Medartis
Annual Report 2006

Plain-text annual report

M e d i f a s t S t a r s 2 00 6 A nn ua l R epor t To our valued shareholders, 2006 marks the 25th anniversary of Medifast, Inc. It was truly another year of fantastic accomplishments for Medifast, as revenues increased 85% and earnings per share rose 100% over the year prior. For a quarter of a century, Medifast has proudly served the medical community and our loyal customer base with quality products and programs, providing cutting edge nutritional solutions for long term health. Our initial physician-based business model has evolved into a dynamic multi-channel distribution strategy that offers a wide variety of service levels to our growing customer base. Medifast, Inc. now offers Medifast products via medical practitioners, our Take Shape For Life network of health coaches, our medically supervised Medifast weight control centers, and direct to consumers through our robust website and call center. Our innovative business model allows the clinically proven Medifast brand to serve a wide range of target customers through unique support and education programs. Medifast offers multiple platforms for growth, and remains a strong, trusted brand within the medical community (having been medically proven in numerous clinical studies). Our marketplace niche is secured not only by our dramatic weight loss programs, but also by our commitment to make lasting improvements to the overall health of our customers. According to a 2006 study published in The Journal of the American Medical Association, almost 7 out of 10 adults in the U.S. are overweight or obese. A study published in Diabetes Care in 2001 notes that diabetes is expected to increase by a staggering 165 percent between 2000 and 2050. The need for a long-term, safe and effective solution is growing and Medifast is committed to expanding its message in order to reach more people in 2007. We are proud to have reached the important milestone of 25 years. We are a company committed to excellence and continuous improvement. As we look forward to the future, we will continue to improve the lives of millions by providing products and programs that offer hope, health and happiness. We thank our dedicated Employees, Medical Practitioners, Take Shape For Life Health Coaches, Clinic Operators, Customers, Vendors and Shareholders for continuing to support our mission – to enrich lives by providing innovative choices for lasting health. Warmest Regards, Michael S. McDevitt 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, 2006 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 --------------------------------------- New York Stock Exchange Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes X No (cid:31) 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 (cid:31) 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 (cid:31) 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. (cid:31) 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 (cid:31) Accelerated filer X Non-accelerated filer (cid:31) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes (cid:31) No X The aggregate market value of the voting common equity held by non-affiliates of the registrant as of June 30, 2006, based upon the closing price of $17.87 per share on the American Stock Exchange on that date, was $208,000,000. As of March 14, 2007, the Registrant had 13,643,998 shares of Common Stock outstanding. Portions of the definitive Proxy Statement for the 2007 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. DOCUMENTS INCORPORATED BY REFERENCE 2 Table of Contents Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4. Item 5. Item 6. Item 7. Item 8. Item 9. Item 9A. Item 10. Item 11. Item 12. Item 13. Item 14. Business Risk Factors Unresolved Staff Comments Properties Legal Proceedings Submission of Matters to a Vote of Security Holders PART I PART II Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management’s Discussion and Analysis of Financial Condition and Results of Operations Financial Statements and Supplementary Data Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Controls and Procedures Directors, Executive Officers and Corporate Governance Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Certain Relationships and Related Transactions, and Director Independence Principal Accounting Fees and Services PART IV PART III Item 15. Exhibits, Financial Statement Schedules Page 4 10 11 11 12 12 12 13 13 16 17 17 19 19 19 19 19 20 3 ITEM 1. BUSINESS. SUMMARY PART I 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. According to a recent study, “Prevalence of Obesity and Overweight in the United States published in April 2006 in the Journal of American Medical Association almost 7 out of 10 adults in the U.S. are overweight or obese. Type 2 Diabetes is expected to increase by 165 % between 2000 and 2050 according to a study “Projection of diabetes burden through 2050: impact of change demography and disease prevalence in the U.S., published in Diabetes Care in 2001. In a study published in the Journal of the American Medical Association (JAMA) it was reported that in 2003-2004, 17.1% of U.S. children and adolescents were overweight and 32.2% of adults were obese. It is important to note the difference between overweight and obese. Obesity among adults is defined as a Body Mass Index (BMI) of 30 or higher; overweight is defined as a BMI of 25 to 30. The amount of overweight adolescents and children ages 6-19 years have more than tripled since 1980. 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 Medifast Direct – Medifast’s primary distribution channel is the direct-to-consumer business. Here, customers have access to support from qualified nutritional practitioners and customer care representatives via telephone, e-mail and online chats. Medifast Direct offers a robust online web community and library for support, information and meal planning for weight loss and weight maintenance. This business is driven by an aggressive multi-media customer acquisition strategy that includes print, television, radio, and web advertising as well as public relations initiatives. In 2006, the Medifast Direct division focused on targeted marketing initiatives and enhancements to its customer support systems by upgrading its call center and nutrition support team to better serve its clients. In addition, Medifast also began using state of the art web technology which features customized meal planning and community components. Take Shape for Life™ - Take Shape for Life is a physician led network of independent health coaches who are trained to provide coaching and support to client on Medifast programs. Health coaches are conduits to give clients the strategies and skills to successfully reach a healthy weight and then provide a road map to empower the individual to take control of their health. Take Shape for Life offers the exclusive BeSlimTM philosophy, which encourages long-term weight maintenance. Take Shape for Life also moves beyond the scope of weight loss to show customers how to achieve optimal health through the balance of body, mind, and finances. Take Shape for Life uses the high quality, medically validated products of Medifast as the platform to launch an integrity based lifelong health optimization program. Program entrants are encouraged to consult with their primary care physician and a Take Shape for Life Health Coach to determine the Medifast program that is right for them. Health Coaches are supported, educated and qualified by The Health Institute, a training group staffed by Medifast professionals. Health Advisors obtain Medifast qualification based upon testing of their knowledge on Medifast products and programs. 4 Medifast Physicians and Clinics – Many Medifast physicians have implemented the Medifast program within their practice. These physicians carry an inventory of Medifast products and resell them to patients. They also provide appropriate medical monitoring, testing, and support for patients on the program. Medifast also offers Medifast physicians a home delivery program “Lifestyles” for their patients. The Lifestyles Program is a network of health care professionals who support patients on the Medifast program. Medifast offers physicians a dedicated website landing page and patients order products directly from the company online or through the call center. 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 recommended 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. The Company offers an additional in-house support program to assist customers that are consulting their primary care physician. Customers have access to registered dieticians that provide program support and advice via a toll free telephone help line, by e-mail and online chats. Medifast and Hi-Energy Weight Control Centers – In 2006, Medifast changed nine of its key corporately owned weight control centers to Medifast Weight Control Centers in Texas and Florida. The centers offer a new medically supervised model and a nationally advertised brand which encourages walk-ins and referrals from other Medifast business channels. In addition to offering a comprehensive Medifast program, the clinics offer customized patient counseling programs, Inbody TM composition analysis as well as appetite suppression medications to customers who qualify. The Company intends to open additional corporately owned Medifast Weight Control Centers in a select market in 2007 in addition to franchising the model throughout the United States. The Company continues to support the Hi-Energy licensees by providing marketing materials, ads, on-site trainings, fitness programs, nutritional programs and clinical operation materials and forms THE MEDIFAST® BRAND Medifast enriches lives by providing innovative choices for lasting health through products and programs. Medifast is physician recommended and clinically proven offering programs for weight management, weight maintenance and long term health through multiple channels of distribution. Medifast products are high quality, portion controlled meal replacement foods. In recent years, Medifast’s core products and programs have continued to expand over a wellness spectrum to include health management products including products specially formulated for people with diabetes as well as products for women’s health, joint health and coronary health. While the entire Medifast line is Diabetic Friendly, Medifast has created products tailored to meet the needs of people with diabetes. Many Medifast Plus for Diabetics products have earned the coveted Seal of Approval from the Glycemic Research Institute. The line, designated as Low Glycemic, does not overly stimulate blood glucose and insulin and does not stimulate fat-storing enzymes. Products included in the Medifast Plus for Diabetics line consist of three delicious patented shakes, and two meal replacement bars. Most Medifast products qualify to make the FDA’s heart healthy claim, “May Reduce the Risk of Heart Disease.” In order to make this claim, a product must contain at least 6.25 grams of soy protein per serving and be low in fat, saturated fat, and cholesterol. Unlike popular fad diets and herbal supplements, Medifast products are a safe, nutritionally balanced choice, offering gender specific formulas containing high protein and low carbohydrates, a soy protein source rather than animal protein source, and vitamin and mineral fortification. It is very difficult to meet the minimum recommended nutritional requirements on a low-calorie diet, but a dieter can easily meet these requirements using the nutrient dense Medifast brand of meal replacement food supplements. Portion controlled, meal replacement weight management programs are continuing to gain popularity, as consumers search for a safe and effective solution that provides balanced nutrition, quick weight loss and valuable behavior modification education. In addition, consumers are becoming more aware of chronic diseases such as diabetes and coronary health. Clinical Research Overview Medifast uses both clinical research studies and retrospective analysis data from its Medifast clinics as the basis of its claim, “clinically proven.” An overview of Medifast clinical research is provided below. Crowell, M.D. & Cheskin L.J, The Johns Hopkins University School of Medicine. Multicenter Evaluation of Health Benefits and Weight Loss on the Medifast Weight Management Program. 