Medartis
Annual Report 2005

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A n n u a l R e p o r 2005 t m edi fast 2005 a nnua l rep or t 1 focus on SHAREH OLD ERS Bradley T. MacDonald Chairman, CEO Michael S. McDevitt President, CFO To our valued shareholders, 20 05 was another ex traord inar y ye ar for M e d i fas t, I nc wi t h reven ues up 47 % from the pr ior year. O u r ag gress ive m ar keting s trate g y i s expanding the mes sage of the M e d i fa s t brand a cros s Ame r i ca and ou r firs t-rate c lient su pp or t p rogram s a re bui l di ng a s ati s fi e d and d evoted custome r base. We are grow ing our comp any on s oli d core val ues an d the steadfa st philosophy of nutr i ti onal i nte r vent i on to com bat obes i t y an d rel ated he alth conditions. O ur di sciplined and focused man ageme nt a pproac h and unwi l li ngnes s to com prom i se i n an industr y full of fad s ha s helped u s to maintain both fi na nci a l s tren g th an d significant growth year af te r ye ar. 2 me difast 2005 ann ual rep o r t The most recent statistics from the Framingham Heart Study show that, even if we are of normal weight at age 50, half of us will become overweight, and 1 in 4 of us are doomed to become obese. There is no question that the need in our society for safe and effective weight loss programs is vast. is bu t also weight; uniq uely improvements remar k able weigh t M edifast po sit ion ed in this growing mar k etplace b ec au se our programs not only he lp p eop le mak e lose signific ant in over al l l oss health. The and he alth outcomes of the M ed if ast scie nt if ica lly program validated in numerous clinic al st ud ies by major research institution s a n d we have maintained our deep i n the m edical communit y ac ro ss ou r business platfor m. ro ot s been have Today, Medifast is evolving from a product development, manufacturing and distribution company to a modern sales, marketing, and ser vice compa ny a s well. We have develope d a di ver se di s tr i b uti on s trateg y inclu ding our M edi fast Direc t chan ne l supp or ted by cons um er mar keting a nd a uniqu e a nd hig hl y su ppor ti ve d i rec t s elli n g co m p any, Take Shape for L ife. We also conti n ue to b ui ld la s tin g pa r t ne rs h i p s with ou r growi ng net wor k of me d i cal prac ti ti oner s th roug h our Lifest yles program that offers pat i ent s hom e d e li ver y. Fi na lly, ou r H i-E ne rgy Weig ht Control Centers provide an innovative approach to weight loss in a center-based environment. m edi fast 2005 a nnua l rep or t 3 The company continues to support the expansion of these models with our manufacturing and distribution divisions, Jason Pharmaceuticals, Inc. and Sunrise Distributing. We are constantly upgrading and expanding our infrastructure in these areas to support dynamic growth. As we look to the f uture, we conti nu e to focu s on our core va lues an d nutr itional solutions for we i g ht los s and i m proved he alth. We are prou d of our management tea m and e mp loye e s for the i r dedication and loyalt y to developi ng our platfor m i n the compet i t i ve lands ca pe of the 21st century. We would like to thank our Medifast Employees, Medifast Practitioners, Take Shape for Life Health Advisors, Hi-Energy Center Operators, Customers, Vendors and our Shareholders f o r y o u r c o n t i n u i n g s u p p o r t o f M e d i f a s t , I n c . Wa r mest R e gards, Bradl ey T. M acD onald Chairman of the Board M icha el S. M cD evitt President and Chief Financial O fficer 4 me difast 2005 ann ual rep o r t focus on VALUES M e d i f a s t t e s t i m o n i a l s : ( l e f t t o r i g h t ) C a t h y , P a m , M i c h e l l e , N n e d i , M a r y J a n e a n d J e n n i f e r . For a qu ar te r of a centur y, M edi fas t, I nc. has s ust ai ne d s trong core values ac ros s an evolvi ng bu si n es s platfor m that encompasses multiple cha nnels of di s tr i buti on . Our focused commitment to a philosophy of nutr itional inter vent ion for c om bating obesit y and other related health c onditions continu es to thr ive and grow. Tod ay, the public health b urden ass oci ate d wi t h b ei ng ove r we ight ha s a magnitu de similar to that of tobacco. S ome re se a rch er s e ve n believe that the r i sing rate of chi ld hood obe s i t y m ay m ake our you ng- est generations the fi rst to have a s h or ter li fe ex pec ta nc y than t hei r parents, despite major a dvancem e nts i n mod e r n m ed i ci ne. M e difast belie ves that peop le are res pons i ble for thei r own ac ti ons and pe rsona l environment s; however, t he y have li ttle or no cont rol m edi fast 2005 a nnua l rep or t 5 over the ex ter nal environment, whi ch i s f ra me d by poli ti cal, so cio economic and comm erc ial force s. Thes e fac tor s larg e ly explai n why Amer ica is exper ienc ing unpre ced ented le ve ls of obe s i t y. I n tod ay ’s realit y, we are s ur rounde d by poor food choi ce s and forced to live hec tic, yet sedentar y li fes t yle s. M edifas t makes c hoosing meals and controlli ng por tion s simple by encou ragi ng 6 s ma ll m eal s throughout the day, helpi ng peop le avoi d difficult food situations and break i ng the c ycle of overeating. Th o u sands of people, lik e Pamela No ord a, are f ina lly finding the answer to a li fetime o f struggles with th eir weight an d health. Th at answer is M edifast. M e d i f a s t P r e s i d e n t , C F O M i c h a e l M c D e v i t t w i t h c u s t o m e r P a m e l a N o o r d a “M y family provided me ever y oppor tu ni t y for s ucce s s i n my li fe. I was given great schooling, great trave li ng exp er i e nce s a nd ta ug ht how to give back to the comm uni t y. The one bi g thi ng that I had ne ver b een taught wa s how to eat cor rec tly and mai ntai n a he althy we i g ht. When both of my parents were diagnos e d wi th Typ e I I Dia betes e ar ly i n t he year, the re alit y of my parents’ eati ng choi ce s was thrown i n my face. Heredit y said that I could have the s am e proble m- I s hare the i r genes an d their bad eati ng habi ts. I ne ed ed to cha nge. M y ray of hope came from seeing my girlfriend who had been recommended Medifast by her do c to r. I star te d M ed ifas t and consi d e r i t the begi nni ng of my n ew life. I l ear ne d that with exerci se, g ood eati ng habi ts and proper p o r t i o n s i z e s , I c o u l d l o s e a n d m a i n t a i n a h e a l t h y w e i g h t . I am in cha rge of my li fe now and i t ’s am az i ng. Wi th M ed i fas t, I lost 65 pou nds in the f irst 4 months and the n an ad di t i onal 20 for a tot al of 85 p ound s.” Pamel a No orda Medifast is a clinically proven and science-based food technology that offers the highest quality, lowest calorie meal replacements in the industr y. 6 me difast 2005 ann ual rep o r t The produc t line cur rently boa s ts ove r 5 0 food i te ms. M e di f ast prou dly introd uced a new Banan a Crè me Shak e i n 20 0 5 th at quic k ly be came one of the m ost popula r i te ms i n the li ne. The ex tensi ve var i et y of M edifas t m ea ls he lps customers stick to the program. The company focuses on formulating only the highest quality products and is constantly exploring new food choices and flavors based on customer feedback. Physicians have recommended the Medifast program since the company ’s inception in 1981. At that time, the products were only available through a physician’s office. Today, the Company ’s technology-based business models continue to ser ve the medical community and provide home deliver y and ex tensive suppor t programs to consumers. M e difast not only helps people los e wei g ht, but can hel p the m m ake signif icant improvements in the i r ove rall h ea lth . A re ce nt s tud y c o n d u c t e d b y r e s e a r c h e r s a t J o h n s H o p k i n s u n i v e r s i t y p r o v e d t h a t participants lost twice as much weight on Medifast and were twice as likely to stick to the Medifast program than a standard ADA* food diet. Add itionally, significant reduc ti ons we re se e n i n s ys toli c a nd di as tolic blood pressure, total cholesterol and triglycerides and blood pressures were normalized in 90% of hyper tensive patients. * American Diabetes Association me d ifast 2005 annual rep or t 7 This ph ilosophy of nutr itional inte r vent i on i s s up por ted n ot on ly by res ea rch, but also the thou sa nds of M edi f ast cli ent s wh o have cha nged their lives and redu ced t he i r m ed i cati on s be caus e of M edifast qualit y prod uc ts and su ppor t progra ms. While many fad diets have come and gone over the years, the Medifast brand has sur vived the tumultuous climate of the weight loss industr y. The onl y way to lose weight and ke ep i t of f i s to re duce tota l ca lor i es and adopt a healthier lifestyle. Restricting the popular macronutrient of the moment, like the low-carb diet or taking the magic pill that promis es a quick fix, will never be the answer to long-term weight loss. Medifast believes that nutritional therapy should be the preferred method for treating obesity and associated conditions and that drug therapy should be used only when medically necessary. Medifast has only just begun to spread this message to consumers. Moving forward, the Company will continue to expand the awareness of the Medifast brand through increased advertising, public awareness campaigns, peer reviewed research, relationships with the medical community, and growing customer support networks. The same core values that have driven the Medifast brand for a quarter of a century also drive the corporate culture. Medifast has developed a unique management team consisting of young entrepreneurial executives, a world-class medical team and seasoned professionals with a wealth of industry experience. It is this team that is transforming Medifast, Inc. from Clockwise from left: Meg MacDonald, Senior VP Operations Brendan Connors, CPA, VP Finance Leo V. Williams, III, Executive VP a manufacturing and distribution company into a cutting-edge marketing, techn o logy, and cus tomer sup por t com pany a s well. M ov i n g for wa rd, M edifast will remain foc used on the val ues that have m a de t he Medifast brand what it is today. Medifast will never lose sight of the intrinsic medical heritage of the Medifast brand while continuing the strong commitment to constantly evolve and provide new tools and services for customers. 8 m edifast 2005 ann ual rep or t focus on CUSTOM ERS At M edif ast, I nc., we recogn ize that cus tom er s come to u s for e s s e n t i a l l y t h e s a m e r e a s o n , t o l o s e w e i g h t a n d i m p r o v e t h e i r health. What sets M edifast apar t f rom th e comp et i ti on are our c l i n i c a l l y p r o v e n p r o d u c t s a n d p r o g r a m s a s w e l l a s a business model that recognizes w hil e most customers usually have common goals, e ver y customer is different . M any of our c ustomers prefer to order produc t an ony mou sly online while others use the web to share their most personal stories in chat rooms and message boards. Some customers prefer to talk to a caring representative from the company over the phone while some customers benefit from having the one-on-one support and mentoring provided by a personal health advisor. Many of our customers feel they are best served under a physician’s supervision or in a clinic environment. m edi fast 2005 a nnua l rep or t 9 M e d i f a s t , I n c . i s u n i q u e l y p o s i t i o n e d i n t h e m a r k e t p l a c e b e c a u s e o f t h e w a y w e s e r v e c u s t o m e r s. T h e Co m p a ny o f fe r s a m e n u o f o p t i o n s f o r s u p p o r t o n t h e p r o g r a m t h r o u g h t h r e e p r i m a r y c h a n n e l s o f d i s t r i b u t i o n , e a c h f o c u s i n g o n t h e i n d i v i d u a l n e e d s o f a g r o w i n g c u s t o m e r b a s e . Medifast’s primary distribution channel is the Medifast Direct web and toll-free business. Here, customers have access to qualified nutritional practitioners, customer care representatives and a robust web library for support and information. This business is driven by an aggressive multi-media customer acquisition strategy that includes print, television, radio, a nd web advertising as well as public relations initiatives. In 2005, as a result of extensive customer research and focus groups, the Company enhanced its marketing message focusing on the true needs and desires of customers. The marketing message emphasized the ease and convenience of the Medifast program and the website was upgraded with a new shopping cart and message board community page. The message boards quickly became one of the most visi ted areas of th e web si te, mak i n g it a destination for dai ly sup por t by allow i ng cu stomers to sh are thei r s ucces s s tor i es and tips online. The Company introduced a new Easy, Fast, Medifast logo and fresh product pac k a ging desi gn. Si multaneo us ly, t he Compa ny an nounced that all M edif ast me al rep lacem e nt p rod uc ts could b e us ed interch ange ably in the “5 & 1” we i g ht los s program offe r i ng mo re flexibilit y and options for c usto me r s. M e d i fas t ’s targ ete d adve r t i si ng effo r ts continued to b e highly prof i ta ble dr i vi ng web sales up 300 percent over 2004. 10 medifa st 2005 an nual re po r t L a t e i n t h e y e a r, M e d i f a s t s e c u r e d a f e a t u r e i n People M agazine’s “Half my Size” is s ue a s one of the top 5 d iets in the indus tr y. This was a result of s trong p ubli c rel ati ons cam pai gns throug hou t t he year. Medifast continues to refine and improve its customer acquisition and retention strategies. In 2006, the Medifast Direc t division will continue to focus on targeted marketing initiatives and enhancements to its customer suppor t systems by u pgrading its call center a nd n utr i ti on s uppor t te am to be tter ser ve i ts clie nts. Addi tiona lly, a state of the ar t web technology fe atu r ing cu stomized meal planning and community components will be unveiled to better serve the growing number of consumers who are choosing the web as their preferred method for shopping and program support. M e d i f a s t ’s s e c o n d c o r e c h a n n e l o f d i s t r i b u t i o n i s t h e T a k e S h a p e f o r L i f e d i r e c t s a l e s b u s i n e s s , w h i c h i s a suppor t program that moves beyond the scope of weight loss to show custom ers how to achi eve optim al health th roug h th e balance of body, mind, and fina nce s. Take Sha pe for Life offers competit ive H ea lth Adv i s or ca ree r oppor t uni t i es to su ccessful cu stomers a nd entre pre ne u rs who prov i de one - on- one personalized coachi ng and sup por t to custome r s on the progra m . T h i s p h y s i c i a n l e d r e l a t i o n s h i p m a r k e t i n g m o d e l h a s excellent customer retention because of the personal suppor t of fered by Healt h Advisors and the B eSlim philosop hy , w h i c h i s a w e i g h t m a i n t e n a n c e p r o g r a m b a s e d o n g a t h e r e d re search re garding effec tive long -te r m we i g ht los s. me d ifast 2005 annual rep or t 1 1 2005 was a year of significant accomplishment in the Take Shape for Life division. The Company focused on the development and training of Health Advisors in addition to its unique customer support programs. Early in the year, the Company released the comprehensive Health Advisor training program “Your Guide to Success” covering topics such as client acquisition and support, and sponsoring and leadership development. Take Sh ape for Life held the highes t at tend ed s um me r conve nti on i n the his tor y of the Comp any in Pa r k Ci t y, U tah. Af te r the conve nt i on, the Company introduced a power ful cli e nt a s s es s me nt tool