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To the Securities and Exchange Commission Chief Accountant Wayne Carnall:

Based on my analysis of Medifast’s (NYSE: MED) financial disclosures below, I respectfully recommend that the Division of Corporation Finance immediately review the company’s revenue recognition policy, before it issues its Q2 2010 10-Q report. Medifast’s relatively vague revenue recognition policy and other skimpy disclosures give rise to reasonable questions concerning the company’s compliance with Generally Accepted Accounting Principles (GAAP) and SEC Staff Accounting Bulletin Topic 13: A.

Medifast's Revenue Recognition Policy

Medifast’s revenue recognition policy is disclosed as follows in its various filings with the Securities and Exchange Commission (See 2009 10-K report pages 20 and 65):

Revenue Recognition. Revenue from product sales is recognized net of discounts, rebates, promotional adjustments, price adjustments, returns and other potential adjustments upon shipment and passing of risk to the customer and when estimates of are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations.

Note: Bold print and italics added by me.

In addition, it takes Medifast up to “24 hours” to process an order. Afterwards, the company ships the product on “the next business day.” See quote from the company website below:

What is your shipping policy? All orders are processed within 24 hours and shipped the next business day. Allow five to seven business days for standard shipping, or three to four business days for expedited shipping (additional charge). V.I.P.

Membership orders of $225 or more (total after coupons and discounts) get FREE standard shipping anywhere in the U.S. Non-V.I.P. Membership orders of $275 or more (total after coupons and discounts) get half-price standard shipping anywhere in the U.S.

As a minimum, Medifast ships customer orders on the very "next business day" after such orders are processed. If a customer order takes, for example, 23 hours to process, the shipment of product can potentially occur two business days after the order is processed.

If a company processes an order from a customer prior to the end of a reporting period, but does not ship the product until after the end of the accounting period, in such instance, the company reports a "deferred revenue" liability (meaning the company owes the customer products that have not been delivered). Here is the accounting entry: Debit- Cash or Accounts Receivable (asset account) and Credit- Deferred Revenue (liability account).

However, Medifast's financial disclosures showed no deferred revenue liabilities in its 2009 10-K report for both 2009 and 2008 fiscal years. See selected disclosures below:

Please note that Medifast makes no line item disclosure for deferred revenue liabilities. In addition, the company's break down of accounts payable and accrued expenses in Note 8 above, includes no reference to deferred revenue liabilities. However, Medifast's shipping policy clearly states that all orders are "shipped the next business day."

I checked Medifast's accounts receivable disclosure and found no indication that deferred revenue liabilities were reported as an offset to receivables. See below:

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.

In any event, Medifast reported a mere $100,000 combined amount for "allowance for sales returns and doubtful accounts" at the end of fiscal year 2009 and 2008. Such amounts do not seem to be enough to cover the items detailed in the disclosure above and also include a provision for deferred revenue liabilities.

I am concerned that Medifast's financial disclosures simply show no deferred revenue liabilities for customer orders processed before the end of fiscal years 2009 and 2008, but shipped after those respective fiscal years.

Recognizing Revenue on Delivery Date

According to SEC Staff Accounting Bulletin Topic 13: A, if risk of loss, in substance, does not pass to the customer until delivery of said ordered product, revenue must be recognized on the date of delivery and not the date of shipment.

The SEC Division of Corporation Finance took that position in its review of Overstock.com’s (NASDAQ: OSTK) revenue recognition policies. Overstock.com was required to report an accounting error because the company was recognizing revenue at the point of shipment, instead of delivery date. In the addition, the SEC required Overstock.com to expand and clarify its revenue accounting disclosures. See the quote below from the SEC Division of Corporation Finance correspondence with Overstock.com:

...in your response, in substance, risk of loss does not transfer to the customer at point of shipment, but instead transfers to the customer upon delivery and acceptance. Since assumption for risk of loss is a significant obligation during the delivery process, we are not persuaded that you should recognize revenue before the delivery process is complete. Please revise disclosure of your accounting policy accordingly to clarify that risk of loss transfers to the customer upon delivery and acceptance for all sales at which time revenue is recognized. Please revise your financial statements accordingly to reflect revenue being recognized based on delivery to the customer for all periods presented and provide the disclosures required by SFAS 154 for correction of an error.

Note: Bold print and italics added by me

Based on a Medifast document entitled "Medifast Return Policy," the company, like Overstock.com, does not "in substance" seem to transfer risk of loss to the customer until the product delivery date. See the quoted information below:

Other Customer Relations Policies

Substitutions

• Depending upon availability, Medifast reserves the right to substitute comparable products in 4-week and 2-week package orders.

Returns Associated with Substandard Product or Errors

• In the event that Medifast ships consumable products with defects or products that were not part of the order, Medifast will issue the customer a Return Merchandise Authorization (RMA) number and shipping labels so that the items in question can be returned at the company’s expense. Customers should report such issues and request RMA’s by calling 800-638-7867. Upon receipt of returned shipment, Medifast conducts a Quality Assurance test to determine appropriate resolution. If the customer receives defective non-consumable goods, the company will send replacement. Shipping charges related to original order will not be refunded.

Exchanges

• Medifast does not accept exchanges on any products.