5 The purpose of this study was to retrospectively evaluate the efficacy of a medically supervised, protein-supplemented modified fasting program (Medifast) for weight reduction and to evaluate the impact of weight reduction on coexisting health problems. The results of the study concluded that medically-supervised, protein-sparing modified fasts offer a safe and effective means of weight reduction and are accompanied by significant improvements in coexisting health problems. Of samples taken, males lost an average of 67 lbs and females lost an average of 47 lbs during fasting. The study found significant reductions in systolic and diastolic blood pressure, total cholesterol and triglycerides, as well as the normalizing of blood pressure and hypertensive patients. Cheskin, MD, FACP, Mitchell, MS, Lewis, BA, Jhaveri, MD Yep, BS. Johns Hopkins University School of Bloomberg Public Health. Efficacy of 2 Diet Plans Designed for People with Type 2 Diabetes on Weight and Health Measures The purpose of this study was to evaluate the efficacy of the standard ADA (American Diabetic Association) self-selected diet (SD) vs. a portion controlled diabetic food diet (PCD) in obese patients with NIDDM. The study also evaluated not only the metabolic effects in the long term, but also compliance and any consequent medication changes in patients of the two weight loss regimens. (16- 34 weeks of active weight loss, 52 weeks of maintenance) The meal replacements (Medifast) used in this study are soy-based products (bars, shakes, soups) that are considerably lower in sugar than their non-diabetic counterparts and other popular diet products on the market. The results discussion is as follows. Significantly greater results were achieved after the initial 34-weeks of weight loss by participants in the PCD group in pounds and percent weight loss, insulin level and hemoglobin A1c. The PCD group also saw significant improvements within group in BMI, systolic BP, diastolic BP, waist/hip measurements, cholesterol, HDL triglycerides, glucose and percent body fat. Dropout rates were less in the PCD in both weight loss and weight maintenance. During weight loss, participants in the PCD group significantly decreased their use of medications to treat Type 2 DM. Participants in the PCD group also self-reported higher ease of compliance with the diet compared to the SD group (64.2% vs. 56.0%). Researchers recommended that a PCD be considered for type 2 diabetics desiring weight loss, but that periodic use of SD during weight maintenance will not adversely affect weight loss efforts. The research supports that using a portion-controlled diet will produce comparable if not better outcomes in type 2 diabetics attempting to control their weight. This study was presented at American Diabetes Association’s 65th Annual Scientific Session in San Diego, CA, June 11, 2005. The information was peer reviewed and printed in ADA’s Diabetes Journal as a written published abstract. Dr. Cheskin, the principle investigator is currently pursuing publication in a leading medical journal. National Institutes of Health: Impaired Capacity to Lose Visceral Adipose Tissue During Weight Reduction in Obese Postmenopausal Women With the Trp64Arg B3- Adrenoceptor Gene Variant This study examined whether women on a weight loss program who are carriers of a genetic variant (Trp64Arg) lose less visceral fat than women who do not have this gene. Participants entered a medically supervised weight loss program aimed at reducing body weight to less than 120% of ideal value. Food was self selected with dietitian supervision, with or without the inclusion of the TakeShapeTM, a Medifast brand modified fasting supplement. Results from the study showed that reductions in body weight, BMI, total fat mass and fat-free mass were not significantly different between carriers and non-carriers of the variant. Both groups experienced weight reduction of 31-36.1 pounds, which the study identified as a significant weight loss effect. A RCT Comparing Balanced Energy Deficit Diets With or Without Meal Replacements for Weight Loss and Maintenance Among Children Dieting Alone or With a Parent. Lawrence J. Cheskin, Lisa M. Davis, Andrea Hanlon-Mitola, Amy Mitchell, Ami Jhaveri, Mary Yep, Vanessa Mitchell. Johns Hopkins Bloomberg School of Public Health, Center for Human Nutrition, Department of International Health, Baltimore, MD 21205 The 18-month study, (6-month weight loss phase, 12-month maintenance phase) examined a joint parent-child dieting approach, as opposed to an individually based approach, to improve weight loss outcomes. It compares diet using Medifast meal replacements to a non-supplemented Food Guide pyramid based diet. Comparative points include, overall weight loss, compliance, palatability, dietary quality and dietary satisfaction. The study also examines whether children who lose weight-using Medifast meal replacements as an adjunct to a Food Guide-pyramid based diet achieve health benefits compared to baseline values and are these health benefits greater than those obtained following the reference diet. The results of this study will be released in 2007. 6 Effectiveness of Medifast Supplements Combined with Obesity Pharmacotherapy: A Clinical Program Evaluation. Principle Investigators: Drs. Walker S.C. Poston, C. Keith Haddock, Jennifer E. Taylor, John Foreyt. The purpose of the study is to evaluate the long-term impact of Medifast meal-replacement supplements combined with appetite suppressant medication (ASM) among participants who received a minimum of 12-weeks of treatment. Results of this study will be released in 2007 and presented at the American Society of Bariatric Physicians annual meeting in May 2007. This study has also been submitted to a major medical journal for publication. COMPETITION There are many different kinds of diet products and programs within the weight loss industry. These include a wide variety of commercial weight loss programs, pharmaceutical products, weight loss books, self-help diets, dietary supplements, appetite suppressants and meal replacement shakes and bars. Some of Medifast’s top competitors are Jenny Craig, Nutrisystems, LA Weight Loss, eDiets, Herbalife, and Weight Watchers. The Company has proven it can compete in this competitive market because its products have been clinically tested and proven in clinical studies conducted by researchers from Johns Hopkins University and other major institutions and have been safely and effectively used by customers and recommended by physicians for over 25 years. Medifast has been on the cutting edge of product development with soy based nutritional and weight management products since 1980. These products are formulated with high-quality, low-calorie, low-fat ingredients that provide alternatives to fad diets or medicinal weight loss remedies. The Company’s diverse multi-channel distribution strategy makes the Medifast brand available through multiple support channels, which target different customer needs. Medifast practitioners offer Medifast to patients through wholesale or an innovative home delivery model and some practitioners choose to prescribe appetite suppression diet drugs to patients in conjunction with a Medifast based diet. Medifast Direct via the website and call center serves customers with free online support and community tools and access to nutritionists and customer service representatives. The Take Shape for Life division offers the personal support of a health coach that is often a person who has achieved success on the Medifast program and has turned their success into a business opportunity generating incremental revenue for the company through relationship marketing. Medifast Weight Control Centers offer a medically supervised and structured model for customers who prefer more accountability and personalized counseling on the program. Medifast Weight Control Centers also offer appetite suppression medications to patients who qualify in addition to a Medifast program to obtain desired results. The Medifast program alone is a mild ketogenic diet that naturally suppresses appetite and eliminates hunger without other therapies for most people. PRODUCTS The Company offers a variety of weight and disease management products under the Medifast® brand and for select private label customers. The Medifast line includes Medifast® 55 Shakes, Medifast® 70 Shakes, Medifast® Plus for Appetite Suppression Shakes, Medifast® Plus for Women’s Health Shakes, Medifast® Plus for Diabetics Shakes, Medifast® Plus for Joint Health Shakes, Medifast® Plus for Coronary Health Shakes, Medifast® Bars, Medifast® Creamy Soups, Medifast® Chicken Noodle Soup, Medifast® Chicken & Wild Rice Soup, Medifast® Minestrone Soup, Medifast® Beef Vegetable Stew, Medifast® Home-style Chili, Medifast® Oatmeal, Medifast® Pudding, Medifast® Scrambled Eggs, Medifast® Hot Cocoa, Medifast® Cappuccino, Medifast® Chai Latte, Medifast® Iced Teas, Medifast® Fruit Drinks, Medifast® Soy Crisps, Medifast® Crackers and Medifast® Fast Soups. Medifast nutritional products are formulated with high-quality, low-calorie, low-fat ingredients. Many Medifast products are soy based and contain 24 vitamins and minerals, as well as other nutrients essential for good health. The Company uses Solae® brand soy protein, which is a high-quality complete protein derived from soybeans. Medifast brand awareness continues to expand through the Company’s marketing campaigns, product development, line extensions, and the Company’s emphasis on quality customer service, technical support and publications developed by the Company’s marketing staff. Medifast products have been proven to be effective for weight and disease management in clinical studies conducted by researchers from the U.S. government and Johns Hopkins University. The Company has continued to develop its sales and marketing operations with qualified management and innovative programs. The Company’s facility in Owings Mills, MD manufactures all powders and subcontracts the production of its Ready-to-Drink products and meal replacement bars. 7 NEW PRODUCTS The Company expanded the Medifast product line in 2006 by introducing Medifast® Scrambled Eggs, Medifast® Vanilla Pudding, Medifast® Beef Vegetable Stew, and Medifast® Soy Crisps in Apple Cinnamon, Ranch and White Cheddar flavors. In addition to these great new additions, Medifast also reformulated all of its meal replacement bars to improve flavor and texture. MARKETING In 2006, the Company continued to build and leverage its core Medifast brand through multiple marketing strategies to its target audiences. Customer Acquisition strategies include advertising in print magazines, television commercials, and radio commercials. These mediums were used to target new customers by stressing Medifast's quick, easy and safe approach to weight management. The Company also developed comprehensive public relations campaigns throughout 2006 securing media coverage in national consumer and business media outlets including People Magazine, Forbes Magazine and CNBC. Also, direct mail campaigns and e-mail newsletters have been utilized to encourage and support existing customers. Online advertising began in 2004 and included keyword search, banner ads, affiliate programs, and targeted direct email campaigns. The online advertising has been supported by Medifast's well designed, user-friendly website, which provides a wealth of information and customer support for easy ordering functionality. In 2006, the online community, meal planner and library, “My Medifast” was added as a free service to all customers. Also in 2006, the Company began sponsoring customer blogs on its website where customers can interact with other customers and ask questions before starting a Medifast program as well as to track their success on the Medifast program. The Company launched a new and improved branding for its Take Shape for Life division in 2006 including revised logo, messaging, web design and support materials giving it a unique positioning as a division of Medifast focused on optimal health. SALES The Company’s Sales division handles three primary areas: Physician and Clinic Sales— The sales team is responsible for prospecting larger medical accounts, clinics, hospitals, and HMOs. During 2006, the sales team attended a number of medical professional trade shows, which expanded Medifast's penetration of the clinical business segment. Medifast Weight Control Centers– The brick and mortar clinics have Counselors that sell Medifast products and full service programs which include weekly one-on-one counseling sessions, medical monitoring and physician oversight. Take Shape for Life— Provides a sales force of independent Health Advisors who support patients and their primary care physicians with a defined support program. Take Shape for Life is a support program that moves beyond the scope of weight loss to show customers how to achieve optimal health through the balance of body, mind, and finances. MANUFACTURING Jason Pharmaceuticals, Inc., the Company’s wholly owned manufacturing subsidiary, produces over 80% of the Medifast products in a state-of-the-art food and pharmaceutical-grade facility in Owings Mills, Maryland. Management purchased the plant in July 2002 for $3.4 million. The company has also invested in increasing production capacity with the purchase of two additional manufacturing lines and a larger capacity blender. The lines will significantly improve the company's production capability, while also improving its overall efficiencies. The manufacturing facility has the capacity for significant increases to its production output with minimal capital expenditures. Adding additional shifts will enable the Company to produce enough products to generate over $250 million in sales. Manufacturing processes, product labeling, quality control and equipment are subject to regulations and inspections mandated by the Food & Drug Administration (FDA), the Maryland State Department of Health and Hygiene, and the Baltimore County Department of Health. The plant strictly adheres to all GMP practices and has maintained its status as an "OU" (Orthodox Union) kosher-approved facility since 1982. GOVERNMENTAL REGULATION HISTORY The formulation, processing, packaging, labeling and advertising of the Company's products are subject to regulation by several federal agencies, but principally by the Food and Drug Administration (the "FDA"). The Company must comply with the 8 standards, labeling and packaging requirements imposed by the FDA for the marketing and sale of foods and nutritional supplements. Applicable regulations prevent the Company from representing in its literature and labeling that its products produce or create medicinal effects or possess drug-related characteristics. The FDA could, in certain circumstances, require the reformulation of certain products to meet new standards, require the recall or discontinuation of certain products not capable of reformulation, or require additional record keeping, expanded documentation of the properties of certain products, expanded or different labeling, and scientific substantiation. If the FDA believes the products are unapproved drugs or food additives, the FDA may initiate similar enforcement proceedings. Any or all such requirements could adversely affect the Company's operations and its financial condition. To the extent that sales of foods and nutritional supplements may constitute improper trade practices or endanger