**Exhibit 99.1**

 

A.D.A.M., Inc.

Consolidated Balance Sheets

(In thousands, except share data)

 
| ** **                                                                                                                                                                                                       | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                       | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **Assets**                                                                                                                                                                                                       | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current  assets                                                                                                                                                                                                  |       |                  |       |   |   |
| Cash and  cash equivalents                                                                                                                                                                                       |       | $                     | 2,816      |   | $ | 3,242 |   |
| Investments,  short term                                                                                                                                                                                         |       | 7,861                 |       | 2,726 |   |
| Accounts  receivable, net of allowances of $147 and $103 respectively                                                                                                                                            |       | 1,840                 |       | 2,112 |   |
| Restricted  time deposits                                                                                                                                                                                        |       | 25                    |       | — |   |
| Inventories,  net                                                                                                                                                                                                |       | 68                    |       | 107 |   |
| Note  receivable from related party                                                                                                                                                                              |       | —                |       | 39 |   |
| Deferred tax  asset                                                                                                                                                                                              |       | 221                   |       | — |   |
| Prepaids and  other assets                                                                                                                                                                                       |       | 463                   |       | 398 |   |
|                                                                                                                                                                                                             |       |                  |       |   |   |
| Total  current assets                                                                                                                                                                                            |       | 13,294                |       | 8,624 |   |
|                                                                                                                                                                                                             |       |                  |       |   |   |
| Property and equipment, net                                                                                                                                                                                      |       | 268                   |       | 184 |   |
| Investment, long term                                                                                                                                                                                            |       | —                |       | 1,000 |   |
| Intangible assets, net                                                                                                                                                                                           |       | 953                   |       | 1,278 |   |
| Goodwill                                                                                                                                                                                                         |       | 2,043                 |       | 2,043 |   |
| Restricted time deposits                                                                                                                                                                                         |       | 43                    |       | 115 |   |
| Deferred tax asset, net of current portion                                                                                                                                                                       |       | 5,279                 |       | — |   |
| Total assets                                                                                                                                                                                                     |       | $                     | 21,880     |   | $ | 13,244 |   |
|                                                                                                                                                                                                             |       |                  |       |   |   |
| **Liabilities and Shareholders’ Equity**                                                                                                                                                                    |       |                  |       |   |   |
| Current liabilities                                                                                                                                                                                              |       |                  |       |   |   |
| Accounts  payable and accrued expenses                                                                                                                                                                           |       | $                     | 1,055      |   | $ | 726 |   |
| Deferred  revenue                                                                                                                                                                                                |       | 3,643                 |       | 3,615 |   |
| Current  portion of capital lease obligations                                                                                                                                                                    |       | 20                    |       | 17 |   |
|                                                                                                                                                                                                             |       |                  |       |   |   |
| Total  current liabilities                                                                                                                                                                                       |       | 4,718                 |       | 4,358 |   |
|                                                                                                                                                                                                             |       |                  |       |   |   |
| Capital lease obligations, net of current  portion                                                                                                                                                               |       | 18                    |       | 37 |   |
|                                                                                                                                                                                                             |       |                  |       |   |   |
| Total  liabilities                                                                                                                                                                                               |       | 4,736                 |       | 4,395 |   |
|                                                                                                                                                                                                             |       |                  |       |   |   |
| Commitments and contingencies                                                                                                                                                                                    |       |                  |       |   |   |
|                                                                                                                                                                                                             |       |                  |       |   |   |
| Shareholders’ equity                                                                                                                                                                                        |       |                  |       |   |   |
| Preferred  stock, no par value; 10,000,000 shares authorized; no shares issued and  outstanding                                                                                                                  |       | —                |       | — |   |
| Common  stock, $.01 par value; 20,000,000 shares authorized; 8,482,772 shares issued  and 8,213,013 shares outstanding at 12/31/2005 and 8,040,906 shares issued  and 7,860,535 shares outstanding at 12/31/2004 |       | 85                    |       | 80 |   |
| Common stock  warrants                                                                                                                                                                                           |       | —                |       | 86 |   |
| Treasury  stock, at cost, 269,759 and 180,371 shares, respectively                                                                                                                                               |       | (1,088                | )          | (592 | ) |
| Additional paid-in  capital                                                                                                                                                                                      |       | 50,350                |       | 48,843 |   |
| Note  receivable from shareholder                                                                                                                                                                                |       | —                |       | (291 | ) |
| Unrealized  gain on investments                                                                                                                                                                                  |       | (11                   | )          | — |   |
| Deferred  compensation for services                                                                                                                                                                              |       | —                |       | (23 | ) |
| Accumulated  deficit                                                                                                                                                                                             |       | (32,192               | )          | (39,254 | ) |
|                                                                                                                                                                                                             |       |                  |       |   |   |
| Total  shareholders’ equity                                                                                                                                                                                 |       | 17,144                |       | 8,849 |   |
|                                                                                                                                                                                                             |       |                  |       |   |   |
| Total  liabilities and shareholders’ equity                                                                                                                                                                 |       | $                     | 21,880     |   | $ | 13,244 |   |

 

The accompanying notes are an integral part ofthese consolidated financial statements.

 

----

 

A.D.A.M., Inc.

ConsolidatedStatements of Operations

(In thousands, except per share data)

 
| ** **                                                                            | ** ** | **Year Ended**        | ** ** | **Year Ended**        | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                            | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                            | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| ** **                                                                            | ** ** | ** **            | ** ** | ** **            | ** ** |
| Revenues, net                                                                         |       | $                     | 10,054     |                  | $          | 8,433 |   |
| ** **                                                                            | ** ** | ** **            | ** ** | ** **            | ** ** |
| Operating costs and expenses                                                          |       |                  |       |                  |       |
| Cost of  revenues (exclusive of depreciation and amortization shown separately below) |       | 2,063                 |       | 1,717                 |       |
| General and  administrative                                                           |       | 3,096                 |       | 1,691                 |       |
| Product and  content development                                                      |       | 1,456                 |       | 1,321                 |       |
| Sales and  marketing                                                                  |       | 1,965                 |       | 1,603                 |       |
| Depreciation  and amortization                                                        |       | 185                   |       | 562                   |       |
|                                                                                  |       |                  |       |                  |       |
| Total  operating costs and expenses                                                   |       | 8,765                 |       | 6,894                 |       |
| ** **                                                                            | ** ** | ** **            | ** ** | ** **            | ** ** |
| Operating  income                                                                     |       | 1,289                 |       | 1,539                 |       |
| Interest income, net                                                                  |       | 313                   |       | 82                    |       |
| Loss on sale of investments                                                           |       | (40                   | )          | —                |       |
| Income  before income taxes                                                           |       | 1,562                 |       | 1,621                 |       |
| Income tax benefit, deferred                                                          |       | 5,500                 |       | —                |       |
| Net Income                                                                            |       | $                     | 7,062      |                  | $          | 1,621 |   |
| Basic net income per common share                                                     |       | $                     | 0.87       |                  | $          | 0.21 |   |
| Basic weighted average number of common  shares outstanding                           |       | 8,108                 |       | 7,879                 |       |
|                                                                                  |       |                  |       |                  |       |
| Diluted net income per common share                                                   |       | $                     | 0.75       |                  | $          | 0.19 |   |
|                                                                                  |       |                  |       |                  |       |
| Diluted weighted average number of common  shares outstanding                         |       | 9,468                 |       | 8,742                 |       |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

----

 

A.D.A.M., Inc.

