<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                ---------------
                                    FORM 10-K
                                ---------------

                                   (MARK ONE)
            [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                    FOR THE FISCAL YEAR ENDED MARCH 31, 1998

                                       OR

            [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                  FOR THE TRANSITION PERIOD FROM _____ TO _____

                         Commission file number 0-26962

                             A.D.A.M. SOFTWARE, INC.
             (Exact name of Registrant as specified in its charter)


                             GEORGIA                             58-1878070
                    (State or other jurisdiction of          (I.R.S. employer
                    incorporation or organization)           identification no.)


                             1600 RiverEdge Parkway
                                    Suite 800
                             Atlanta, Georgia 30328
                    (Address of Principal Executive Offices)
                                 (770) 980-0888
              (Registrant's telephone number, including area code)

          Securities registered pursuant to Section 12 (b) of the Act:
                                      NONE

          Securities registered pursuant to Section 12 (g) of the Act:

        Title of Each Class            Name of Each Exchange on which Registered
        -------------------            -----------------------------------------
      Common Stock $.01 par value            Nasdaq National Market System

                              --------------------
     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes  X   No 
                                              ---    ---

    Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.

    The aggregate market value of the voting stock held by non-affiliates of the
Registrant was $9,642,562 at June 25, 1998 based on the closing market price of
the Common Stock on such date as reported by the Nasdaq Stock Market's National
Market. As of such date, there were 4,657,230 shares of the Registrant's Common
Stock, par value $.01 per share, outstanding, excluding shares held in treasury
by the Registrant.

DOCUMENTS INCORPORATED BY REFERENCE

    Portions of the Registrant's Proxy Statement in connection with its Annual
Meeting of shareholders to be held September 24, 1998 are incorporated by
reference in Part III.


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TABLE OF CONTENTS

PART I                                                                                            Page
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<S>               <C>                                                                             <C>    
    Item   1.     Business........................................................................  1
    Item   2.     Properties......................................................................  12
    Item   3.     Legal Proceedings...............................................................  12
    Item   4.     Submission of Matters to a Vote of Security Holders.............................  12
    Item   X      Executive Officers of the Registrant............................................  13

PART II
    Item   5.     Market for Registrant's Common Equity and Related
                      Stockholder Matters.........................................................  14
    Item   6.     Selected Financial Data.........................................................  15
    Item   7.     Management's Discussion and Analysis of Financial
                      Condition and Results of Operations.........................................  17
    Item   8.     Financial Statements and Supplementary Data.....................................  22
    Item   9.     Changes in and Disagreements With Accountants on
                      Accounting and Financial Disclosures........................................  22

PART III
    Item   10.    Directors and Executive Officers of the Registrant..............................  23
    Item   11.    Executive Compensation..........................................................  23
    Item   12.    Security Ownership of Certain Beneficial Owners
                      and Management..............................................................  23
    Item   13.    Certain Relationships and Related Transactions..................................  23

PART IV
    Item   14.    Exhibits, Financial Statement Schedules and Reports
                      on Form 8-K.................................................................  24
</TABLE>

SIGNATURES







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PART I

ITEM 1.      BUSINESS

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

    Portions of this Annual Report include forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Although the Company believes that the
expectations reflected in such forward-looking statements are based upon
reasonable assumptions, it can give no assurance that its expectations will be
achieved. Important factors that could cause actual results to differ materially
from the Company's current expectations are disclosed in conjunction with the
forward-looking statements included herein. Among the factors that could cause
actual results to differ materially are the following: business conditions and
the general economy, increased competition, general risks of technology and
software obsolescence, the loss of a principal customer in a given period if the
Company is unable to replace sales to such customer, the loss of a primary
distributor and the other risk factors described in the Company's reports filed
from time to time with the Securities and Exchange Commission.

GENERAL

     A.D.A.M. Software, Inc. ("the Company" or "A.D.A.M.") is a leading
developer of anatomy/medical content (including two-dimensional ("2-D") and
three-dimensional ("3-D") imagery, animations and text) and software
technologies. In addition to licensing content and software components, A.D.A.M.
creates, publishes and markets multimedia software products, along with content
and Internet-ready applications that provide anatomical, medical and
health-related information for the education, consumer and healthcare
professional markets. A.D.A.M. products use the Company's proprietary, branded
A.D.A.M. Image Database of visual anatomical content, and the Company's clinical
database of text-based patient and professional information acquired from Mosby,
Inc. ("Mosby") during the fiscal year ended March 31, 1998 ("fiscal 1998").

    Following six years of losses, the Company has achieved four consecutive
quarters of profitability, and has reported results for fiscal 1998 as its first
profitable year since inception. The Company attributes this turnaround to
stronger education market sales, less emphasis on the consumer software market
and improved expense controls. Going forward, the Company believes that the
growth of the Internet and intranets will provide new cost-efficient ways to
distribute A.D.A.M. content, and that the Company's strong commitment to the
healthcare professional markets may provide the Company new growth
opportunities.

The Company is a Georgia corporation and it commenced operations in March 1990.

STRATEGY

    The Company's strategy is to deploy its expanded product line and
proprietary content to the education, healthcare, pharmaceutical, legal and
broadcast markets. Using CD-ROM, the Internet, and broadcast and print media,
the Company intends to capitalize on its recognized brand name and become a
leading publisher and provider of anatomical and medical content.

The key elements of the Company's business strategy are to continue to:

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 -   Enhance the "A.D.A.M.," Brand Name as a Recognized Leader in Anatomical and
     Medical Content in the Education Market, and in New Markets. Management of
     the Company believes that brand name recognition for "A.D.A.M.(TM)" across
     the Company's various markets is an important element of the Company's
     long-term goals of technological superiority and profitability in all of
     its market segments. The Company has invested significant time and
     resources in brand development including, without limitation, seeking
     protection of its trademarks, copyrights and other proprietary rights, and
     management believes that these investments create a strong competitive
     advantage while enhancing customer satisfaction and building a loyal
     customer base. The Company has established an online brand "ADAM.com," a
     World Wide Web site that is currently used for marketing and general
     corporate purposes. Management believes this brand and website could be
     modified to become a commercial, revenue generating website by leveraging
     the Company's reputation as an innovative supplier of health and medical
     information, and by using the Company's existing database of animations,
     illustrations and clinical assets.

-    Integrate the Internet into Most Areas of the Company's Business. The
     Internet has emerged as a major new distribution channel and business
     opportunity and management believes many of the Company's content assets
     are suitable for online delivery and distribution. The Company has
     established new online products and licensable assets that take advantage
     of the Internet and the World Wide Web, and management intends to focus
     attention on building A.D.A.M.'s Internet presence and business.

-    Seek Opportunities to Grow the Size and Scope of A.D.A.M.'s Businesses.
     During fiscal 1998, A.D.A.M. completed its first acquisition since becoming
     a publicly traded company by acquiring three products from Mosby.
     Management believes that strategic alliances or acquisitions may enable the
     Company to access new markets more efficiently than through internal
     development. Furthermore, A.D.A.M.'s education business may benefit from
     strategic alliances or acquisitions that provide additional products to the
     Company's product portfolio.

-    Maintain Strong Expense Control. Management believes that maintaining
     strong control over expense growth has been one of the key factors in the
     Company's recent profitability. Having developed significant content assets
     over the years, management believes it can produce new products and content
     in a cost effective manner by leveraging existing resources. Furthermore,
     management believes it can market and distribute new and existing titles
     through established sales channels, particularly in the education market,
     thereby adhering to its disciplined approach regarding costs.


PRODUCTS

General

    The Company creates software products with varying levels of content,
functionality and price for the education, consumer and professional markets,
and licenses its content and software technologies. A.D.A.M.'s educational
products serve the medical school, undergraduate, allied health (nursing,
physical therapy, occupational therapy, etc.) and K-12 market, consumer products
serve home computer users, and professional products serve the healthcare,
pharmaceutical, legal and broadcast market. In addition, A.D.A.M. licenses
content and software technologies for online distribution of information, and
provides content for incorporation into third party applications.

    Most of the Company's products incorporate images from the A.D.A.M. Image
Database. The original database was assembled by a team of master's degreed
medical illustrators, anatomists, commercial illustrators, multimedia experts
and software engineers over a three and one-half year period. Each year, the
Company creates content, with recent emphasis placed on 3-D modeling. Currently,
the A.D.A.M. Image Database contains approximately 32 gigabytes of visual
anatomical and medical content in the form of illustrations, animations, 3-D
models and interactive, dissectible imagery. A.D.A.M. images are assembled and
linked together to present an interactive view of the human anatomy, allowing
users to observe and identify anatomical structures at different magnification
levels, "peel-back" successive layers of anatomy (i.e., to go from the skin to
the bone, layer by layer, at a given point on the body), highlight individual
anatomical systems or structures and view anatomical systems or structures from
multiple perspectives.