the safety of consumers, the operations of the Company may also be subject to the regulations and enforcement powers of the Federal Trade Commission ("FTC"), and the Consumer Product Safety Commission. The Company's activities are also regulated by various agencies of the states and localities in which the Company's products are sold. The Company's products are manufactured and packaged in accordance with customers’ specifications and sold under their private labels both domestically and in foreign countries through independent distribution channels. PRODUCT LIABILITY AND INSURANCE The Company, like other producers and distributors of ingested products, faces an inherent risk of exposure to product liability claims in the event that, among other things, the use of its products results in injury. The Company maintains insurance against product liability claims with respect to the products it manufactures. With respect to the retail and direct marketing distribution of products produced by others, the Company's principal form of insurance consists of arrangements with each of its suppliers of those products to name the Company 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, 2006, the Company employed 265 full-time and contracted employees, of whom 84 were engaged in manufacturing, warehouse management, and shipping, and 180 in marketing, administrative, call center and corporate support functions. None of the employees are subject to a collective bargaining agreement with the Company. INFORMATION SYSTEMS INFRASTRUCTURE In November of 2005, the Company began an IT project to implement an Enterprise Resource Planning (ERP) solution to upgrade our technology infrastructure and improve manufacturing and business processes. The new IT infrastructure will enable the Company to handle additional business growth and improve the efficiencies across the business platform. The new ERP system went live in December of 2006 without incident. AVAILABLE INFORMATION All periodic and current reports, registration statements, code of conduct, code of ethics and other material that the Company is required to file with the Securities and Exchange Commission (“SEC”), including the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 (the “1934 Act Reports”). These materials are available free of charge through the Company’s investor relations page at www.medifastdiet.com . Such documents are available as soon as reasonably practicable after electronic filing of the material with the SEC. The Company’s Internet web site and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K. EXECUTIVE OFFICERS OF THE COMPANY Name Bradley T. MacDonald Michael S. McDevitt Leo Williams Margaret MacDonald Brendan N. Connors Age 59 28 59 29 Position Chief Executive Officer and Chairman of the Board of Directors President and Chief Financial Officer Executive Vice President Senior Vice President of Operations Vice President of Finance 9 Bradley T. MacDonald Mr. MacDonald became Chairman of the Board and Chief Executive Officer of Medifast, Inc. on January 28, 1998. Mr. MacDonald was previously employed by the Company as its Chief Executive Officer from September 1996 to August 1997. In 2006, Mr. MacDonald was named “Entrepreneur of the Year” in consumer products for the State of Maryland. Prior to joining the Company, he was appointed as Program Director of the U.S. Olympic Coin Program of the Atlanta Centennial Olympic Games. From 1991 through 1994, Colonel MacDonald returned to active duty to be Deputy Director and Chief Financial Officer of the Retail, Food, Hospitality and Recreation Businesses for the United States Marine Corps. Prior thereto, Mr. MacDonald served as Chief Operating Officer of the Bonneau Sunglass Company, President of Pennsylvania Optical Co., Chairman and CEO of MacDonald and Associates, which had major financial interests in a retail drug, consumer candy, and pilot sunglass companies. Mr. MacDonald was national president of the Marine Corps Reserve Officers Association and retired from the United States Marine Corps Reserve as a Colonel in 1997, after 27 years of service. He has been appointed to the Defense Advisory Board for Employer Support of the Guard and Reserve (ESGR). Mr. MacDonald serves on the Board of Directors of the Wireless Accessories Group (OTCBB: WIRX). He is also on the Board of Directors of the Marine Corps Reserve Toys for Tots Foundation and is a Foundation Trustee of the Marine Reserve Association. Michael S. McDevitt Mr. McDevitt joined Medifast in 2002 as the Controller and was promoted to Vice President of Finance in January 2004. In March 2005, he was promoted to President and in January of 2006 was also named Chief Financial Officer. Prior to joining Medifast, Mr. McDevitt worked as a Financial Analyst for the Blackstone Group, an investment advisory firm based in New York, NY. Leo Williams Mr. Williams became Executive Vice President of Medifast, Inc. in January of 2004. Prior to joining Medifast, he was a Future Vehicles Marketing Plans Director for Ford Division sport utility vehicles and pickup trucks. A retired Marine Corps Reserve major general, he was ordered to active duty from October 2002 to September 2003 to serve as Deputy Director of the Marine Corps Combat Development Command. Mr. Williams is a Board of Director of the Marine Corps Reserve Toys for Tots Foundation and the Direct Selling Association. Margaret MacDonald, MBA Ms. MacDonald joined Medifast in 2000 as the Director of Sales and Administration. In 2002 she was promoted to VP of Operations and in 2004 promoted to Senior VP of Operations. In May of 2006, Ms. MacDonald received an Executive MBA from Loyola University. Prior to joining Medifast, Ms. MacDonald was a legal assistant at Carrington, Coleman, Sloman, and Blumenthal in Dallas, TX. Brendan N. Connors, CPA Mr. Connors joined Medifast as the Vice President of Finance in April of 2005. Prior to joining Medifast, Mr. Connors worked as a Senior Accountant at Wolf & Company P.C., a certified public accounting and consulting firm in Boston, MA. ITEM 1A. RISK FACTORS The following risk factors should be considered when reading this Annual Report on Form 10-K. If any of the events described below occurs, the Company’s financial condition and operating results could be adversely affected. Much of our growth and future profitability depends on the effectiveness of our advertising spend in the Direct to consumer channel. Our marketing expenditures may not result in increased revenue or generate sufficient awareness of the program or the brand to the consumer. We may not be able to manage our advertising spend in a cost effective manner thereby increasing the cost to acquire a new customer to an elevated level that will decrease profits. We may be subject to health related claims from our customers A customer that suffers health problems may allege that the Medifast program contributed to the ailment. The Company is not currently the subject of any such claims, however, we would defend ourselves vigorously against such accusations. Regardless of the ultimate outcome, defending against such claims would be costly and could adversely affect our results of operations. A competitor or new entrant into the market may develop a product and program similar to ours Many of our competitors are significantly larger than us and have more financial resources to develop new products and programs. Our business could be affected if one of our competitors or a new entrant to the market develops similar products and programs through similar marketing channels. This could result in lower sales as well as pricing competition which could adversely affect the Company’s results from operations. 10 New fad diets or pharmaceutical solutions could put us at a competitive disadvantage The weight loss industry is subject to fad diets. The Atkins craze hit the U.S. a few years ago and had an impact on many weigh loss companies. Another fad diet could sweep the nation and have an adverse affect on our results of operations. In addition, pharmaceutical companies are constantly trying to develop safe, effective, drugs that lead to weight loss. If successful, many dieters could perceive this to be easier than the Medifast program and this would put us at a competitive disadvantage. The business may grow too quickly for the current infrastructure to handle If our advertising is extremely successful and our Take Shape for Life relationship marketing division sees a large uptick in recruitment we may be unable to handle the growth from an operational perspective. Increasing demands on our infrastructure could cause long hold times in the call center as well as delays on our website. In addition, there could be delays in order processing. packaging and shipping. We could run out of a majority of our inventory if growth exceeded our production capacity. If these difficulties are encountered in a period of hyper-growth then our operating results could suffer. Our stock price may experience volatility due to fluctuations in our operating results Our stock price is subject to fluctuations in response to our operating results, a competitor’s operating results, or our ability to meet stock analysts forecasts and our yearly revenue and EPS guidance. In addition, general trends in the weight-loss industry as a whole can have an affect on our stock price. These factors may have an adverse affect on the market price of our stock and cause it to fluctuate significantly. We may be subject to claims that our employees are unqualified to provide weight loss counseling Our Medifast Weight Control center division provides medical assessments and counseling to our customers. We may be subject to claims that our employees lack the proper training and qualifications to provide proper advice regarding weight loss. We could be subject to claims if an employee in one of our clinics gives inappropriate weight loss advice that results in health problems. Such claims could result in damage to our reputation and could have an affect on our operating results. Negative publicity in the weight loss industry could adversely affect our business If the press were to come out with negative media about low-calorie diets, meal replacements, or soy protein this could harm our business. Even if not directed at Medifast, this perception could be instilled in our target market and cause harm to our operating results. Our results of operations may decline as a result of a downturn in general economic conditions or consumer confidence Our results of operations are highly dependent on product sales and program fees. A downturn in general economic conditions or consumer confidence and spending in any of our major markets could result in people curtailing their discretionary spending, which, in turn, could lead to a decrease in product sales in our Medifast Direct and Take Shape for Life divisions and a decrease in product and program fees at our Medifast Weight Control Centers and Internet product subscriptions. Any such reduction would adversely affect our results of operations. Our Business is subject to regulatory and legislative restrictions A number of laws and regulations govern our advertising. The FTC and certain states regulate advertising, disclosures to consumers, privacy, consumer pricing or billing arrangements, and other consumer matters. Future legislation or regulations, including legislation or regulations affecting our marketing and advertising practices, relations with consumers or our food and weight management products and services, may have an adverse impact on us. ITEM 1B. UNRESOLVED STAFF COMMENTS None ITEM 2. DESCRIPTION OF PROPERTY The Company owns a 49,000 square-foot facility in Owings Mills, Maryland, which contains its Corporate Headquarters and manufacturing plant. In 2003, the Company purchased a state-of-the-art 119,000 square-foot distribution facility in Ridgely, 11 Maryland. The facility gives the Company the ability to distribute over $250 million of Medifast product 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 its corporately owned Medifast Weight Control clinics throughout Florida and Texas. The leases range in terms from one to five years. ITEM 3. LEGAL PROCEEDINGS. There were no material pending legal matters as of December 31, 2006. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. (a) The Company's Common Stock has been quoted under the symbol MED since December 20, 2002. The old symbol, MDFT, had been traded since February 5, 2001. The common stock is traded on the New York Stock Exchange. The following is a list of the low and high closing prices by fiscal quarters for 2006 and 2005: Quarter ended March 31, 2006 ................... Quarter ended June 30, 2006 .................... Quarter ended September 30, 2006............... Quarter ended December 31, 2006 ................ 2006 ----------------- Low High ----- ------ 9.23 5.40 20.90 8.75 19.49 8.21 8.41 14.52 2005 ----------------- Low High ----- ------ Quarter ended March 31, 2005 ................... 3.62 2.67 Quarter ended June 30, 2005 .................... 3.30 2.82 7.08 Quarter ended September 30, 2005............... 3.01 Quarter ended December 31, 2005 ................ 3.83 5.70 (b) The quotations reflect inter-dealer prices, without retail mark-up, markdown or commissions and may not represent actual transactions. (c) There were approximately 209 record holders of the Company's Common Stock as of March 14, 2007. This number does not include beneficial owners of our securities held in the name of nominees. The Company had no preferred holders of the Company’s stock as of December 31, 2006. (d) No dividends on common stock were declared by the Company during 2006 or 2005. 