ConsolidatedStatements of Changes in Shareholders’ Equity

(In thousands, except share data)

 
| ** **                                                                                                                | ** ** | ** **       | ** ** | ** ** | ** ** | ** **         | ** ** | ** **  | ** ** | ** ** | ** ** | ** **       | ** ** | **Note**          | ** ** | ** **       | ** ** | **Accumulated** | ** ** | ** **  | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------|------------|--------------------|------------|-------------|------------|------------|------------|------------------|------------|-------------------|------------|------------------|------------|-----------------|------------|-------------|------------|------------|------------|
| ** **                                                                                                                | ** ** | ** **       | ** ** | ** ** | ** ** | **Common**         | ** ** | ** **  | ** ** | ** ** | ** ** | **Additional**   | ** ** | **Receivable**    | ** ** | **Deferred**     | ** ** | **Other**       | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **                                                                                                                | ** ** | **Common Stock** | ** ** | **Stock**  | ** ** | **Treasury Stock** | ** ** | **Paid-in** | ** ** | **from**   | ** ** | **Compensation** | ** ** | **Comprehensive** | ** ** | **Accumulated**  | ** ** | ** **      | ** ** |
| ** **                                                                                                                | ** ** | **Shares**       | ** ** | **Amount** | ** ** | **Warrants**       | ** ** | **Shares**  | ** ** | **Amount** | ** ** | **Capital**      | ** ** | **Shareholder**   | ** ** | **for Services** | ** ** | **Loss**        | ** ** | **Deficit** | ** ** | **Total**  | ** ** |
| Balance at December 31, 2003                                                                                         |       | 7,710,728        |       | $          | 77         |               | $          | 353         |       |       | —     |             | $          | —            |       | $                | 48,306     |            | $          | (291        | )          | $          | (50        | ) | $ | — |   | $ | (40,875 | ) | $ | 7,520 |   |
| Net income                                                                                                                |       | —           |       | —     |       | —             |       |        |       | —     |       | —           |       | —            |       | —           |       | —          |       | 1,621       |       | 1,621      |       |
| Issuance of restricted shares and related deferred  compensation in connection with stock purchase agreement for services |       | 50,000           |       | 1          |       | —             |       | —      |       | —     |       | 119              |       | —            |       | (35              | )          | —          |       |        |       | 85         |       |
| Stock compensation for services                                                                                           |       | —           |       | —     |       | —             |       | —      |       | —     |       | —           |       | —            |       | 62               |       | —          |       | —      |       | 62         |       |
| Warrants, expired                                                                                                         |       | —           |       | —     |       | (267               | )          | —      |       | —     |       | 267              |       | —            |       | —           |       | —          |       | —      |       | —     |       |
| Treasury Stock purchased                                                                                                  |       |             |       | —     |       | —             |       | (180,371    | )          | (592       | )          | —           |       | —            |       | —           |       | —          |       | —      |       | (592       | )          |
| Exercise of common stock options                                                                                          |       | 280,178          |       | 2          |       | —             |       | —      |       | —     |       | 151              |       | —            |       | —           |       | —          |       | —      |       | 153        |       |
| Balance at December 31, 2004                                                                                         |       | 8,040,906        |       | $          | 80         |               | $          | 86          |       | (180,371   | )          | $                | (592       | )                 | $          | 48,843           |       | $               | (291       | )           | $          | (23        | )          | $ | — |   | $ | (39,254 | ) | $ | 8,849 |   |
| Comprehensive income                                                                                                      |       |             |       |       |       |               |       |        |       |       |       |             |       |              |       |             |       |            |       |        |       |       |       |
| Net income                                                                                                                |       | —           |       | —     |       | —             |       | —      |       | —     |       | —           |       | —            |       | —           |       | —          |       | 7,062       |       | 7,062      |       |
| Unrealized loss on investments                                                                                            |       | —           |       | —     |       | —             |       | —      |       | —     |       | —           |       | —            |       | —           |       | (11             | )          | —      |       | (11        | )          |
| Total comprehensive income                                                                                                |       |             |       |       |       |               |       |        |       |       |       |             |       |              |       |             |       |            |       |        |       | 7,051      |       |
| Repayment of Exercise Note                                                                                                |       | —           |       | —     |       | —             |       | —      |       | —     |       | —           |       | 291               |       | —           |       | —          |       | —      |       | 291        |       |
| Stock compensation for services                                                                                           |       | —           |       | —     |       | —             |       | —      |       | —     |       | —           |       | —            |       | 23               |       | —          |       | —      |       | 23         |       |
| Expense for variable priced options                                                                                       |       | —           |       | —     |       | —             |       | —      |       | —     |       | 643              |       | —            |       | —           |       | —          |       | —      |       | 643        |       |
| Warrants, expired                                                                                                         |       | —           |       | —     |       | (70                | )          | —      |       | —     |       | 70               |       | —            |       | —           |       | —          |       | —      |       | —     |       |
| Warrants, exercised                                                                                                       |       | 10,000           |       | —     |       | (16                | )          | —      |       | —     |       | 29               |       | —            |       | —           |       | —          |       | —      |       | 13         |       |
| Treasury stock purchased                                                                                                  |       | —           |       | —     |       | —             |       | (89,388     | )          | (496       | )          | —           |       | —            |       | —           |       | —          |       | —      |       | (496       | )          |
| Exercise of common stock options                                                                                          |       | 431,866          |       | 5          |       | —             |       | —      |       | —     |       | 765              |       | —            |       | —           |       | —          |       | —      |       | 770        |       |
| Balance at December 31, 2005                                                                                         |       | 8,482,772        |       | $          | 85         |               | $          | —      |       | (269,759   | )          | $                | (1,088     | )                 | $          | 50,350           |       | $               | —     |        | $          | —     |       | $ | (11 | ) | $ | (32,192 | ) | $ | 17,144 |   |
|                                                                                                                           |            |                  |            |            |            |                    |            |             |            |            |            |                  |            |                   |            |                  |            |                 |            |             |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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A.D.A.M., Inc.

ConsolidatedStatements of Cash Flows

(In thousands)

 
| ** **                                                                          | ** ** | **Year Ended**        | ** ** | **Year Ended**        | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                          | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                          | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| Cash flows from operating activities                                                |       |                  |       |                  |       |
| Net income                                                                          |       | $                     | 7,062      |                  | $          | 1,621 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities:  |       |                  |       |                  |       |
| Depreciation  and amortization                                                      |       | 894                   |       | 1,151                 |       |
| Deferred  income taxes                                                              |       | (5,500                | )          | —                |       |
| Writeoff of  interest bearing note receivable                                       |       | —                |       | 50                    |       |
| Stock  compensation for services                                                    |       | 23                    |       | 62                    |       |
| Stock  compensation for variable priced options                                     |       | 643                   |       | —                |       |
| Loss on sale  of investment available-for-sale                                      |       | 40                    |       | —                |       |
| Other, net                                                                          |       | —                |       | (23                   | )          |
| Changes in  assets and liabilities                                                  |       |                  |       |                  |       |
| Accounts  receivable                                                                |       | 272                   |       | (705                  | )          |
| Inventories                                                                         |       | 39                    |       | (41                   | )          |
| Prepaids and  other assets                                                          |       | (94                   | )          | (80                   | )          |
| Accounts  payable and accrued liabilities                                           |       | 569                   |       | 90                    |       |
| Deferred  revenue                                                                   |       | 28                    |       | 1,320                 |       |
| Net cash  provided by operating activities                                          |       | 3,976                 |       | 3,445                 |       |
| Cash flows from investing activities                                                |       |                  |       |                  |       |
| Purchases of  property and equipment                                                |       | (204                  | )          | (101                  | )          |
| Proceeds  from sales of property and equipment                                      |       | —                |       | 2                     |       |
| Net change  in restricted time deposits                                             |       | 47                    |       | 123                   |       |
| Software  product and content development costs                                     |       | (455                  | )          | (691                  | )          |
| Maturities  and reclassifications of investments                                    |       | 5,232                 |       | —                |       |
| Purchase of  investments available for sale                                         |       | (9,418                | )          | (2,726                | )          |
| Purchase of  investments held to maturity                                           |       | —                |       | (1,000                | )          |
| Net cash  used in investing activities                                              |       | (4,798                | )          | (4,393                | )          |
| Cash flows from financing activities                                                |       |                  |       |                  |       |
| Proceeds  from sales of common stock                                                |       | —                |       | 85                    |       |
| Proceeds  from exercise of common stock options and warrants                        |       | 783                   |       | 153                   |       |
| Repayments  on notes receivable                                                     |       | 125                   |       | —                |       |
| Repurchase  of common stock to be held as treasury stock                            |       | (496                  | )          | (592                  | )          |
| Repayments  on capital leases                                                       |       | (16                   | )          | (10                   | )          |
| Net cash  provided by (used in) financing activities                                |       | 396                   |       | (364                  | )          |
| Decrease in cash and cash equivalents                                               |       | (426                  | )          | (1,312                | )          |
| Cash and cash equivalents, beginning of  year                                       |       | 3,242                 |       | 4,554                 |       |
| Cash and cash equivalents, end of year                                              |       | $                     | 2,816      |                  | $          | 3,242 |   |
| Interest paid                                                                       |       | $                     | 7          |                  | $          | 10 |   |
| Supplemental  disclosure of non-cash activities  Incurred capital lease obligations |       | $                     | —     |                  | $          | 19 |   |
| Repayment on  notes receivable via accrued bonus                                    |       | $                     | 205        |                  | $          | — |   |

 

The accompanying notes are an integral part ofthese consolidated financial statements.