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    During fiscal 1998, the Company acquired three products from Mosby that use
a text-based clinical database of patient and professional information.
Management believes that portions of this new clinical content database will
also be used in a variety of the Company's existing and new products.


EDUCATION. For fiscal 1998, sales of products to the education market accounted
for approximately 77.8% of the Company's revenues.

    A.D.A.M. Interactive Anatomy ("AIA"), the Company's flagship product
released in the first quarter of fiscal 1998, provides an integrated environment
for the teaching and study of human anatomy at the higher education and
professional levels. Powerful tools and search capabilities offer the user
unprecedented access to over 20,000 anatomical structures in six different
views. Three-dimensional images based on the Visible Human data set, cadaver
photographs from the Bassett collection, pinned anatomical images and Slide Show
(a built-in curriculum integration and authoring tool), augment AIA's digital
medical illustrations. In addition, one-button Internet access provides
solutions for distance learning and offer seamless integration of the World Wide
Web and its capabilities.

    A.D.A.M. 3-D Library 2 is the second collection of 3-D models from A.D.A.M.
and offers 3-D rotation capabilities and the ability to simulate a "fly-thru" of
different body organs. This program is used in conjunction with A.D.A.M.
Interactive Anatomy. This comprehensive collection includes eye, ear, brain and
female and male reproductive models, and was introduced in the fourth quarter of
fiscal 1998.

    A.D.A.M. Practice Practical ("APP") simulates gross anatomy practical exams,
complete with pinned atlas images and time limits. Tests can be customized by
region, system or specific course syllabus. APP combines 15,000 questions with
over 500 detailed A.D.A.M. illustrations, cadaver photographs and radiographs.

    A.D.A.M. Comprehensive is a program designed for the medical school,
graduate institution and medically-related professional marketplace. The key
features of A.D.A.M. Comprehensive include: (1) approximately 1,000 layers of
anatomy and 22,000 identifiable anatomical structures; (2) extensive medical
terminology and comprehensive labeling designed for graduate level study; (3)
anterior, posterior, medial and lateral dissectible views of anatomy; (4) three
levels of magnification; (5) histologies, cross-sections, radiologies, MRIs,
text overviews and select audio pronunciations; and (6) interactive systems
study that permits the exploration of each system of the human body.

    A.D.A.M. Benjamin/Cummings Interactive Physiology ("IP") is a series of
five co-developed products between A.D.A.M. Software, Inc. and Addison Wesley
Longman, Inc. ("Addison Wesley") which were designed for the undergraduate
health sciences curriculum and completed during the fiscal year ended March 31,
1997 ("fiscal 1997"). Each module is designed to complement the A.D.A.M.
Standard product (described below) by integrating anatomical structures with
physiological functions. IP uses animation, audio, narration and video to
explain difficult and complicated physiology concepts and processes. Its
organization and self-test features provide the methodology for curriculum
integration. The five modules are described below:

-   Cardiovascular System offers colorful images and informative animations
    that present topics related to heart and blood vessel physiology. Covered
    in this module are: Heart Physiology-Anatomy Review of the Heart, Intrinsic
    Conduction System, Cardiac Action Potential, Cardiac Cycle, Cardiac Output
    Blood Vessel Physiology, Blood Vessel Structure and Function, Factors That
    Affect Blood Pressure, Measuring Blood Pressure and Autregulation and
    Capillary Dynamics.

-   Muscular System uses the detailed and accurate illustrations of muscles at
    gross and micro-levels to demonstrate the structure and function of the
    muscular system. Topics covered in the Muscular Module include: Anatomy
    Review-Skeletal Muscle Tissue, The Neuromuscular Junction, Sliding Filament
    Theory, Muscle Metabolism, Contraction of Motor Units and Contraction of
    Whole Muscle.

-   Respiratory System offers detailed information at the gross and cellular
    level of the respiratory system. The module includes: Anatomy
    Review-Respiratory Structures, Pulmonary Ventilation, Gas Exchange, Gas
    Transport and Control of Respiration.


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 -   Nervous System, sub-titled "The Neuron: The Action Potential," presents
     in-depth information on Neurons, Resting Membrane Potential and the
     Generation/Propagation of the Action Potential within the nervous system.
     The module includes: Orientation, Anatomy Review, Ion Channels, Membrane
     Potential and Action Potential.

-    Urinary Systems details Glomerular Filtraton, Early Filtrate Processing and
     Late Filtrate Processing by the urinary system. The Anatomy Review includes
     key features of: The Nephron, Tubular Segments and Associated Blood Vessels
     and Renal Corpuscle.

    A.D.A.M. Standard is a program designed primarily for undergraduate
institutions with health science programs. It is the intermediate-level
application in the A.D.A.M. Scholar Series and provides a thorough overview of
human anatomy. The key features of A.D.A.M. Standard are: (1) approximately 200
layers of anatomy and 18,000 identifiable anatomical structures; (2) scientific
and medical terminology consistent with undergraduate level of study; (3)
anterior, posterior and limited lateral dissectible views of anatomy and a
static medial view; (4) three levels of magnification; (5) histologies,
cross-sections, MRI's, text, overviews and select audio pronunciations; and (6)
interactive systems study that permits the exploration of each system of the
human body.

    A.D.A.M. Essentials is designed primarily for high school biology/anatomy
teachers, libraries and introductory/non-major college courses. A.D.A.M.
Essentials incorporates a simplified interface design that enables the user to
explore dissectible anatomy and animations of physiological content in a simple,
easy-to-use manner. The key features of A.D.A.M. essentials include: (1)
approximately 100 layers of anatomy and 4,000 identifiable anatomical
structures; (2) lay and scientific terminology, labeling and an audio
pronunciation guide appropriate for introductory level study; (3) interactive
systems study with 38 animations and text overviews that permits the exploration
of each system of the human body and its related functions; (4) anterior and
posterior dissectible views of anatomy; (5) two levels of magnification; and (6)
interactive puzzles designed to enhance learning comprehension.

    A.D.A.M. Essentials - School Edition is a curriculum-oriented solution for
the study of human anatomy and physiology at the high school level. It combines
A.D.A.M. Essentials with a comprehensive Teachers' Guide that includes student
worksheets, ideas for classroom activities, laboratory exercises, a bibliography
of additional learning resources and teacher reference materials.

    A.D.A.M. At Home Series - School Editions include A.D.A.M. The Inside Story
- School Edition, Nine Month Miracle - School Edition and Life's Greatest
Mysteries - School Edition. These products combine the stand-alone A.D.A.M. At
Home Products with comprehensive Teachers' Guides to meet the needs of a
classroom setting. A.D.A.M. The Inside Story - School Edition enables students
to study human anatomy and physiology in a middle school biology or life
sciences course, while Nine Month Miracle - School Edition is designed to
supplement the study of human reproduction at the high school level. The
Teachers' Guides for each product include student worksheets, ideas for
classroom activities, laboratory exercises, a bibliography of additional
learning resources and teacher reference materials.


PROFESSIONAL. For fiscal 1998, sales of products to the professional market
accounted for approximately 11.9% of the Company's revenues.

        Iliad is a medical expert software CD-ROM program used worldwide by
health care clinicians to provide expert diagnostic consultations and patient
simulations. Iliad covers more than 930 diseases and 1,500 syndromes and
provides treatment protocols for each including the ICD-9 codes for each
diagnosis. Iliad also includes 11,900 disease manifestations covering topics in
Internal Medicine, Pediatrics, Dermatology, Psychiatry, OB/GYN, Peripheral
Vascular Diseases and Sleep Disorders. Iliad acts as an expert consultant that
provides a differential diagnosis, or acts as a second opinion to critique a
presumptive diagnosis. The program can assist in selecting the most appropriate
and cost-effective data at any stage in the patient work up. The program also
comes with 90 simulated patient cases that can be used to test specific
diagnostic problem solving skills. This product was acquired from Mosby in
October 1997.

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    MLI's Winning Medical Illustrations is a 5-volume set of CD-ROM discs
containing high-quality anatomical, trauma, and medical-related images and
exhibits for use in settlement brochures, jury education materials and trial
exhibits. Designed primarily for personal injury and medical malpractice
attorneys, the image database includes over 10,000 medical illustrations used in
over 2,500 exhibits and approximately 1,300 cases.