t hat al lows H ealth Ad vi sors to q uic k ly a nd ea si ly ex plai n the Tak e Sh ap e for Life program to pros pec tive c li e nts a nd oth er H ea lth Adv i s or s. Take Shape for Life continued to enhance support systems by redes igni ng the Tak e Shape for Life cor p orate and co - b ran ded webs i te s, and by offe r i ng a dedicated he lp line for the BeSlim Club (autoship) and a toll-free, pre -recorded message exp la ining the mi ss ion and vis ion of Ta k e Shape for Life. I n th e fall of 2005, Tak e Shape for Life released “ The Future is Now.” This i nitiative was the culmi nat i on of creative efforts resulting in a new presentation, website, leads program, suppo r t featu res and up dated tools for H ea lth Adv i sor s. “ The Future is Now ” was s u p p o r t e d b y a nationwide training tour covering seven key markets for Take Shape for Life. As a result of these efforts, new Health Advisor sponsoring and enrollments increased and relationship m a r k e t i n g f i e l d development accelerated at a record pace. 12 medifa st 2005 an nual re po r t I n 2 0 0 6 , Ta k e S h a p e f o r L i f e w i l l b e e x e c u t i n g a s t r a t e g i c p l a n t o transfo r m TSF L into an industr y lead er with the vision of mak ing Amer ica and the wor ld healthy . D ed icated m ar keti ng ac tiv ities wi ll focus more attention on the unique needs of the TSFL direct selling network in order to facilitate its expansion to its fullest potential. The division is planning a major upgrade to its branding and c o r p o r a t e m e s s a g e b y l a u n c h i n g a redesign of the company logo and tagline su ppor ted by a new comprehensive “Business in a Box” that will contain DVDs, audio CDs and manuals used for the training, developme nt and re cr uiting of new Hea lth Advi sors. Health Advis or b usi ne ss ma na gem ent tools will be enha nced acros s t he platform to make starting and managing a business in Take Shape for Life even ea sier and more attra c ti ve. Th e cor p orate we bs i te wi ll a ls o be redesigned with enhanced features to improve the cu stome r exper ience with a new shopping cart and online meal planner tied to Take Shape for Life’s exclusive BeSlim philosophy. remains focused on exceptional patient outcomes with the traditional medical practitioner distribution channel . M e difast medi cal p rac ti tioner s a re prov i ded wi th a we ight management program that complements their existing medical practice. Combining produc ts and protocol s w i th the comp any ’s me d ifast 2005 annual rep or t 1 3 Internet capabilities allows Medifast medical prac titioners to provide an exceptional weight management program to their patients. The spectrum of services offered to medical practitioners includes professional account management, marketing and co - o p adver tising su pp or t, web re fe r rals, in- ser vice training, and a revenu e s ha re for practitioner-to-patient counseling and support. The Medifast Lifestyles Program is a medically-supported net wo r k of health c are professiona ls who support their patients on the Medifast program. Patients order products directly from the Medifast website or toll-free number for home delivery, referencing their Lifestyles code. Medifast also offers a wholesale purchasing service to medically-licensed program providers such as hospitals, weight-loss clinic operators, and health care institutions. The Company also supports medical practitioners with extended business development services through the Professional Division of Take Shape for Life. D ur ing 2005, M ed ifas t ac tively s uppor te d t he Am er i ca n D i ab etes Ass ociation, The Amer i can Assoc i at i on of Di ab ete s Educator s a n d T h e A m e r i c a n S o c i e t y o f B a r i a t r i c P h y s i c i a n s . W e a l s o developed and sponsored a 1.5 credit hour ACPE Continuing Education program for pharmacists call ed The Emerging Cr i sis of Ob e s i t y i n Am e r i ca : A Pre ve ntati ve Cha llenge to Phar macists and H e althca re Profes s i ona ls. Th i s on li n e continuing education program has been very well received acros s the countr y with over 2500 phar maci s ts en rolle d s o far. The Company remains at the leading edge of clinical excellence. Medifast products and suppor t se r vices are well pos i t i one d to comp lem ent a wide var iet y of med ical weight l os s protocols. M edi f as t i s a lso a n excell ent low calorie supplement that may be used in conjunc tion with existing and promising ne w a ppetite sup pressa nt pres cr i p ti on med ications in a medi cal environme nt. I n 2 00 6 , M e di f as t wi ll be focused on fur ther developing i ts cli n i cal protocols a nd re se arch studies to continue to validate t he M edi f a st p rogram i n the treatment of obesity and related health conditions such as Diabetes. 14 medifa st 2005 an nual re po r t The H i -Energ y Weig ht Control Cente r divi sion s pecializes in medical ly monitored weight management programs to prom ote we ig ht loss and imp roved hea lth . Th i s br i ck an d m or t ar cli ni c m odel offers the suppor t of weight loss counselors and a H i- Energ y private label produc t. The H i -Energ y system i s s up por te d by a com preh en si ve DJ radio and testimoni al p r i nt a dver t i s i ng s t rateg y to dr i ve lea ds to the ce nters. In 2005, the Company successfully expanded its network of licensees and opened corporately owned and operated Hi-Energy centers in Orlando, Florida and Dallas, Texas. The Company moved corporate headquar ters to Owings Mills, Maryland and consolidated the management team to better serve the system of licensees. The Company focused on improving customer acquisition strategies and center management to create a replicatable model for expansion. M oving for wa rd in 2006, H i -Ene rg y wi ll la unch a new propr i et ar y a nd compre hensi ve patient- couns eli ng p rogram de ve lope d by a l ea di n g behavioral psychologist in obesity research. The Company is also testing innovative approaches to tra ining and s elli ng as well as the use of an enhanced medical model within the center system. me d ifast 2005 annual rep or t 1 5 focus on GR O W TH A s o f D e c e m b e r 3 1 , 2 0 0 5 , M e d i f a s t , I n c . h a s e x p e r i e n c e d 2 5 co nsecutive q u ar ters of profitab ilit y . This tremendous succes s has be e n a chi e ve d be caus e of the growi ng reco gnition of the wor ld - c lass M edi f as t brand. The Com pany ha s b een ex tremely ef fe c tive in maintaini ng a low cus tom e r acqui s i ti on cos t thro ugh e ffec tive and targeted mar ke ti ng cam pai gns, whi ch h i ghli ght real success stor ies f rom the c lini ca lly prove n and ef fe c ti ve products. These campaigns were successful in driving over 70 percent of customers to the Company ’s medifastdiet. com we bs i te i n 20 0 5 . As the Company continues to increase the adver tising budget, more people are hearing ab out M edifast and star ting the program , whi ch i s fue li ng uni ver sal growth in all busines s c hannels. 16 medifa st 2005 an nual re po r t In 2005, revenues increased by 47% from the prior year due to the continued success of direct-to-consumer sales and the expansion of the Take Shape for Life direct sales network. Take Shape for Life continued to improve support tools and training in an effort to make supporting customers and recruiting new heath advisors easier. This effort resulted in the extension of the health network into new cities as well as expansion in current locations. The continued growth of the Medifast brand can be attributed to the Company’s disciplined management strategy and the extraordinary commitment from executives and employees who drive the business every day. In 2005, Medifast placed increased emphasis on a modern multi-channeled distribution strategy for the Medifast brand and continues to exploit the immense opportunities in the direct-to-consumer, direct sales network and clinical business models. Medifast will continue to hire talented employees in all areas of the Company to contribute additional insight and expertise to the business. In 2006, we anticipate significant growth across our platform. The first quarter of 2006, as compared to the first quarter of 2005, saw an increase in revenues to $19 million up 130%. After-tax diluted earnings per share increased from $.04 at March 31, 2005 to $.13 at March 31, 2006. As a result of this growth, the Company will continue to maintain production and call center functions in-house, however, the Company has begun preparing for the over-sourcing of these functions in order to achieve scalability for continued expansion in the future. The Company will also be implementing an Enterprise Resource Planning solution to upgrade technology infrastructure and improve manufacturing and business processes. The new IT infrastructure will enable the Company to handle additional growth and improve operating efficiencies across the business platform. In addition, the Company is implementing new software in the Take Shape for Life direct sales network that will facilitate the support and success of health advisors and clients, which is expected to fuel additional growth in this channel. Medifast’s vision has always been to help people combat obesity and become healthier through sound nutritional intervention. Today, more than ever, our original vision remains vibrant and strong. Medifast is committed to accelerating growth by constantly evolving our business models, providing world class products and services, exploiting the use of new technology and building internal infrastructure to sustain substantial expansion. me d ifast 2005 annual rep or t 1 7 B oard O f Direc tors Bradley T. MacDonald Chairman of the Board Chief Executive Officer Medifast Inc. Rev. Joseph D. Calderone, OSA Director Associate Director of Campus Ministry, Villanova University George Lavin Jr. ESQ Director Senior Partner Lavin, Oneil, Ricci, Ceprone and Disipio Michael C. MacDonald Director President of Global Accounts and Marketing Operations, Xerox Corporation Michael J. McDevitt Director Senior Executive (retired), Federal Bureau of Investigation Rev. Donald F. Reilly, OSA Director Provincial, Augustinian Order of Villanova, PA Mary T. Travis Director Senior Vice President of Wholesale Operations, Sunset Mortgage Company, LP H e a d q ua r t e r s : M e difast, I nc. • 1 1445 Cronhill Dr i ve • O wi n g s M i lls, MD 2 1 11 7 800. 223. 1809 • w w w.medi fastdi et.com corporate officers: Bradley T. MacDonald (Chairman of the Board, CEO) • Michael S. McDevitt (President, CFO) • Leo V. Williams, III (Executive Vice President) • Richard J. Law (Vice President) • Brendan Connors, CPA ( Vice President Finance) • Meg MacDonald (Senior Vice President Operations) i n v e s to r r e l at i o n s co n tac t: Kelli e Piz zico (As sis tant S ecretar y) sto ck excHange list in g: American Stock Exchange Trading Symbol: MED i n d e p e n d e n t p u b l i c acco u n ta n t s : Bage ll, Josephs & Comp any, LLC Gibbsboro, New Jersey • BDO S e i dm an Af fi l i ate t r a n s f e r ag e n t a n d r e g i s t e r : Ame r ican Stock Transfer and Tru st Com pany 59 M aiden Lane • Plaz a Level • Ne w Yor k Ci t y, NY 10 0 38 • 8 0 0. 937. 5449 a n n ua l M e e t i n g : S eptem ber 8, 2006 18 medifas t 2005 ann ual re por t For m 10-K MEDIFAST INC - MED Fi led: M arch 15, 2006 (per iod : D ec embe r 31 , 20 0 5) T A B L E O F C O N T E N T S PAR T I ITEM 1 . BU SINESS. ITEM 2 . DESCR IP TIO N OF P R OP ER T Y ITEM 3 . LEG AL PR O C EE DI NGS ITEM 4 . SUB MISSI ON OF MAT TERS TO A V OT E OF SE C U RIT Y HO L DE RS PAR T II ITEM 5 . MAR KE T FO R COMM ON E QUI T Y AN D RE L ATE D STO C KHO LDER MAT T ERS ITEM 6 . SELEC TED FI NANC IA L DATA ITEM 7 . MANAG EMENT ’S DIS CUS S ION AND A N A LYS IS OF FI NA N C I A L CON DITIO N AND RE SULTS ITEM 8 . FINAN CIAL S TATE ME NTS ITEM 9 . CH ANGES AND DIS AGRE EMENTS W I TH ACCOU N TA N TS ON ACCO UNT ING ITEM 9 A. CON TR O L S AND PR OC EDURE S PAR T III ITEM 1 0. DIR EC TO RS AN D EXECUT I VE DIR EC TOR S OF RE GI ST R A NT ITEM 1 1. EX ECU TIV E COMPE NSATI ON ITEM 1 2. SECU RIT Y O WN ERSH IP OF C ER TAI N B E NE F IC IA L O W NE R S AND MA NAGEMENT PAR T IV ITEM 1 4. EX HIBITS AND RE POR TS ON FORM 8 -K . SIG NATUR ES Index to Exhibits EX-31.1 EX-31.2 EX-32.1 medifast 2005 annual rep or t 19 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 Commission File No. 000-23016 MEDIFAST, INC. DELAWARE 13-3714405 Incorporation State Tax Identification number 11445 CRONHILL DRIVE, OWINGS MILLS, MD 21117 Principal Office Address 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 20 medifa st 2005 an nual re po r t Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes |_| No |X| Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No |X| Indicate by check mark 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 preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes |_| No |X| The aggregate market value of the voting common equity held by non-affiliates of the registrant as of June 30, 2005, based upon the closing price of $3.04 per share on the American Stock Exchange on that date, was $32,985,000. As of March 14, 2006, the Registrant had 12,786,124 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement for the 2006 Annual Meeting of Stockholders, which will be filed within 120 days after the end of the fiscal year, are incorporated by reference into Part III. medifast 2005 annual rep or t 2 1 M E D I FA S T , I N C . A N D S U B S I D I A R I E S C O N T E N T S CON SOLIDATE D FINANCI AL STAT EMENTS PAGE R epor t of I ndependent R egistere d Pu bl i c Accounting Fir m Ba lan ce sheets as of D ecember 31 , 20 0 5 a n d 2 0 04 St atements of incom e for the yea r s e n d e d D ece mber 31, 2005, 2004 and 20 0 3 St atement of changes in stoc k h o l d e r s’ e qu i t y a n d accumulated other comprehensive income (loss) for the years ended D ecem ber 31, 2005 , 2 0 0 4 , a n d 20 0 3 St atements of c ash flow for the ye a r s e n d e d D ece mber 31, 2005, 2004, and 20 0 3 22 23 24 25 - 27 28 Note s to consolidated financia l s tatem e nt s 29 - 44 22 medifas t 2005 ann ual re por t REPOR T OF INDEPENDENT R EGIS T ERE D PUBLIC ACCO UNTI NG FIRM Board of Directors and Stockholders Medifast, Inc. Owings Mills, Maryland We have audited the accompanying consolidated balance sheets of Medifast, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders equity, and cash flow for each of the three years in the period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with standards established by the Public Company Accounting Oversight 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 financial 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, 2005 and 2004, 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, Levine & Company, LLC Gibbsboro, New Jersey March 2, 2006 medifast 2005 annual rep or t 2 3 MEDIFAST, INC. AND SUBS IDIARIE S CONSOLIDATED BA LANC E SHEE TS As of D ecembe r 31, 2005 a nd 200 4 ASSETS CURRENT ASSETS: Cash Accounts receivable-net of allowance for doubtful accounts of $100,000 and $87,000 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 2005 2004 $ 1,484,000 $ 612,000 985,000 1,063,000 5,475,000 4,251,000 2,700,000 2,626,000 525,000 321,000 3,273,000 1,079,000 - 19,000 14,442,000 9,971,000 9,535,000 8,698,000 6,508,000 7,138,000 - 91,000 60,000 70,000 TOTAL ASSETS $30,545,000 $25,968,000 LIABILITIES AND STOCKHOLDERS’ EQUITY CURRENT LIABILITIES: Accounts payable and accrued expenses $ 2,263,000 $ 940,000 899,000 674,000 Income taxes payable - 65,000 Dividends payable 633,000 369,000 Line of credit Current maturities of long-term debt 561,000 458,000 Deferred tax liability - current 90,000 - TOTAL CURRENT LIABILITIES 4,446,000 2,506,000 OTHER LIABILITIES AND DEFERRED CREDITS Long-term