 

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**A.D.A.M., Inc.**

**Notesto Consolidated Financial Statements**

 

**1. Description of Business and Summary ofSignificant Accounting Policies**

 

**Business**

 

We specialize in the creation and delivery of interactive healthinformation and decision support tools primarily marketed to healthcareorganizations, public and restricted access Internet websites, and educationalapplications that are primarily marketed to educational institutions.

 

Our products for healthcare are designed to educate and inform healthcareconsumers on various aspects of their health and wellness. These products canbe used for learning about general health concerns, specific diseases andtreatments, surgical procedures, drug information, specialty health subjects(such as women’s health and children’s health), nutrition, alternative medicineand more. We sell our health products and decision support tools primarilythrough annual licensing agreements to many different types of healthcare andhealth-related organizations including hospitals, health plans, pharmaceuticalcompanies, disease management vendors, health-oriented Internet websites,healthcare technology companies and large employers. Our health informationtools can be incorporated into a customer’s website, imbedded in healthcareapplications such as an electronic medical record or disease managementapplication, contained in a printed format, or combined with other productsthat may be offered to a healthcare consumer.

 

Our educational products include applications designed to teachstudents gross anatomy and physiology as well as to allow educators to developinteractive, multimedia-based classroom curriculum.

 

**Basis of Presentation**

 

**Principles of consolidation**

 

The accompanying consolidated financial statements include the accountsof A.D.A.M., Inc. and its wholly owned subsidiaries, Integrative MedicineCommunications, Inc. (“IMC”) and Nidus Information Services, Inc. (“Nidus”).All inter company transactions and balances have been eliminated.

 

**Use of estimates**

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of net revenues and expenses during thereporting period. Actual results could differ from those estimates.

 

**Revenue recognition**

 

We generate revenues mainly in two ways – Internet-based licensing andshipped product sales. Internet revenues consist primarily of license fees thatusually consist of an annual, up-front fee that is initially recorded asdeferred revenue. This revenue is recognized ratably over the term of thelicense agreement beginning after delivery has occurred, upon customeracceptance, when we have determined that the fees from the agreement are fixedand determinable, and there are no significant return or acceptance provisions.When a contract includes multiple elements, such as services, the entire fee isallocated to each respective element, based on vendor specific objectiveevidence of fair value, and recognized when the revenue criteria for eachelement is met. Service revenues are generally recognized upon completion andacceptance by the customer. For Internet revenue arrangements in which we sellthrough a reseller, we do not recognize any revenue until an agreement has beenfinalized between the customer and our authorized reseller and the content hasbeen delivered to the customer by the reseller. Revenue is not recognized underany circumstances unless collectibility is reasonably assured. Shipped productrevenues represent the sales of software products and revenues earned undercertain royalty agreements. Revenues from product sales are generallyrecognized at the time title passes to customers, distributors or resellers.Revenues from royalty agreements are recognized as earned based uponperformance or product shipment. We recognize revenue in accordance with SECStaff Accounting Bulletin No. 101, “Revenue Recognition in FinancialStatements,” as amended by SAB 101A and 101B and as revised by SAB 104, “RevenueRecognition” and Statement of Position No. 97-2, “Software RevenueRecognition.” Accordingly, we recognize revenue when: (1) persuasiveevidence of an arrangement exists; (2) delivery has occurred or servicesrendered; (3) the fee is fixed or determinable; and (4) collectibilityis reasonably assured.

 

Allowances for estimated product returns are provided at the time ofsale. We evaluate the adequacy of allowance for returns based upon ourevaluation of historical and expected sales experience and by channel ofdistribution. As certain conditions change, such as sell-through experience,channels of distribution, and general economic conditions, the estimatedreserve required for returns may also change.

 

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**Concentration of sales and credit risk**

 

Financial instruments that potentially subject us to concentration ofcredit risk consist primarily of trade receivables. For the years ended December 31,2005 and 2004, no one customer accounted for more than 10% of net revenues.

 

**Fair value of financial instruments**

 

The carrying amounts of our financial instruments, including cash andcash equivalents, accounts receivable, restricted time deposits, accountspayable, and accrued expenses, approximate fair value due to their shortmaturities. At December 31, 2004 the cost of our investments approximatedfair value. However, during 2005 we changed the classification of ourinvestments from “held-to-maturity” to “available–for-sale”; as such at December 31,2005 our investments are recorded at the current fair value.

 

**Cash and cash equivalents**

 

Cash and cash equivalents include cash on hand and deposits and highlyliquid investments with original maturities of three months or less.

 

**Investments**

 

Mutual funds are categorized asavailable-for-sale which requires the securities to be reported at fair value,with unrealized gains and losses reported as a separate component ofshareholders’ equity, if significant. Realized gains or losses, if any, arerecorded within the statement of operations as other income. For the purpose ofcomputing realized gains and losses, cost is identified on a specificidentification basis.

 

In 2005, we transferred the classification of our marketable debtsecurities from held-to-maturity to available-for-sale as we no longer have thepositive intent to hold these investments to maturity. As such, at December 31,2005, our investments are recorded at fair value based on current market ratesand are classified as available-for-sale. Changes in the fair value areincluded in the equity section of our balance sheet and reported in ourConsolidated Statement of Changes in Shareholders’ Equity. At December 31,2004 these securities were stated at cost with corresponding premiums ordiscounts, if any, amortized over the life of the investment to interestincome.

 

**Equity method investment**

 

As of December 31, 2005 and 2004, we had an approximate 34% votinginterest in ThePort Network, Inc., a related company (see Note 13). Thisinvestment is accounted for under the equity method. As of December 31, 2005and 2004, the carrying value of this investment was $0. We have no futureobligations to fund ThePort Network, Inc.

 

**Cost method investment**

 

As of December 31, 2005 and 2004, we held a 2% and 3% ownership inBeBetter Networks, Inc. respectively, a related company (seeNote 13). This investment is accounted for under the cost method and at December 31,2005 and 2004 its carrying value was $0.

 

**Accounts receivable**

 

Accounts receivable are stated at the amountmanagement expects to collect from outstanding balances. Management providesfor probable uncollectible amounts through a charge to earnings and a credit toa valuation allowance based on its assessment of the current status ofindividual accounts. Balances that are still outstanding after management hasperformed reasonable collection efforts are written off through a charge to thevaluation allowance and a credit to accounts receivable. We grant credit to ourcustomers without requiring collateral. The amount of accounting loss for whichwe are at risk in these unsecured accounts receivable is limited to theircarrying value.

 

**Inventories**

 

Inventories consist principally of computer software media, books andrelated shipping materials and are stated at the lower of cost or market. Costis determined using the first-in, first-out method. The valuation of inventoryrequires us to estimate net realizable value. We write down our inventory forestimated obsolescence or to the lesser of cost or market value.

 

**Property and equipment**

 

Property and equipment are recorded at cost and depreciated over theirestimated useful lives using the straight-line method. Property and equipmentheld under capital leases and leasehold improvements are amortized over theshorter of the lease term or the estimated useful life of the related asset.Upon retirement or sale, the cost of assets disposed of and the relatedaccumulated depreciation are removed from the accounts and any resulting gainor loss is credited or charged to income. Repairs and maintenance costs areexpensed as incurred.

 

**Intangible assets**

 

Intangible assets consist of purchased intellectual content, purchasedcustomer contracts, capitalized software product and content development coststo be sold, leased or otherwise marketed, and software development costs forinternal use software.