12 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. Revenue Operating income Income from continuing operations EPS - basic EPS - diluted 2006 2005 2004 2003 2002 74,086,000 8,112,000 7,338,000 40,129,000 4,074,000 3,930,000 27,340,000 3,004,000 2,906,000 25,379,000 3,598,000 3,558,000 12,345,000 1,752,000 1,698,000 0.40 0.38 0.20 0.19 0.16 0.14 0.25 0.22 0.36 0.30 Total assets current portion of long-term debt and revolving credit facilities Total long-term debt 36,927,000 1,804,000 3,509,000 30,545,000 1,194,000 3,977,000 25,968,000 827,000 4,256,000 24,230,000 819,000 4,564,000 9,888,000 395,000 2,701,000 Weighted average shares outstanding Basic Diluted 12,699,066 13,482,894 12,258,734 12,780,959 10,832,360 12,413,424 9,305,731 10,952,367 6,722,505 8,737,292 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. FORWARD LOOKING STATEMENTS This document contains forward-looking statements which may involve known and unknown risks, uncertainties and other factors that may cause Medifast, Inc. actual results and performance in future periods to be materially different from any future results or performance suggested by these statements. Medifast, Inc. cautions investors not to place undue reliance on forward-looking statements, which speak only to management's expectations on this date. 2006 COMPARISON WITH 2005 OPERATING Revenue: Revenue increased to $74.1 million in 2006 as compared to $40.1 million in 2005, an increase of $34 million or 85%. The direct marketing sales channel accounted for 60% of total revenue, Take Shape for Life 30%, doctors 5%, and clinics 5%. The direct marketing sales channel, which is fueled primarily by consumer advertising, increased revenues by approximately 142% year-over year. Take Shape for Life sales, which are fueled by person-to-person recruiting and support increased by 46% year-over-year. The growth in revenue is primarily the result of an increased advertising campaign in 2006, which fueled growth across the Company’s multiple distribution channels. The Company has expanded into additional print media and national cable and network TV spots. The Company also continues to expand its presence on the web through multiple marketing initiatives. Additionally, the Take Shape for Life network continues to grow as the sales network expands into additional states and increased penetration in existing states. The Company continues to create new marketing tools and training materials for health advisors to help increase the recruitment of both active Health Advisors as well as the lifetime value of their customers. 13 Due to the significant growth in the first half of 2006, Medifast, Inc. began exploring third party over-sourcing capabilities in the call center. The Company began using an outsourced call center for overflow call volume in late April. The outsourced call center allowed the company to prepare in the fourth quarter of 2006 for anticipated sales growth in the first quarter of 2007 so that a shortage of call center representatives would not be experienced as it was in the first quarter of 2006. The Company is currently exploring bringing all call center functions in-house. Capital expenditure for a new phone system would be necessary, however, the return on investment would be under a year. The Company has also invested in increasing production capacity with the purchase of two additional manufacturing lines and a larger capacity blender. The lines will significantly improve the Company's production capability, while also improving its overall efficiencies. In addition, the Company implemented a new Enterprise Resource Planning (ERP) system in December of 2006. The system adds critical functions and controls necessary for Sarbanes Oxley compliance and significantly increases the Company’s ability to track and forecast inventory. The system provides enhanced reporting on all business units and enables the Company to handle significantly increased sales volume. The Company believes that these capabilities will provide the Company with the scalability necessary to seamlessly handle increased demands as the business continues to grow. The Company is exploring the ownership of its call center, which would require a new phone system. The Company expects that this would be the last large capital expense expected. The Company now has the manufacturing, distribution, and IT capability to handle approximately $250 - $300 million in sales volume Costs and Expenses: Cost of revenue increased $8.1 million to $18.2 million in 2006 from $10.2 million in 2005. As a percentage of sales, gross margin increased to 75.4% in 2006 as compared to 74.7% in 2005. The slight increase in gross margin is primarily due to decreased raw material costs as a result of increased volume discounts. The new machines are expected to add to efficiency in the future. Advertising expense in 2006 was approximately $14.3 million as compared to approximately $3.8 million in 2005, an increase of $10.5 million. The increased marketing was spent primarily for TV advertising, print, and web media. The Company continues to test, analyze and adapt the advertising message and placements on TV, print and web media to achieve the lowest cost to acquire new customers. This testing will allow the company to spend our advertising dollars most effectively as we plan on increasing our advertising budget for the year of 2007. The branding effect of advertising has proven to have impact in all channels of the business driving customers to the web and call center, leads to Take Shape for Life health advisors, patients to local Medifast practitioners and significant walk-ins to Medifast Weight Control Center clinics. Other Income/Expense: Stock compensation expense in 2006 was $533,000 as compared to $0 in 2005. This expense represents the vesting of share-based compensation to key executives over five and six-year terms as well as FASB 123R expense for the vesting of options. In 2006, expense relating to FASB 123R amounted to $40,000. The Company has reviewed unvested options and concluded that the effects of FASB 123R are immaterial. On January 17, 2006 the assets of Consumer Choice Systems, a division of Medifast, Inc., were sold to a former Board member. The promissory note calls for monthly principal only payments over a 10-year term. Therefore, when imputing an interest rate on the loan, a $323,000 loss had to be realized due to the difference in the present value of the note receivable compared to the amount realizable over 10-years. This is a one-time loss that will not affect any future periods. The loss is recouped monthly in interest income over a period of 120 months or upon payment of the note in its entirety. Income taxes: In the third quarter of 2006, the Company had a $1 million federal tax refund receivable. A portion of this refund was factored into the Company’s income tax provision, which lowered the estimated tax rate for 2006. In 2006, the Company recorded $2.3 million in income tax expense, which represents an annual effective rate of 31%. In 2005, we recorded income tax expense of $1.2 million, which reflected an estimated annual effective tax rate of 30.1%. The Company anticipates a tax rate of approximately 36-39% in 2007. Net income: Net income increased to $5.1 million in 2006 as compared to $2.4 million in 2005, which reflected an increase of 108% or $2.6 million. The increase in net income is due to an increase in sales offset by increased selling, general, and administrative expenses, that primarily consist of increased advertising, commissions paid to Take Shape for Life health advisors, outsourced call center reps, and new employees. LIQUIDITY AND CAPITAL RESOURCES The Company had stockholders’ equity of $28,114,000 and working capital of $9,612,000 on December 31, 2006 compared with $22,021,000 and $9,996,000 at December 31, 2005, respectively. The $6.1 million net increase in stockholder’s equity reflects the increased profitability of the Company. The Company’s cash and cash equivalents position decreased from $1.5 million at December 31, 2005 to $1.1 at December 31, 2006. The decrease is due to increased cash outlays for infrastructure to include the new ERP system and new production lines and blender, as well as inventory build-up for the first quarter of 2007. In addition, prepaid advertisements for January and payments to our third party call center were uses of cash. On December 31, 2006 the Company’s current ratio was 3 to 1. 14 In October 2006, Medifast, Inc.’s wholly owned subsidiary Jason Pharmaceuticals, Inc. renewed its $5,000,000 Secured Line of Credit from Mercantile Safe-Deposit and Trust of Baltimore, Maryland. The line of credit is at LIBOR plus 1.3 percent. The increased line may be used to finance equipment, advertising, inventory, and receivables of Medifast, Inc. The Company currently has no off- balance sheet arrangements. In the year ended December 31, 2006, the Company generated cash flow of $5,845,000 from operations, primarily attributable to higher operating income. This was offset by net changes in operating assets and liabilities that decreased cash flow by $3,650,000. The largest use of cash was for the purchase of inventory. We increased inventory in the fourth quarter in order to meet anticipated demand in the first quarter of 2007. This was offset by an increase in accounts payable and a reduction in our accounts receivable and prepaid balances. In the year ended December 31, 2006, net cash used in investing activities was $6,747,000, which primarily consisted of the purchase of intangible assets and purchases of property and equipment. In 2006, the Company built a large amount of infrastructure. This included a new Enterprise Resource Planning system, two new state of the art manufacturing lines, larger capacity blender and improvements at our distribution facility as well as the build out of our new Medifast Weight Control Centers. In the year ended December 31, 2006, financing activities generated $503,000 in cash flow, representing principal repayments of long-term debt, and the purchase of 25,000 shares of treasury stock. This was offset by an increase in the line of credit and issuances of warrants and options exercised with cash. In pursuing its business strategy, the Company may require additional cash for operating and investing activities. The Company expects future cash requirements, if any, to be funded from operating cash flow and cash flow from financing activities. There are no current plans or discussions in process relating to any material acquisition that is probable in the foreseeable future. 2005 COMPARISON WITH 2004 OPERATING Revenue: 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 in 2005. In addition, the Company expanded it remarketing campaign to drive new customers to the call center and website. The Take Shape for Life division added a Take Shape for Life replicating website option for Health Advisors, an Internet distribution program for their customers, and provided health advisors with additional sponsoring tools to make training and recruiting easier. These have proven to be effective at generating revenues and recruiting Health Advisors into the Take Shape for Life Network. The increased training and recruitment initiatives in 2005 have resulted in the expansion of the sales network into additional locations as well as growth in current locations. Costs and Expenses: Cost of sales increased from 6,746,000 in 2004 to $10,161,000 in 2005, an increase of $3,415,000. As a percentage of sales, cost of goods sold increased slightly due to increased fuel charges charged by the major shipping companies. Gross margin was 75% at December 31, 2005 and 2004. Selling, general and administrative (SG&A) expenses of $25,894,000 for 2005 were $8,304,000 more than the $17,590,000 in 2004, due to increased costs associated with the increased scale of the business. The Company increased its advertising expense to include additional print and web advertising as well as strategic testing of television advertising. In 2005, the Company experienced income from operations of $4,074,000. This compares with income from operations of $3,004,000 in 2004, an increase of 36%. The increase in income is primarily due to higher gross profit from increased revenue offset by higher general and administrative expenses. Income Taxes: In 2005, the Company realized a tax expense of $1,203,000, as compared to a tax expense of $1,159,000 in 2004. The slight increase in tax expense despite the increase in sales is due to timing differences between book and tax purposes for intangible assets, and other temporary and permanent differences. Interest expense increased to $317,000 in 2005, as compared to $245,000 in 2004. This increase was due to a full year of interest expense paid on a new loan acquired in 2004. Net Income: The Company reported net income of $2,436,000, or $0.20 per basic share ($0.19 per diluted share), versus $1,729,000 or $0.16 per basic share ($0.14 per diluted share), with a dilution increase of 368,000 shares. Earnings per share were effected by the interest associated with the conversion of the Series “B” preferred stock. This conversion included a $260,000 stock dividend on Series “B” preferred stock and a $19,000 stock dividend on Series “C” preferred stock. As of December 31, 2005 all Series “B” and Series “C” preferred stock have been converted to common stock and included in the weighed average diluted shares. There will be no additional stock dividend payments. 