debt, net of current portion 3,977,000 4,256,000 Deferred tax liability - non-current 101,000 - TOTAL LIABILITIES 8,524,000 6,762,000 STOCKHOLDERS’ EQUITY: Series B Convertible Preferred Stock; par value $1.00; 600,000 shares authorized; 0 and 300,614 shares issued and outstanding Series C Convertible Preferred Stock; stated value $1.00; 1,015,000 shares authorized; 0 and 200,000 shares issued and outstanding Common stock; par value $.001 per share; 20,000,000 shares authorized; 12,782,791 and 11,001,070 shares issued and outstanding 13,000 11,000 Additional paid-in capital 21,759,000 20,556,000 Accumulated other comprehensive income (loss) 282,000 (39,000) Retained earnings (deficit) 1,149,000 (1,287,000) - 301,000 - 200,000 23,203,000 19,742,000 (1,075,000) (536,000) Less: cost of 210,902 and 78,160 shares of common stock in treasury Less: Unearned compensation (107,000) TOTAL STOCKHOLDERS’ EQUITY 22,021,000 19,206,000 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $30,545,000 $25,968,000 The accompanying notes are an integral part of these consolidated financial statements 24 medifas t 2005 ann ual re por t MEDIFAST, INC. AND S UBS IDIAR IE S CONSOLIDATE D STATEMENTS OF I NCOM E Ye ars En ded D ecemb er 3 1, 20 0 5, 20 0 4 and 2 003 2005 2004 2003 Revenue Cost of sales $40,129,000 $27,340,000 $25,379,000 (10,161,000) (6,746,000) (6,825,000) GROSS PROFIT 29,968,000 20,594,000 18,554,000 Selling, general, and administration (25,894,000) (17,590,000) (14,956,000) INCOME FROM OPERATIONS 4,074,000 3,004,000 3,598,000 OTHER INCOME (EXPENSE): Interest expense Interest income Other income (expense) (317,000) (245,000) (150,000) 158,000 154,000 110,000 15,000 (7,000) - (144,000) (98,000) (40,000) NET INCOME BEFORE PROVISION FOR INCOME TAXES Provision for income taxes 3,930,000 2,906,000 3,558,000 (1,203,000) (1,159,000) (1,148,000) NET INCOME 2,727,000 1,747,000 2,410,000 Less: Preferred stock dividend requirement (291,000) (18,000) (58,000) NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS $2,436,000 $1,729,000 $2,352,000 Basic earnings per share Diluted earnings per share $0.20 $0.16 $0.25 $0.19 $0.14 $0.22 Weighted average shares outstanding - Basic 12,258,734 10,832,360 9,305,731 Diluted 12,780,959 12,413,424 10,952,367 The accompanying notes are an integral part of these consolidated financial statements medifast 2005 annual rep or t 2 5 MEDIFAST, INC. AND S UBSIDIAR IES CONSOLIDATED STATEMENT OF CHA N GE S IN STOCK HOLDERS’ EQUIT Y AND ACCUMU LATE D OTH E R COMPREHENSIVE INCO ME (LO SS ) Ye ars En ded D ecem be r 31, 2005, 2 00 4 a nd 20 03 Series B Preferred Stock Series C Preferred Stock Number of Shares Stated Value Amount Number of Shares Stated Value Amount Balance, December 31, 2002 521,290 $521,000 985,000 $985,000 Preferred converted to Common Stock (117,556) (117,000) (718,000) (718,000) Options exercised to Common Stock Warrants Converted to Common Stock Common Stock issued to Directors, consultants, and acquisitions Common Stock issued for Series “C” dividend Dividend paid in stock Net Income Balance, December 31, 2003 403,734 404,000 267,000 267,000 Preferred converted to Common Stock (103,120) (103,000) (67,000) (67,000) Options exercised to Common Stock Warrants Converted to Common Stock Conversion of debt to equity Conversion of debt to equity out of Treasury Common stock issued to Consultants Shares issued out of Treasury Common Stock issued for Series “C” dividend Dividend paid in stock Net Income Balance, December 31, 2004 300,614 301,000 200,000 200,000 Preferred converted to Common Stock (300,614) (301,000) (200,000) (200,000) Warrants Converted to Common Stock Options excercised to common stock Common Stock issued for Series “C” dividend Dividend paid in stock Common stock issued for Series “B” dividend Common stock issued to Employees Treasury shares issued to employees Shares issued to officer with two year vesting period Treasury shares repurchased Net income Balance, December 31, 2005 - $ - - $ - The accompanying notes are an integral part of these consolidated financial statements 26 medifas t 2005 ann ual re por t MEDIFAST, INC. AND S UBS IDIAR IE S CONSOLIDATED STATEMENT OF CHA N GE S IN STOCKHOLDERS’ EQUIT Y AND ACCU MULAT ED OT HE R COMPREHENSIVE INCOME (LOSS ) - (CO N TIN UE D ) Ye ars E nded D ec ember 31, 200 5, 2 00 4 a nd 2 0 03 Common Stock Number of Shares Par Value $0.00 Amount Additional Paid-in Capital Retained Earnings (deficit) Balance, December 31, 2002 7,204,693 $7,000 $9,613,000 ($5,381,000) Preferred converted to Common Stock 1,671,108 2,000 833,000 Options exercised to Common Stock 615,714 590,000 Warrants Converted to Common Stock 288,724 350,000 Common Stock issued to Directors, 665,970 1,000 8,716,000 consultants, and acquisitions Common Stock issued for Series “C” dividend 36,400 18,000 Dividend paid in stock (45,000) Net Income 2,410,000 Balance, December 31, 2003 10,482,609 10,000 20,120,000 (3,016,000) Preferred converted to Common Stock 340,240 170,000 Options exercised to Common Stock 47,221 1,000 34,000 Warrants Converted to Common Stock 46,700 125,000 Conversion of debt to equity 55,400 28,000 Conversion of debt to equity out of Treasury 114,000 Common stock issued to Consultants 15,500 93,000 Shares issued out of Treasury (135,000) Common Stock issued for Series “C” dividend 13,400 7,000 (7,000) Dividend paid in stock (11,000) Net Income 1,747,000 Balance, December 31, 2004 11,001,070 11,000 20,556,000 (1,287,000) Preferred converted to Common Stock 1,001,228 1,100 500,000 Warrants Converted to Common Stock 2,000 - 2,000 Options excercised to common stock 138,335 100 190,000 Common Stock issued for Series “C” dividend 38,000 - 19,000 (19,000) Dividend paid in stock (11,000) Common stock issued for Series “B” dividend 521,158 600 260,000 (261,000) Common stock issued to Employees 81,000 100 271,000 Treasury shares issued to employees 100 (39,000) Shares issued to officer with two year vesting period Treasury shares repurchased Net income 2,727,000 Balance, December 31, 2005 12,782,791 $13,000 $21,759,000 $1,149,000 The accompanying notes are an integral part of these consolidated financial statements medifast 2005 annual rep or t 2 7 MEDIFAST, INC. AND S UBSIDIAR IES CONSOLIDATED STATEMENTS OF C HA N GE S IN STOCK HOLDERS’ EQUIT Y AND ACCUMU LATE D OTH E R COMPREHENSIVE INCOME (LOSS ) - (CO N TIN UE D) Ye ars En ded D ecem be r 31, 2005, 2 00 4 a nd 20 03 Accumulated other comprehensive income (loss) Total Treasury Stock Unearned Compensation Balance, December 31, 2002 $ - $5,745,000 ($167,000) $ - Preferred converted to Common Stock Options exercised to Common Stock 590,000 (516,000) Warrants Converted to Common Stock 350,000 Common Stock issued to Directors, consultants and acquisitions 8,717,000 Common Stock issued for Series “C” dividend 18,000 Dividend paid in stock (45,000) Net Income (25,000) 2,385,000 Balance, December 31, 2003 (25,000) 17,760,000 (683,000) - Preferred converted to Common Stock Options exercised to Common Stock 35,000 (31,000) Warrants Converted to Common Stock 125,000 (123,000) Conversion of debt to equity 28,000 Conversion of debt to equity out of Treasury 114,000 166,000 Common stock issued to Consultants 93,000 135,000 Shares issued out of Treasury (135,000) 135,000 Common Stock issued for Series “C” dividend Dividend paid in stock (11,000) Net Income (14,000) 1,733,000 Balance, December 31, 2004 (39,000) 19,742,000 (536,000) - Preferred converted to Common Stock (124,000) Warrants Converted to Common Stock 2,000 Options excercised to common stock 190,000 Common Stock issued for Series “C” dividend Dividend paid in stock (11,000) Common stock issued for Series “B” dividend Common stock issued to Employees 271,000 Treasury shares issued to employees (39,000) 38,000 Shares issued to officer with two year vesting period (122,000) Vesting of unearned compensation 15,000 Treasury shares repurchased (453,000) Net income 321,000 3,048,000 Balance, December 31, 2005 $282,000 $23,203,000 ($1,075,000) ($107,000) The accompanying notes are an integral part of these consolidated financial statements 28 medifas t 2005 ann ual re por t MEDIFAST, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW Years Ended December 31, 2005, 2004 and 2003 2005 2004 2003 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,727,000 $ 1,747,000 $2,410,000 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES FROM OPERATIONS: Depreciation and amortization 1,741,000 1,210,000 648,000 Realized (gain) loss on investment securities 10,000 19,000 (1,000) Common stock issued for services 150,000 93,000 207,000 Vesting of unearned compensation 15,000 - - Net change in other accumulated comprehensive income (loss) 321,000 (14,000) - Provision for bad debts 13,000 - - Deferred income taxes 301,000 486,000 1,138,000 CHANGES IN ASSETS AND LIABILITIES: Decrease (increase) in accounts receivable 65,000 (422,000) (357,000) (Increase) in inventory (1,225,000) (1,263,000) (1,729,000) (Increase) in prepaid expenses and other current assets (2,194,000) (143,000) (687,000) (Increase) in deferred compensation (204,000) - (321,000) Decrease (increase) in other assets 10,000 (25,000) 44,000 Increase (decrease) in accounts payable and accrued expenses 1,323,000 (460,000) 525,000 Increase in income taxes payable 160,000 674,000 - NET CASH PROVIDED BY OPERATING ACTIVITIES 3,213,000 1,902,000 1,877,000 CASH FLOWS FROM INVESTING ACTIVITIES: Sale (purchase) of investment securities, net (84,000) 1,338,000 (3,564,000) Purchase of building - (566,000) (1,823,000) Purchase of property and equipment (1,672,000) (1,490,000) (1,309,000) Purchase of intangible assets (276,000) (2,792,000) (2,458,000) NET CASH (USED IN) INVESTING ACTIVITIES (2,032,000) (3,510,000) (9,154,000) CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock, options and warrants 66,000 7,000 6,722,000 Increase (decrease) in line of credit, net 561,000 314,000 (36,000) Purchase of treasury stock (452,000) - - Proceeds from long-term debt - 475,000 2,669,000 Principal repayments of long-term debt (473,000) (1,089,000) (346,000) Dividends paid on preferred stock (11,000) (11,000) (45,000) NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (309,000) (304,000) 8,964,000 NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 872,000 (1,912,000) 1,687,000 Cash and cash equivalents - beginning of the year 612,000 2,524,000 837,000 Cash and cash equivalents - end of year $ 1,484,000 $ 612,000 $ 2,524,000 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Interest paid $ 317,000 $ 245,000 $ 154,000 Income taxes $ 1,983,000 $ - $ - SUPPLEMENTAL DISCLOSURE OF NON CASH ACTIVITY: Conversion of preferred stock B and C to common stock $ 501,000 $ 170,000 $ 835,000 Common stock for services $ 150,000 $ 93,000 $ 207,000 Common stock for intangibles and fixed assets $ - $ - $1,949,000 Conversion of debt to equity $ - $ 307,000 $ - Preferred B and C Stock Dividends $ 287,000 $ 7,000 $ 18,000 Line of credit converted to long-term debt $ 369,000 $ - $ - Common stock issued for compensation to be earned upon vesting $ 122,000 $ - $ - The accompanying notes are an integral part of these consolidated financial statements medifast 2005 annual rep or t 2 9 MEDIFAST, INC. AND S UBSIDIAR IES N OTES TO CONS OLIDATED FINANC IA L STATE ME N TS D ecember 3 1, 200 5, 2 004 and 20 03 NOTE A - BUSINESS NOTE B - SIGNIFICANT ACCOUNTING POLICIES Medifast, Inc. (the “Company”, or “Medifast”) Significant accounting policies followed is a Delaware corporation, incorporated in 1980. in the preparation of the consolidated financial The Company’s operations are primarily conducted statements are as follows: through five of its wholly owned subsidiaries, Jason Pharmaceuticals, Inc. (“Jason”), Take Shape for Life, [1] PRINCIPLES OF CONSOLIDATION AND BASIS OF Inc. (“TSFL”), Jason Enterprises, Inc., Jason Properties, LLC PRESENTATION: and Seven Crondall, LLC. The Company is engaged in the production, distribution, and sale of weight The consolidated financial statements management and disease management products include the accounts of the Company and its and other consumable health and diet products. wholly owned subsidiaries, Jason Pharmaceuticals, Medifast, Inc.’s product lines include weight and Inc., Take Shape For Life, Inc., Seven Crondall disease management, meal replacement and sports Associates, LLC, Jason Properties, LLC and nutrition products manufactured in a modern, FDA Jason Enterprises, Inc. All inter-company accounts approved facility in Owings Mills, Maryland. have been eliminated. The Company is engaged in the manufactur- [2] CASH AND CASH EQUIVALENTS: ing and distribution of Medifast® and Hi-Energy® branded and private label weight and disease For the purposes of the consolidated state- management products. These products are sold ments of cash flow, the Company considers all through various channels of distribution, to highly liquid debt instruments purchased with include web, call center, independent health maturity of three months or less to be cash advisors, medical professionals, weight loss clinics, equivalents. At December 31, 2005, the Company direct consumer marketing supported via the had $789,000 in a money market account, $365,000 phone and the web. The processing, formulation, in miscellaneous short-term investments through packaging, labeling and advertising of the Company’s Merrill Lynch that are considered cash equivalents products are subject to regulation by one or more due to terms of maturity, and $330,000 in operating federal agencies, including the Food and Drug checking accounts. Administration, the Federal Trade Commission, the Consumer Product Safety Commission, the At December 31, 2004, the Company had United States Department of Agriculture, and the invested in four $100,000 certificates of deposit, United States Environmental Protection Agency. of which three were considered cash equivalents. In 2005, all certificates of deposit matured and were rolled into a money market account. 30 medifas t 2005 ann ual re po r t NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONT.) [3] ACCOUNTS RECEIVABLE AND ALLOWANCE FOR the estimated useful lives of the assets acquired DOUBTFUL ACCOUNTS as follows: Accounts receivable are recorded net of Building and building improvements 39 years reserves for sales returns and allowances, and Equipment and fixtures 3 - 15 years net of provisions for doubtful accounts. Allow- Vehicles 5 years ances for sales returns and discounts are based on an analysis of historical trends, and allowances The carrying amount of all long-lived assets for doubtful accounts are based primarily on an is evaluated periodically to determine whether analysis of aging accounts receivable balances adjustment to the useful life or to the unamortized and on the creditworthiness of the customer as balance is warranted. Such evaluation is based determined by credit checks and analysis, as well principally on the expected utilization of the as the customer’s payment history. long-lived assets and the projected undiscounted cash flows of the operations in which the long- [4] INVENTORY: lived assets are used. Inventory is stated at the lower of cost or [7] INCOME TAXES: market, utilizing the first-in, first-out method. The cost of finished goods includes the cost of raw The Company accounts for income taxes in materials, packaging supplies, direct and indirect accordance with Statements of Financial Accounting labor and other indirect manufacturing costs. Standards No. 109, “Accounting for Income Taxes,” [5] ADVERTISING: which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income taxes and liabilities are Advertising costs such as preparation, layout, computed annually for differences between the design and production of advertising are deferred. financial statement and the tax basis of assets They are expensed when the advertisement and liabilities that will result in taxable or deductible is first used, except for the costs of executory amounts in the future based on enacted tax laws contracts, which are amortized as performance and rates applicable to the periods in which the under the contract is received. Advertising costs differences are expected to affect taxable income. deferred at December 31, 2005 and 2004, were Valuation allowances are established when $585,000 and $478,000 respectively. Advertising necessary to reduce deferred tax assets to the expense for the years ended December 31, amount expected to be realized. 