 

----

 

Capitalized software product and content development costs to be sold,leased or otherwise marketed consist principally of salaries and certain otherexpenses directly related to the development and modifications of softwareproducts and content capitalized in accordance with the provisions of SFAS No. 86,“Accounting for the Costs of Computer Software to be Sold, Leased, or OtherwiseMarketed.” Amortization of capitalized software product and content developmentcosts is provided at the greater of the ratio of current product revenue to thetotal of current and anticipated product revenue or on a straight-line basisover the estimated economic life of the software, which we have determined togenerally be two years.

 

In accordance with the American Institute of Certified Public Accountants’(“AICPA”) Statement of Position (“SOP”) 98-1, “Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use,” we expense costsincurred in the preliminary project planning stage and thereafter capitalizecosts incurred in developing or obtaining internal use software. Costs, such asmaintenance and training, are expensed as incurred. Capitalized costs areamortized over their estimated useful life, generally three years.

 

**Impairment of long-lived assets and goodwill**

 

We evaluate impairment of long-lived assets, including property andequipment and intangible assets with finite lives, whenever events or changesin circumstances indicate that the carrying amount of such assets may notbe recoverable. If the sum of the expected future undiscounted cash flows isless than the carrying amount of the asset, an impairment loss is recognized.Measurement of an impairment loss for long-lived assets is based on discountedcash flows and the fair value of the asset.

 

We evaluate goodwill for impairment on an annual basis. Additionally,goodwill is tested for impairment between annual tests if an event occurs orcircumstances change that would more likely than not reduce the fair value ofan entity below its carrying value. These events or circumstances would includea significant change in the business climate, legal factors, operatingperformance indicators, competition, sale or disposition of a significantportion of the business or other factors. The carrying value of goodwill isevaluated in relation to the operating performance and estimated futurediscounted cash flows of the entity.

 

**Product and content development expenditures**

 

Product and content development expenditures include costs incurred inthe development, enhancement and maintenance of our content and technology.These costs have been charged to expense as incurred.

 

**Restricted time deposits**

 

In connection with our non-cancelable operating leases for our officespace and telephone system, we are required to purchase time deposits to secureletters of credit with the bank guaranteeing payments under the leases. Thetime deposits bear interest at an average rate of****approximately1.61% and are carried at cost, which approximates fair value. Theclassification of these investments is determined based on the expected term ofthe collateral requirement and not necessarily the maturity date of theunderlying securities.

 

**Income taxes**

 

We account for income taxes utilizing the liability method and deferredincome taxes are determined based on the differences between the financialreporting and income tax basis of assets and liabilities and for income taxcarryforwards ad credits given the provisions of the enacted tax laws. Avaluation allowance is provided against deferred tax assets for which it ismore likely than not that the asset will not be realized.

 

**Stock-based employee compensation**

 

We account for stock-based employee compensation using the intrinsicvalue method prescribed in Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related Interpretations and we provide thedisclosures required by SFAS No. 123, “Accounting for Stock-BasedCompensation.” Accordingly, compensation cost for stock options issued toemployees is measured as the excess, if any, of the quoted market price of ourstock at the date of the grant over the amount an employee must pay to acquirethe stock.

 

Had we determined employee compensation costs using a fair value basedmethodology at the grant date for our stock options under SFAS No. 123,our pro forma consolidated net income (loss) would have been as follows (inthousands, except per share data):

 

----

 
| ** **                                                                                                      | ** ** | **Year Ended**        | ** ** | **Year Ended**        | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                      | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                      | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| ** **                                                                                                      | ** ** | ** **            | ** ** | ** **            | ** ** |
| Net income  as reported                                                                                         |       | $                     | 7,062      |                  | $          | 1,621 |   |
| Add back  stock based employee compensation included in reported net income                                     |       | 643                   |       | —                |       |
| Deduct total  stock-based employee compensation expense determined under fair-value base  method for all awards |       | (780                  | )          | (415                  | )          |
|                                                                                                            |       |                  |       |                  |       |
| Pro forma  net income                                                                                           |       | $                     | 6,925      |                  | $          | 1,206 |   |
|                                                                                                            |       |                  |       |                  |       |
| Basic net  income per share                                                                                     |       |                  |       |                  |       |
| As reported                                                                                                     |       | $                     | 0.87       |                  | $          | 0.21 |   |
| Pro forma                                                                                                       |       | $                     | 0.85       |                  | $          | 0.15 |   |
|                                                                                                            |       |                  |       |                  |       |
| Diluted net  income per share                                                                                   |       |                  |       |                  |       |
| As reported                                                                                                     |       | $                     | 0.75       |                  | $          | 0.19 |   |
| Pro forma                                                                                                       |       | $                     | 0.73       |                  | $          | 0.14 |   |

 

**Net income per common share**

** **

Net income per share is computed in accordance with SFAS No. 128, “EarningsPer Share.” We compute basic net income per share by dividing net income by theweighted average number of common shares outstanding for each period. Dilutednet income per share is based upon the addition of the effect of common stockequivalents (stock options and warrants) to the denominator of the basic netincome per share calculation using the treasury stock method, if their effectis dilutive. The computation of net income per share for the years ended December 31,2005 and 2004 is as follows (in thousands, except per share data):

 
| ** **                                                                | ** ** | **Year Ended**        | ** ** | **Year Ended**        | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                | ** ** | **2005**              | ** ** | **2004**              | ** ** |
|                                                                      |       |                  |       |                  |       |
| Net income                                                                |       | $                     | 7,062      |                  | $          | 1,621 |   |
| Weighted  average common shares outstanding                               |       | 8,108                 |       | 7,879                 |       |
| Weighted  average common shares equivalents  (stock options and warrants) |       | 1,360                 |       | 863                   |       |
| Weighted  average diluted common shares outstanding                       |       | 9,468                 |       | 8,742                 |       |
| Net income  per share:                                                    |       |                  |       |                  |       |
| Basic                                                                     |       | $                     | 0.87       |                  | $          | 0.21 |   |
| Diluted                                                                   |       | $                     | 0.75       |                  | $          | 0.19 |   |
|                                                                      |       |                  |       |                  |       |
| Anti-dilutive  stock options and warrants outstanding                     |       | 426                   |       | 1,703                 |       |

 

**Comprehensive income**

 

Our comprehensive income for the year ended December 31, 2004 asrequired to be reported by SFAS No. 130 “Reporting Comprehensive Income,”was identical to the actual net income reported for this period. During theyear ended December 31, 2005 we recorded an other comprehensive loss of $11,000for unrealized losses related to our short-term investments (see theConsolidated Statement of Changes in Shareholders’ Equity and Note 2 –Investments).

 

**Reclassifications**

 

Certain amounts in the prior years’ financial statements and relateddiscussions have been reclassified to conform to the current yearpresentation. In the opinion of management, all adjustments (consisting ofnormal recurring adjustments) considered necessary for a fair presentation havebeen included.

 

**Recent accounting pronouncements**

 

On December 16, 2004, the Financial Accounting Standards Board(FASB) issued FASB Statement No. 123 (revised 2004), “Share-Based Payment,”which is a revision of FASB Statement No. 123, “Accounting for Stock-BasedCompensation.” Statement 123(R) supersedes APB Opinion No. 25, “Accountingfor Stock Issued to Employees,” and amends FASB Statement No. 95, “Statementof Cash Flows.” The approach to accounting for share-based payments inStatement 123(R) is similar to the approach described in Statement 123.However, Statement 123(R) requires all share-based payments to employees,including grants of employee stock

 

----

 

options, to be recognized in the financial statements based on theirfair values and no longer allows pro forma disclosure as an alternative tofinancial statement recognition.

 

We will adopt Statement 123(R) at the beginning of our quarter ending March 31,2006 using the modified prospective method and reflect compensation expense inaccordance with the SFAS 123(R) transition provisions. Under the modifiedprospective method, prior periods are not restated to reflect the impact of adoptingthe new standard at earlier dates. Pro forma disclosures regarding the effecton our net income and net income per common share in 2005 and 2004, had weapplied the fair value method of accounting for share-based compensation asprescribed by SFAS 123, are contained in the “Stock-based employee compensation”section of Note 1. Based on share-based compensation granted through December 31,2005 and the fair values previously calculated under SFAS 123, we project wewill record an immaterial amount of additional compensation expense in 2006related to stock options upon the adoption of SFAS 123R compared to theexisting accounting method under APB Opinion No. 25. We will continue toevaluate the impact this new standard will have on our Stock Incentive Plan.