    The Spine is a CD-ROM program offering over 5,000 frames of animated
material relating to the spine and is used primarily by attorneys involved in
medical-related litigation. The interactive information is broken down into
three different areas, including spinal anatomy, spinal injury and spinal
surgery.

    ActiveX Dissectible Anatomy Component - Management believes this product is
the most comprehensive digital database of detailed anatomical images in the
world, which includes illustrated, fully dissectible male and female bodies. The
product utilizes powerful features such as Pixel Level Recognition to identify
over 24,000 structures. The component presentation allows the dissectible
anatomy to be incorporated into third party applications, making it possible to
integrate A.D.A.M. content into electronic medical records and other health
information systems. This component was introduced in the fourth quarter of
fiscal 1998.

    Online Encyclopedias: Medical Encyclopedia, Pediatric Encyclopedia, and
Sexually Transmitted Disease Encyclopedia contain thousands of articles
complemented with color photographs and illustrations make up these easy-to-use,
HTML-based, interactive online encyclopedias covering a full range of topics
including diseases, symptoms, medical tests, surgeries, drugs, nutrition,
poisons and injuries.

    Containing thousands of 2-D images and illustrations, animations, 
high-resolution 3-D images and interactive movies, the A.D.A.M. Image Database
is known for its detailed and medically accurate anatomy, pathology and surgical
imagery. The Company licenses its imagery for various mediums including print,
broadcast and online, and began actively pursuing a licensing strategy during
fiscal 1998.

CONSUMER. For fiscal 1998, sales of products to the consumer market accounted
for approximately 9.5% of the Company's revenues.

    A.D.A.M. The Inside Story is a consumer "edutainment" program designed for
family use that provides A.D.A.M. anatomy content in an easy-to-use software
application. A.D.A.M. The Inside Story features a "Family Scrapbook" in which
modern-day Adam and Eve characters lead a light-hearted, animated tour through
each system of the body. These characters are given personalities and provide an
entertaining story-line approach to the exploration of human anatomy. Fifty-two
animations, six interactive puzzles and a medical glossary provide an engaging
and educational multimedia experience.

    A.D.A.M. The Inside Story 1997 Edition is an upgraded version of the
Company's flagship consumer software title, and includes new features such as
3-D content, the "Quizmeister" testing feature, one-button Internet access,
additional imagery and updated print capabilities.

    Nine Month Miracle is a consumer "edutainment" program designed for use by
family members with an interest in pregnancy. Nine Month Miracle contains
animations and video in which modern-day Adam and Eve characters join medical
experts for a month-by-month tour depicting the development of a fetus from
conception through delivery. This product also integrates dramatic intra-uterine
photography by Lennart Nilsson, an informative glossary from the American
College of Obstetricians and Gynecologists and video footage from the Nine
Months documentary to create a unique multimedia experience. Nine Month Miracle
also features "Emily's New Sister," a chapter where cartoon animations allow
younger children to discover the miracle of a new baby through the eyes of a
7-year old character named Emily.

    Life's Greatest Mysteries is a consumer "edutainment" program designed for
family use which provides an interactive exploration of the myths, mysteries and
curiosities of the human body. Using detailed animations and a simple "Q&A"
format, a character named Bob Winkle reveals answers to dozens of questions
ranging from "What is cancer?" and "What causes Alzheimer's Disease?" to
curiosities such as "What causes headaches?" and "Why does hair turn gray?"
Life's Greatest Mysteries also includes activities to help reinforce key
concepts, a supplemental text reference section and a glossary of key terms.

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    Physician's Home Assistant and Pediatrician's Home Assistant, are
easy-to-use symptom analysis tools and medical reference guides intent on
creating an informed patient. These products offer extensive disease, nutrition,
surgery, medical record, drug side-effect and interaction databases. These
products were acquired from Mosby in October 1997.


PRODUCT DEVELOPMENT

    The Company believes in a thorough and systematic approach to product
development, which includes stages of market analysis, specification
development, product creation and testing.

    All product ideas that have received preliminary approval from the Company's
senior management for potential development are subject to extensive market
analysis prior to product definition. This analysis focuses on market size,
product potential, sales projections and pricing strategies. As a result of the
analysis, a return on investment, sales potential and overall strategic value is
determined for each product concept. The completed analysis is then presented to
the Company's senior management for a final product development decision.

    Once approved for development, product candidates enter into the
specification stage, during which the product concept develops into a detailed
design. During this stage, writers, content experts and other production
partners are identified and brought under contract. Additionally, third party
content such as images, audio tracks and existing video are located and
licensed. When appropriate, the Company may develop simple prototypes during the
specification stage to test interface, navigation and content with internal and
external focus groups.

    Upon completion of the specification stage, products enter the product
development stage. During this stage, the Company's designers, illustrators,
programmers and other creative talent become actively involved in product
development. At several points during the development stage the product is sent
to various evaluators, including potential customers, to conduct functionality
tests and to gain user feedback; then results of such feedback are integrated
back into the design specifications. In addition to the functionality and
testing stages, management believes it is important for the Company to
continually market test products at several other levels. The Company constantly
assesses the accuracy of the content, including all text, illustrations,
animations, video and audio. Products also undergo usability testing to
determine the friendliness of the interface, appropriateness of tools and other
aspects of a user's interaction with the product.

    Capitalized software development costs consist principally of salaries and
certain other expense directly related to development and modifications of
software products capitalized in accordance with the provisions of Statement of
Financial Accounting Standards (SFAS) No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed." Capitalization of
such costs begins when a working model has been produced, as evidenced by
completion of design, planning, coding and testing, such that the product meets
its design specifications and has thereby established "technological
feasibility" as defined in SFAS No. 86. Capitalization of such costs ends when
the resulting product is available for general release to the public.
Amortization of capitalized software development costs is provided at the
greater of the ratio of current product revenue to the total of current and
anticipated product revenue or on a straight-line basis over the estimated
economic life of the software.

SERVICES

    The Company uses its Image Database to create custom services in the
professional market for various customers, including book publishers and
pharmaceutical companies. The A.D.A.M. production staff works closely with its
customers to create content and presentations that are medically accurate and
visually engaging. A.D.A.M. Software typically retains copyright ownership on
its custom development work. For fiscal 1998, custom service work accounted for
approximately 1.8% of the Company's revenues.

SALES, MARKETING AND DISTRIBUTION

    The Company employs a wide range of marketing and distribution strategies in
the academic and professional markets to promote brand name recognition broaden
product distribution and increase market 

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share. In fiscal 1997, the Company licensed its consumer product line to
Mindscape, Inc. ("Mindscape") for distribution into the retail market, relieving
the Company of sales, marketing and distribution responsibilities in the
consumer market. 

    In the education market, the Company markets its products through both
direct and indirect channels. The Company employs four direct telesales
representatives and four field sales people, and engages a network of value
added resellers and catalog resellers to sell its products. In addition, the
Company works non-exclusively with Addison Wesley, Mindscape, Williams
and Wilkins and other distributors for the education market. Sales and marketing
activities include advertising, media relations, direct mailings, distribution
of brochures, participation in educational seminars, campus visits by field
sales personnel, telemarketing and telesales efforts.

    In fiscal 1998, the Company launched an aggressive series of national grant
and training programs designed to enhance the Company's position as a market
leader in education anatomy products and increase the average institutional
sales order. These grant and training programs offer hands-on instruction on
A.D.A.M. products and offer educators the opportunity to propose ideas on topics
such as curriculum integration and online strategies, in return the Company
provides these educators with free software. The Company also instituted a
highly successful competitive upgrade program for its higher education products.
The upgrade program had two primary purposes: (i) capture additional
institutional budgetary dollars and (ii) develop new account relationships.
Marketing support for the Company's indirect sales efforts includes the
development of print and electronic catalogs, creation and supply of special
demonstrative software, training kits and media relations. In fiscal 1998,
management believes that approximately $1.5 million of revenue was attributable
to these marketing programs.

    In addition, during fiscal 1998 the Company terminated a non-exclusive
relationship with a distributor. for the K-12 market and created new
non-exclusive relationships with other distributors, including Mindscape. These
and other changes led to increased revenue for the Company from the fast growing
K-12 market.

    In international markets, the Company maintains exclusive distribution
relationships with Matsushita in Japan, Pearson Professional in Australia, and a
non-exclusive distribution relationship with Churchill Livingstone UK in Europe.
International revenues comprised 23.9% of the Company's total net revenues in
fiscal 1998, mainly from the education and professional markets.