Damaged Goods

• If a package arrives damaged and unacceptable, Medifast must be notified within fifteen (15) days of purchase. If notification is not given within fifteen (15) days, no claim will be placed with the shipping agent, and replacement products will not be shipped for the damaged package.

Shipping Errors

• If a package is shipped to the wrong destination and it is the company’s error, the company will pay to have the package shipped to the proper location. Medifast will ship expedited freight for any products needed immediately (i.e. customer is out of supplements completely), but will ship UPS Ground for all other products. If the error is on the client’s part, they must make their own arrangements to send the shipment back to Medifast in order to receive credit. If the shipping agent (i.e. Federal Express, UPS, USPS) has delivered the shipment inaccurately, Medifast will send shipping labels to the customer. The customer will then bring the package to a shipping provider to have it returned to Medifast.

Order Cancellation

• If a request for cancellation occurs after the order has been shipped; the customer will be instructed to refuse the package. Cost of products will be refunded however the customer is responsible to pay for shipping and handling.

Theft Losses

• If a package is stolen from a doorstep, Medifast will ship a replacement order which will require a signature upon delivery. This policy applies to one occurrence of theft only. Medifast will investigate the theft of the original package and file a claim with the shipping agent. Medifast reserves the right to refuse replacement shipments based on customer history at any time.

As detailed above, the Medifast clearly transfers risk of loss to the customer upon delivery and acceptance of said product to its customers, since the company clearly assumes such risk for: Returns associated with substandard product or errors, damaged goods, shipping errors, order cancellation, and theft losses before delivery. However, Medifast's vague revenue recognition policy says that:

Revenue from product sales is recognized ...upon shipment and passing of risk to the customer...."

Based on the above disclosure, it seems that Medifast is recognizing revenue upon shipment and not delivery. As a minimum, Medifast, like Overstock.com, should be required to expand and clarify its disclosures to avoid confusing investors.

Again, I note that Medifast's disclosures apparently show no deferred revenue liabilities at the end of fiscal year 2009 and 2008. It does not seem reasonable that the $100,000 reserved for "allowance for sales returns and doubtful accounts" at the end of those fiscal years also includes a provision for deferred revenue liabilities.

However, Medifast's website states:

Allow five to seven business days for standard shipping, or three to four business days for expedited shipping (additional charge).

It is a concern that Medifast's financial disclosures simply show no deferred revenue (a liability) for customer orders processed before the end of fiscal years 2009 and 2008 and product delivered "five to seven business days" after those respective fiscal years.

Materiality

SEC Staff Accounting Bulletin No. 99 clearly states that registrants are not permitted to make intentional immaterial misstatements "in a manner inconsistent with GAAP." See below:

Immaterial Misstatements That are Intentional

Facts: A registrant's management intentionally has made adjustments to various financial statement items in a manner inconsistent with GAAP. In each accounting period in which such actions were taken, none of the individual adjustments is by itself material, nor is the aggregate effect on the financial statements taken as a whole material for the period. The registrant's earnings "management" has been effected at the direction or acquiescence of management in the belief that any deviations from GAAP have been immaterial and that accordingly the accounting is permissible.

Question: In the staff's view, may a registrant make intentional immaterial misstatements in its financial statements?

Interpretive Response: No. In certain circumstances, intentional immaterial misstatements are unlawful.

Therefore, a public company cannot recognize revenue "in a manner inconsistent with GAAP" even if "any deviations from GAAP have been immaterial." Please consider that even relatively small misstatements of revenue can cause disproportionate material misstatements of reported earnings, such as what happened with Overstock.com. A departure from GAAP is considered a material reportable event.

My open letter does not allege any violations of GAAP or SEC rules by Medifast. However, based on my analysis of Medifast's disclosures cited above, there is a reasonable cause for concern for the SEC to review the company's compliance with GAAP and SEC disclosure rules before another financial report is issued.

Respectfully,

Sam E. Antar

Disclosure: I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals.

Recently, I exposed financial reporting violations by Overstock.com (NASDAQ: OSTK) as an independent whistleblower. The Securities and Exchange Commission is investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

In addition, the SEC is investigating possible GAAP violations by Bidz.com (NASDAQ: BIDZ) after I alerted them to the company's inventory accounting practices.

I do not own Overstock.com or Bidz.com securities long or short. My exposure of confirmed financial reporting violations by Overstock.com and possible financial reporting violations by Bidz.com was a freebie to securities regulators to get me into heaven, though I doubt that I will ever get there.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

In the past, I was compensated by Fraud Discovery Institute to do certain research on InterOil and Medifast's auditors. However, I do not own InterOil or Medifast securities long or short. Fraud Discovery Institute, co-founder, Barry Minkow has publicly disclosed that he has held short positions in InterOil and Medifast securities.

I posted this open letter on my blog simply because I could. In America, even convicted felons like me have rights under the First Amendment to the U.S. Constitution. If anyone has any complaints, please ask your elected officials to change the Constitution, feel free to complain to the SEC, take other legal measures, or rant, yell and scream. I personally don't give a damn.

Finally, I invite Medifast to publish a detailed line-by-line response to my concerns and I will post such response on my blog.

Source: An Open Letter to the SEC About Medifast's Accounting Disclosures