 

**2. Investments**

 

Short-term investments at December 31, 2005 included the following(in thousands):

 
| **Description**              | ** ** | **Balance** | ** ** | **Purchased** | ** ** | **Maturity** | ** ** | **Yield at 12/31/2005** | ** ** |
|------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|-------------------------|------------|
| Mutual Funds                 |       |        |       |          |       |         |       |                    |       |
| - Eaton Vance Floating Fund  |       | $           | 2,021      |          | 3/17/2005  |         | 3/17/2006  |                    | 4.33       | % |
| - AIM Floating Fund          |       | 2,014       |       | 9/1/2005      |       | 9/1/2006     |       | 4.91                    | %          |
| - AIM Floating Fund          |       | 1,007       |       | 9/22/2005     |       | 9/22/2006    |       | 4.91                    | %          |
| - AIM Floating Fund          |       | 1,007       |       | 9/23/2005     |       | 9/23/2006    |       | 4.91                    | %          |
| - AIM Floating Fund          |       | 503         |       | 10/14/2005    |       | 10/14/2006   |       | 4.91                    | %          |
| - AIM Floating Fund          |       | 1,008       |       | 11/15/2005    |       | 11/15/2006   |       | 4.91                    | %          |
| - AIM Floating Fund          |       | 301         |       | 12/16/2005    |       | 12/16/2006   |       | 4.91                    | %          |
| Total Short-term Investments |       | $           | 7,861      |          |       |         |       |                    |       |   |

 

During the quarter ended June 30, 2005, we transferred theclassification of our marketable debt securities from held-to-maturity toavailable-for-sale as we no longer have the positive intent to hold theseinvestments to maturity. As such, our investments are recorded at fair valuebased on current market rates and are classified as available for sale. Changesin the fair value are included in the equity section of our balance sheetand reported in our Consolidated Statement of Changes in Shareholders’ Equity.

 

Our short-term investments at December 31, 2004 included thefollowing (in thousands):

 
| **Description**              | ** ** | **Balance** | ** ** | **Purchased** | ** ** | **Maturity** | ** ** | **Yield at  12/31/2004** | ** ** |
|------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|--------------------------|------------|
| Time Deposit                 |       | $           | 1,000      |          | 8/8/2004   |         | 8/8/2005   |                     | 2.33       | % |
| Time Deposit                 |       | 99          |       | 9/7/2004      |       | 3/7/2005     |       | 2.22                     | %          |
| Time Deposit                 |       | 127         |       | 2/24/2004     |       | 1/21/2005    |       | 1.61                     | %          |
| Mutual Funds:                |       |        |       |          |       |         |       |                     |       |
| - Eaton Vance Floating Fund  |       | 1,000       |       | 6/15/2004     |       | 6/15/2005    |       | 3.54                     | %          |
| - Eaton Vance Floating Fund  |       | 500         |       | 11/16/2004    |       | 11/16/2005   |       | 3.54                     | %          |
|                         |       |        |       |          |       |         |       |                     |       |
| Total Short-term Investments |       | $           | 2,726      |          |       |         |       |                     |       |   |

 

At December 31, 2004, the cost of the above investments approximatedfair value.

 

----

 

**3. Property and Equipment**

 

Property and equipment are summarized as follows (in thousands):

 
| ** **                                        | ** ** | **Estimated**   | ** ** | ** **            | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-----------------|------------|-----------------------|------------|------------|------------|
| ** **                                        | ** ** | **Useful Life** | ** ** | **December 31,** | ** ** |
| ** **                                        | ** ** | **(Years)**     | ** ** | **2005**              | ** ** | **2004**   | ** ** |
|                                              |       |            |       |                  |       |       |       |
| Computers                                         |       | 3               |       | $                     | 1,044      |       | $          | 1,629 |   |
| Equipment                                         |       | 5               |       | 301                   |       | 500        |       |
| Furniture and fixtures                            |       | 5               |       | 236                   |       | 539        |       |
| Leasehold improvements                            |       | 5               |       | 62                    |       | 56         |       |
|                                              |       |            |       |                  |       |       |       |
|                                              |       |            |       | 1,643                 |       | 2,724      |       |
| Less - accumulated depreciation and  amortization |       |            |       | (1,375                | )          | (2,540     | )          |
|                                              |       |            |       |                  |       |       |       |
|                                              |       |            |       | $                     | 268        |       | $          | 184 |   |

 

Depreciation expense for the years ended December 31, 2005 and 2004was $115,000 and $102,000, respectively.

 

**4. Product and Content DevelopmentExpenditures**

 

Product and content development expenditures are summarized as follows(in thousands):

 
| ** **                                                               | ** ** | **Year Ended**        | ** ** | **Year Ended**        | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
|                                                                     |       | **December 31,** | ** ** | **December 31,** | ** ** |
|                                                                     |       | **2005**              | ** ** | **2004**              | ** ** |
|                                                                     |       | ** **            | ** ** | ** **            | ** ** |
| Total product and content development  expenditures                      |       | $                     | 1,911      |                  | $          | 2,012 |   |
| Less: additions to capitalized software  product and content development |       | (455                  | )          | (691                  | )          |
|                                                                     |       |                  |       |                  |       |
| Product and content development expense                                  |       | $                     | 1,456      |                  | $          | 1,321 |   |

 

**5. Intangible Assets**

 

Intangible assets are summarized as follows (in thousands):

 
| ** **                                                                          | ** ** | **Estimated**     | ** ** | ** **            | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|------------|------------|
| ** **                                                                          | ** ** | **amortizable**   | ** ** | **December 31,** | ** ** |
| ** **                                                                          | ** ** | **lives (years)** | ** ** | **2005**              | ** ** | **2004**   | ** ** |
| ** **                                                                          | ** ** | ** **        | ** ** | ** **            | ** ** | ** ** | ** ** |
| Capitalized  software products and content to be sold, leased or otherwise marketed |       | 2                 |       | $                     | 3,351      |       | $          | 3,358 |   |
| Software  developed for internal use                                                |       | 3                 |       | 263                   |       | 352        |       |
| Purchased  intellectual content                                                     |       | 3                 |       | 1,431                 |       | 1,431      |       |
| Purchased  customer contracts                                                       |       | 2                 |       | 333                   |       | 333        |       |
|                                                                                |       |              |       |                  |       |       |       |
| Intangible  assets, gross                                                           |       |              |       | 5,378                 |       | 5,474      |       |
|                                                                                |       |              |       |                  |       |       |       |
| Less  accumulated amortization:                                                     |       |              |       |                  |       |       |       |
| Capitalized  software products and content to be sold, leased or otherwise marketed |       |              |       | (2,559                | )          | (2,426     | )          |
| Software  developed for internal use                                                |       |              |       | (102                  | )          | (77        | )          |
| Purchased  intellectual content                                                     |       |              |       | (1,431                | )          | (1,360     | )          |
| Purchased  customer contracts                                                       |       |              |       | (333                  | )          | (333       | )          |
|                                                                                |       |              |       |                  |       |       |       |
| Accumulated  amortization                                                           |       |              |       | (4,425                | )          | (4,196     | )          |
|                                                                                |       |              |       |                  |       |       |       |
| Intangible  assets, net                                                             |       |              |       | $                     | 953        |       | $          | 1,278 |   |

 

Amortization expense, which includes the amortization of capitalizedsoftware product and content development costs reported in cost of revenues,for the years ended December 31, 2005 and 2004 was $779,000 and $1,049,000,respectively. Estimated amortization expense for the years 2006, 2007 and 2008is approximately $628,000, $299,000, and $26,000, respectively, at which pointthese

 

----

 

intangible assets will be fully amortized.