2005 and 2004 amounted to $3,784,000 and $1,055,000, respectively. [8] EARNINGS PER COMMON SHARE: [6] PROPERTY, PLANT AND EQUIPMENT: Basic earnings per share is calculated by dividing net profit attributable to common Property, plant and equipment are stated at stockholders by the weighted average number of cost less accumulated depreciation and amortization. outstanding common shares during the year. The Company computes depreciation and Basic earnings per share exclude any dilutive amortization using the straight-line method over effects of options, warrants and other stock-based NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONT.) compensation, which are included in diluted accepted in the United States of America requires m ed ifa st 2005 annual repor t 31 earnings per share. [9] REVENUE: management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and Revenue is recognized for product sales expenses during the reporting periods. Actual upon shipment and passing of risk to the customer results could differ from those estimates. and when estimates of discounts, rebates, promo- tional adjustments, price adjustments, returns, [11] FAIR VALUE OF FINANCIAL INSTRUMENTS: and other potential adjustments are reasonably determinable, collection is reasonably assured The carrying amounts reported in the and the Company has no further performance consolidated balance sheets for cash, certificates obligations. These estimates are presented in the of deposit, accounts receivable, accounts payable financial statements as reductions to net revenues and accrued liabilities approximate fair value and accounts receivable. Estimated sales returns, because of the immediate or short-term maturity allowances and discounts are provided for. of the financial instruments. Outbound shipping charges to customers and approximates fair value based on current yields outbound shipping-related costs are netted and for debt instruments with similar terms. The Company believes that its indebtedness included in “cost of sales.” Returns - Consistent with industry practice, the [12] CONCENTRATION OF CREDIT RISK: Company maintains a return policy that allows its customers to return product within a specified Financial instruments that potentially subject period (30 days). Because the period of payment the Company to credit risk consist of cash, generally approximates the period revenue certificates of deposit, investment securities and was originally recognized, refunds are recorded as trade receivables. Cash, money markets and a reduction of revenue when paid. The Company’s investments exceed the federal insurance coverage estimate for returns is based upon its historical by $2,248,000 and $3,525,000, respectively. The experience with actual returns. While such experience Company securities at December 31, 2005 and has allowed for reasonable estimation in the past, 2004, include amounts deposited with multiple history may not always be an accurate indicator of financial institutions markets its products primarily future returns. The Company continually monitors its to medical professionals, clinics, and Internet estimates for returns and makes adjustments medical sales and has no substantial concentrations when it believes that actual product returns may of credit risk in its trade receivables. differ from the established accruals. [10] ESTIMATES: As of December 31, 2005 and 2004, the Company had two customers that individually represented over 10% of the accounts receivable The preparation of financial statements in and in the aggregate, approximately 36% and conformity with accounting principles generally 49% of the accounts receivable, respectively. 32 medifas t 2005 ann ual re por t NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONT.) [13] STOCK-BASED COMPENSATION: Company’s common stock to officers, employees, directors and consultants. Incentive options are to The Company has adopted Statement of Financial be granted at fair market value. Options are to be Accounting Standards No. 123, “Accounting for Stock exercisable as determined by the stock option Based Compensation” (“SFAS 123”). The provisions of committee. SFAS 123 allow companies to either expense the estimated value of stock options or to continue to In November 1997, June 2002 and July 2004, the follow the intrinsic value method set forth in Company amended the Plan by increasing the number Accounting Principles Bulletin Opinion No. 25, of shares of the Company’s common stock subject to “Accounting for Stock Issued to Employees” (“APB 25”), the Plan by an aggregate of 200,000 shares, 300,000 but disclose the pro forma effects on net income (loss) shares and 250,000 shares respectively. had the fair value of the options been expensed. The Company has elected to continue to apply APB 25 in The Company has elected to continue to account accounting for its employee stock option incentive for stock option grants in accordance with APB 25 and plans. Under APB 25, where the exercise price of the related interpretations. Under APB 25, where the Company’s employee stock options equals the market exercise price of the Company’s employee stock price of the underlying stock on the date of grant, no options equals the market price of the underlying stock compensation is recognized. on the date of grant, no compensation is recognized. STOCK OPTION PLAN If compensation expense for the Company’s On October 9, 1993 and as amended in May 1995, consistent with SFAS 123, the Company’s net income the Company adopted a stock option plan (“Plan”) and net income per share including pro forma results authorizing the grant of incentive and nonincentive would have been the amounts indicated below: options for an aggregate of 500,000 shares of the stock-based compensation plans had been determined Ye ars End ed D ecem be r 31 2005 2004 2003 Net income: As reported $2,727,000 $1,747,000 $2,410,000 Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (280,000) (108,000) (403,000) Pro forma $2,447,000 $1,639,000 $2,007,000 Net income per share: as reported: Basic $ 0.20 $ 0.16 $ 0.25 Diluted $ 0.19 $ 0.14 $ 0.22 Pro forma: Basic $ 0.20 $ 0.15 $ 0.21 Diluted $ 0.19 $ 0.13 $ 0.18 m ed ifa st 2005 annual repor t 33 NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONT.) 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 granted is estimated as of the date of grant using the Black-Scholes option-pricing model with the following assumptions: 2005 2004 2003 Dividend yield 0.0% 0.0% 0.0% Expected volatility 0.70 0.40 0.40 Risk-free interest rate 4.50% 4.50% 3% - 5% Expected life in years 1-5 1-5 1-5 The weighted average fair value at date of grant for options granted during the years 2005, 2004, and 2003 were $2.64, $8.60, and 5.32, respectively, using the above assumptions. The following summarizes the stock option activity for the years ended December 31: 2005 2004 2003 Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price Outstanding at beginning of year 389,397 1.51 439,455.00 1.76 891,669.00 0.69 Options granted 333,333 2.64 30,000.00 8.60 163,500.00 5.32 Options reinstated - 0.00 - 0.00 - 0.00 Options exercised (138,335) (1.83) (47,221) (1.19) (615,714) (1.16) Options forfeited or expired (299,668) (1.17) (32,837) (7.01) - 0.00 Outstanding at end of year 284,727 2.41 389,397.00 1.51 439,455.00 1.76 Options exercisable at year end 254,725 3.17 350,336.00 1.11 302,668.00 0.76 Options available for grant at end of year 965,273 860,603 810,545 The following table summarizes information about stock options outstanding and exercisable at December 31, 2005: Options Outstanding Options Exercisable Weighted Average Contractual Weighted Weighted Range of Life Average Average Exercise Number Remaining Exercise Number Exercise Prices Outstanding (in Years) Price Exercisable Price $0.25 6,669 1.0 $0.25 6,669 $0.25 $0.32 3,334 .40 $0.32 3,334 $0.32 $0.80 16,666 1.5 $0.80 16,666 $0.80 $2.67 178,334 4.1 $2.67 178,334 $2.67 $3.83 40,000 4.8 $3.83 13,332 $3.83 $4.80 19,724 2.3 $4.80 19,724 $4.80 $8.60 10,000 3.0 $8.60 6,666 $8.60 $11.15 10,000 2.5 $11.15 10,000 $11.15 284,727 $2.41 254,725 $3.17 34 medifas t 2005 ann ual re por t NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONT.) [15] RECENT ACCOUNTING PRONOUNCEMENTS categories: held-to-maturity, available-for-sale and trading. The Company’s investments consist In December 2004, the FASB issued Financial of debt and equity securities classified as Accounting Standards No. 123 (revised 2004) (FAS available-for-sale securities. Accordingly, they are 123R), “Share-Based Payment, “ FAS 123R replaces carried at fair value in accordance with FAS FAS No. 123, “Accounting for Stock-Based No. 115. Further, according to FAS No. 115 the Compensation”, and supersedes APB Opinion No. unrealized holding gains and losses for available- 25, “Accounting for Stock Issued to Employees.” for-sales securities are excluded from earnings FAS 123R requires compensation expense, measured and reported, net of deferred income taxes, as a as the fair value at the grant date, related to share- separate component of stockholders’ equity, based payment transactions to be recognized unless the loss is classified as other than a tempo- in the financial statements over the period that rary decline in market value. an employee provides service in exchange for the award. The Company intends to adopt FAS [17] GOODWILL AND OTHER INTANGIBLE ASSETS 123R using the “modified prospective” transition method as defined in FAS 123R. Under the modified In June 2001, the Financial Accounting Standards prospective method, companies are required to Board (“FASB”) issued Statement No. 142 “Goodwill record compensation cost prospectively for the and Other Intangible Assets”. This statement unvested portion, as of the date of adoption, of addresses financial accounting and reporting for previously issued and outstanding awards over the acquired goodwill and other intangible assets remaining vesting period of such awards. FAS 123R and supersedes APB Opinion No. 17, “Intangible is effective January 1, 2006. The Company is Assets”. It addresses how intangible assets that evaluating the impact of FAS 123R on the Company’s are acquired individually or with a group of other results and financial position. assets (but not those acquired in a business combination) should be accounted for in In November 2004, the FASB issued Financial financial statements upon their acquisition. This Accounting Standards No. 151 (FAS 151), “Inventory Statement also addresses how goodwill and other Costs - an amendment of ARB No. 43, Chapter intangible assets should be accounted for after 4”. FAS 151 clarifies the accounting for abnormal they have been initially recognized in the financial amounts of idle facility expense, freight, handling statements. The Company, in its acquisitions, costs and spoilage. In addition, FAS 151 requires recognized $893,850 of goodwill. The Company companies to base the allocation of fixed production performs its annual impairment test for goodwill overhead to the costs of conversion on the nor- at year-end. As of December 31, 2005, the Company mal capacity of production facilities. FAS 151 is has determined that there is no impairment of effective for fiscal years beginning after June 15, its goodwill. 2005. FAS 151 did not have a material impact on its results or financial statements. In addition, the Company has acquired other [16] INVESTMENTS intangible assets, which include: customer lists, non-compete agreements, trademarks and patents. The non-compete agreements are being amortized In accordance with FAS No. 115, “Accounting over the legal life of the agreements ranging for Certain Investments in Debt and Equity between 3 to 7 years. The customer lists are being Securities”, securities are classified into three amortized over a period ranging between 5 to 10 m ed ifa st 2005 annual repor t 35 NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONT.) years based on management’s best estimate of NOTE C - INVENTORY the expected benefits to be consumed or otherwise used up. Trademarks and patents are Inventory consists of the following at December 31, 2005 and 2004: regularly reviewed to determine whether the 2005 2004 facts and circumstances exist to indicate that the Raw materials $1,906,000 $1,085,000 useful life is shorter than originally estimated Packaging 1,142,000 958,000 or the carrying amount of the assets may not be Finished goods 2,427,000 2,208,000 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. [18] COMPREHENSIVE INCOME (LOSS) $5,475,000 $ 4,251,000 NOTE D - PREPAID EXPENSES AND OTHER CURRENT ASSETS Prepaid expense and other current assets as of December 31, 2005 and 2004, consist of the following: 2005 2004 Marketing and advertising $800,000 $478,000 Taxes 779,000 25,000 Commissions 792,000 - Supplies 393,000 - Comprehensive income (loss) is defined as the Insurance 294,000 273,000 change in equity of a business enterprise during Services 50,000 73,000 a period from transactions and other events and Other 165,000 230,000 circumstances from non-owner sources, including $3,273,000 $1,079,000 unrealized gains and losses on marketable securities. The Company presents comprehensive NOTE E - PROPERTY, PLANT AND EQUIPMENT income in its consolidated statements of stockholders equity. [19] RECLASSIFICATIONS Certain amounts for the years ended December 31, 2004 and 2003 have been reclassified to conform to the presentation of the December 31, 2005 amounts. The reclassifications have no effect on net income for the years ended December 31, 2004 and 2003. Property, plant and equipment as of December 31, 2005 and 2004, consist of the following: 2005 2004 Land $ 650,000 $ 650,000 Building and building improvements 6,871,000 6,728,000 Equipment and fixtures 5,583,000 4,062,000 Vehicle 19,000 11,000 13,123,000 11,451,000 Less accumulated depreciation and amortization 3,588,000 2,753,000 Property, plant and equipment - net $ 9,535,000 $ 8,698,000 Substantially all of the Company’s property, plant and equipment are pledged as collateral for various loans (see Note J). Depreciation expense for the years ended December 31, 2005, 2004, and 2003 were $835,000, $804,000 and $421,000, respectively. 36 medifas t 2005 ann ual re por t NOTE F - TRADEMARKS AND INTANGIBLES AS OF DECEMBER 31, 2005 AS OF DECEMBER 31, 2004 GROSS GROSS CARRYING ACCUMULATED CARRYING ACCUMULATED AMOUNT AMORTIZATION AMOUNT AMORTIZATION Customer lists $ 4,514,000 $ 873,000 $ 4,355,000 $ 394,000 Non-compete agreements 840,000 566,000 840,000 248,000 Trademarks and patents 1,821,000 121,000 1,703,000 12,000 Goodwill 894,000 - 894,000 - Total $ 8,069,000 $ 1,560,000 $ 7,792,000 $ 654,000 AMORTIZATION EXPENSE FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 WAS AS FOLLOWS: 2005 2004 2003 Customer lists $ 479,000 $ 244,000 $ 127,000 Non-compete agreements 369,000 162,000 86,000 Trademarks and patents 58,000 - 14,000 Total trademarks and intangibles $ 906,000 $ 406,000 $ 227,000 Amortization expense is included in selling, general and administrative expenses. The estimated future amortization expense of trademarks and intangible assets is as follows: For the years ending December 31, Amount 2006 $1,125,000 2007 755,000 2008 640,000 2009 462,000 2010 462,000 medifast 2005 annual rep or t 3 7 NOTE G - ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses as of December 31, 2005 and 2004 consist of the following: 2005 2004 Trade payables $ 1,695,000 $ 343,000 Accrued expenses and other - 116,000 Accrued payroll and related taxes 314,000 215,000 Sales commissions payable 254,000 266,000 Total $ 2,263,000 $940,000 NOTE H - 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 with leases commencing 2004 and 2005. 