    The Company has designated four employees to pursue sales opportunities in 
professional markets such as healthcare, pharmaceutical, legal and broadcast.
The Company sales, marketing and distribution in professional markets involve
building awareness of the Company's products, attending industry events,
establishing relationships with prospective companies and customers and
conducting thorough market research. In the healthcare market, the Company
intends to develop strategic marketing initiatives designed to target top tier
healthcare and pharmaceutical companies. These initiatives will include
seminars, partnership development and focused national account management. In
the legal market, the Company has built a direct marketing and sales model that
links mail and print advertising with outbound telesales. The Company works
exclusively with CNN Newssource, a division of Time-Warner, Inc., to address the
domestic broadcast market. CNN Newssource is responsible for all sales,
marketing and distribution to the local and national broadcast market in return
for a percentage of the revenue generated.

    The Company also signed a major licensing agreement with Kainos Laboratories
("Kainos"), a Japanese pharmaceutical company, during fiscal 1998. The agreement
provides Kainos a 99-year license for the exclusive rights to Japanese-language
versions of the three products A.D.A.M. acquired from Mosby, and exclusive
distribution of English-language versions in Japan. This agreement accounted for
approximately 10.9% of the Company's revenues in fiscal 1998.


STRATEGIC ALLIANCES

    The Company has established a number of important relationships with
companies that operate in the markets A.D.A.M. Software serves. A summary of the
Company's significant alliances is set forth below:

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    Addison Wesley Longman, Inc., a subsidiary of Pearson PLC

    Addison Wesley is a major publisher for the undergraduate market for
science, health science, nursing and allied health. Addison Wesley is a
significant shareholder of the Company and has product development and
distribution relationships with the Company. The Company and Addison Wesley
co-developed a series of multimedia products, known as A.D.A.M.
Benjamin/Cummings Interactive Physiology, for the undergraduate health science
market. Both companies sell these products, with A.D.A.M. Software focused on
the institutional market and Addison Wesley focused on the student market.

    Mindscape, Inc., a subsidiary of The Learning Company, Inc.

    During the last quarter of fiscal 1998, the Company and Mindscape entered
into a non-exclusive distribution agreement for the K-12 marketplace. In March
1997, the Company and Mindscape entered into a worldwide distribution agreement
for A.D.A.M.'s consumer products. The agreement granted Mindscape exclusive
distribution rights for English language consumer products in retail markets, to
equipment manufacturers and by direct mail, and non-exclusive rights in certain
other retail market segments.

    CNN Newssource, a division of Time Warner, Inc.

    During fiscal 1998, the Company signed an agreement with CNN Newssource for
distribution of a special compilation of A.D.A.M. content into the broadcast
news marketplace. The Company granted CNN Newssource exclusive domestic rights
to distribute the A.D.A.M. Image Database to television news broadcasters for
use in health and medical news coverage. CNN Newssource is responsible for the
sales, marketing and distribution of the A.D.A.M. content into the local and
national broadcast news market. CNN Networks, including Cable News Network, CNN
Headline News and CNN International, were initial customers of this new
service.

ANATOMICAL REVIEW BOARD AND EDITORIAL REVIEW BOARD

    The Company has an Anatomical Review Board composed of individuals with
expertise in the fields of anatomy, biology and medicine that assists the
Company in its endeavor to ensure that the A.D.A.M. Image Database conforms to
the highest standards of anatomical accuracy and instructional utility. Members
of the Anatomical Review Board make periodic recommendations to the Company
regarding content accuracy and testing reliance of the Company's products and
product development candidates.

    With the release of A.D.A.M. Interactive Anatomy (AIA), the Company
established an Editorial Review Board composed of 125 educators and healthcare
professionals whose role is to review the A.D.A.M. Image Database and advise the
product development teams on user interface design, product features and
functionality. The Editorial Review Board provides important feedback that helps
the Company create products and services that meet the needs of the marketplace.

MANUFACTURING

     The production of the Company's software includes CD-ROM pressing, assembly
of purchased product components, printing of product packaging and user manuals
and shipping of finished goods, which is performed by third-party vendors in
accordance with the Company's specifications and forecasts. The Company believes
that there are alternate sources of these services that could be implemented
without material delay.

PROPRIETARY RIGHTS AND LICENSES

    The Company regards its software and the A.D.A.M. Image Database as
proprietary and relies primarily on a combination of copyright, trademark, trade
secret and confidential information laws, employee and third-party nondisclosure
agreements and other methods to protect its proprietary rights. There can be no
assurance that these protections will be adequate to protect the Company's
intellectual property rights or that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technologies. The Company has obtained federal registrations of
the trademarks "A.D.A.M.," "SCHOLAR SERIES," "NINE MONTH MIRACLE," and

                                       10
<PAGE>   11

the "WALKING MAN" logo in the United States. The Company has applied for
registration of approximately ten additional trademarks in the United States.
The Company has also obtained registrations of the "A.D.A.M." trademark in 22
foreign countries and has applications for registration of the mark pending in
an additional five countries. The Company does not currently hold any patents or
have any patent applications pending. The Company believes that, due to the
rapid pace of innovation within the multimedia and software industries, factors
such as the technological and creative skills of its personnel and the quality
of the content of its products are more important in establishing and
maintaining a leadership position within the industry than are the various legal
protections of its technology.

    The Company licenses certain software programs from third-party developers
and incorporates them into its products. Such software products are widely
licensed by the respective developers thereof for incorporation by other
developers (like A.D.A.M.) in their products and provide specific functionality
required in order to operate the product. For example, the Company licenses
Macromind Director, a program distributed by Macromedia, which permits a product
to display animated sequences. This product is incorporated in several A.D.A.M.
products. Generally, the licenses grant to the Company non-exclusive, worldwide
rights with respect to the subject program and terminate only upon a material
breach by the Company. Certain of the licenses require payment of annual license
fees (but such annual license fees do not exceed $25,000 per annum in the
aggregate). If a third-party agreement for licensed software expires or
terminates and the Company is unable to renew or extend the agreement, the
Company could be required to engage in independent development of replacement
software or to obtain a suitable replacement. The Company generally believes
that licenses for alternative software programs are generally available on
commercial terms from a number of licensors. The Company owns and does not
license the anatomical illustrations included in the A.D.A.M. Image Database,
but licenses certain additional multimedia content from various third parties
that the Company incorporates in its products, including video, photographs,
music and text. Such licenses generally provide the Company with fully-paid
perpetual, worldwide licenses to include the licensed content in a designated
product.

    The Company believes that its products, trademarks and other proprietary
rights do not infringe upon the proprietary rights of third parties. However, as
the number of software products in the multimedia industry increases and the
functionality of these products further overlaps, software developers may become
increasing subject to infringement claims. There can be no assurance that
third parties will not assert infringement claims against the Company in the
future with respect to current or future products, trademarks or other Company
works or that any assertion may not require the Company to enter into royalty
arrangements or result in costly litigation.

COMPETITION

    The educational multimedia software industry is intensely competitive and
demand for particular software products may be adversely affected by the
increasing number of available competitive products. The Company competes in the
academic marketplace primarily with other companies offering educational
software products on anatomy, health and medical topics and, to a lesser extent,
with larger publishers of traditional print textbooks on anatomy and medicine.
Existing competitors may continue to broaden their product lines and potential
competitors, including large hardware or software manufacturers and educational
publishers, may enter or increase their focus on the academic market, resulting
in greater competition for the Company.

    In the K-12 academic marketplace, the Company faces direct competition from
other companies offering educational software products. In the consumer market,
the Company faces direct competition from other companies offering educational
software products, as well as competition for shelf space from companies
offering entertainment and consumer software products. Numerous companies serve
the healthcare, pharmaceutical and legal markets, including large publishers
such as Mosby, Thomson and Reed Elsevier, as well as numerous small companies
that may have many more years of industry experience and contacts than A.D.A.M.
Although the Company has entered into and began selling to these market segments
in fiscal 1998, additional resources have been allocated such that increased
penetration and presence in this market are expected in fiscal 1999.

    The Internet represents a new and fast growing market. While A.D.A.M.
believes it can offer content resources for the Internet, there are many
existing competitors that exist who have greater resources,

                                       11
<PAGE>   12

experience and relationships. There can be no assurance A.D.A.M. will be
successful licensing its content for use on the Internet or developing other
Internet related business.

    Moreover, competition for the Company's products is influenced by the timing
of competitive product releases and the similarity of such products to those of
the Company, which may result in significant price competition, reduced profit
margins, loss of shelf space or a reduction in sell-through of the Company's
products at retail stores. There can be no assurance that any of the Company's
software products will compete effectively against other interactive multimedia
software products in general or anatomical, health, medical and educational
information products, in particular. The Company's competitors include many
companies, many of which have substantially greater financial, development,
marketing and personnel resources than those of the Company. Moreover, the price
of the Company's products and the computer hardware required to operate them may
be higher in cost than alternative competitive informational sources such as
anatomy textbooks.