15 LIQUIDITY AND CAPITAL RESOURCES At December 31, 2005, the Company had net working capital of $9,996,000, an increase of $2,531,000 from the $7,465,000 net working capital balance at December 31, 2004. Cash and investment securities at December 31, 2005 were $4,184,000. In November 2005, Medifast, Inc.’s wholly owned subsidiary Jason Pharmaceuticals, Inc. renewed its $5,000,000 Secured Line of Credit from Mercantile Safe-Deposit and Trust of Baltimore, Maryland. The line of credit is at LIBOR plus 1.3 percent. The increased line may be used to finance equipment, inventory, and receivables of Medifast, Inc. The Company currently has no off-balance sheet arrangements. In the year ended December 31, 2005, the Company generated cash flow of $3,213,000 from operations, primarily attributable to higher operating income. This was offset by net changes in operating assets and liabilities that decreased cash flow by $2,065,000. The largest uses of cash were for the purchase of inventory and prepaid expenses, which primarily consisted of prepaid taxes, insurance, and advertising. In the year ended December 31, 2005, net cash used in investing activities was $2,032,000, which primarily consisted of the purchase of intangible assets and purchases of property and equipment. In the year ended December 31, 2005, net cash used in financing activities was $309,000, representing the principal repayments of long-term debt and purchase of treasury stock offset by an increase in the line of credit. Medifast, Inc. purchased 110,000 shares of its common stock from October 6, 2005 through October 17, 2005 at an average price of $4.03 per share, aggregating $452,000. In pursuing its business strategy, the Company may require additional cash for operating and investing activities. The Company expects future cash requirements, if any, to be funded from operating cash flow and cash flow from financing activities. There are no current plans or discussions in process relating to any material acquisition that is probable in the foreseeable future. SEASONALITY The Company's weight management products and programs have historically been subject to seasonality. Traditionally the holiday season in November/December of each year is considered poor for diet control products and services. January and February generally show increases in sales, as these months are considered the commencement of the “diet season.” The Company did not experience the same degree of seasonality in 2006. This is largely due to the increase in the consumer’s awareness of the overall health and nutritional benefits accompanied with the use of the Company’s product line. As consumers continue to increase their association of nutritional weight loss programs with overall health, seasonality will continue to decrease. INFLATION To date, inflation has not had a material effect on the Company's business. ITEM 8. FINANCIAL STATEMENTS. The information required by this item is set forth on pages 22 through 43 hereto and incorporated by reference herein. 16 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, 2006. ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures We have established disclosure controls and procedures to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the rules and forms of the Securities and Exchange Commission. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based upon the evaluation of the Company’s disclosure controls and procedures by the Company’s management, under the supervision and with the participation of our principal executive officer and principal financial officer, as of December 31, 2006, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) are effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the rules and forms of the Securities and Exchange Commission. Management’s Annual Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). There are inherent limitations in the effectiveness of any internal controls over financial reporting, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Our internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2006 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by Bagell, Josephs, Levine & Company, LLC, independent registered public accounting firm, as stated in their report which is included below. Changes in Internal Controls over Financial Reporting There were no significant changes in the Company’s internal controls over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting. 17 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors Medifast, Inc. and subsidiaries Owing Mills, Maryland We have audited management's assessment, included in Management’s Annual Report on Internal Control over Financial Reporting, that Medifast Inc. and subsidiaries maintained effective control over financial reporting as of December 31 2006, based on "criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria)." Medifast Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Medifast, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also in our opinion, Medifast Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Medifast Inc. and subsidiaries as of December 31, 2006 and the consolidated results of their operations and their consolidated cash flow for the year then ended and our report dated March 15, 2007 expressed an unqualified opinion thereon. Bagell, Josephs, Levine & Co. Gibbsboro, New Jersey March 15, 2007 18 PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE The information required by this item is incorporated by reference to Medifast’s Proxy Statement for its 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2006. The required information as to executive officers is set forth in Part I hereof and is incorporated herein by reference. The Company has adopted a code of business conduct and ethics applicable to the Company’s directors, officers, and employees, knows as the Code of Business Conduct. The Code of Business Conduct is available on the Company’s website. In the event that we amend or waive any of the provision of the Code of Business Conduct applicable to one of our principal officers that relates to any element of the code of ethics definition enumerated in Item 406(b) of Regulation S-K, we intend to disclose the same on the Company’s website at www.medifastdiet.com . ITEM 11. EXECUTIVE COMPENSATION. The information required by this item is incorporated by reference to Medifast’s Proxy Statement for its 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2006. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this item is incorporated by reference to Medifast’s Proxy Statement for its 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2006. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE The information required by this item is incorporated by reference to Medifast’s Proxy Statement for its 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2006. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this item is incorporated by reference to Medifast’s Proxy Statement for its 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2006. 19 PART IV ITEM 15. EXHIBITS AND FINACIAL STATEMENT SCHEDULES (a) 1. Financial Statements See Index to the Consolidated Financial Statements on page 21 of this Annual Report 2. Financial Statement Schedules None, as all information required in these schedules is included in the Notes to the Consolidated Financial Statements. 3. Exhibits Reference is made to the Exhibit Index on page 41 of this Annual Report for a list of exhibits required by Item 601 of Registration S-K to be filed as part of this Annual Report. 20 MEDIFAST, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Stockholders’ Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 22 23 24 25 27 29 21 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders of Medifast, Inc. We have audited the accompanying consolidated balance sheets of Medifast, Inc. as of December 31, 2005 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Medifast, Inc. at December 31, 2005 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Medifast, Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 15, 2007 expressed an unqualified opinion theron. Bagell, Josephs, Levine & Company, LLC Gibbsboro, New Jersey March 15, 2007 22 MEDIFAS T, INC. AND S UBS IDIARIES CONS OLIDATED BALANCE S HEETS As of December 31, 2006 and 2005 AS S ETS Current assets: Cash and cash equivalents Accounts receivable-net of allowance for doubtful accounts of $100,000 Inventory Investment securities Deferred compensation Prepaid expenses and other current assets Note receivable - current 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 Note receivable, net of current assets Other assets 2006 2005 $ 1,085,000 448,000 $ 1,484,000 985,000 8,255,000 1,540,000 673,000 2,599,000 174,000 90,000 14,864,000 14,020,000 6,274,000 367,000 1,355,000 47,000 5,475,000 2,700,000 525,000 3,273,000 - 14,442,000 9,535,000 6,508,000 - - 60,000 TOTAL AS S ETS $ 36,927,000 $ 30,545,000 LIABILITIES AND S TOCKHOLDERS ' EQUITY Current liabilities: Accounts payable and accrued expenses Income taxes payable Dividends payable Line of credit Current maturities of long-term debt Deferred tax liability - current Total current liabilities Other liabilities and deferred credits Long-term debt, net of current portion Deferred tax liability - non-current Total liabilities S tockholders' Equity: Preferred stock, $.001 par value (1,500,000 authorized, no shares issued and outstanding) Common stock; par value $.001 per share; 20,000,000 shares authorized; 13,631,898 and 12,782,791 shares issued and outstanding Additional paid-in capital Accumulated other comprehensive income Retained earnings Less: cost of 249,184 and 210,902 shares of common stock in treasury Less: Unearned compensation Total stockholders' equity $ 2,913,000 535,000 - 1,256,000 548,000 5,252,000 3,509,000 - 8,761,000 $ 2,263,000 899,000 - 633,000 561,000 90,000 4,446,000 3,977,000 101,000 8,524,000 - - 14,000 26,629,000 334,000 6,231,000 33,208,000 (1,686,000) (3,356,000) 28,166,000 13,000 21,759,000 282,000 1,149,000 23,203,000 (1,075,000) (107,000) 22,021,000 TOTAL LIABILITIES AND S TOCKHOLDERS ' EQUITY $ 36,927,000 $ 30,545,000 The accompanying notes are an integral part of these consolidated financial statements 23 MEDIFAS T, INC. AND S UBS IDIARIES CONS OLIDATED S TATEMENTS OF INCOME Years Ended December 31, Revenue Cost of sales Gross profit 2006 2005 2004 $74,086,000 (18,237,000) 55,849,000 $40,129,000 (10,161,000) 29,968,000 $27,340,000 (6,746,000) 20,594,000 Selling, general, and administration (47,737,000) (25,894,000) (17,590,000) Income from operations 8,112,000 4,074,000 3,004,000 Other income (expense): Interest expense Interest income Stock compensation exp Loss on sale of CCS Other income (expense) Income before provision for income taxes Provision for income taxes (369,000) 175,000 (533,000) (323,000) 276,000 (774,000) 7,338,000 (2,256,000) (317,000) 158,000 (245,000) 154,000 15,000 (144,000) 3,930,000 (1,203,000) (7,000) (98,000) 2,906,000 (1,159,000) Net income 5,082,000 2,727,000 1,747,000 Less: Preferred stock dividend requirement - (291,000) (18,000) Net income attributable to common shareholders $5,082,000 $2,436,000 $1,729,000 Basic earnings per share Diluted earnings per share Weighted average shares outstanding - Basic Diluted $0.40 $0.38 $0.20 $0.19 $0.16 $0.14 12,699,066 13,482,894 12,258,734 12,780,959 10,832,360 12,413,424 The accompanying notes are an integral part of these consolidated financial statements 24 MEDIFAS T, INC. AND S UBS IDIARIES CONS OLIDATED S TATEMENT OF CHANGES IN S TOCKHOLDERS ' EQUITY AND ACCUMULATED OTHER COMPREHENS IVE INCOME (LOS S ) Years Ended December 31, 2006, 2005, and 2004 Balance, December 31, 2003 Preferred converted to Common Stock 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 Preferred converted to Common Stock 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 Vesting of unearned compensation Treasury shares repurchased Net income Balance, December 31, 2005 Warrants converted to common stock Common stock issued to Directors Common stock issued to consultants Dividend paid in stock Options excercised to common stock Options granted to CEO FASB 123R vesting Shares issued to executives with 5 & 6 year vesting period Treasury shares issued to employees Net income Balance, December 31, 2006 Series B Preferred Stock Series C Preferred Stock Number of Shares Stated Value Amount 403,734 (103,120) 404,000 (103,000) Number of Shares 267,000 (67,000) Stated Value Amount 267,000 (67,000) Common Stock Par Value $0.001 Amount 10,000 1,000 Number of Shares 10,482,609 340,240 47,221 46,700 55,400 15,500 13,400 Additional Paid-In Capital 20,120,000 170,000 34,000 125,000 28,000 114,000 93,000 (135,000) 7,000 300,614 301,000 200,000 200,000 11,001,070 11,000 20,556,000 (300,614) (301,000) (200,000) (200,000) 1,001,228 2,000 138,335 38,000 521,158 81,000 1,100 - 100 - 600 100 100 500,000 2,000 190,000 19,000 260,000 271,000 (39,000) 0 $0 0 $0 12,782,791 $13,000 $21,759,000 Retained Earnings (deficit) (3,016,000) (7,000) (11,000) 1,747,000 (1,287,000) (19,000) (11,000) (261,000) 2,727,000 $1,149,000 142,810 10,750 2,500 128,047 565,000 200 100 100 100 600 (100) 762,000 69,000 17,000 240,000 383,000 41,000 3,374,000 (16,000) 0 $0 0 $0 13,631,898 $14,000 $26,629,000 5,082,000 $6,231,000 The accompanying notes are an integral part of these consolidated financial statements 25 MEDIFAST, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) – (CONTINUED) Years Ended December 31, 2006, 2005, and 2004 Consolidated Statement of Changes in Stockholders’ Equity and Accumulated Other Comprehensive Income (Loss) Common Stock Balance, December 31, 2003 Preferred converted to Common Stock 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 Preferred converted to Common Stock 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 Vesting of unearned compensation Treasury shares repurchased Net income Balance, December 31, 2005 Warrants converted to common stock Common stock issued to Directors Common stock issued to consultants Dividend paid in stock Options excercised to common stock Options granted to CEO FASB 123R vesting Shares issued to executives with 5 & 6 year vesting period Vesting of unearned compensation Treasury shares issued to employees Net income Balance, December 31, 2006 Accumulated other comprehensive income (loss) (25,000) (14,000) (39,000) Total 17,760,000 35,000 125,000 28,000 114,000 93,000 (135,000) (11,000) 1,733,000 19,742,000 2,000 190,000 (11,000) 271,000 (39,000) Unearned Compensation - - Treasury Stock (683,000) (31,000) (123,000) 166,000 135,000 135,000 (536,000) (124,000) 38,000 (453,000) (122,000) 15,000 321,000 $282,000 3,048,000 $23,203,000 ($1,075,000) ($107,000) 763,000 69,000 17,000 241,000 383,000 41,000 3,374,000 52,000 $334,000 (16,000) 5,133,000 $33,208,000 (137,000) (490,000) 16,000 (383,000) (3,374,000) 508,000 ($1,686,000) ($3,356,000) The accompanying notes are an integral part of these consolidated financial statements 26 MEDIFAS T, INC. AND S UBS IDIARIES CONS OLIDATED S TATEMENTS OF CAS H FLOW Years Ended December 31, Cash flows from Operating Activities: Net income Adjustments to reconcile net income to net cash provided by operating activities from operations: Depreciation and amortization Realized (gain) loss on investment securities Loss on sale of Consumer Choice Systems Common stock issued for services Vesting of unearned compensation Stock options vested during year Excess tax benefits from share-based payment arrangements Net change in other accumulated comprehensive income (loss) Provision for bad debts Deferred income taxes Changes in Assets and Liabilities: Decrease (increase) in accounts receivable (Increase) in inventory (Increase) decrease in prepaid expenses and other current assets (Increase) in deferred compensation Decrease (increase) in other assets Increase (decrease) in accounts payable and accrued expenses Increase (decrease) in income taxes payable Net cash provided by operating activities Cash Flows from Investing Activities: Sale (purchase) of investment securities, net Purchase of building Purchase of property and equipment Purchase of intangible assets Net cash (used in) investing activities Cash Flows from Financing Activities: Issuance of common stock, options and warrants Increase in line of credit, net Excess tax benefits from share-based payment arrangements Purchase of treasury stock Proceeds from long-term debt Principal repayments of long-term debt Dividends paid on preferred stock Net cash provided by (used in) financing activities NET INCREAS E (DECREAS E) IN CAS H AND CAS H EQUIVALENTS Cash and cash equivalents - beginning of the year Cash and cash equivalents - end of year S upplemental disclosure of cash flow information: Interest paid Income taxes S upplemental disclosure of non cash activity: Common stock issued to executives over 6-year vesting period Common shares issued for options and warrants Options vested during period Conversion of preferred stock B and C to common stock Common stock for services Conversion of debt to equity Preferred B and C Stock Dividends Line of credit converted to long-term debt 2006 2005 2004 $ 5,082,000 $ 2,727,000 $ 1,747,000 2,396,000 (79,000) 323,000 86,000 509,000 40,000 16,000 52,000 - (648,000) 379,000 (3,138,000) 675,000 (148,000) 13,000 651,000 (364,000) 5,845,000 1,237,000 - (5,557,000) (2,427,000) (6,747,000) 795,000 623,000 (14,000) (420,000) - (481,000) - 503,000 1,741,000 10,000 - 150,000 15,000 - - 321,000 13,000 301,000 65,000 (1,225,000) (2,194,000) (204,000) 10,000 1,323,000 160,000 3,213,000 (84,000) - (1,672,000) (276,000) (2,032,000) 66,000 561,000 - (452,000) - (473,000) (11,000) (309,000) 1,210,000 19,000 - 93,000 - - - (14,000) - 486,000 (422,000) (1,263,000) (143,000) - (25,000) (460,000) 674,000 1,902,000 1,338,000 (566,000) (1,490,000) (2,792,000) (3,510,000) 7,000 314,000 - - 475,000 (1,089,000) (11,000) (304,000) (399,000) 872,000 (1,912,000) 1,484,000 1,085,000 $ 612,000 1,484,000 $ 2,524,000 612,000 $ $ 369,000 $ 317,000 $ 245,000 $ 3,403,000 $ 1,983,000 $ - $ 3,373,000 $ - $ 591,000 $ - $ 40,000 $ - $ - $ - $ - $ - $ 501,000 $ 170,000 $ 86,000 $ 150,000 $ 93,000 $ - $ - $ 307,000 $ - $ 287,000 $ 7,000 $ - $ 369,000 $ - Common stock issued for compensation to be earned upon vesting - $ $ 122,000 $ - MEDIFAS T, INC. AND S UBS IDIARIES CONDENS ED CONS OLIDATED S TATEMENTS OF CAS H FLOWS (CONT.) 2006 Years Ended December 31, 2005 2004 Supplemental disclosure of non cash activity: Sale of Consumer Choice Systems Inventory Accounts Receivable Intangible assets, net Note receivable Loss on sale of Consumer Choice Systems $358,000 131,000 1,337,000 (1,503,000) (323,000) $ - - - - - $ - - - - - $ - $ - $ - T he accompanying notes are an integral part of these consolidated financial statements 28 Medifast, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2006, 2005, 2004 1. BACKGROUND Nature of the Business Medifast, Inc. (the "Company", or "Medifast") is a Delaware corporation, incorporated in 1980. The Company’s operations are primarily conducted through five of its wholly owned subsidiaries, Jason Pharmaceuticals, Inc. ("Jason"), Take Shape for Life, Inc. (“TSFL”), Jason Enterprises, Inc., Jason 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, and meal replacement products manufactured in a modern, FDA approved facility in Owings Mills, Maryland. The Company is engaged in the manufacturing and distribution of Medifast(cid:1) and Hi-Energy(cid:1) branded and private label weight and disease management products. These products are sold through various channels of distribution, to include web, call center, independent health advisors, medical professionals, weight loss clinics, direct consumer marketing supported via the phone and the web. The processing, formulation, packaging, labeling and advertising of the Company’s products are subject to regulation by one or more federal agencies, including the Food and Drug Administration, the Federal Trade Commission, the Consumer Product Safety Commission, the United States Department of Agriculture, and the United States Environmental Protection Agency. 2. Summary of Significant Accounting Policies Significant accounting policies followed in the preparation of the consolidated financial statements are as follows: Principles of Consolidation and Basis of Presentation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Jason Pharmaceuticals, Inc., Take Shape For Life, Inc., Seven Crondall Associates, LLC, Jason Properties, LLC and Jason Enterprises, Inc. All inter-company accounts have been eliminated. Cash and Cash Equivalents For the purposes of the consolidated statements of cash flow, the Company considers all highly liquid debt instruments purchased with maturity of three months or less to be cash equivalents. At December 31, 2006, the Company had $979,000 in miscellaneous short-term investments through Merrill Lynch that are considered cash equivalents due to terms of maturity, and $106,000 in operating checking accounts. At December 31, 2005, the Company had $789,000 in a money market account, $365,000 in miscellaneous short-term investments through Merrill Lynch that are considered cash equivalents due to terms of maturity, and $330,000 in operating checking accounts. Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable are recorded net of reserves for sales returns and allowances, and net of provisions for doubtful accounts. Allowances for sales returns and discounts are based on an analysis of historical trends, and allowances for doubtful accounts are based primarily on an analysis of aging accounts receivable balances and on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history. Inventory Inventory is stated at the lower of cost or market, utilizing the first-in, first-out method. The cost of finished goods includes the cost of raw materials, packaging supplies, direct and indirect labor and other indirect manufacturing costs. Advertising Advertising costs such as preparation, layout, design and production of advertising are deferred. They are expensed when the advertisement is first used, except for the costs of executory contracts, which are amortized as performance under the 29 contract is received. Advertising costs deferred at December 31, 2006 and 2005, were $960,000 and $585,000 respectively. Advertising expense for the years ended December 31, 2006 and 2005 amounted to $14,300,000 and $3,784,000, respectively Property, Plant, and Equipment Property, plant and equipment are stated at cost less accumulated depreciation and amortization. The Company computes depreciation and amortization using the straight-line method over the estimated useful lives of the assets acquired as follows: Building and building improvements Equipment and fixtures Vehicles 39 years 3 - 15 years 5 years The carrying amount of all long-lived assets is evaluated periodically to determine whether adjustment to the useful life or to the unamortized balance is warranted. Such evaluation is based principally on the expected utilization of the long-lived assets and the projected undiscounted cash flows of the operations in which the long-lived assets are used. Income Taxes The Company accounts for income taxes in accordance with Statements of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income taxes and liabilities are computed annually for differences between the financial statement and the tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Earnings Per Common Share Basic earnings per share is calculated by dividing net profit attributable to common stockholders by the weighted average number of outstanding common shares during the year. Basic earnings per share exclude any dilutive effects of options, warrants and other stock-based compensation, which are included in diluted earnings per share. Revenue Recognition Revenue is recognized for product sales upon shipment and passing of risk to the customer and when estimates of discounts, rebates, promotional adjustments, price adjustments, returns, and other potential adjustments are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations. These estimates are presented in the financial statements as reductions to net revenues and accounts receivable which also include estimated sales returns, allowances and discounts. Outbound shipping charges to customers and outbound shipping-related costs are netted and included in “cost of sales.” Returns – Consistent with industry practice, the Company maintains a return policy that allows its customers to return product within a specified period (30 days). Because the period of payment generally approximates the period revenue was originally recognized, refunds are recorded as a reduction of revenue when paid. The Company’s estimate for returns is based upon its historical experience with actual returns. While such experience has allowed for reasonable estimation in the past, history may not always be an accurate indicator of future returns. The Company continually monitors its estimates for returns and makes adjustments when it believes that actual product returns may differ from the established accruals. Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the 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 expenses during the reporting periods. Actual results could differ from those estimates. 30 Fair Value of Financial Instruments The carrying amounts reported in the consolidated balance sheets for cash, certificates of deposit, accounts receivable, accounts payable and accrued liabilities approximate fair value because of the immediate or short-term maturity of the financial instruments. The Company believes that its indebtedness approximates fair value based on current yields for debt instruments with similar terms. Concentration of Credit Risk Financial instruments that potentially subject the Company to credit risk consist of cash, certificates of deposit, investment securities and trade receivables. Cash, money markets and investments exceed the federal insurance coverage by $2,610,000 and $2,248,000, respectively. The Company securities at December 31, 2006 and 2005, include amounts deposited with multiple financial institutions markets its products primarily to medical professionals, clinics, and Internet medical sales and has no substantial concentrations of credit risk in its trade receivables. As of December 31, 2006 and 2005, the Company had two customers that individually represented over 10% of the accounts receivable and in the aggregate, approximately 12% and 21% of the accounts receivable, respectively. Stock-Based Compensation Effective January 1, 2006, the Company adopted the provisions of Financial Accounting Standards Board Statement of Financial Accounting Standard (“SFAS”) No. 123(R), “Share-Based Payments,” which establishes the accounting for employee stock-based awards. Under the provisions of SFAS No.123(R), stock-based compensation is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period of the grant). The Company adopted SFAS No. 123(R) using the modified prospective method and, as a result, periods prior to December 31, 2005 have not been restated. The Company recognized stock-based compensation for awards issued under the Company’s stock option plans in other income/expenses included in the Condensed Consolidated Statement of Operations. Additionally, no modifications were made to outstanding stock options prior to the adoption of SFAS No. 123(R), and no cumulative adjustments were recorded in the Company’s financial statements. Prior to December 31, 2005, the Company accounted for stock-based compensation in accordance with provisions of Accounting Principles Board Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees,” and related interpretations. Under APB No. 25, compensation cost was recognized based on the difference, if any, on the date of grant between the fair value of the Company’s stock and the amount an employee must pay to acquire the stock. The Company grants stock options at an exercise price equal to 100% of the market price on the date of grant. Accordingly, no compensation expense was recognized for the stock option grants in periods prior to the adoption of SFAS No. 123(R). Unearned compensation represents shares issued to executives that will be vested over a 5-6 year period. These shares will be amortized over the vesting period in accordance with FASB 123(R). The expense related to the vesting of unearned compensation was $509,000 and $0 at December 31, 2006 and December 31, 2005, respectively. Expense related to vesting of options under FASB 123R was $40,000 and $0 at December 31, 2006 and December 31, 2005, respectively. SFAS No. 123(R) requires disclosure of pro-forma information for periods prior to the adoption. The pro-forma disclosures are based on the fair value of awards at the grant date, amortized to expense over the service period. The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, for the period prior to the adoption of SFAS No. 123(R), and the actual effect on net income and earnings per share for the period after the adoption of SFAS No. 123(R). 