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, 2005: For the Years Ending December 31, 2006 $ 227,000 2007 191,000 2008 147,000 2009 142,664 2010 53,000 Total minimum payments required $ 760,664 38 m edi fas t 2005 ann ual re por t NOTE I - INCOME TAXES Significant components of the income tax benefit for the years ended December 31 are as follows: 2005 2004 2003 Current: Federal $ 685,000 $ 600,000 $ 973,000 State 217,000 90,000 175,000 Total Current 902,000 690,000 $ 1,148,000 Deferred: Federal $ 261,000 $ 408,000 $ - State 40,000 61,000 - Total deferred 301,000 469,000 - Income tax expense $ 1,203,000 $ 1,159,000 $ 1,148,000 A reconciliation between the provision for income taxes calculated at the U.S. federal statutory income tax rate and the consolidated income tax benefit in the consolidated statements of income for the years ended December 31 is as follows: 2005 2004 2003 Provision at the U.S. federal statutory rate $ 1,272,000 $ 1,087,000 $ 973,000 State taxes, net of federal benefit 198,000 145,000 175,000 Intangible assets (153,000) (73,000) - Other temporary differences (98,000) - - Permanent differences (16,000) - - Income tax expense $ 1,203,000 $ 1,159,000 $ 1,148,000 medifast 2005 annual rep or t 3 9 NOTE I - INCOME TAXES (CONTINUED) Medifast, Inc.’s deferred income taxes reflect the net tax effect of temporary differences between the bases of assets and liabilities for financial reporting purposes and their bases for income tax purposes. Significant components of the Company’s deferred tax liabilities and assets as of December 31 are as follows: 2005 2004 Deferred tax assets Net operating loss carryforwards $ - $ - Intangible assets - 110,000 Accounts receivable - - Inventory overhead and write downs - - Section 263A - - Total deferred tax assets $ - $ 110,000 Deferred Tax Liabilities Intangible assets $ (113,000) $ - Accounts receivable (37,000) - Inventory overhead and write downs (41,000) - Total deferred tax liabilities $ (191,000) $ - The 2005 effective income tax rate of 30.6% differed from the federal statutory rate of 34% due to the amortization of intangible assets, timing differences for other temporary and permanent differences, and state income taxes. The 2004 effective income tax rate differed from the federal statutory rate due to state taxes, amortization of intangible assets, and for a net operating loss deduction carried forward from 2003. The 2003 effective income tax rate differed from the federal statutory rate due to state taxes. 40 medifas t 2005 ann ual re por t NOTE J- LONG-TERM DEBT AND LINE OF CREDIT Long-term debt as of December 31, 2005 and 2004, consist of the following: 2005 2004 $2,850,000 fifteen year term loan secured by the building and land at a variable rate which was 7.13% at December 31, 2005 $ 2,201,000 $ 2,391,000 $1,760,000 ten-year reducing revolver line of credit rate at LIBOR plus 220 bps , which was 6.58% on December 31, 2005 1,506,000 1,623,000 $186,976 three-year term loan secured by 20,000 restricted common shares variable rate which was 10.25% at December 31, 2005 59,000 111,000 $200,000 five-year term loan secured by equipment fixed rate was 3% at December 31, 2005 90,000 130,000 $475,000 seven-year loan secured by the building and land at a variable rate at LIBOR plus 250 bps, which was 6.885% on December 31, 2005 428,000 459,000 $366,000 three-year term loan secured by certain assets at LIBOR plus 250 basis points, which was at 6.885% at December 31, 2005 254,000 - $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, 2004. - - 4,538,000 4,714,000 Less current portion 561,000 458,000 $ 3,977,000 $ 4,256,000 Future principal payments on long-term debt for the next 5 years are as follows: 2006 $561,000 2007 503,000 2008 356,000 2009 339,000 2010 339,000 Thereafter 2,440,000 $4,538,000 The Company has established a $5 million revolving line of credit at the LIBOR rate plus 1.30% with Mercantile Safe Deposit and Trust Company secured by substantially all of the assets of Jason Pharmaceuticals, Inc. Effective January 17, 2004, $650,000 of the line of credit was converted to a note payable secured by all assets of Jason Pharmaceuticals excluding trademarks at a variable rate at libor plus 250 basis points which was 6.38% on December 31, 2005. The outstanding balance on this line was $633,000 and $369,000 at December 31, 2005 and 2004, respectively. The outstanding balance on this line was $633,000 and $369,000 at December 31, 2005 and 2004, respectively. The line of credit is renewed annually in October. medifast 2005 annual rep or t 4 1 NOTE K - EMPLOYMENT AGREEMENTS share of common stock for each share of convertible preferred stock. In 2001, 157,000 shares opted to The CEO of Medifast, Inc., Bradley T. MacDonald, convert to Series “C” Preferred Convertible Stock has a two-year employment agreement for an and 85,000 shares were redeemed under the partial aggregate annual base salary of $225,000 with a settlement and conversion to Series “C” preferred bonus potential of 50% of base salary provided convertible stock offered to Series “A” preferred the Company makes its profit plan per the Board stockholders as approved by the Board of Directors. approved forecast. This contract has been extended In 2002 the remaining 75,000 shares were redeemed. 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 Company, the Board of Directors approved a Selective Executive 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 deferred by Mr. MacDonald followed by a Company match of $50,000. In 2005, the Board of Directors approved the funding of $100,000 into Mr. MacDonald’s Selective Executive Retirement Compensation Plan. This brought the Selective Executive Retirement Compensation Plan total funded value to $550,000. Beginning January 1, 2006 the agreement was modified whereby the deferred compensation will be earned over a 5-year vesting period due January 1, 2011. Mr. MacDonald exercised 13,333 options at $2.67 in July of 2005 and executed 2,000 warrants at $.35 in March 2005. NOTE L - 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 convertible into the Company’s common stock on the basis of one NOTE M - 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 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. On January 15, 2005, 300,614 shares of Series “B” Convertible Preferred Stock were converted into 601,228 shares of Common Stock. Additionally, a 10% common stock dividend was paid out upon conversion that resulted in 521,158 shares being issued to the Series “B” Convertible Preferred stock investors. As of December 31, 2005 there were no shares of Series “B” Convertible Preferred Stock remaining. 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 conversion price will be 75% of the market value of the Company’s common stock on the day prior to conversion with a maximum conversion price of $.50 per share subject to adjustment 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 42 medifas t 2005 ann ual re por t conversions of Series “B” preferred at $0.50 per per year over a five-year period. These are share in common stock and eliminated the spiral five-year warrants to purchase common shares at conversion provision and reduced voting to 2 an exercise price of $4.80 per share. These votes per share. warrants may be cancelled, with a 90-day notice, if the consultants fail to perform to the satisfaction NOTE N - SERIES “C” PREFERRED CONVERTIBLE of the Company. During 2005, 120,000 unvested 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 warrants issued to James Paradis and Anthony Burrascono were cancelled. In addition, the Company canceled 120,000 unvested warrants issued to David Scheffler. $1.00 per share. Each share is entitled to a dividend During 2003, the Company issued 50,000 of 10% of liquidation value $1.00 ($.10) per share warrants to Consumer Choices Systems, Inc. and is to be converted on December 31, 2006 (“CCS”) as part of the payment for the purchase of unless converted prior thereto. Each Holder of the assets of CCS. These warrants are three-year Preferred Series “C” Stock is entitled to one (1) warrants to purchase common shares at an vote per share in all matters in which holders of exercise price of $10.00 per share. Of this amount, the Company’s Common Stock are entitled to 25,000 warrants were exercised in 2004. 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 distributed proportionately to Series “C’ preferred holders. 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 On August 2, 2005, 200,000 shares of Series average price, all pursuant to the terms of that “C” Preferred Convertible Stock were converted certain Securities Purchase Agreement by and into 400,000 shares of Common Stock. As of between the Company and Mainfield Enterprises, December 31, 2005 there were no shares of Series Inc. and Portside Growth & Opportunity Fund “C” Preferred Convertible Stock remaining and no dated as of July 24, 2003. additional dividend payments are owed. NOTE O - WARRANTS at $.35. During 2005, there were 2,000 warrants exercised During 2003, the Company issued 200,000 The fair value of these warrants were estimated warrants to James Paradis and Anthony Burrascono, using the Black-Scholes pricing model with the both affiliated with Villanova University and following assumptions: interest rate 4.5%, 200,000 warrants to Mr. David Scheffler, an dividend yield 0%, volatility 0.40 and expected investment banker, for advisory and consulting life of five years. services provided to the Company. The warrants vest in five equal installments of 40,000 warrants medifast 2005 annual rep or t 4 3 NOTE O - WARRANTS (CONTINUED) The Company has the following warrants outstanding for the purchase of its common stock: Years Ended Exercise December 31, Price Expiration Date 2005 2004 2003 $0.35 August, 2004 - - 40,100 $0.35 March, 2005 - 2,000 - $0.63 September, 2004 - - 2,500 $4.80 April, 2008 160,000 360,000 400,000 $10.00 June, 2006 25,000 25,000 25,000 $16.78 July, 2008 82,500 82,500 82,500 267,500 469,500 550,100 Weighted average exercise price $8.98 $7.16 $6.49 As of December 31, 2005, 267,500 of the warrants are exercisable. NOTE P - COMMITMENTS, CONTINGENCIES AND OTHER MATTERS The Company, like other manufacturers and distributors 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 Q - LITIGATION There was no material pending or threatened litigation against Medifast, Inc. or its subsidiaries as of December 31, 2005. 44 medifas t 2005 ann ual re por t NOTE R - QUARTERLY RESULTS (Unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter 2005 Revenue $8,326,000 $10,555,000 $10,985,000 10,263,000 Gross Profit 6,253,000 7,932,000 8,310,000 7,473,000 Operating Income 912,000 1,154,000 1,266,000 742,000 Net Income 507,000 753,000 607,000 860,000 Earnings per common share - diluted (1) 0.04 0.06 0.05 0.07 2004 Revenue 6,817,000 7,357,000 7,268,000 5,898,000 Gross Profit 5,467,000 5,411,000 5,382,000 4,334,000 Operating Income 919,000 982,000 527,000 576,000 Net Income 647,000 656,000 391,000 35,000 Earnings per common share - diluted (1) 0.05 0.06 0.03 0.00 (1) -Earnings per common share is computed independently for each of the quarters presented; accordingly, in the sum of the quarterly earnings per common share may not equal the total computed for the year. On January 17, 2006, Jason Enterprises, Inc., a wholly owned subsidiary of Medifast, Inc. sold certain assets of its Consumer Choice Systems division. Consumer Choice Systems distributes products focused on women’s well being to include supplements for menopause relief and urinary tract infections. The sale price was $1.82 million which included $358,000 in inventory, $131,000 in receivables, and $1,337,000 in net intangible assets. Consumer Choice Systems was sold to a former Medifast, Inc. board member. The sale price was $1.8 million and will be recorded as a note receivable by Medifast, Inc. over a 10-year term. The loan is collateralized by 50,000 shares of Medifast, Inc. stock. The following table illustrates segment information from the date Consumer Choice Systems was purchased by Medifast, Inc. on June 11, 2003 through December 31, 2005. 2005 2004 2003 Revenues, net $958,000 $1,498,000 $851,000 Cost of Sales 733,000 686,000 343,000 Gross Profit 225,000 812,000 508,000 Compensation and Professional Fees 290,000 213,000 254,000 Selling, General and Administrative Expenses 208,000 256,000 212,418 Depreciation and Amortization 209,000 90,000 95,000 Interest (net) 8,000 17,000 8,000 Net income (loss) (490,000) 236,000 (61,418) Earnings per share - basic (0.04) 0.02 (0.01) Earnings per share - diluted (0.04) 0.02 (0.01) Segment Assets 2,216,000 2,625,000 2,497,000 Fixed assets, net of depreciation 54,000 71,000 91,000 Inventory 293,000 391,000 470,000 Prepaid expenses 327,000 - 53,000 Accounts receivable 171,000 629,000 221,000 Intangible assets 443,000 635,000 635,500 Goodwill 893,500 893,500 893,500 medifast 2005 annual rep or t 4 5 PAR T I ITEM 1. BUSINESS. SUMMARY 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, 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 increased dramatically. The Centers for Disease Control (CDC) estimate that 64% of the U.S. adult population is over- weight, and 30% of these individuals (60 million) are obese which is defined as having a Body Mass Index >30. 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. 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 physical inactivity account for more than 300,000 premature deaths per year in the U.S. A 2003 market research study concluded consumers spend about $39 billion per year trying to lose weight or prevent weight gain. This includes consumer spending on diet foods, medically supervised and commercial weight loss programs, diet books, appetite suppressants, fitness clubs, diet sodas, and videos and cassettes. DISTRIBUTION CHANNELS THE MEDIFAST LIFESTYLES PROGRAM- The Medifast Lifestyles 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 program. Management estimates that more than 15,000 physicians nationwide have prescribed Medifast as a treatment for their overweight patients since 1980, and over an estimated 1 million patients have used its’ products to lose and maintain their weight. Direct-to-consumer sales represent approximately 45% of Medifast, Inc.’s total sales. 