EMPLOYEES

    As of March 31, 1998, the Company employed 62 persons. Of these, 22 were
engaged primarily in product development, 15 in sales, eight in marketing and 17
in finance and administration. The Company currently employs ten masters-degreed
medical illustrators. None of the Company's employees is covered by a collective
bargaining agreement and the Company has experienced no work stoppages. The
Company considers its employee relations to be good. Management believes that
the Company's future growth and success will depend upon its ability to retain
and continue to attract highly skilled and motivated personnel in all areas of
its operations.

ITEM 2.  PROPERTIES

    The Company's headquarters and principal operations are located in
approximately 26,000 square feet of leased office space in Atlanta, Georgia. The
space is leased for a term ending in 2002. In February 1998 the Company
sub-leased approximately 3,100 square feet of its leased space to another
company for a period of 18 months, the term of which may be extended at the
Company's option. Management of the Company believes that the Company's current
facilities will be adequate through at least 1999. If additional facilities are
required, the Company believes that suitable facilities will be available.


ITEM 3.   LEGAL PROCEEDINGS

    On April 25, 1996, a class action lawsuit in Fulton County Superior Court in
Atlanta, Georgia was filed against the Company and certain of its then officers
and directors. The complaint alleges violations of sections 11, 12(2) and 15 of
the Securities Act of 1933, violations of the Georgia Securities Act and
negligent misrepresentation arising out of alleged disclosure deficiencies in
connection with the Company's initial public offering which was completed on
November 10, 1995. The complaint seeks compensatory damages and reimbursements
for plaintiff's fees and expenses. A motion to dismiss is pending and the
Company and its officers and directors are vigorously defending against the
allegations.


ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1998.

                                       12
<PAGE>   13



ITEM X.  EXECUTIVE OFFICERS OF THE REGISTRANT

The persons who are executive officers of the Company and their positions are as
follows:

<TABLE>
<CAPTION>

NAME                                          AGE       POSITIONS WITH THE COMPANY
----                                          ---       --------------------------
<S>                                           <C>       <C>    
Robert S. Cramer, Jr.                         37        Chairman of the Board, Co-Founder, Chief Executive
                                                        Officer

Gregory M. Swayne                             40        Co-Founder, Vice-Chairman, Vice President of
                                                        Production and Director

Michael Fisher                                35        Corporate Secretary, Director of Finance and
                                                        Administration
</TABLE>

     ROBERT S. CRAMER, JR. Mr. Cramer, a co-founder of the Company, has served
as Chairman of the Board and a Director since the Company's inception in March
1990, and Chief Executive Officer since September 1996. From 1987 to 1992, he
served as Chairman of the Board of Directors of Medical Legal Illustrations,
Inc. ("MLI"), a predecessor to the Company. Previously, Mr. Cramer served as a
magazine publisher and television news producer. Since 1994 Mr. Cramer has
served as Chairman of the Board of the Atlanta Task Force for the Homeless, a
community-wide non profit organization working with and on the behalf of
homeless people.

     GREGORY M. SWAYNE. Mr. Swayne, a co-founder of the Company, has served
as Vice President of Production and Vice-Chairman of the Company since
March 1997 and as a Director since March 1990. Previously, he served as
President from March 1990 until March 1997. As the original founder of MLI, he
served as President from 1985 until February 1992, and as a director of MLI from
1985 until the merger of MLI and the Company in May 1992. Mr. Swayne is a master
degree medical illustrator who completed a three year graduate program in
medical illustration that required him to participate in all the first year
medical school courses (including gross anatomy, histology, embryology and
neuroanatomy) as well as a full year of direct surgical observation and
illustration.

     MICHAEL S. FISHER. Mr. Fisher joined the Company in September 1993 as
Controller, became Director of Finance and Administration in February 1997 and
was appointed Corporate Secretary in March 1997. From June 1990 through August
1993 he served as Controller for Morgan Medical Holdings, Inc., a publicly held
medical diagnostic services firm, and was responsible for all financial
functions. Previously thereto, he served two years as an accountant with
BDO/Seidman. Mr. Fisher is a CPA licensed in the state of New York.

                                       13
<PAGE>   14



PART II


ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

    The Company's Common Stock is quoted on the Nasdaq National Market system
under the symbol "ADAM". The following table sets forth the high and low bid
quotations of the Company's Common Stock as reported by Nasdaq

<TABLE>
<CAPTION>

                                                     High          Low
                                                     ----          ---
    <S>                                              <C>           <C>    
    FISCAL 1997
    -----------
    First Quarter                                     5                3
    Second Quarter                                    5                2-1/8
    Third Quarter                                     4                2-1/8
    Fourth Quarter                                    2-7/8            2

    FISCAL 1998
    -----------
    First Quarter                                     2-5/16           1-3/4
    Second Quarter                                    3-5/8            2
    Third Quarter                                     3-5/8            1-7/8
    Fourth Quarter                                    3-1/4            2-1/8

    FISCAL 1999
    -----------
    First Quarter (through June 25, 1998)             6-5/8            2-5/8
</TABLE>


    At June 25, 1998 there were approximately 192 record holders of the
Company's Common Stock.

    The Company has never paid or declared any cash dividends on its Common
Stock and does not intend to pay dividends on its Common Stock in the near
future. The Company presently expects to retain its future anticipated earnings
to finance development of and expansion of its business. The payment by the
Company of dividends, if any, on its Common Stock in the future is subject to
the discretion of the Board of Directors and will depend on the Company's
earnings, financial condition, capital requirements and other relevant factors.

                                       14
<PAGE>   15


ITEM 6.   SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>

                                                                           Fiscal Year Ended March 31,
                                                                           ---------------------------
                                                             1998           1997         1996         1995         1994
                                                             ----           ----         ----         ----         ----
                                                                     (in thousands, except per share amounts)
<S>                                                         <C>           <C>          <C>         <C>           <C>    
STATEMENT OF OPERATIONS:
   Net revenues                                             $    6,888     $  4,591     $  6,447    $   5,742    $   2,813
                                                                              
   Cost and expenses:
      Cost of revenues                                           1,178        1,280        1,491          791          293
      Sales and marketing                                        2,778        4,494        4,090        3,666        1,965
      Product development                                        1,512        2,260        2,847        2,401        1,759
      General and administrative                                 1,293        2,369        2,008        1,774        1,554
      Restructuring charge                                           -          490            -            -            -

        Total costs and expenses                                 6,761       10,893       10,436        8,632        5,571

      Income (loss) before income                                  127       (6,302)      (3,989)      (2,890)      (2,758)
   Interest expense                                                 (3)          (8)        (317)        (383)         (90)    
   Interest income                                                 529          869          415           43           64
                                                            ----------    ---------    ---------   ----------   ----------

      Income (loss) from continuing operations                     653       (5,441)      (3,891)      (3,230)      (2,784)  
    Loss from discontinued operations                                -            -            -            -         (400)
                                                            ----------    ---------    ---------   ----------   ----------

      Income (loss) before income taxes and
          Extraordinary item                                       653       (5,441)      (3,891)      (3,230)      (3,184)
                                                                            
   Income Taxes                                                    (75)           -            -            -            -
                                                            ----------    ---------    ---------   ----------   ----------

        Income (loss) before extraordinary item                    578       (5,441)      (3,891)      (3,230)      (3,184)
                                                                            
   Extraordinary loss from early extinguishment
      of debt, net of income tax benefit of $29                      -            -          (46)           -            -
                                                            ----------    ---------    ---------   ----------   ----------

         Net income (loss)                                  $      578    $  (5,441)   $  (3,937)    $ (3,230)  $   (3,184)
                                                                           

   Net income (loss) per share from continuing operations   $      .12    $   (1.03)   $   (1.13)    $  (1.22)  $    (1.11)

   Net income (loss) per share                                     .12        (1.03)       (1.14)       (1.22)       (1.27)
                                                                             

   Weighted average number of common shares
      and share equivalents outstanding                          4,959        5,258        3,673        2,694        2,510
</TABLE>

                                       15
<PAGE>   16



<TABLE>
<CAPTION>


                                                                                 As of March 31,
                                                        ------------------------------------------------------------------
                                                             1998           1997         1996         1995         1994
                                                                                  (in thousands)
BALANCE SHEET DATA:
<S>                                                              <C>         <C>          <C>         <C>          <C>   
   Cash and cash equivalents                                        704       2,422        5,352          940          716
   Working capital (deficiency)                                   9,011       9,982       15,354       (1,736)        (593)
   Total assets                                                  11,900      13,662       18,871        4,247        3,632 
   Short-term debt                                                    -           -          250        2,530          284
   Long-term debt                                                     -           -            -          298          336
   Convertible Preferred Stock                                        -           -            -        2,022            -
   Total shareholders' equity (deficit)                          10,713      11,555       16,896       (1,943)      (1,284)
</TABLE>

                                                                             
                                       16
<PAGE>   17


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
RESULTS OF OPERATIONS

    The following discussion should be read in conjunction with the Financial
Statements and Notes thereto of the Company presented elsewhere herein.