 

**6. Goodwill**

 

The goodwill balance at December 31, 2005and 2004 was made up of the following (in thousands):

 
| ** **               | ** ** | **IMC** | ** ** | **Nidus** | ** ** | **Total** | ** ** |
|--------------------------|------------|---------|------------|-----------|------------|-----------|------------|
| Goodwill carrying amount |       | $       | 1,367      |      | $          | 676       |       | $ | 2,043 |   |
|                          |            |         |            |           |            |           |            |  |  |  |

 

**7. Accounts Payable and Accrued Expenses**

 

Accounts payable and accrued expenses consist of the following (inthousands):

 
| ** **                                 | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                       |       |                  |       |   |   |
| Accounts payable                           |       | $                     | 97         |   | $ | 1 |   |
| Accrued professional fees                  |       | 100                   |       | 85 |   |
| Accrued compensation and employee benefits |       | 134                   |       | 225 |   |
| Other accrued expenses                     |       | 724                   |       | 415 |   |
|                                       |       |                  |       |   |   |
|                                       |       | $                     | 1,055      |   | $ | 726 |   |

 

**8. Income Taxes**

 

The provision for income taxes differs from the amount computed byapplying the applicable U.S. statutory federal income tax rate of34 percent to income before income taxes as a result of the following (inthousands):

 
| ** **                                                                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                                                                      |       |                  |       |   |   |
| Federal tax provision on income before  income taxes at statutory federal income tax rate |       | $                     | 531        |   | $ | 551 |   |
| Increase In tax credits available                                                         |       | —                |       | (305 | ) |
| Change in valuation allowance                                                             |       | (5,680                | )          | (281 | ) |
| State taxes, net of federal benefit                                                       |       | 39                    |       | 65 |   |
| Other differences                                                                         |       | (390                  | )          | (30 | ) |
|                                                                                      |       |                  |       |   |   |
| Total income tax benefit                                                                  |       | $                     | (5,500     | ) | $ | — |   |

 

----

 

The components of our deferredtax assets and liabilities are as follows (in thousands):

 
| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                               |       |                  |       |   |   |
| **Deferred tax assets**                            |       |                  |       |   |   |
| Accrued  expenses and other liabilities            |       | $                     | 299        |   | $ | 91 |   |
| Allowance  for doubtful accounts                   |       | 28                    |       | 39 |   |
| Intangible  assets                                 |       | 429                   |       | 462 |   |
| Fixed assets                                       |       | 2                     |       | 204 |   |
| Research and  development credits                  |       | 1,044                 |       | 1,044 |   |
| Capitalized  product and content development       |       | 880                   |       | 1,071 |   |
| Capital loss  carryforwards                        |       | 161                   |       | 161 |   |
| Net  operating loss carryforwards                  |       | 12,991                |       | 13,051 |   |
|                                               |       |                  |       |   |   |
|                                               |       | 15,833                |       | 16,122 |   |
| Deferred tax liabilities                           |       |                  |       |   |   |
| Software  development costs                        |       | (357                  | )          | (466 | ) |
|                                               |       |                  |       |   |   |
| Net deferred tax asset before valuation  allowance |       | 15,476                |       | 15,656 |   |
|                                               |       |                  |       |   |   |
| Valuation allowance                                |       | (9,976                | )          | (15,656 | ) |
|                                               |       |                  |       |   |   |
| Net deferred tax asset                             |       | $                     | 5,500      |   | $ | — |   |

 

During the third quarter 2005, we re-evaluated our fully reserveddeferred tax asset balance and determined that $5,600,000 of the $15,600,000should be recognized. The recognition of the asset, net of the $100,000 incometax provision recorded in the fourth quarter, is reflected as an income taxbenefit included in our 2005 statement of operations and on our balance sheetas current and non-current deferred tax assets of $221,000 and $5,279 ,000,respectively. At December 31, 2004 the entire deferred tax asset balancewas reserved and no provision for income taxes had been reflected for the yearthen ended.

 

In periodically assessing our ability to realize our deferred taxassets, management considers whether it is more likely than not that someportion or all of our deferred tax assets will be realized. Management analyzesseveral factors including the amount and timing of the scheduled expiration andreversals of our net operating loss carry forwards (NOLs) and deferred tax items,respectively, as well as potential generation of future taxable income over theperiods for which the NOLs are applicable. Certain estimates used in thisanalysis are based on the current beliefs and expectations of management, aswell as assumptions made by, and information currently available to,management. Although we believe the expectations reflected in these estimatesare based upon reasonable assumptions, we can give no assurance that actualresults will not differ materially from these expectations. (See “DisclosureRegarding Forward-Looking Statements”)

 

At December 31, 2005approximately $480,000 of the valuation allowance was attributable to theacquisition of IMC and, if reversed, would reduce goodwill. Also, at December 31,2005 approximately $1,127,000 of the valuation allowance was attributable totax deductions for the exercise of employee stock options in excess of relatedcompensation expense recorded in the financial statements. The reversal of thisportion of the deferred tax asset would be recorded as additional paid-incapital.

 

At December 31, 2005, wehad net operating loss (NOL) and R&D credit carryforwards available for taxpurposes of approximately $34 million and $1 million, respectively, which willexpire on December 31 in years 2006 through 2022 and 2007 through 2023,respectively. We acquired approximately $10 million of NOL carry forwards as aresult of the acquisition of IMC in December of 2001. Internal RevenueCode Section 382 limits the utilization of NOL carryforwards when a changein ownership, as defined by the Internal Revenue Service, occurs. Theacquisition of IMC resulted in an ownership change within the meaning ofInternal Revenue Section 382. The total annual Section 382 limitationis approximately $60,000. Of the total $10 million pre-changed NOLs acquiredfrom IMC, the pre-change NOLs estimated to be available for use after theapplication of the IRC 382 limitation is approximately $1.2 million.

 

Net operating losscarryforwards expiring over the next five years are as follows (in thousands):

 

----

 
| **Year Ending  December 31,** | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| 2006                               |       | $          | 553        |   |
| 2007                               |       | 2,877      |       |
| 2008                               |       | 2,922      |       |
| 2009                               |       | 3,452      |       |
| 2010                               |       | 4,023      |       |
|                               |       | $          | 13,827     |   |

 

**9. Equity Purchase Agreements**

 

On May 22, 2002, we entered into a Common Stock Purchase Agreementwith Fusion Capital Fund II, LLC. Pursuant to this agreement, Fusion Capitalagreed to purchase up to an aggregate of $12,000,000 of our common stock. Wehave the right to sell up to $15,000 of our common stock per trading day underthis agreement unless our stock price equals or exceeds $7.00, in which casethe daily amount may be increased at our option. Fusion Capital is notobligated to purchase any shares of our common stock on any trading days thatthe market price of our common stock is less than $1.00. Since we registered3,500,000 shares for sale to Fusion Capital pursuant to the agreement, theselling price of our common stock to Fusion Capital will have to average atleast $3.43 per share for us to receive the maximum proceeds of $12,000,000without registering additional shares of common stock, which we have the rightbut not the obligation to do. Assuming a purchase price of $1.00 per share andthe purchase by Fusion Capital of the full 3,500,000 shares under theagreement, proceeds to us would be $3,500,000. If we decided to sell more thanthe 1,352,100 shares to Fusion Capital (19.99% of our outstanding shares as of May 22,2002, the date of the agreement, exclusive of the 160,000 shares issued toFusion Capital as a commitment fee), we would first be required to seekshareholder approval of the agreement in order to be in compliance with Nasdaqrules. We may, but shall be under no obligation to, request our shareholders toapprove the transaction contemplated by the agreement. We may terminatethe agreement at any time, and Fusion Capital may terminate the agreementat any time after August 2005, approximately 40 months following thedate the purchase obligation under the agreement became effective. During theyear ended December 31, 2003, we sold 486,566 shares for aggregateproceeds of $733,000 under this agreement. Since that time and through December 31,2005, there have been no further transactions under this agreement.

 

**10. Treasury Stock**

 

In May 2004 we announced a stock repurchase program to purchase upto 500,000 shares of our common stock to be held as Treasury Stock. During theyear ended December 31, 2004 we repurchased 180,371 shares to our commonstock for a total purchase price of $592,000. During January and February of2005, we repurchased a total of 89,388 shares of our common stock for a totalpurchase price of $496,000. In February 2005 we suspended this program andhave not purchased any additional treasury shares since then.

 

**11. Consulting Agreements**

 

On August 1, 2003, we entered into a RestrictedCommon Stock Purchase Agreement with James T. Atenhan and Victor P.Thompson (each a “Purchaser”) in connection with of the consulting agreementwith a financial services firm controlled by the Purchasers. Each Purchaserpurchased 38,889 shares of our common stock at a purchase price of $.90 pershare. The purchase price of our common stock was discounted from the $1.86market price on the date we entered into the agreement. In connection with thesale, we recorded deferred compensation for services of $74,667. This deferredcompensation expense was expensed over the twelve-month service period.