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 support. The Company also offers an additional in-house support program to assist customers that are consulting their primary care physician. Customers have access to qualified nutritional counselors for program support and advice via a toll free telephone help line or by e-mail. 46 medifas t 2005 ann ual re por t TAKE SHAPE FOR LIFE™ - Take Shape for Life is HI-ENERGY WEIGHT CONTROL CENTERS - In 2003, a physician led network of independent health the Company acquired Hi-Energy Weight Control coaches who are specifically trained to provide Centers, a national company specializing in emotional support and are conduits to give weight management programs, with weight loss clients the strategies and skills to successfully centers in over 50 locations. Hi-Energy Weight reach a healthy weight and then provide a road Control Centers offer a competitive marketing map to empower the individual to take control of edge through a regional advertising program, their health. Take Shape for Life is a support exclusive territories and marketing support. The program that moves beyond the scope of weight Company continues to seek out qualified licensees loss to show customers how to achieve optimal to add to its growing number of weight control health through the balance of body, mind, and clinics nationwide. Additionally, the Company is finances. Take Shape for Life uses the high quality, operating 11 corporately owned clinics that serve medically validated products of Medifast as the as models to attract qualified licensees. Hi-Energy platform to launch an integrity based lifelong clinics account for approximately 7% of Medifast, health optimization program. Inc.’s total sales. Program entrants are encouraged to consult with their primary care physician and a Take THE MEDIFAST® BRAND Shape for Life Health Advisor to determine the Medifast program that is right for them. Physician Medifast is a medically supervised weight directed Health Advisors are supported, educated management program, which specializes in multi- and qualified by The Health Institute, a training disciplinary patient education programs using the group staffed by Medifast professionals. Health highest quality meal replacement supplements. In Advisors obtain Medifast qualification based recent years Medifast’s core products and programs upon testing of their knowledge on Medifast have continued to expand over a wellness spectrum products and programs. to include health management products. Medifast offers products specially formulated for diabetics Take Shape for Life accounts for approximately as well as products for women’s health, joint 35% of Medifast, Inc.’s total sales. health and coronary health. MEDIFAST PHYSICIANS AND CLINICS - Many In 2003, Medifast began a two-year study Medifast physicians have chosen to implement with The Johns Hopkins Bloomberg School of the Medifast program within their practice. These Public Health to evaluate the efficacy of its physicians carry an inventory of Medifast products Medifast Plus for Diabetics compared to basic and resell them to patients. They also provide nutrition recommendations by the American appropriate testing, medical support and evaluations Diabetes Association (ADA). Final results showed for patients on the program. Physicians can also that participants using Medifast Plus for Diabetics direct their patients to order directly from lost twice as much weight and were twice as able Medifast, if they do not have space to stock to stay on the program as those following the inventory. Physician sales account for approximately ADA’s guidelines. Additionally, two-thirds of those 10% of Medifast, Inc.’s total sales. on the Medifast program lost at least 5% of their weight, which is a standard measure of the Food and Drug Administration’s (FDA) medifast 2005 annual rep or t 4 7 threshold to indicate clinically significant weight diseases such as diabetes and coronary health. loss, versus one-quarter of those on the ADA diet. In addition to weight loss, the initial study results COMPETITION indicate that Medifast participants sustained an There are many different kinds of diet products average 9% decrease in blood fasting glucose and and programs within the weight loss industry. These an average 19% decrease in insulin levels. include a wide variety of commercial weight loss programs, pharmaceutical products, weight loss Many Medifast Plus for Diabetics products books, self-help diets, dietary supplements, have earned the coveted Seal of Approval from appetite suppressants and meal replacement the Glycemic Research Institute. The line, shakes and bars. designated as Low Glycemic, does not overly stimulate blood glucose and insulin and does not The Company has proven it can compete stimulate fat-storing enzymes. Products included in this competitive market because its products in the Medifast Plus for Diabetics line consist of have been clinically tested and proven at Johns three delicious patented shakes, home style chili, Hopkins University and have been safely and apple cinnamon, French vanilla berry oatmeal, effectively used by customers for over 20 maple and brown sugar oatmeal, creamy chicken years. Medifast has been on the cutting edge of soup, creamy broccoli soup, chicken noodle soup, product development with soy based nutritional minestrone soup and two snack bars. and weight management products since 1989. These products are formulated with high-quality, Most Medifast products qualify to make the low-calorie, low-fat ingredients that provide FDA’s heart healthy claim, “May Reduce the Risk alternatives to fad diets or medicinal weight of Heart Disease.” In order to make this claim, a loss remedies. product must contain at least 6.25 grams of soy protein per serving and be low in fat, saturated The Medifast program has been recommended fat, and cholesterol. Unlike popular fad diets and by physicians for more than 25 years and some herbal supplements, Medifast products are a safe, Medifast practitioners choose to prescribe nutritionally balanced choice, offering gender appetite suppression diet drugs to patients in specific formulas containing high protein and low conjunction with a Medifast based diet. Diet drug carbohydrates, a soy protein source rather than therapies such as those that suppress appetite animal protein source, and vitamin and mineral usually require a restricted calorie diet in order for tification. It is ver y difficult to meet the to obtain desired results. Medifast is a minimum recommended nutritional requirements on dosage/portion controlled weight management a low-calorie diet, but a dieter can easily meet these solution that is effective in conjunction with requirements using the nutrient dense Medifast drug therapy as prescribed by physicians working brand of meal replacement food supplements. within the individual needs of their patients. The Medifast program alone is a mild ketogenic diet that Medically supervised, low calorie diets are naturally suppresses appetite and eliminates hunger continuing to gain popularity, as consumers search without other therapies for most people. for a safe and effective solution that provides balanced nutrition, quick weight loss and valuable behavior modification education. In addition, consumers are becoming more aware of chronic 48 medifas t 2005 ann ual re por t PRODUCTS NEW PRODUCTS The Company offers a variety of weight and The Company expanded the Medifast product disease management products under the Medifast® line in 2005 by introducing Medifast® Banana Creme brand and for select private label customers. The Shake, Medifast® Peach Oatmeal, Medifast® Beef Medifast line includes Medifast® 55, Medifast® 70, Vegetable Stew, Medifast® Red Bell Pepper Italian Medifast® Plus for Appetite Suppression, Medifast® dressing, and Medifast® Ranch dressing. Medifast Plus for Diabetics, Medifast® Plus for Joint Health, also introduced a line of diabetic products that Medifast® Plus for Women’s Health, Medifast® Plus includes shakes and bars under the Medifast® for Coronary Health, Medifast® Fit!, Medifast® Take Maintain line. Shape™, Medifast® Supplement Bars, Medifast® Creamy Soups, Medifast® Minestrone Soup, MARKETING Medifast® Hot Cocoa, Medifast® Oatmeals, Medifast® Pro Teas, Medifast® Chicken Noodle Soup, Medifast® The Company continued to build and leverage Fast Soups, Medifast® Homestyle Chili and Medifast® its core Medifast brand through multiple marketing Multigrain Crackers. strategies to its target audiences. Print advertising, television, and radio were all used to target new Medifast nutritional products are formulated customers by stressing Medifast’s quick, easy and with high-quality, low-calorie, low-fat ingredients. safe approach to weight management. Also, direct Many Medifast products are soy based and contain mail has been utilized to encourage and support 24 vitamins and minerals, as well as other nutrients existing customers. essential for good health. The Company uses DuPont Protein Technologies’ Supro® brand soy Online advertising began to be used in 2004 protein, which is a high-quality complete protein and it included keyword search, banner ads, affiliate derived from soybeans. programs, and targeted direct email campaigns. The online advertising has been supported by Medifast’s Medifast brand awareness continues to well designed, user-friendly website, which provides expand through the Company’s marketing campaigns, a wealth of information and customer support for product development, line extensions, and the easy ordering functionality. Company’s emphasis on quality customer service, technical support and publications developed by SALES the Company’s marketing staff. Medifast products have been proven to be effective for weight and The Company’s Sales division handles three primary disease management in clinical studies conducted areas: by the U.S. government and Johns Hopkins University. The Company has continued to develop its sales Physician and Clinic Sales-- The sales team is an d ma r keting operations with qu ali f i ed responsible for prospecting larger medical man agement and innovative programs. The accounts, clinics, hospitals, and HMOs. During Company’s facility in Owings Mills, MD manufactures 2005, the sales team attended a number of medical powders and a portion of its supplement bars and professional trade shows, which expanded Medifast’s subcontracts the production of its Ready-to-Drink penetration of the clinical business segment. products and additional bars. Hi-Energy Weight Control Centers-- During 2005 medifast 2005 annual rep or t 4 9 Hi-Energy provided ongoing support to its licensees GOVERNMENTAL REGULATION HISTORY as well as to the Company’s 11 corporately owned centers which opened at the end of 2004. This support included marketing 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 physicians to provide Hi-Energy programs and services to local hospitals and private practices. 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 Take Shape for Life-- Provides a sales force of in its literature and labeling that its products produce independent Health Advisors who support patients or create medicinal effects or possess drug-related and their primary care physicians with a defined characteristics. The FDA could, in certain circumstances, support program. Take Shape for Life is a support require the reformulation of certain products to meet program that moves beyond the scope of weight new standards, require the recall or discontinuation loss to show customers how to achieve optimal of certain products not capable of reformulation, or health through the balance of body, mind, and finances. require additional record keeping, expanded MANUFACTURING documentation of the properties of certain products, expanded or different labeling, and scientific Jason Pharmaceuticals, Inc., the Company’s substantiation. If the FDA believes the products are wholly owned manufacturing subsidiary, produces unapproved drugs or food additives, the FDA may over 80% of the Medifast products in a state-of-the-art initiate similar enforcement proceedings. Any or food and pharmaceutical-grade facility in Owings all such requirements could adversely affect the Mills, Maryland. Management purchased the plant Company’s operations and its financial condition. in July 2002 for $3.4 million. The FDA also requires “medical food” labeling to list The manufacturing facility has the capacity for the name and quantity of each ingredient and identify significant increases to its production output with the product as a “weight management/modified fasting minimal capital expenditures. Adding additional or fasting supplement” in the labeling. shifts, along with minor capital expenditures for machinery would enable the Company to produce enough products to generate over $200 million in sales. 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 Manufacturing processes, product labeling, regulations and enforcement powers of the Federal quality control and equipment are subject to Trade Commission (“FTC”), and the Consumer Product regulations and inspections mandated by the Safety Commission. The Company’s activities are also Food & Drug Administration (FDA), the Maryland regulated by various agencies of the states and localities State Department of Health and Hygiene, and the in which the Company’s products are sold. The Company’s Baltimore County Department of Health. The plant products are manufactured and packaged in accordance strictly adheres to all GMP practices and has with customers’ specifications and sold under their maintained its status as an “OU” (Orthodox Union) private labels both domestically and in foreign kosher-approved facility since 1982. countries through independent distribution channels. 50 medifas t 2005 ann ual re por t PRODUCT LIABILITY AND INSURANCE its corporately owned Hi-Energy Weight Control The Company, like other producers and distributors and Texas. The leases range in terms from one to clinics throughout Florida, Arkansas, Mississippi of ingested products, faces an inherent risk of five years. 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 IT EM 3. LE GA L PR OCEE DING S. product liability claims with respect to the products it manufactures. With respect to the retail and direct There were no material pending legal matters marketing distribution of products produced by as of 12/31/05. others, the Company’s principal form of insurance consists of arrangements with each of its suppliers of those products to name the Company 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. EMPLOYEES As of December 31, 2005, the Company employed 164 full-time and contracted employees, of whom 62 were engaged in manufacturing, IT EM 4. SU BM IS SI ON OF MAT TE RS TO A V OT E OF S ECUR IT Y H OLDERS The Medifast Annual Shareholder Meeting was held on September 16, 2005 at the Roland E. Powell Convention Center in Ocean City, Maryland. The shareholders voted Michael C. MacDonald (96%), Mary T. Travis* (98%) and Joseph D. Calderone, O.S.A* (98%) as Class II Directors that will hold office until 2008, and Michael J. McDevitt (97%), and warehouse management, and shipping, and 102 in George Lavin, Jr., Esq* (98%) as Class III Directors. marketing, administrative, call center and corporate Class III Directors will hold office until the next support functions. None of the employees are subject to a collective bargaining agreement with the Company. ITEM 2. DESCRIPTION OF PROPERT Y 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 & Company, LLC, an independent member of the BDO Seidman The Company owns a 49,000 square-foot Alliance, as the Company’s independent auditors facility in Owings Mills, Maryland, which contains its for the fiscal year ending December 31, 2005. Lastly, Corporate Headquarters and manufacturing plant. the shareholders voted to increase the number of In 2003, the Company purchased a state-of-the-art authorized shares of common stock by 5 million 119,000 square-foot distribution facility in Ridgely, shares to 20 million shares authorized. Maryland. The facility gives the Company the ability to distribute over $200 million of Medifast product * Independent Director sales per year. In 2004, the Company purchased a 3,000 square foot conference and training facility 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 medifast 2005 annual rep or t 5 1 Th e following are the B oard of Direc tor s: Date First Name Age Position Became Director Bradley T. MacDonald 58 Chairman of the Board, 1996 Chief Executive Officer and Director Donald F. Reilly 58 Director 1998 Michael C. MacDonald 52 Director 1998 Mary T. Travis 55 Director 2002 Joseph D. Calderone 57 Director 2003 George Lavin, Jr 76 Director 2005 Michael J. McDevitt 57 Director 2002 bradleY