferred Stock; par value $1.00; 600,000 shares authorized; 300,614 and 403,734 shares issued and outstanding Series C Convertible Preferred Stock; stated value $1.00; $612,000 1,063,000 4,251,000 2,626,000 321,000 1,079,000 19,000 $2,524,000 641,000 2,988,000 3,983,000 321,000 936,000 596,000 9,971,000 11,989,000 8,698,000 7,138,000 91,000 70,000 7,449,000 4,749,000 - 45,000 $25,968,000 $24,232,000 $940,000 $1,714,000 674,000 65,000 369,000 458,000 2,506,000 4,256,000 6,762,000 - 58,000 55,000 764,000 2,591,000 4,564,000 7,155,000 301,000 404,000 1,015,000 shares authorized; 200,000 and 267,000 shares issued and outstanding 200,000 267,000 Common stock; par value $.001 per share; 15,000,000 shares authorized; 11,001,070 and 10,482,609 shares issued and outstanding Additional paid-in capital Accumulated comprehensive loss Accumulated deficit Less: cost of 78,160 and 83,863 shares of common stock in treasury Total Stockholders’ Equity 11,000 10,000 20,556,000 20,120,000 (39,000) (1,287,000) 19,742,000 (536,000) (25,000) (3,016,000) 17,760,000 (683,000) 19,206,000 17,077,000 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $25,968,000 $24,232,000 The accompanying notes are an integral part of these consolidated financial statements Medifast Inc. 2004 Annual Report F-3 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders Medifast, Inc. Owings Mills, Maryland We have audited the consolidated balance sheets of Medifast, Inc. and its subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders’ equity and comprehen- sive loss and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial state- ments based on our audits. We conducted our audits in accordance with standards established by the Public Company Accounting Over- sight Board (United States). Those standards require that we plan and perform the audits 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 finan- cial 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Medifast, Inc. and subsidiaries as of December 31, 2004 and 2003, and the consolidated results of their operations and their consolidated cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Bagell, Josephs & Company, LLC Gibbsboro, New Jersey March 4, 2005 F-2 Medifast Inc. 2004 Annual Report Exhibit 31.2 CFO Certification CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a) I, Bradley T. MacDonald, certify that: 1. I have reviewed this report on Form 10-KSB of Medifast, Inc.; Based on my knowledge, this report does not contain any untrue statement of a material fact or omit 2. 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the regis- trant as of, and for, the periods presented in this report; I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Ex- 4. change Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and proce- dures to be designed under our supervision, to ensure that material information relating to the registrant, includ- ing its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this 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 the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. I have disclosed, based on my most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control 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: May 27, 2005 /s/ Bradley T. MacDonald Bradley T. MacDonald Chairman Of the Board and Chief Financial Officer Medifast Inc. 2004 Annual Report 21 CFO Certification CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Medifast, Inc. (the “Company”) on Form 10-KSB for the year ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I Bradley T. MacDonald, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and (2) The information contained in the report fairly presents, in all material respects, the financial condition and results of the operations of the Company. By: /s/ Bradley T. MacDonald Bradley T. MacDonald Chief Executive Officer Chief Financial Officer May 27, 2005 22 Medifast Inc. 2004 Annual Report MEDIFAST, INC. AND ITS SUBSIDIARIES CONTENTS CONSOLIDATED FINANCIAL STATEMENTS PAGE Report of Independent Registered Public Accounting Firm ….......... Balance sheets as of December 31, 2004 and 2003………................ Statements of income for the years ended December 31, 2004 and 2003 ..................................……...…........... Statement of changes in stockholders’ equity and comprehensive loss for the years ended December 31, 2004 and 2003 ....…………………………..…........... Statements of cash flow for the years ended December 31, 2004 and 2003 ...................................……..…............ Notes to consolidated financial statements .....................………....... F-2 F-3 F-5 F-4 F-6 F-7

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