31 If compensation expense for the Company's stock-based compensation plans had been determined consistent with SFAS 123, the Company's net income and net income per share including pro forma results would have been the amounts indicated below: Net income: Years Ended December 31 2005 2006 2004 As reported Add: Stock-based employee compensation expense included in net income, net of related tax effects Deduct: Total stock-based employee compensation determined under fair value based method for all awards, net of related tax effects 5,082,000 2,727,000 1,747,000 24,000 (24,000) (280,000) (108,000) Net income, pro forma 5,082,000 2,447,000 1,639,000 Net income per share: as reported: Basic Diluted Pro forma: Basic Diluted $ $ 0.40 0.38 $ $ 0.20 0.19 $ $ 0.16 0.14 $ $ 0.40 0.38 $ $ 0.20 0.19 $ $ 0.15 0.13 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: Dividend yield ................... Expected volatility .............. Risk-free interest rate .......... Expected life in years ........... 2006 0.0% 0.70 4.50% 2005 2004 0.0% 0.0% 0.40 0.70 4.50% 4.50% 1-5 1-5 1-5 Recent Accounting Pronouncements In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140.” SFAS No. 155 resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets,” and permits fair value re- measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of the first fiscal year that begins after September 15, 2006. The Company is currently evaluating the effect the adoption of SFAS No. 155 will have on its financial position or results of operations. 32 In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140.” SFAS No. 156 requires an entity to recognize a servicing asset or liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract under a transfer of the servicer’s financial assets that meets the requirements for sale accounting, a transfer of the servicer’s financial assets to a qualified special-purpose entity in a guaranteed mortgage securitization in which the transferor retains all of the resulting securities and classifies them as either available-for-sale or trading securities in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and an acquisition or assumption of an obligation to service a financial asset that does not relate to financial assets of the servicer or its consolidated affiliates. Additionally, SFAS No. 156 requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, permits an entity to choose either the use of an amortization or fair value method for subsequent measurements, permits at initial adoption a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights and requires separate presentation of servicing assets and liabilities subsequently measured at fair value and additional disclosures for all separately recognized servicing assets and liabilities. SFAS No. 156 is effective for transactions entered into after the beginning of the first fiscal year that begins after September 15, 2006. The Company is currently evaluating the effect the adoption of SFAS No. 156 will have on its financial position or results of operations. In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements, (“FAS 157”). This Standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The adoption of FAS 157 is not expected to have a material impact on the Company’s financial position, results of operations or cash flows. The FASB also issued in September 2006 Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statement No. 87, 88, 106 and 132(R), (“FAS 158”) . This Standard requires recognition of the funded status of a benefit plan in the statement of financial position. The Standard also requires recognition in other comprehensive income certain gains and losses that arise during the period but are deferred under pension accounting rules, as well as modifies the timing of reporting and adds certain disclosures. FAS 158 provides recognition and disclosure elements to be effective as of the end of the fiscal year after December 15, 2006 and measurement elements to be effective for fiscal years ending after December 15, 2008. The Company has not yet analyzed the impact FAS 158 will have on its financial condition, results of operations, cash flows or disclosures. In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108, “Quantifying Misstatements.” SAB 108 provides interpretative guidance on how public companies quantify financial statement misstatements. There have been two common approaches used to quantify such errors. Under an income statement approach, the “roll-over” method, the error is quantified as the amount by which the current year income statement is misstated. Alternatively, under a balance sheet approach, the “iron curtain” method, the error is quantified as the cumulative amount by which the current year balance sheet is misstated. In SAB 108, the SEC established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the roll-over and iron curtain methods. SAB 108 is effective for the first fiscal year ending after November 15, 2006. The adoption of SAB 108 did not have a material impact on the Company’s consolidated financial position and results of operations. In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48 is not expected to have a material impact on the Company’s consolidated financial position and results of operations. Investments In accordance with FAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, securities are classified into three categories: held-to-maturity, available-for-sale and trading. The Company’s investments consist of debt and equity securities classified as available-for-sale securities. Accordingly, they are carried at fair value in accordance with FAS No. 115. Further, according to FAS No. 115 the unrealized holding gains and losses for available-for-sales securities are excluded from earnings and reported, net of deferred income taxes, as a separate component of stockholders’ equity, unless the loss is classified as other than a temporary decline in market value. 33 Goodwill and Other Intangible Assets In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement No. 142 “Goodwill and Other Intangible Assets”. This statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, “Intangible Assets”. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Upon the sale of Consumer Choice Systems, Inc. on January 17, 2006, the goodwill balance of $894,000 was removed from the Company’s books. In addition, the Company has acquired other intangible assets, which include: customer lists, non-compete agreements, trademarks and patents. The non-compete agreements are being amortized over the legal life of the agreements ranging between 3 to 7 years. The customer lists are being amortized over a period ranging between 5 to 10 years based on management’s best estimate of the expected benefits to be consumed or otherwise used up. Trademarks and patents are regularly reviewed to determine whether the facts and circumstances exist to indicate that the useful life is shorter than originally estimated or the carrying amount of the assets may not be recoverable. The Company assesses the recoverability of its trademarks and patents by comparing the projected discounted net cash flows associated with the related asset, over their remaining lives, in comparison to their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. Comprehensive Income (Loss) Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including unrealized gains and losses on marketable securities. The Company presents comprehensive income in its consolidated statements of stockholders equity. Reclassifications Certain amounts for the years ended December 31, 2005 and 2004 have been reclassified to conform to the presentation of the December 31, 2006 amounts. The reclassifications have no effect on net income for the years ended December 31, 2005 and 2004. 3. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITES The following summarizes cash, cash equivalents, and marketable securities: Cost Accrued interest Fair value Cash and cash equivalents Demand deposits M oney market accounts December 31, 2006 Marketable S ecurities M arketable securities December 31, 2006 Cash and cash equivalents Demand deposits M oney market accounts December 31, 2005 $ 106,000 979,000 1,085,000 $ - $ - $ - $ $ 106,000 979,000 1,085,000 $ $ 1,206,000 1,206,000 $ $ 334,000 334,000 $ $ 1,540,000 1,540,000 $ 330,000 1,154,000 1,484,000 $ - $ - $ - $ $ 330,000 1,154,000 1,484,000 Cash equivalents and marketable securities M arketable securities December 31, 2005 $ $ 2,418,000 2,418,000 $ $ 282,000 282,000 $ $ 2,700,000 2,700,000 34 4. INVENTORY Inventory consists of the following at December 31, 2006 and 2005: Raw materials ....................…. Packaging…………………… Finished goods ........................ $1,872,000 1,625,000 4,758,000 $8,255,000 2006 2005 $1,906,000 1,142,000 2,427,000 $ 5,475,000 5. PREPAID EXPENSES AND OTHER CURRENT ASSETS Prepaid expense and other current assets as of December 31, 2006 and 2005, consist of the following: M arketing and advertising Taxes Supplies Insurance Services Other 2006 2005 1,830,000 - 158,000 519,000 92,000 1,592,000 779,000 393,000 294,000 50,000 165,000 2,599,000 3,273,000 6. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment as of December 31, 2006 and 2005, consist of the following: Land Building and building improvements Equipment and fixtures Vehicle Less accumulated depreciation and amortization Property, plant and equipment - net 2006 $ 650,000 7,182,000 10,805,000 43,000 2005 $ 650,000 6,871,000 5,583,000 19,000 18,680,000 13,123,000 4,660,000 $ 14,020,000 3,588,000 $ 9,535,000 Substantially all of the Company's property, plant and equipment are pledged as collateral for various loans (see Note Payable footnote). Depreciation expense for the years ended December 31, 2006, 2005, and 2004 were $1,072,000, $835,000 and $804,000, respectively. 35 7. TRADEMARKS AND INTANGIBLES As of December 31, 2006 As of December 31, 2005 Gross Carrying Amount Accumulated Amortization Gross Carrying Amount Accumulated Amortization Customer lists Non-compete agreements Trademarks and patents Goodwill $ 6,346,000 840,000 1,707,000 - $ 1,636,000 840,000 143,000 $ 4,514,000 840,000 1,821,000 894,000 $ 873,000 566,000 121,000 - Total $ 8,893,000 $ 2,619,000 $ 8,069,000 $ 1,560,000 Amortization expense for the years ended December 31, 2006, 2005 and 2004 was as follows: Customer lists Non-compete agreements Trademarks and patents 2006 $ 966,000 273,000 85,000 2005 $ 479,000 369,000 58,000 2004 $ 244,000 162,000 - Total trademarks and intangibles $ 1,324,000 $ 906,000 $ 406,000 On January 17, 2006 the Consumer Choice Systems division of the Company was sold which included the sale of $1,601,000 in gross intangible assets and $265,000 in accumulated amortization. The estimated future amortization expense of trademarks and intangible assets is as follows: For the years ending December 31, Amount 2007 2008 2009 2010 2011 $1,640,000 1,615,000 675,000 600,000 590,000 8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses as of December 31, 2006 and 2005 consist of the following: Trade payables Accrued payroll and related taxes Sales commissions payable Total 2006 $ 2,214,000 328,000 371,000 $ 2,913,000 2005 $ 1,695,000 314,000 254,000 $2,263,000 36 9. COMMITMENTS AND CONTINGENCIES The Company leases office space for its eleven corporately owned Medifast Weight Control Centers under lease terms ranging from one to five years with leases commencing in 2004, 2005, 2006 and 2007. Monthly payments under the leases range in price from $1,200 to $3,500. 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, 2006: For the Years Ending December 31, 2007 2008 2009 2010 2011 $ 253,000 221,000 215,000 110,000 70,000 Total minimum payments required $ 869,000 Rent expense for the years ended December 31, 2006, 2005, and 2004 was $116,000, $211,000, and $229,000, respectively. There is no pending or threatened legal action that would have material adverse on the Company’s consolidated financial position, results or operations or cash flows in future years. 10. INCOME TAXES Significant components of the income tax benefit for the years ended December 31 are as follows: 2006 2005 2004 Current: Federal State Total Current Deferred: Federal State Total deferred Income tax expense $ $ 1,184,000 314,000 1,498,000 $ $ 685,000 217,000 902,000 $ $ 600,000 90,000 690,000 $ $ $ 657,000 101,000 758,000 2,256,000 261,000 40,000 301,000 1,203,000 408,000 61,000 469,000 1,159,000 $ $ $ 37 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: Provision at the U.S. federal statutory rate State taxes, net of federal benefit Intangible assets Other temporary differences Cost segregation study Permanent differences Income tax expense $ 2006 2,492,000 366,000 (298,000) - (275,000) (29,000) 2,256,000 $ 2005 1,272,000 198,000 (153,000) (98,000) - (16,000) 1,203,000 $ $ $ 2004 1,087,000 145,000 (73,000) - - - $ 1,159,000 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: 2006 2005 Deferred tax assets Intangible assets Accounts receivable Inventory overhead and write downs Deferred compensation Total deferred tax assets $ $ 330,000 37,000 49,000 41,000 457,000 - $ - - - $ - Deferred Tax Liabilities Intangible assets Accounts receivable Inventory overhead and write downs Total deferred tax liabilities $ - - - $ - $ $ (113,000) (37,000) (41,000) (191,000) The 2006 effective income tax rate of 30.7% differed from the federal statutory rate of 34% due to the amortization of intangible assets, a cost segregation study performed on fixed assets, as well as timing differences for other temporary and permanent differences, and state income taxes. 