t. Macdonald became Chairman of the Board of Directors of the Marine Corps Reserve Toys Board and Chief Executive Officer of Medifast, Inc. for Tots Foundation. on January 28, 1998. Prior to joining the Company, he was appointed as Program Director of the U.S. reverend donald francis reillY, o.s.a., a Olympic Coin Program of the Atlanta Centennial Director, holds a Doctorate in Ministry (Counseling) Olympic Games. Mr. MacDonald was previously from New York Theological and an M.A. from employed by the Company as its Chief Executive Washington Theological Union as well as a B.A. Officer from September 1996 to August 1997. From from Villanova University. Reverend Don Reilly was 1991 through 1994, Colonel MacDonald returned to ordained a priest in 1974. His assignments included active duty to be Deputy Director and Chief Financial Associate Pastor, Pastor at St. Denis, Havertown, Officer of the Retail, Food, Hospitality and Pennsylvania, Professor at Villanova University, Recreation Businesses for the United States Marine Personnel Director of the Augustinian Province Corps. Prior thereto, Mr. MacDonald served as Chief of St. Thomas of Villanova, Provincial Counselor, Operating Officer of the Bonneau Sunglass Company, Founder of SILOAM Ministries where he ministers President of Pennsylvania Optical Co., Chairman and and counsels HIV/AIDS patients and caregivers. He CEO of MacDonald and Associates, which had major is currently on the Board of Directors of Villanova financial interests in a retail drug, consumer candy, University, is President of the board of “Bird Nest” in and pilot sunglass companies. Mr. MacDonald was Philadelphia, Pennsylvania and is Board Member of national president of the Marine Corps Reserve Prayer Power. Fr. Reilly was recently elected Provincial Officers Association and retired from the United of the Augustinian Order at Villanova, PA. He States Marine Corps Reserve as a Colonel in 1997, oversees more than 300 Augustinian Friars and their after 27 years of service. He has been appointed to service to the Church, teaching at universities and the Defense Advisory Board for Employer Support high schools, ministering to parishes, serving as of the Guard and Reserve (ESGR). Mr. MacDonald chaplain in the Armed Forces and hospitals, serves on the Board of Directors of the Wireless ministering to AIDS victims, and serving missions in Accessories Group (AMEX:XWG). He is also on the Japan and South America. 52 medifas t 2005 ann ual re por t MicHael c. Macdonald, a Director, is a corporate MicHael J. Mcdevitt, a Director, is a retired FBI officer and President of Global Accounts and Special Agent with over 29 years of government Marketing Operations, for the Xerox Corporation. service with the United States Marine Corps and the Mr. MacDonald’s former positions at Xerox Corporation FBI. He had attained Senior Executive status within include executive positions in the sales and marketing the FBI’s Investigative Technology Branch and is areas. He is currently on the Board of Trustees of currently providing consulting services, focusing on Rutgers University and a Director of the Jimmy V phys ical threat and r isk as sess m ent s an d Foundation. Mr. MacDonald is the brother of cond uc ti ng speciali zed trai ni ng for law Bradley T. MacDonald, the CEO of the Company. enforcement and US Government entities. george lavin, Jr. esq., of Philadelphia, is a MarY t. travis, a Director, is currently employed nationally-known trial attorney. After serving as with Sunset Mortgage Company, L.P. in Pennsylvania an FBI Special Agent for several years, he began a as the Senior Vice President of wholesale operations private legal career in Philadelphia and was formerly the Vice President of operations with a prominent law firm, where he quickly for the Financial Mortgage Corporation. Mrs. Travis developed a national reputation as a defense is an expert in mortgage banking with over 36 lawyer in civil litigation. Since the 1970’s, he has years of diversified experience. She is an approved defended national corporations at trials in many instructor of the Mortgage Bankers Association parts of the country. In 1985, he founded his own Accredited School of Mortgage Banking. Mrs. Travis Philadelphia law firm, which has developed into was also formally a delegate and 2nd Vice president a group of more than 65 lawyers who engage in of the Mortgage Bankers Association of Greater a multi-faceted general practice while remaining Philadelphia and the Board of Governors of the State strong in the defense of civil litigation. Mr. Lavin, of Pennsylvania. She is the key financial executive on who has successfully tried hundreds of cases, is the Company’s Audit Committee providing a Fellow of the American College of Trial Lawyers, oversight of the Company’s external auditors. a committee member of the National Judicial College, a lecturer and adjunct professor at several reverend JosepH d. calderone, o.s.a., a law schools, and an honored member of a number Director, is the Associate Director of Campus Ministry of other national legal organizations. Mr. Lavin at Villanova University. He formerly spent over eight and Chilton D. Varner, a nationally-prominent years with the Loyola University Medical Center as woman civil trial attorney, are the co-authors the hospital Chaplain and taught multiple courses of a new book that will appear later this year, including Introduction to the Practice of Medicine entitled Silent Advocacy: A Practical Primer and Business Ethics. Rev. Calderone is currently a for the Trial Attorney. Captain in the US Navy Reserves and serves as the Wing Chaplain for the 4th Marine Aircraft Wing. medifast 2005 annual rep or t 5 3 PAR T 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 2005 and 2004: 2005 Low High Quarter ended March 31, 2005 2.67 3.62 Quarter ended June 30, 2005 2.82 3.30 Quarter ended September 30, 2005 3.01 7.08 Quarter ended December 31, 2005 3.83 5.70 2004 Low High Quarter ended March 31, 2004 8.60 14.05 Quarter ended June 30, 2004 4.78 9.33 Quarter ended September 30, 2004 3.05 5.09 Quarter ended December 31, 2004 3.20 5.24 (b) The quotations reflect inter-dealer prices, without retail mark-up, markdown or commissions and may not represent actual transactions. (c) There were approximately 7,112 record holders of the Company’s Common Stock, as of December 31, 2005. The Company had no preferred holders of the Company’s stock as of December 31, 2005. (d) No dividends on common stock were declared by the Company during 2005 or 2004. 54 me dif ast 2005 annu al re p or t ITEM 6. SELECTED FINANCIAL DATA The selected condensed consolidated financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as Part II, Item 7 of this Annual Report on Form 10-K, and the consolidated financial statements and notes thereto of the company included in Part II Item 8 of this Annual Report on Form 10-K. The historical results provided below are not necessarily indicative of future results. 2005 2004 2003 2002 2001 Revenue 40,129,000 27,340,000 25,379,000 12,345,000 5,022,000 Operating income 4,074,000 3,004,000 3,598,000 1,752,000 745,000 Income from continuing operations 3,930,000 2,906,000 3,558,000 1,698,000 566,000 EPS - basic 0.20 0.16 0.25 0.36 0.08 EPS - diluted 0.19 0.14 0.22 0.30 0.07 Total assets 30,545,000 25,968,000 24,230,000 9,888,000 3,357,000 current portion of long-term debt and revolving credit facilities 1,194,000 827,000 819,000 395,000 98,000 Total long-term debt 3,977,000 4,256,000 4,564,000 2,701,000 234,000 Weighted average shares outstanding Basic 12,258,734 10,832,360 9,305,731 6,722,505 6,524,969 Diluted 12,780,959 12,413,424 10,952,367 8,737,292 8,069,646 ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 2005 COMPARISON WITH 2004 OPERATING 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. Consolidated net sales for 2005 were $40,129,000 as compared to 2004 sales of $27,340,000, an increase of $12,789,000, or 47%. A major reason for the revenue increase for the Company is attributed to the continued success of direct sales to consumers as well as the expansion of the Take Shape for Life division. The increase in direct sales was attributed to an expanded direct marketing campaign via print, mail, web and television to drive customers to the call center and website. Through the effectiveness of our online ads and improved web branding a higher percentage of customers ordered on the Company’s website medifast 2005 annual rep or t 5 5 in 2005. In addition, the company expanded it purposes for intangible assets, and other remarketing campaign to drive new customers to temporary and permanent differences. Interest the call center and website. The Take Shape for expense increased to $317,000 in 2005, as Life division added a Take Shape for Life replicating compared to $245,000 in 2004. This increase was website option for Health Advisors, an Internet due to a full year of interest expense paid on a distribution program for their customers, and new loan acquired in 2004. provided health ad vi sors wi th ad di t i onal sponsoring tools to make training and The Company reported net income of $2,436,000, recruiting easier. These have proven to be effective or $0.20 per basic share ($0.19 per diluted share), at generating revenues and recruiting Health versus $1,729,000 or $0.16 per basic share ($0.14 Advisors into the Take Shape for Life Network. per diluted share), with a dilution increase of The increased training and recruitment initiatives 368,000 shares. Earnings per share were effected in 2005 have resulted in the expansion of the by the interest associated with the conversion sales network into additional locations as well as of the Series “B” preferred stock. This conversion growth in current locations. included a $260,000 stock dividend on Series Cost of sales increased from 6,746,000 “B” preferred stock and a $19,000 stock dividend in 2004 to $10,161,000 in 2005, an increase of on Series “C” preferred stock. As of December 31, $3,415,000. As a percentage of sales, cost of 2005 all Series “B” and Series “C” preferred stock goods sold increased slightly due to increased have been converted to common stock and fuel charges charged by the major shipping included in the weighed average diluted shares. companies. Gross margin was 75% at December There will be no additional stock dividend payments. 31, 2005 and 2004. Selling, general and administrative (SG&A) LIQUIDITY AND CAPITAL RESOURCES expenses of $25,894,000 for 2005 were $8,304,000 more than the $17,590,000 in 2004, due to increased At December 31, 2005, the Company had costs associated with the increased scale of the net working capital of $9,996,000, an increase business. The company increased its advertising of $2,531,000 from the $7,465,000 net working expense to include additional print and web capital balance at December 31, 2004. Cash and advertising as well as strategic testing of television investment securities at December 31, 2005 were advertising. In 2005, Company experienced $4,184,000. In November 2005, Medifast, Inc.’s income from operations of $4,074,000. This wholly owned subsidiary Jason Pharmaceuticals, compares with income from operations of Inc. renewed its $5,000,000 Secured Line of Credit $3,004,000 in 2004, an increase of 36%. The from Mercantile Safe-Deposit and Trust of Baltimore, increase in income is primarily due to higher gross Maryland. The line of credit is at LIBOR plus 1.3 profit from increased revenue offset by higher percent. The increased line may be used to finance general and administrative expenses. equipment, inventory, and receivables of Medifast, Inc. The Company currently has no off-balance In 2005, the Company realized a tax expense sheet arrangements. of $1,203,000, as compared to a tax expense of $1,159,000 in 2004. The slight increase in tax In the year ended December 31, 2005, the expense despite the increase in sales is due to Company generated cash flow of $3,213,000 from timing differences between book and tax operations, primarily attributable to higher operating 56 medifas t 2005 ann ual re por t income. This was offset by net changes in operating A major reason for the revenue increase for the assets and liabilities that decreased cash flow by Company is attributed to the continued success $2,065,000. The largest uses of cash were for the from the Take Shape for Life division, national purchase of inventory and prepaid expenses, advertising, the Hi-Energy acquisition and the which primarily consisted of prepaid taxes, insurance, redesigned website. The Take Shape for Life and advertising. division added a Take Shape for Life replicating website option for Health Advisors, an Internet In the year ended December 31, 2005, net distribution program for their customers, as well cash used in investing activities was $2,032,000, as the new Tasting Party Program. These have which primarily consisted of the purchase of proven to be effective at generating revenues and intangible assets and purchases of property recruiting Health Advisors into the Take Shape for and equipment. Life Network. The national advertising campaign included print, TV, radio, direct mail and web marketing. In the year ended December 31, 2005, net The Company increased its Internet sales in 2004 cash used in financing activities was $309,000, as compared to 2003, by redesigning its representing the principal repayments of website and increasing its web marketing. The long-term debt and purchase of treasury stock redesigned website created an easy to use shopping offset by an increase in the line of credit. cart and a more user-friendly interface. The Medifast, Inc. purchased 110,000 shares of its acquisition of Hi-Energy Weight Control Centers common stock from October 6, through October contributed to revenues throughout 2004. 