OVERVIEW

    A.D.A.M. Software, Inc. ("the Company" or "A.D.A.M.") is a leading developer
of anatomy/medical content (including 2-D and 3-D imagery, animations and text)
and software technologies. In addition to licensing content and software
components, A.D.A.M. creates, publishes and markets multimedia software
products, content and Internet-ready applications that provide anatomical,
medical and health-related information for the education, consumer and
professional markets. The Company sells its products into the academic markets
through alliances with distributors and by direct sales and marketing
activities. In March 1997 consumer distribution was outsourced to Mindscape.

    Revenue from product sales is generally recognized at the time of shipment
to customers, distributors and resellers or, in the case of consignment
arrangements, at the time of shipment from the consignee to their customers.
Licensing revenue is recognized when contracts are finalized in cases where no
further performance by the Company is required, and over the term of the
contract in cases where further performance by the Company is required. The
Company records allowances for product returns based on historical experience
and anticipated returns. Payments received in advance of shipments are recorded
as deferred revenue in the balance sheet and are recognized as revenue when the
related software is shipped and all applicable obligations are fulfilled.

    The Company's initial products addressed the graduate education and
professional markets, which were characterized by higher unit prices, lower cost
of goods sold as a percentage of selling price and lower unit volumes than the
Company's consumer products. Accordingly, such products had a significantly
higher gross margin than the Company's consumer products. In early 1994, the
Company made the strategic decision to leverage its A.D.A.M. Image Database and
its multimedia capabilities toward developing products for the larger consumer
and general education markets. As a result, the Company's product mix shifted
from predominately higher priced products for graduate education and
professional markets to a broad array of products with lower price points for
the general education and consumer markets. The Company's consumer products
generally had a lower unit price, higher cost of goods sold as a percent of
price and lower gross margin. As a result of releasing a new, flagship academic
product in the first quarter of fiscal 1998 and outsourcing the distribution of
consumer products to Mindscape in March 1997, the average net revenues received
by the Company increased to approximately $36.00 per unit for the 120,000 units
of software sold in fiscal 1998 compared to approximately $24.00 per unit for
the 189,000 units of software sold in fiscal 1997, and approximately $50.00 per
unit for the 129,000 units of software sold in the year ended March 31, 1996
("fiscal 1996"). A significant reduction in price points due to changes in
product mix, as well as up to 40% price reductions in April 1996 of several
academic products, had resulted in lower gross margins and higher costs of
revenue as a percentage of net revenue for fiscal 1997 as compared to fiscal
1996 and fiscal 1998. Approximately 63% of revenues in fiscal 1998 were derived
from actual product shipments, compared to 96% in fiscal 1996 due to increased
licensing and royalty income activity in fiscal 1998.

        The Company experienced its first profitable year in fiscal 1998.
However, substantial losses since the Company's inception in prior years has
resulted in an accumulated deficit of approximately $21.9 million as of March
31, 1998. For fiscal 1998, the Company earned net income of $578,000 and for the
fiscal 1997, 1996 and 1995, the Company incurred net losses of approximately
$5.4 million, $3.9 million and $3.2 million, respectively. Management believes
that the profit for fiscal 1998 was primarily due to successful implementation
of the Company's restructuring Plan (the "Plan") during fiscal 1997, which
enabled the Company to bring costs in line with revenues. The Plan was designed
to enhance overall competitiveness, productivity and efficiency through the
reduction of overhead costs. The major costs associated with the Plan included
severance costs, employee termination costs, and costs associated with the
termination of a non-cancelable lease. The basis for determination of the cost
accrued with respect to the non-cancelable lease was gross rental payments due
through the end of the lease plus broker's commission less expected rental
receipts from subleasing the space. The cost benefits of reduction in 

                                       17
<PAGE>   18

personnel was largely realized in the third and fourth quarters of fiscal 1997,
and the lease termination benefits were realized in fiscal 1998.

    At March 31, 1998, the Company had net operating loss carryforwards
available for tax purposes of approximately $19.1 million, which will expire in
years 2007 through 2013. Future sale of shares by certain significant
shareholders could create a substantial ownership change (as defined by the
Internal Revenue Service) which would limit the amount of the Company's future
taxable income that may be offset by pre-ownership net operating loss
carryforwards.

RESULTS OF OPERATIONS

    The following table sets forth for the periods indicated selected financial
data and the percentages of the Company's net revenues represented by each line
item and the percentage change in each line item.


<TABLE>
<CAPTION>

                                                                                       PERCENTAGE CHANGE
                                                  FISCAL YEAR ENDED MARCH 31,        -----------------------
                                              ------------------------------------    1997 TO      1996 TO
                                                1998           1997        1996        1998         1997
                                                ----           ----        ----        ----         ----        
<S>                                             <C>            <C>         <C>        <C>          <C>   
Net revenues                                        100%          100%        100%       50.0%        (28.8)%
Costs and expenses:
     Cost of revenues                              17.1          27.9        23.1        (8.0)        (14.2)
     Sales and marketing                           40.3          97.9        63.4       (38.2)          9.9
     Product development                           22.0          49.2        44.2       (33.1)        (20.6)              
     General and administration                    18.8          51.6        31.1       (45.4)         18.0
     Restructuring charge                             -          10.7           -      (100.0)        100.0
                                              ---------      --------    --------

            Total costs and expenses               98.2         237.3       161.8
                                              ---------      --------    --------

Operating income (loss)                             1.8        (137.3)      (61.8)
</TABLE>


    The following table sets forth for the periods indicated the revenues
derived by the Company from the academic, consumer and professional markets and
from other sources. Other revenues include royalty income, license fees and
support services.



<TABLE>
<CAPTION>
                                                                  FISCAL YEAR ENDED MARCH 31,
                                                           -------------------------------------------
                                                             1998             1997           1996
                                                             ----             ----           ----
                                                                          (in thousands)
<S>                                                        <C>           <C>             <C>  
Education                                                  $  5,357      $        2,523  $      3,688
Professional                                                    821                   -             -
Consumer                                                        652               1,978         2,533
Other revenues                                                   58                  90           226
                                                           --------      --------------   -----------

         Net revenues                                      $  6,888      $        4,591   $     6,447
                                                           ========      ==============   ===========
</TABLE>

Fiscal 1998 Compared to Fiscal 1997

    Total net revenues increased 50.0% to $6,888,000 in fiscal 1998 compared to
$4,591,000 in fiscal 1997 as a result of increased sales of the Company's
high-end, flagship product in the education market, increased revenue from the
professional market and increased licensing revenue. Total unit shipments of the
Company's products decreased to approximately 120,000 units in fiscal 1998 from
approximately 189,000 units in fiscal 1997. The increased net revenues and
decreased unit shipments reflect higher

                                       18
<PAGE>   19

revenues per unit shipped, which are the result of higher pricing for the
Company's new flagship product, A.D.A.M. Interactive Anatomy released in the
first quarter of fiscal 1998, distribution of lower priced consumer products
such as A.D.A.M. The Inside Story and Nine Month Miracle through a third party,
and greater focus on sale of higher margin education products during fiscal
1998.

     Net revenues from the education market increased 112.3% to 5,357,000 in
fiscal 1998 from $2,523,000 in fiscal 1997 due primarily to increased sales of
the flagship product education product, A.D.A.M. Interactive Anatomy, as well as
increased unit sales of other, more mature products such as the Benjamin
Cummings Interactive Physiology series and A.D.A.M. Practice Practical. The
Company's agreement with Kainos represented $750,000 of the education market net
revenues. In addition, in fiscal 1998 the Company recognized approximately
$389,000 of revenue related to upgrade rights granted to purchasers of certain
products that was deferred during fiscal 1997. As a percent of total net
revenues, net revenues from the education market increased to 77.8% in fiscal
1998 compared to 54.9% in fiscal 1997.