 

On September 1, 2004, we entered into a twelve month extension ofthe Restricted Common Stock Purchase Agreement. Under the agreement, eachPurchaser purchased 25,000 shares of our common stock at a purchase price of$1.70 per share. The purchase price was discounted from the $2.40 market priceon the date we entered into the agreement. In connection with the sale, werecorded deferred compensation expense for services of $35,000. This deferredcompensation was expensed over the twelve-month service period which ended August 31,2005.

 

**12. Common Stock Options and Warrants**

 

In 2002, our Board adopted andour shareholders approved our 2002 Stock Incentive Plan, under which we havereserved 1,500,000 shares of common stock pursuant to the grant of incentive ornon-qualified stock options to full-time employees and key persons. Options aregranted at an exercise price as determined by our Board of Directors, which may notbe less than the fair market value of our common stock at the date of thegrant, and the options generally vest ratably over a three-year period. Optionsgranted under the Plan generally expire ten years from the date of grant.

 

----

 

As of December 31, 2005,we had options outstanding to purchase a total of 2,818,331 shares of ourcommon stock under our 2002 Stock Incentive Plan and our 1992 Option Plan.Under the 1992 Option Plan, we had reserved 4,500,000 shares of common stockand no additional options may be granted under the 1992 Plan. At December 31,2005, there were approximately 928,000 shares available for future optiongrants under the 2002 Stock Incentive Plan.

 

The fair value of each optiongrant is estimated on the date of the grant using the Black-Scholesoption-pricing model with the following weighted-average assumptions used forgrants in the years ended December 31, 2005 and 2004: dividend yield of0%; expected volatility of 101% and 107%, respectively; risk-free interestrates of 3.66% and 3.05%, respectively; and an expected life of 3.5 years, withthe exception of options granted during 2004 and 2003 with one-year vestingperiods, which have an expected life of two years.

 

The following table summarizesstock option activity for the years ended December 31, 2005 and 2004:

 
| ** **                            | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Weighted** | ** ** |
|---------------------------------------|------------|------------|------------|--------------|------------|--------------|------------|
| ** **                            | ** ** | ** ** | ** ** | **Average**  | ** ** | **Average**  | ** ** |
| ** **                            | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Fair**     | ** ** |
| ** **                            | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Value**    | ** ** |
| Outstanding at December 31, 2003 |       | 3,702,176  |       | $            | 3.34       |         | —     |   |
|                                  |       |       |       |         |       |         |       |
| Granted                               |       | 65,000     |       | $            | 2.39       |         | $          | 1.64 |   |
| Exercised                             |       | (280,178   | )          | $            | 0.55       |         | —     |   |
| Canceled or  expired                  |       | (251,701   | )          | $            | 4.03       |         | —     |   |
|                                  |       |       |       |         |       |         |       |
| Outstanding at December 31, 2004 |       | 3,235,297  |       | $            | 3.52       |         | —     |   |
|                                  |       |       |       |         |       |         |       |
| Granted                               |       | 41,250     |       | $            | 5.47       |         | $          | 3.68 |   |
| Exercised                             |       | (431,866   | )          | $            | 1.78       |         | —     |   |
| Canceled or  expired                  |       | (26,350    | )          | $            | 4.87       |         | —     |   |
|                                  |       |       |       |         |       |         |       |
| Outstanding at December 31, 2005 |       | 2,818,331  |       | $            | 3.81       |         | —     |   |

 

At December 31, 2005 and2004 there were 2,535,832 and 2,652,701 options exercisable, respectively.

 

The following table summarizes additional information about stock optionsoutstanding at December 31, 2005:

 
| ** **          | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|---------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **          | ** ** | ** **              | ** ** | **Weighted**            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Number**              | ** ** | **Average**             | ** ** | **Weighted** | ** ** | **Number** | ** ** | **Weighted** | ** ** |
| ** **          | ** ** | **Outstanding at**      | ** ** | **Remaining**           | ** ** | **Average** | ** ** | **Exercisable at** | ** ** | **Average** | ** ** |
| **Range of**        | ** ** | **December 31,**   | ** ** | **Contractual**         | ** ** | **Exercise** | ** ** | **December 31,** | ** ** | **Exercise** | ** ** |
| **Exercise Prices** | ** ** | **2005**                | ** ** | **Life (years)**        | ** ** | **Price** | ** ** | **2005** | ** ** | **Price** | ** ** |
|                |       |                    |       |                    |       |   |   |   |   |   |   |
| $0.41 to $0.85      |       | 632,720                 |       | 7.01                    |       | $ | 0.41 |   | 406,470 |   | $ | 0.41 |   |
| $1.58 to $2.94      |       | 627,282                 |       | 5.21                    |       | $ | 2.08 |   | 615,616 |   | $ | 2.08 |   |
| $3.06 to $4.81      |       | 763,360                 |       | 5.59                    |       | $ | 3.31 |   | 756,277 |   | $ | 3.30 |   |
| $5.00 to $6.23      |       | 374,052                 |       | 3.99                    |       | $ | 5.46 |   | 336,552 |   | $ | 5.45 |   |
| $7.94 to $12.75     |       | 235,778                 |       | 3.39                    |       | $ | 8.58 |   | 235,778 |   | $ | 8.58 |   |
| $13.00 to $20.63    |       | 185,139                 |       | 3.95                    |       | $ | 13.87 |   | 185,139 |   | $ | 13.87 |   |
|                |       |                    |       |                    |       |   |   |   |   |   |   |
|                |       | 2,818,331               |       | 5.32                    |       | $ | 3.81 |   | 2,535,832 |   | $ | 4.09 |   |

 

On January 14, 1999, certain grants were canceled at the option oftheir holders and then replaced that day on a one-for-one basis with newoptions with an exercise price equal to the closing market price that day,$5.25. These options are accounted for in accordance with FASB Interpretation No. 44(“FIN 44”), “Accounting for Certain Transactions involving Stock Compensation(an interpretation of APB 25),” which provides guidance on the accounting forcertain stock option transactions and subsequent amendments to stock optiontransactions. FIN 44 requires compensation cost for these variably

 

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priced options to be recorded to the extent that the current marketprice exceeds the options’ grant price. The expense is to be adjusted forincreases or decreases in the intrinsic value of the modified awards insubsequent periods and until the awards have been exercised, forfeited, orexpired. We had 224,638 and 231,438 variably priced options outstanding at December 31,2005 and December 31, 2004, respectively, under this Interpretation. Therewere 6,800 variably priced options exercised during March 2005 when themarket value of our stock was $7.08. At December 31, 2005, the marketvalue of our stock was $8.06. In accordance with FIN 44, we have recorded stockcompensation expense of approximately $644,000 for the year ended December 31,2005. During 2004, there was no compensation costs recorded for these optionsas the fair value of our common stock at December 31, 2004 had notexceeded $5.25 per share.

 

As of December 31, 2004,we had warrants outstanding to purchase a total of 35,000 shares of our commonstock at a weighted average exercise price of $2.66 per share. These warrantswere issued in conjunction with the issuance of notes on December 31, 1999and were exercisable at any time at the election of the holders, expiring atvarious dates through December 31, 2005. In June 2005, 25,000warrants at an exercise price of $3.20 per share expired. The remaining 10,000warrants were exercised in December 2005 at $1.30.

 

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**13. RelatedParty Transactions**

 

**PromissoryNote with Our Chairman of the Board of Directors**

 

On May 30, 2001, we received afull-recourse promissory note from our Chairman of the Board of Directors, and thenChief Executive Officer (“Executive”), for approximately $341,000 (the “ExerciseNote”) for the exercise of 150,000 options at $1.94 per share and a $50,000promissory note (the “Tax Note”) in connection with a loan to our Executive topay taxes related to the stock exercise. The notes accrued interest of 6.25%per annum and were due in full on or before May 29, 2006. Part of theExercise Note, $291,000, was secured by 150,000 shares of our common stock andis recorded in shareholders’ equity. As of December 31, 2005 both notesand related interest had been fully satisfied using bonuses earned and paidunder the Executive’s amended employment agreement (see paragraph below).