17, 2005 at an average price of $4.03 per share, aggregating $452,000. Cost of sales decreased from $6,825,000 in 2003 compared to $6,746,000 in 2004, a decrease In pursuing its business strategy, the Company of $79,000. The decrease is attributed to decreases may require additional cash for operating and in costs through economies of scale. investing activities. The Company expects future cash requirements, if any, to be funded from Gross margins increased to 75% in 2004 operating cash flow and cash flow from from 73% in 2003. This was largely due to greater financing activities. economies of scale as a result of the acquisition of the Company’s 119,000 square foot distribution There are no current plans or discussions in process facility thereby creating higher margins of the relating to any material acquisition that is probable Medifast products through purchasing capabilities. in the foreseeable future. The increase is also attributed to the increased 2004 COMPARISON WITH 2003 Shape for Life programs. Selling, general and margin of Medifast direct and Internet sales directly to patients via the Lifestyles and Take OPERATING administrative (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 Consolidated net sales for 2004 were endorsements, expenses involved with starting $27,340,000 as compared to 2003 sales of and operating new corporately owned Hi-Energy $25,379,000, an increase of $1,961,000, or 8%. Weight Control Clinic locations, the expansion medifast 2005 annual rep or t 57 of the Take Shape for Life commissioned sales and accrued expenses. organization, and overall corporate infrastructure improvements. The Company experienced income In the year ended December 31, 2004, net from operations for the year 2004 of $3,004,000. cash used in investing activities was $3,510,000, This compares with income from operations of which primarily consisted of the purchase of $3,598,000 in 2003, a decrease of 17%. intangible assets, purchase of property and In 2004, the Company realized a tax expense of $1,159,000, as compared to a tax expense of In the year ended December 31, 2004, net $1,148,000 in 2003 as a result of the elimination cash used in financing activities was $304,000, of the deferred tax asset and the net operating representing the principal repayments of equipment, and the purchase of a building. loss for income tax purposes. Interest expense long-term debt. increased to $245,000 in 2004, as compared to $154,000 in 2003. This increase was due to a complete In pursuing its business strategy, the Company year of additional debt, which was acquired in 2003. may require additional cash for operating and investing A preferred stock dividend in the amount of requirements, if any, to be funded from operating $18,000 was expensed to shareholders in 2004. cash flow and cash flow from financing activities. activities. The Company expects future cash LIQUIDITY AND CAPITAL RESOURCES There are no current plans or discussions in process relating to any material acquisition that is As of December 31, 2004, the Company had probable in the foreseeable future net working capital of $7,465,000, a decrease of $1,933,000 from the $9,398,000 net working On June 11, 2003 Jason Enterprises, Inc. capital balance at December 31, 2003. Cash and acquired the assets of Consumers Choice Systems, Inc., investment securities at December 31, 2004 were a Delaware Corporation. The Company obtained all $3,238,000. On November 7, 2003 Medifast, Inc.’s the assets of the business that support their retail and wholly owned subsidiary Jason Pharmaceuticals, international business including the distribution Inc. increased its Secured Line of Credit from rights in 18,000 retail food and drug stores. Jason $1,000,000 to $5,000,000 from Mercantile Enterprises, Inc. acquired the assets for 76,120 Safe-Deposit and Trust of Baltimore, Maryland. shares of Medifast, Inc. restricted common stock The line of credit is at LIBOR plus two percent. and 50,000 five-year warrants at a purchase price The increased line may be used to finance of $10.00 per share. The transaction will be accounted equipment, inventory, and receivables of for as an asset purchase transaction. The Company Medifast, Inc. The Company currently has no is expecting to record limited and selected liabilities off-balance sheet arrangements. that amount to approximately $1.35 million. In the year ended December 31, 2004, the On July 25, 2003, the Company announced Company generated cash flow of $1,902,000 from that it had sold an aggregate of 550,000 shares of operations, primarily attributable to higher common stock and warrants to purchase 82,500 operating income, non-cash expenditures for shares of common stock (the “PIPE Shares”) to depreciation and amortization and purchases of Mainfield Enterprises, Inc. and Portside Growth & inventory and the pay down of accounts payable Opportunity Fund. The shares of common stock 58 medifas t 2005 ann ual re por t were sold for a cash consideration of $12.40 per experience the same degree of seasonality in share, or a total of $6,820,000, and the warrants, 2005. This is largely due to the increase in the exercisable for a period of five years from the consumer’s awareness of the overall health and date of issuance, at an exercise price equal to one nutritional benefits accompanied with the use of hundred fifteen percent (115%) of the five-day the Company’s product line. As consumers volume weighted average price (the “PIPE Transaction”), continue to increase their association of nutritional all pursuant to the terms of that certain Securities weight loss programs with overall health, Purchase Agreement by and between the Company and seasonality will continue to decrease. Mainfield Enterprises, Inc. and Portside Growth & Opportunity Fund dated as of July 24, 2003 (the INFLATION “Securities Purchase Agreement”). To date, inflation has not had a material effect On September 12, 2003 Medifast, Inc.’s on the Company’s business. wholly owned subsidiary Seven Crondall, LLC purchased a 119,825 sq. foot distribution facility located at 601 Sunrise Ave., Ridgely, Maryland INFORMATION SYSTEMS INFRASTRUCTURE 21660 from New Roads, Inc. for $2,200,000. The Company financed $1,760,000 through Merrill In November of 2005, the Company began an Lynch Capital at the 30 day LIBOR interest rate IT project to implement an Enterprise Resource plus 220 basis points over seven years. Planning solution to upgrade our technology infrastructure and improve manufacturing and On November 7, 2003 Medifast, Inc.’s wholly business processes. The new IT infrastructure will owned subsidiary Jason Properties, LLC purchased enable the Company to handle additional business the assets of Hi-Energy Weight Control Centers, growth and improve the efficiencies across the located in Gulf Breeze, Florida. The acquisition business platform. In addition, the Company is includes equipment, inventory, trademarks, and implementing new software for the Take Shape licenses for fifty Hi-Energy clinics. The clinics are for Life direct selling network. The software will located primarily in the southeastern region of transform and empower Take Shape for Life’s direct the United States. The assets were purchased for sales model by implementing the infrastructure, $1,500,000 in cash, which included selected tools, and support critical to increasing competitive liabilities, capital expenditures, costs of assets advantage, improving expansion and proliferation and miscellaneous fees. of the direct selling channel, facilitating support, SEASONALITY The Company’s weight management products and programs have historically been subject to seasonality. Traditionally the holiday season in success, and growth of the independent Health Advisor network, and meeting the evolving needs of Take Shape for Life’s customers. November/December of each year is considered IT EM 8. FI NANCIA L S TAT EMENTS. poor for diet control products and services. January and February generally show increases in sales, as See pages 23 through 44. these months are considered the commencement of the “diet season.” The Company did not medifast 2005 annual rep or t 5 9 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, 2005. 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, ITEM 9A. CONTROLS AND PROCEDURES and customers. (a) Evaluation of Disclosure Controls and Procedures TRADING POLICY The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) of the Securities 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 information 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 In March 2003, the Company implemented a Trading Policy whereby if a director, officer or employee has material non-public information relating to the Company, 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 business days after an earnings or special announcement to include the 10-K, 10-Q and 8-K in order to insure that investors have available the same information necessary to make investment decisions as insiders. ensuring that required information will be disclosed on a timely basis in our reports filed PA R T III under the Exchange Act. (b) Changes in Internal Control over Financial Reporting No change in our internal control over financial reporting (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 reasonably likely to materially affect, our internal control over financial reporting. ITEM 10. DIRECTORS AND EXECUTIVE DIRECTORS OF REGISTRANT Information pertaining to directors and executive officers of the Company and the Company’s Code of Conduct are incorporated herein by reference to the Company’s Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the end of the year covered by this Form 10-K with respect to the Annual M eeting of Stock holders to be he ld on S eptem ber 8, 2006. 60 medifas t 2005 ann ual re por t ITEM 11. EXECUTIVE COMPENS ATIO N. The following table sets forth information as to the compensation of the Chief Executive Officer of the Company and each other executive officer that received compensation in excess of $100,000 for 2005, 2004, and 2003. Annual Compensation Value of Common/ Preferred Stock Issued Salary Bonus in Lieu Option Other Annual Name Year ($) ($) of Cash Awards Compensation Bradley T. MacDonald 2005 225,000 - - 40,000 100,000 (Chairman of the Board 2004 225,000 - - - - & CEO) 2003 225,000 112,000 - - - Annual Compensation Value of Common/ Preferred Stock Issued Salary Bonus in Lieu Option Other Annual Name Year ($) ($) of Cash Awards Compensation Leo V. Williams, III 2005 125,000 - 12,000 10,000 - (Executive Vice President) 2004 118,000 - - 10,000 - medifast 2005 annual rep or t 6 1 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, 2005 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 2005, and a list of aggregated options and the value of these options, is provided. ALL CURRENT ALL CURRENT EXECUTIVE INDEPENDENT BRADLEY T. OFFICERS DIRECTORS MACDONALD (1) AS A GROUP AS A GROUP Options granted 255,000 210,000 110,000 Average exercise price $0.86 $2.20 $1.07 Options exercised 228,333 49,999 100,000 Average exercise price $0.97 $0.88 $0.70 Shares sold - - - Options unexercised as of 12/31/05 - 160,001 10,000 Approximate 5 YR Value of FY 05 Grants @ Potential Realizable Unexercised Unexercised Price &Expiration Value at 10% Annual Options Options Month/Year Stock Appreciation as of 12/31/05 as of 12/31/05 Current Executive Officers and Directors 135,000@$2.67 2010 $4.30 135,000 $ - Employees 158,333@$2.69 2010 $4.33 71,666 - Consultants - - - 206,966 $ - 62 medifas t 2005 ann ual re por t NUTRACEUTICAL GROUP INDUSTRY COMPARISON OF STOCK PRICES December 31, December 31, 2005 2004 $ % Company Stock Price Stock Price Change Change Medifast (MED) $5.24 $3.52 1.72 48.9% Natural Alternatives International, Inc. (NAII) 6.48 9.23 (2.75) (29.8)% Weider Nutrition (WNI) 5.09 4.35 .74 17.0% Natures Sunshine Products, Inc. (NATR) 18.08 20.36 (2.28) (11.2)% December 31, December 31, 2005 2004 $ % Company Stock Price Stock Price Change Change Medifast (MED) $5.24 $.14 5.10 3642 % Natural Alternatives International, Inc. (NAII) 6.48 2.19 4.29 196 % Weider Nutrition (WNI) 5.09 2.12 2.97 140 % Natures Sunshine Products, Inc. (NATR) 18.08 6.81 11.27 165% INDEX COMPARISON $100 invested in 2000 would return: 2000 2005 Nutraceutical Group Index $100 $1,136 Medifast $100 $3,740 Factual material is obtained from sources believed to be reliable, but the publisher is not respon- sible 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 a total of $56,400 in Director’s fees and/or expenses in 2005. See “Executive Compensation - Stock Options” for stock options granted under the 1993 Plan to the Directors. medifast 2005 annual rep or t 6 3 ITEM 12. SECURIT Y O WNER SHIP OF CER TAIN BE NEFICI AL O WNER S A ND 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, 2005 of the Chief Executive Officer, each Director, each nominee for Director, each current executive officer named in the Summary Compensation Table under “Executive Compensation” and all executive officers and Directors as is determined under the rules of the Securities and Exchange Commission and the information is not necessarily 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, 2006 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 a group. The number of shares beneficially owned forth in the table. NUMBER % OF NAME AND ADDRESS* OF SHARES OUTSTANDING Bradley T. MacDonald 1,304,479(1) 10.2% Donald F. Reilly 72,452 0.6% Michael C. MacDonald 53,419 0.4% Mary Travis 17,000 0.1% Michael J. McDevitt 22,900 0.2% Joseph Calderone 6,500 0.1% Executive Officers and Directors as a group (9 persons) 1,495,250 11.7% *The address is c/o Medifast, Inc., 11445 Cronhill Drive, Owings Mills, Maryland 21117 (1) Mr. MacDonald beneficially owns 1,304,479 shares of common stock. Mrs. Shirley D. MacDonald and Ms. Margaret E. MacDonald, wife and daughter of Mr. MacDonald, individually or jointly own 716,332 shares of stock. 64 me dif ast 2005 annu al re p or t PAR T IV ITEM 14. EXHIBITS AND REPOR TS ON FORM 8-K . (a) Exhibits (b) Reports on Form 8-K 3.1 Certificate of Incorporation of the September 21, 2005 to report the Annual Meeting Company and amendments thereto* of Shareholders September 16, 2005 3.2 By-Laws of the Company* October 19, 2005, to report the repurchase of 10.1 1993 Stock Option Plan of the Company as amended* 110,000 shares of common stock January 17, 2006, to report the sale of Consumer Choice Systems assets, the promotion of Michael 10.3 Lease relating to the Company’s S. McDevitt to Chief Financial Officer, and 2006 Owings Mills, Maryland facility** financial guidance 10.4 Employment agreement with Bradley T. MacDonald*** IT EM 14 . ACCOU NTING FEES In 2005, the Company incurred $90,000 in accounting fees as compared to $70,000 in 2004. These fees include work performed on quarterly audits and the preparation of the Company’s 10-Q’s * Filed as an exhibit to and incorporated by and 10-K. Tax fees in 2005 and 2004 were $10,000. 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. medifast 2005 annual rep or t 65 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 Dated: March 15, 2006 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 /s/ BRADLEY T. MACDONALD Chairman of the Board, March 15, 2006 Bradley T. MacDonald Director, Chief Executive Officer /s/ GEORGE LAVIN Director March 15, 2006 George Lavin /s/ MICHAEL C. MACDONALD Director March 15, 2006 Michael C. MacDonald /s/ MARY T. TRAVIS Director March 15, 2006 Mary T. Travis /s/ REV. DONALD F. REILLY, OSA Director March 15, 2006 Rev. Donald F. Reilly, OSA /s/ MICHAEL J. MCDEVITT Director March 15, 2006 Michael J. McDevitt /s/ JOSEPH D. CALDERONE Director March 15, 2006 Joseph D. Calderone 66 medifas t 2005 ann ual re por t 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 pursuant 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 Sarbanes-Oxley Act of 2002 medifast 2005 annual rep or t 6 7 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-K of Medifast, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit 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 registrant as of, and for, the periods presented in this report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange 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 procedures to be designed under our supervision, to ensure that material information relating to the registrant, including 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: March 15, 2006 /s/ Bradley T. MacDonald Bradley T. MacDonald Chairman Of the Board and Chief Executive Officer 68 medifas t 2005 ann ual re por t Exhib it 31.2 CFO Certification CERTIFICATION PURSUANT TO RULE 13a-14(a)/15d-14(a) I, Michael S. McDevitt, certify that: 1. I have reviewed this report on Form 10-K of Medifast, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit 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 registrant as of, and for, the periods presented in this report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange 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 procedures to be designed under our supervision, to ensure that material information relating to the registrant, including 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: March 15, 2006 /s/ Michael S. McDevitt Michael S. McDevitt President, Chief Financial Officer medifast 2005 annual rep or t 6 9 Exhibit 32.1 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-K for the year ended December 31, 2005 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 March 15, 2006 By: /s/ Michael S. McDevitt Michael S. McDevitt Chief Financial Officer March 15, 2006 M edifast, I nc. 11445 Cronhil l Dr ive O wings M i ll s, M ar y land 21117 m edi fastdi et. com 800 • 2 23 • 1809 M edi fas t I nc. 2005 Annual R epor t V . 6 . 9 . 0 6

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