    Net revenues from the consumer market decreased 67.0% to $652,000 in fiscal
1998 compared to $1,978,000 in fiscal 1997 due primarily to the March 1997
distribution agreement with Mindscape pursuant to which the Company receives
royalties on the sale of consumer products rather than recognizing gross sales
price as it had previously done. As a percent of total net revenues, net
revenues from the consumer market decreased to 9.5% in fiscal 1998 compared to
43.1% in fiscal 1997.

     Net revenues from the professional market were $821,000 in fiscal 1998.
These net revenues were derived from sales of custom services, license fees for
software components developed by the Company, and product sales each of which
accounted for 15%, 41%, and 44% of the total professional market net revenues,
respectively. Approximately 47% of product sales, or $170,000, into this market
resulted from sales of Medical-Legal Series products introduced during fiscal
1997. As a percent of total net revenues, net revenues from the professional
market was 11.9% in fiscal 1998.

    The Company believes that anticipated future revenue growth will depend on,
among other things, its ability to improve and upgrade existing products and
become a content provider of anatomical imagery that can become more widely
adopted through licensing models, education curriculums, professional market
intranets and Internet website markets. Additionally, continued adoption of
electronic commerce on the Internet, the extent of competition, unit pricing
trends, the demand for its software in the education, consumer and professional
markets and the performance of the Company's strategic partners in the areas of
marketing, sales and distribution of the Company's products will be significant
factors. In this regard, the Company considers its future revenues to be
unpredictable.

    Cost of revenues decreased 8.0% to $1,178,000 in fiscal 1998 compared to
$1,280,000 in fiscal 1997. Cost of revenues, which includes the cost of support,
packaging, documentation, royalties and amortization of capitalized software
development costs decreased primarily due to the significant reduction of
consumer product units shipped as a result of the Mindscape distribution
agreement reached in March 1997, partially offset by significant increases in
royalty expenses related to increased sales of A.D.A.M. Benjamin/Cummings
Interactive Physiology series products, increased capitalized software
amortization and decreased software support costs. As a percent of total net
revenues, cost of revenues decreased to 17.1% in fiscal 1998 compared to 27.9%
in fiscal 1997 due to changes in product mix, specifically, the decreased unit
sales of lower priced, lower margin consumer products, increased sales of the
higher margin, higher priced flagship education product and the impact on net
revenues from the recognition of income for certain education product sales that
was deferred in fiscal 1997.

    Sales and marketing expenses decreased 38.2% to $2,778,000 in fiscal 1998
from $4,494,000 in fiscal 1997, primarily as a result of decreased marketing
activities related to the sale and distribution of the company's consumer market
products as a result of the March 1997 Mindscape distribution agreement. Sales
and marketing costs attributable to sale and distribution of consumer products
in fiscal 1997 totaled $1,693,000 and was insignificant for fiscal 1998,
accounting for nearly the entire reduction in overall sales and marketing costs
for fiscal 1998. As a percentage of total net revenues, sales and marketing
expenses decreased to 40.3% in fiscal 1998 from 97.9% in fiscal 1997.

    Product development costs decreased 33.1% to $1,512,000 in fiscal 1998 from
$2,260,000 in fiscal 1997 due primarily to decreases in salary and consulting
costs incurred in fiscal 1997 associated with the development of language
lexicons for the Company's international products and maintenance of the
consumer product line in fiscal 1997. In addition, the amount of development
costs capitalized for fiscal

                                       19
<PAGE>   20
1998 increased by $41,000 compared to fiscal 1997, primarily resulting from
earlier achievement of "working models" in the development process of products
developed during fiscal 1998. As a percentage of total net revenues, product
development expenses decreased to 22.0% in fiscal 1998 from 49.2% in fiscal
1997. Total expenditures for product development, including capitalized
expenses, decreased to $2,054,000 in fiscal 1998 compared to $2,761,000 in
fiscal 1997. The Company capitalized product development expenses of $542,000
and $501,000 in fiscal 1998 and fiscal 1997, respectively, which represented
26.4% and 18.1% of total expenditure for product development in these respective
periods. Amortization of capitalized product development cost totaled $340,000
and $119,000 in fiscal 1998 and 1997, respectively, and is included in cost of
revenues described above.

    General and administrative expenses decreased 45.4% to $1,293,000 in fiscal
1998 from $2,369,000 in fiscal 1997. As a percentage of total net revenues,
general and administrative expenses decreased to 18.8% in fiscal 1998 compared
to 51.6% in fiscal 1997. The decrease was mainly due to decreased legal, rent,
bad debt, investor relations, and salary expenses. Rent and salary decreases in
fiscal 1998 are the result of the Company's restructuring in the second quarter
of fiscal 1997.

    Interest income decreased 39.1% to $529,000 in fiscal 1998 from $869,000 in
fiscal 1997 due to reduced average cash and short term securities balances
during fiscal 1998. The lower balances during fiscal 1998 are the result of the
Company's net loss during fiscal 1997.

Fiscal 1997 Compared to Fiscal 1996

    Total net revenues decreased 28.8% to $4,591,000 in fiscal 1997 compared to
$6,447,000 in fiscal 1996 as a result of decreased sales of the Company's
products to both the consumer and academic markets. Total unit shipments of the
Company's products increased to approximately 189,000 units in fiscal 1997 from
approximately 129,000 units in fiscal 1996. The decreased net revenues and
increased unit shipments reflect lower revenues per unit shipped, which are the
result of lower pricing of the Company's aging consumer products, price
decreases for academic products implemented in April 1996, increased unit sales
of lower priced academic products such as A.D.A.M., The Inside Story - School
Edition and A.D.A.M. Practice Practical, heavy discounting of the high end
A.D.A.M. Comprehensive product in anticipation of release of A.D.A.M.
Interactive Anatomy and significantly increased volume sales of the newest
flagship consumer title, A.D.A.M. The Inside Story - 1997 Edition (ATIS '97).

    Net revenues from the academic market decreased 31.6% to $2,523,000 in
fiscal 1997 from $3,688,000 in fiscal 1996 due primarily to lower sales of the
flagship academic product, A.D.A.M. Comprehensive, in anticipation by the market
of an upgraded flagship product, as well as price reductions implemented at the
beginning of fiscal 1997 which were not offset by the increased volume of units
shipped. Also, the Company deferred approximately $389,000 of revenue during the
second and third quarters of fiscal 1997 related to upgrade rights granted to
purchasers of certain products. The upgraded versions were not released until
after the close of fiscal 1997. As a percent of total net revenues, net revenues
from the academic market decreased to 54.9% in fiscal 1997 compared to 57.2% in
fiscal 1996.

    Net revenues from the consumer market decreased 21.9% to $1,978,000 in
fiscal 1997 from $2,533,000 in fiscal 1996 due primarily to lower selling prices
of aging consumer titles not offset by the increased unit volumes shipped of the
newly released ATIS '97. Lower selling prices per unit of titles in the aging
consumer product line, such as Nine Month Miracle and Life's Greatest Mysteries,
did not result in significant increases in unit shipments of those titles, and
adversely affected overall revenues per unit in the consumer market. As a
percent of total net revenues, net revenues from the consumer market increased
to 43.1% in fiscal 1997 compared to 39.3% in fiscal 1996.

                                       20
<PAGE>   21

    Cost of revenues decreased 14.2% to $1,280,000 in fiscal 1997 compared to
$1,491,000 in fiscal 1996. Cost of revenues, which includes the cost of support,
packaging, documentation, royalties, and amortization of capitalized software
development costs, decreased primarily from decreases in amortization of
capitalized software development costs, as well as operating efficiencies and
new cost controls which offset the cost for significantly increased units
shipped for fiscal 1997. As a percent of total net revenues, cost of revenues
increased to 27.9% in fiscal 1997 compared to 23.1% in fiscal 1996 due to
changes in the product mix sold, specifically, the increased unit sales of lower
priced, lower margin consumer and academic products, and the impact on net
revenues from the deferral of income for certain academic product sales.

    Sales and marketing expenses increased 9.9% to $4,494,000 in fiscal 1997
from $4,090,000 in fiscal 1996, primarily as a result of increased marketing
activities such as the ADAM Across America Tour and Mothers Day promotions in
support of A.D.A.M. The Inside Story - 1997 Edition and Nine-Month Miracle
consumer products, respectively. Also, increased marketing activities relating
to the launch (in the first quarter of fiscal 1998) of A.D.A.M. Interactive
Anatomy and development of the professional market did not result in
significant revenue for fiscal 1997. As a percentage of total net revenues,
sales and marketing expenses increased to 97.9% in fiscal 1997 from 63.4% in
fiscal 1996.