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. 38 11. STOCK OPTION PLAN On October 9, 1993 and as amended in May 1995, the Company adopted a stock option plan ("Plan") authorizing the grant of incentive and non-incentive options for an aggregate of 500,000 shares of the Company's common stock to officers, employees, directors and consultants. Incentive options are to be granted at fair market value. Options are to be exercisable as determined by the stock option committee. In November 1997, June 2002 and July 2004, the Company amended the Plan by increasing the number of shares of the Company's common stock subject to the Plan by an aggregate of 200,000 shares, 300,000 shares and 250,000 shares respectively. The Company has elected to continue to account for stock option grants in accordance with APB 25 and related interpretations. Under APB 25, where the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation is recognized. The following summarizes the stock option activity for the years ended December 31: 2006 2005 2004 Weighted Average Exercise Price $ 2.71 6.25 6.36 (2.11) (8.36) Shares 359,727 100,000 16,666 (128,147) (26,667) Weighted Average Exercise Price $ 1.51 2.64 0.00 (1.83) (1.17) Shares 389,397 333,333 - (138,335) (224,668) Weighted Average Exercise Price $ 1.76 8.60 0.00 (1.19) (7.01) Shares 439,455.00 30,000.00 - (47,221) (32,837) Outstanding at beginning of year Options granted Options reinstated Options exercised Options forfeited or expired Outstanding at end of year Options exercisable at year end 321,579 211,577 $ 3.88 $ 2.77 359,727 $ 2.71 389,397.00 $ 1.51 329,725 $ 2.56 350,336.00 $ 1.11 The weighted average fair value at date of grant for options granted during the years 2006, 2005, and 2004 were $6.25, $2.64, and $8.60, respectively. In 2005, the Company incorrectly cancelled 75,000 options to a former consultant. The options were correctly added back to the 2005 and 2006 option schedule above. The omission from the schedule in prior year had no impact on earnings per share. During 2006, the former consultant exercised 25,000 options and 50,000 remain outstanding. 39 Average Exercise Price $0.50 $1.60 $2.67 $3.83 $4.80 $6.25 Range of Exercise Prices $0.50 $1.60 $2.87 $3.83 $4.80 $6.25 The following table summarizes information about stock options outstanding and exercisable at December 31, 2006: Options Outstanding Weighted Average Options Exercisable Contractual Weighted Weighted Life Average Number Remaining Exercise Number Outstanding (in Years) Price Exercisable 50,000 2,779 123,334 23,334 15,000 1.0 .7 3.3 3.9 1.3 4.1 1.4 $0.50 $1.60 $2.87 $3.83 $4.80 $6.25 50,000 2,779 123,334 13,332 15,000 - $11.12 7,132 100,000 $11.12 7,132 $11.15 321,579 $3.88 211,577 $2.77 12. LONG-TERM DEBT AND LINE OF CREDIT Long-term debt as of December 31, 2006 and 2005, consist of the following: 2006 2005 $3,539,000 ten year term loan secured by two buildings and land at a variable rate which was 7.1% at December 31, 2006. Due 2016 $200,000 five-year term loan secured by equipment fixed rate was 3% at December 31, 2006. Due 2008 49,000 90,000 $475,000 seven-year loan secured by the building and land at a variable rate at LIBOR plus 250 bps, which was 7.85 % on December 31, 2006. Due 2011 396,000 428,000 $366,000 three-year term loan secured by certain assets at LIBOR plus 250 basis points, which was at 7.82% at December 31, 2006. Due 2008 $1,256,000 ten-year reducing revolver line of credit rate at LIBOR plus 220 bps , which was 6.62% on December 31, 2006 $186,976 three-year term loan secured by 20,000 restricted common shares variable rate which was 10.25% $ 2,201,000 59,000 $ 3,480,000 1,506,000 132,000 - - 254,000 Less current portion 4,057,000 4,538,000 548,000 561,000 $ 3,509,000 $ 3,977,000 40 Future principal payments on long-term debt for the next 5 years are as follows: 2007 ...................................... $548,000 404,000 2008 ...................................... 386,000 2009...................................... 386,000 2010 ……………………….. 2011……………………….. 386,000 Thereafter…………………... 1,947,000 $4,057,000 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. The outstanding balance on this line was $1,256,000 and $633,000 at December 31, 2006 and 2005, respectively. Effective October 2, 2006, the 10-year revolver with an original balance of $1,256,000 was refinanced with the Company’s other building loan for a total of $3,539,000 with Mercantile Safe Deposit and Trust Company secured by two buildings and land at a variable rate which was 7.1% on December 31, 2006. 13. EMPLOYMENT AGREEMENTS The Board of Directors of Medifast, Inc. is in the process of implementing a management succession plan which will take place over the next 24 months. In doing so, they have had 3 key executive officers sign 6-year employment contracts to ensure that there will be minimal turnover in selected key management positions. The Executives associated with this succession plan include Michael S. McDevitt, President and Chief Financial Officer, Margaret MacDonald, VP of Operations and Brendan Connors, CPA, VP of Finance. Bradley T. MacDonald, the Executive Chairman of the Board of Directors and CEO has signed and executed a new 5 year employment agreement as the Executive Chairman of the Board of Directors and will provide on- going executive mentoring, financial and M&A advice, and new business development for the Company. On February 8, 2006, three executive officers of the Company signed 6-year employment contracts. The officers received shares of common stock in varying amounts totaling 380,000 shares at $6.25 per share that will be vested over 6 years. In addition, Bradley T. MacDonald, Chairman and CEO signed a new 5-year employment agreement and was granted 100,000 stock options at $6.25 that will vest over 5 years beginning on February 8, 2007. 14. WARRANTS During 2003, the Company issued 200,000 warrants to James Paradis and Anthony Burrascono, both affiliated with Villanova University and 200,000 warrants an investment banker, for advisory and consulting services provided to the Company. The warrants vest in five equal installments of 40,000 warrants per year over a five-year period. These are five-year warrants to purchase common shares at an exercise price of $4.80 per share. These warrants may be cancelled, with a 90-day notice, if the consultants fail to perform to the satisfaction of the Company. During 2005, 120,000 unvested warrants issued to James Paradis and Anthony Burrascono were cancelled. In 2006, James Paradis and Anthony Burrascano exercised 80,000 warrants at $4.80. In 2005, the Company incorrectly cancelled 80,000 warrants to a former consultant. The warrants were correctly added back to the 2005 and 2006 warrant schedule. The omission from the schedule in prior year had no impact on earnings per share. During 2006, the former consultant exercised 40,000 warrants and 120,000 remain outstanding. During 2003, the Company issued 50,000 warrants to Consumer Choices Systems, Inc. (“CCS”) as part of the payment for the purchase of the assets of CCS. These warrants are three-year warrants to purchase common shares at an exercise price of $10.00 per share. Of this amount, 25,000 warrants were exercised in 2004. Of the remaining 25,000 warrants, 22,810 were exercised in 2006 and the remaining 2,190 expired. During 2003, the Company issued 63,750 warrants and 18,750 warrants to Mainfield Enterprises, Inc. and Portside Growth & Opportunity Fund. These warrants are five-year warrants to purchase common shares at exercise prices of $16.78 per share, which was equal to one hundred fifteen percent (115%) of the five-day volume weighted average price, all pursuant to the terms of that certain Securities Purchase Agreement by and between the Company and Mainfield Enterprises, Inc. and Portside Growth & Opportunity Fund dated as of July 24, 2003. 41 During 2006, there were 120,000 warrants exercised at $4.80 and 22,810 warrants exercised at $10. In addition, 2,190 warrants expired. The fair value of these warrants was estimated using the Black-Scholes pricing model with the following assumptions: interest rate 4.5%, dividend yield 0%, volatility 0.70 and expected life of five years. The Company has the following warrants outstanding for the purchase of its common stock: Exercise Price Expiration Date 2006 Years Ended December 31, 2005 $0.35 M arch, 2005 $4.80 $10.00 $16.78 January, 2009 June, 2006 July, 2008 Weighted average exercise price - 120,000 0 82,500 202,500 9.68 - 240,000 25,000 82,500 347,500 8.02 2004 2,000 360,000 25,000 82,500 469,500 $7.16 As of December 31, 2006, 82,500 of the warrants are exercisable. 15. QUARTERLY RESULTS (Unaudited) 2006 Revenue Gross Profit Operating Income Net Income Earnings per common share - diluted (1) 2005 Revenue Gross Profit Operating Income Net Income Earnings per common share - diluted (1) First Quarter Second Quarter Third Quarter Fourth Quarter $19,183,000 14,405,000 3,054,000 1,694,000 0.13 $19,954,000 15,101,000 2,541,000 1,475,000 0.11 $19,642,000 14,937,000 1,970,000 1,470,000 0.11 $15,307,000 11,406,000 547,000 443,000 0.03 $8,326,000 6,253,000 912,000 507,000 0.04 $10,555,000 7,932,000 1,154,000 753,000 0.06 $10,985,000 8,310,000 1,266,000 607,000 0.05 $10,264,000 7,473,000 742,000 849,000 0.04 (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. 42 16. DISPOSAL OF A BUSINESS SEGMENT 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. Revenues, net Cost of Sales Gross Profit Compensation and Professional Fees Selling, General and Adminstrative Expenses Depreciation and Amortization Interest (net) Net income (loss) Earnings per share - basic Earnings per share - diluted Segment Assets Fixed assets, net of depreciation Inventory Prepaid expenses Accounts receivable Intangible assets Goodwill 2005 $958,000 733,000 225,000 290,000 208,000 209,000 8,000 (490,000) (0.04) (0.04) 2,216,000 54,000 293,000 327,000 171,000 443,000 893,500 2004 $1,498,000 686,000 812,000 213,000 256,000 90,000 17,000 236,000 0.02 0.02 2,625,000 71,000 391,000 - 629,000 635,000 893,500 2003 $851,000 343,000 508,000 254,000 212,418 95,000 8,000 (61,418) (0.01) (0.01) 2,497,000 91,000 470,000 53,000 221,000 635,500 893,500 43 INDEX TO EXHIBITS No. 3.1 Certificate of Incorporation of the Company and amendments thereto* 3.2 By-Laws of the Company* 10.1 1993 Stock Option Plan of the Company as amended* 10.3 Lease relating to the Company's Owings Mills, Maryland facility** 10.4 Employment agreement with Bradley T. MacDonald*** 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 ________ * Filed as an exhibit to and incorporated by reference to the Registration Statement on Form SB-2 of the Company, File No. 33-71284-NY. ** Filed as an exhibit to and incorporated by reference to the Registration Statement on Form S-4 of the Company, File No. 33-81524. ***Filed as an exhibit to 10KSB, dated April 15, 1999 of the Company, file No. 000-23016. (b) Reports on Form 8-K September 21, 2005 to report the Annual Meeting of Shareholders September 16, 2005 October 19, 2005, to report the repurchase of 110,000 shares of common stock January 17, 2006, to report the sale of Consumer Choice Systems assets, the promotion of Michael S. McDevitt to Chief Financial Officer, and 2006 financial guidance August 14, 2006, to report the acceptance by the New York Stock Exchange to list common shares on the NYSE September 25, 2006, to report the results of the Annual Meeting of Shareholder on September 8, 2006 October 2, 2006, to announce the election of two new Board of Directors March 1, 2007, to announce Michael S. McDevitt promoted to CEO, Margaret MacDonald promoted to President and COO, and Bradley T..MacDonald named Executive Chairman of the Board. March 7, 2007, to announce full-year 2007 revenue and diluted earnings per share guidance 44 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 Executive Chairman of the Board Dated: March 16, 2007 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 ------------------------------------------- Bradley T. MacDonald /s/ GEORGE LAVIN ------------------------------------------ George Lavin /s/ MICHAEL C. MACDONALD ------------------------------------------ Michael C. MacDonald /s/ MARY T. TRAVIS ------------------------------------------ Mary T. Travis /s/ REV. DONALD F. REILLY, OSA ------------------------------------------ Rev. Donald F. Reilly, OSA /s/ MICHAEL J. MCDEVITT ------------------------------------------ Michael J. McDevitt /s/ JOSEPH D. CALDERONE ------------------------------------------ Joseph D. Calderone /s/ CHARLES P. CONNOLLY ------------------------------------------ Charles P. Connolly /s/ DENNIS M. MCCARTHY ------------------------------------------ Dennis M. McCarthy Chairman of the Board, Director March 16, 2007 Director March 16, 2007 Director March 16, 2007 Director March 16, 2007 Director March 16, 2007 Director March 16, 2007 Director March 16, 2007 Director March 16, 2007 Director March 16, 2007 45 Exhibit 31.1 CEO 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 16, 2007 /s/ Michael S. McDevitt Michael S. McDevitt Chief Executive Officer, Chief Financial Officer Exhibit 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 46 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 16, 2007 /s/ Michael S. McDevitt Michael S. McDevitt Chief Executive Officer, Chief Financial Officer 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, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I Michael S. McDevitt, 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: 47 (1) (2) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 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/ Michael S. McDevitt Michael S. McDevitt Chief Executive Officer, Chief Financial Officer March 16, 2007 48 

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