 

Effective May 10, 2005, we entered into an amended and restatedemployment agreement with our Chief Executive Officer. The employment agreementprovided for bonuses in an aggregate amount of up to approximately $420,000through May 2008. Under the terms of the agreement, the bonuses payable in2005 and 2006 were to be paid by reducing the amounts outstanding under theExercise Note and Tax Note mentioned above. The 2005 bonus was paid in May 2005and was applied accordingly. Subsequently, on December 28, 2005, inconnection with a second amended and restated employment agreement, a $317,000final one-time bonus payment was made. This payment was applied to fullysatisfy the outstanding note receivable balance and related interest.

 

In January 2006, our thenChief Executive Officer, Mr. Robert Cramer, was replaced in that position byMr. Kevin Noland. Mr. Cramer continues to serve as the Chairman ofthe Board of Directors.

 

**Investment andSublease with BeBetter Networks, Inc.**

 

At December 31, 2005 and2004, we had a 2% and 3% investment in BeBetter Networks, Inc. (“BeBetter”),respectively. BeBetter’s president is also an A.D.A.M. board member and held anapproximate 11% and 15% voting interest in BeBetter at December 31, 2005and 2004, respectively. As of December 31, 2005 and 2004, our Chairman ofthe Board of Directors held an approximate 2% and 3% voting interest in thiscompany, respectively. We account for the investment under the cost method, aswe have less than a 20% ownership and do not exercise significant influenceover the investee. In addition to our stock ownership in BeBetter, we also heldwarrants to purchase 25,000 common shares of BeBetter at an exercise price of$2 per share. These warrants expired on December 31, 2005. During 2002 werecorded an impairment charge of $84,000 to write off our investment based uponmanagement’s assessment that the decline in its carrying value was “other thantemporary.” At December 31, 2005 and 2004 the carrying value of ourinvestment was $0. We have no plans to provide additional investment inBeBetter in the future.

 

In September 2005, BeBettervacated the space we had been subleasing to them on a month to month basis at$585 per month.

 

**Investment andSublease with ThePort Network, Inc.**

 

Asof December 31, 2005 and 2004, we held an approximate 34% voting interestin ThePort Network, Inc. (“ThePort”). Our Chairman of the Board ofDirectors, who also currently serves as the Chairman of the Board of Directorsof ThePort, held an approximate 10% voting interest in ThePort at December 31,2005 and 2004 and held a convertible note and loans from ThePort in the amountof approximately $1,369,000 and$1,019,000 at December 31, 2005 and 2004, respectively. Two of our otherdirectors also own equity interests in ThePort. The investment is beingaccounted for under the equity method (see Note 1).

 

AtDecember 31, 2005 and 2004, after recording a permanent impairment chargeof $92,000 in 2002, the carrying value of our investment was $0. We did notreduce our investment below zero for our share of ThePort’s losses in 2005 and2004 as we have not provided or committed to provide any additional financialsupport to ThePort.

 

During2004 and through December 2005 we leased space to ThePort on amonth-to-month basis. During 2004 we received no consideration for this space,however from March to December 2005 we collected $1,200 per month.

 

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**14.Commitments and Contingencies**

 

We lease office space and equipment undernon-cancelable lease agreements expiring on various dates through 2008. We alsohave capital lease commitments for certain equipment. Additionally, we haveentered into certain agreements to license content for our services fromvarious unrelated third parties. At December 31, 2005, future minimumrentals for noncancelable leases with terms in excess of one year and totalpayments due under license agreements were as follows (in thousands):

 
| ** **                                                                 | ** ** | ** **     | ** ** | ** **      | ** ** | **Other**     | ** ** | ** **  | ** ** |
|----------------------------------------------------------------------------|------------|----------------|------------|-----------------|------------|---------------|------------|-------------|------------|
| **Year Ending**                                                            | ** ** | **License**    | ** ** | **Real Estate** | ** ** | **Operating** | ** ** | **Capital** | ** ** |
| **December 31,**                                                      | ** ** | **Agreements** | ** ** | **Leases**      | ** ** | **Leases**    | ** ** | **Lease**   | ** ** |
| ** **                                                                 | ** ** | ** **     | ** ** | ** **      | ** ** | ** **    | ** ** | ** **  | ** ** |
| 2006                                                                       |       | $              | 114        |            | $          | 234           |       | $           | 17         |   | $ | 24 |   |
| 2007                                                                       |       | —         |       | 239             |       | 21            |       | 19          |       |
| 2008                                                                       |       | —         |       | 182             |       | 5             |       | —      |       |
| Total future  minimum lease payments and payments under license agreements |       | $              | 114        |            | $          | 655           |       | $           | 43         |   | $ | 43 |   |
|                                                                       |       |           |       |            |       |          |       |        |       |
| Less -  amounts representing interest                                      |       |           |       |            |       |          |       | (5          | )          |
|                                                                       |       |           |       |            |       |          |       |        |       |
| Present  value of future minimum lease payments                            |       |           |       |            |       |          |       | 38          |       |
|                                                                       |       |           |       |            |       |          |       |        |       |
| Less -  current portion                                                    |       |           |       |            |       |          |       | (20         | )          |
|                                                                       |       |           |       |            |       |          |       |        |       |
|                                                                       |       |           |       |            |       |          |       | $           | 18         |   |

 

On December 28, 2005, in connection with a second amended andrestated employment agreement, a $317,000 final one-time bonus payment was madein full satisfaction of any future bonus payments due under an employmentagreement that originally had bonus commitments scheduled through 2008.

 

Rent expense for the years ended December 31,2005 and 2004 was $234,000 and $220,000, respectively. Our headquarters arelocated in approximately 12,000 square feet of leased office space in Atlanta,Georgia.

 

In November 2002, the FASBissued FASB Interpretation No. 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers” which clarifies disclosure, recognition and measurement requirementsrelated to certain guarantees. We indemnify our customers from third partyclaims of intellectual property infringement relating to the use of ourproducts. Historically, costs related to this guarantee have not beensignificant and we are unable to estimate the potential impact of thisguarantee on our future results of operations.

 

At the end of the third quarterended September 30, 2005, we received a demand notice from a former reselleralleging underpayments of royalties. We filed a breach of contract counterclaim for damages relating to non-performance of the reseller agreement. Bothof these matters have been settled through arbitration and we expensed the related$100,000 settlement in December 2005. We paid the settlement in full inFebruary 2006.

 

**15. SegmentInformation**

 

We operate in one segmentcomprised of three revenue sources: licensing, education, and other productofferings.

 

We sell our products throughagreements, which grant territorial rights to international and domesticdistributors. During the years ended December 31, 2005 and 2004, we hadnet revenues from international sales of approximately $354,000 and $324,000,respectively. A summary of revenues based on geographic location of customersis as follows (in thousands):

 

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| ** **           | ** ** | **December 31,** | ** ** |
|----------------------|------------|-----------------------|------------|
| ** **           | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                 |       |                  |       |   |   |
| United States        |       | $                     | 9,700      |   | $ | 8,109 |   |
| Europe               |       | 123                   |       | 33 |   |
| Pacific Rim and Asia |       | 98                    |       | 144 |   |
| Other                |       | 133                   |       | 147 |   |
|                 |       |                  |       |   |   |
|                 |       | $                     | 10,054     |   | $ | 8,433 |   |

 

No customers contributed greater than 10% of total revenues for theyears ended December 31, 2005 and 2004.

 

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Report of IndependentRegistered Public Accounting Firm

 

To the Board of Directors and Shareholders

A.D.A.M., Inc.

 

We have audited the accompanying consolidatedbalance sheets of A.D.A.M., Inc. and subsidiaries (the “Company”) as of December 31,2005 and 2004, and the related consolidated statements of operations, changesin shareholders’ equity, and cash flows for the years then ended. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. The Company is not required to have, nor were we engagedto perform an audit of internal control over financial reporting. Ouraudits included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of A.D.A.M., Inc. and subsidiaries as of December 31,2005 and 2004, and the results of their operations and their cash flows for theyears then ended in conformity with accounting principles generally accepted inthe United States of America.

 

 
| /s/ Tauber & Balser, P. C. |   |
|-------------------------------------|--------|
| Atlanta, Georgia                    |
| March 10, 2006                 |

 

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