    Product development costs decreased 20.6% to $2,260,000 in fiscal 1997 from
$2,847,000 in fiscal 1996 due primarily to decreases in consulting costs related
to product development activity and a $408,000 increase in the amount of
development costs capitalized for fiscal 1997 compared to fiscal 1996. The
increase in capitalized development costs was primarily related to the
significant resources allocated to A.D.A.M. Interactive Anatomy. This product
was released in the first quarter of fiscal 1998. As a percentage of total net
revenues, product development expenses increased to 49.2% in fiscal 1997 from
44.2% in fiscal 1996. Total expenditures for product development, including
capitalized expenses, decreased to $2,761,000 in fiscal 1997 compared to
$2,940,000 in fiscal 1996. The Company capitalized product development expenses
of $501,000 and $93,000 in fiscal 1997 and fiscal 1996, respectively, which
represented 18.1% and 3.2% of total expenditure for product development in these
respective periods. Amortization of capitalized product development cost totaled
$119,000 and $356,000 in fiscal 1997 and 1996, respectively, and was charged to
and included in cost of revenues described above.

    General and administrative expenses increased 18.0% to $2,369,000 in fiscal
1997 from $2,008,000 in fiscal 1996. As a percentage of total net revenues,
general and administrative expenses increased to 51.6% in fiscal 1997 from 31.1%
in fiscal 1996. The increase was mostly due to legal fees of approximately
$212,000 relating to the shareholder class action lawsuit. The Company does not
expect these legal costs to continue in fiscal 1998.  The decrease in premises
rental cost as a result of the restructuring was realized beginning April 1,
1997.

    During the second quarter of fiscal 1997, the Company implemented the
Plan, designed to enhance overall competitiveness, productivity and efficiency
through the reduction of overhead costs. The Plan resulted in a pre-tax charge
of approximately $490,000. The charge principally reflects severance costs
resulting from workforce reductions of 29 employees and realignments throughout
the Company, employee termination costs and costs associated with non-cancelable
leases net of estimated sublease rental income. Total payments of approximately
$301,000, primarily related to severance agreements were made subsequent to the
implementation of the Plan. Accrued restructuring at March 31, 1997 was
approximately $189,000.

    Interest expense decreased 97.5% to $8,000 in fiscal 1997 from $317,000 in
fiscal 1996 primarily due to the repayment of outstanding indebtedness,
consisting of principal and accrued interest outstanding under the subordinated
bridge notes issued to certain investors in fiscal 1995, the Company's term loan
with a bank and third party advances.

    Interest income increased 109.4% to $869,000 in fiscal 1997 from $415,000
in fiscal 1996 due to interest on the net proceeds from the Company's initial
public offering completed in November 1995.

    The increase in capitalized software development costs in fiscal 1997 was
due mainly to development costs related to ADAM Interactive Anatomy. During
fiscal 1996 and the year ended March 31, 1995 ("fiscal 1995"), the majority of
the
                                        
                                        
                                       21

<PAGE>   22

Company's development efforts were focused on consumer products, which generally
reach TF much later in the development cycle due to their newly designed
functionalities and uncertain content. Accordingly, development cost
capitalization periods for the newly created consumer products was shorter than
for AIA, which, as an academic product, drew upon a more established content and
core technology base.

    The Company deferred the recognition of approximately $389,000 of revenue
during the second and third quarters of fiscal 1997 due to free upgrade rights
granted with the sale of certain academic products. Accordingly, the Company
deferred liability at March 31, 1997 that it recognized as income during the
first and second quarters of fiscal 1998.

LIQUIDITY AND CAPITAL RESOURCES

    At March 31, 1998 the Company had cash and cash equivalents of $704,000,
short-term investments of $7,664,000, and working capital of $9,011,000. Cash
used in operating activities was $344,000 in fiscal 1998, $4,858,000 in fiscal
1997 and $2,601,000 in fiscal 1996, principally as a result of net losses for
fiscal 1997 and fiscal 1996.

    The Company uses its working capital to finance ongoing operations and to
fund expansion and development of its product lines. In addition, the Company
evaluates from time to time other acquisitions of products or companies that
compliment the Company's business. At this time, the Company is not committed to
incur any significant capital expenditure in fiscal 1999.

    In April 1997, the Board of Directors adopted a stock repurchase program.
The program authorized the repurchase of the Company's Common Stock from time to
time prior to December 31, 1997 in open market transactions on the Nasdaq Stock
market at an aggregate purchase price of up to $1 million. In February 1998, the
Board approved continuation of the stock repurchase program up to the purchase
of 25% of the Company's outstanding shares. Any repurchase of the Company's
Common Stock will be made based upon market conditions and other factors. The
Company will use cash on hand to fund the repurchase program, and the
repurchased stock will be held as treasury stock. Pursuant to the program, the
Company repurchased 635,550 shares of Common Stock on the open market for an
average price of approximately $2.39 per common share and an aggregate purchase
price of approximately $1,519,000 through June 30, 1997. Repurchased shares
represented approximately 12.0% of the shares of Common Stock outstanding.

    The Company expects that cash flow from operations and existing cash and
short-term investments will be adequate to meet the Company's cash requirements
for at least the next two years.

YEAR 2000 COMPLIANCE

     The Company believes that all of its internal management information
systems are currently Year 2000 compliant and, accordingly, does not anticipate
any significant expenditures to remediate or replace existing internal-use
systems. Although most of the Company's products are Year 2000 compliant, two
products acquired by the Company from Mosby are not Year 2000 compliant. The
Company is currently developing and testing solutions for its non-compliant
products and currently estimates that all of these products will be Year 2000
compliant by mid-1999 at an estimated aggregate cost of approximately $25,000,
including both remediation and testing costs.  However, any unexpected
difficulties in achieving Year 2000 compliance for the A.D.A.M. products could
have a material adverse effect on the Company's business, financial condition
and results of operations.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         This information is set forth under Item 14(a)(1) and (2).


ITEM. 9  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
         FINANCIAL DISCLOSURES

         Not applicable

                                       22
<PAGE>   23


PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

    The sections under the headings "Election of Directors" entitled "Nominees
for Election - Term Expiring in 2001", "Directors Continuing in Office until
1999" and "Directors Continuing in Office until 2000" of the Proxy Statement for
the Annual Meeting of shareholders to be held September 24, 1998 (the "Proxy
Statement") are incorporated hereby by reference for information on Directors of
the Registrant. See Item X in Part I hereof for information regarding executive
officers of the Registrant. The section under the heading "Other Matters"
entitled "Section 16(a) Beneficial Ownership Reporting Compliance" of the Proxy
Statement is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

    The section under the heading "Election of Directors" entitled "Compensation
of Directors" of the Proxy Statement and the sections under the heading
"Executive Compensation" entitled "Summary Compensation Table", "Option Grants
in Last Fiscal Year", "Aggregated Option Exercises in Last Fiscal Year and
Fiscal Year-End Option Values", "Employment Agreements", "Compensation Committee
Interlocks and Insider Participation" and "Section 16(a) Beneficial Ownership
Reporting Compliance" of the Proxy Statement are incorporated herein by
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

    The section under the heading "Common Stock Ownership by Management and
Principal Shareholders" of the Proxy Statement is incorporated herein by
reference.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

    The section under the heading "Certain Transactions" of the Proxy Statement
is incorporated herein by reference.

                                       23
<PAGE>   24


PART IV


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

  (a) The following documents are included as part of this report:

<TABLE>
<CAPTION>

                                                                                 Page
                                                                                 ----
       <S>                                                                       <C>    
       (1)  Financial Statements:
       Report of Independent Accountants                                          F-1
       Balance Sheet at March 31, 1998 and 1997                                   F-2
       Statement of Operations for the three years ended March 31, 1998           F-3
       Statement of Changes in Shareholders' Equity for the
            three years ended March 31, 1998                                      F-4
       Statement of Cash Flows for the three years ended March 31, 1998           F-5
       Notes to Financial Statements                                              F-6


       (2)  Financial Statement Schedule:
            For the three years ended March 31, 1998
                II - Valuation and Qualifying Accounts
</TABLE>

        All other schedules have been omitted because they are not applicable or
are not required or the information required to be set forth therein is included
in the Financial Statements or Notes thereto.

<TABLE>
<CAPTION>

  EXHIBIT
  NO.          DESCRIPTION
  ---          -----------
   <S>     <C> 
    *3.1   Amended and Restated Articles of Incorporation of the Company.
    *3.2   Amended and Restated By-Laws of the Company.
     4.1   Amended and Restated Articles of Incorporation of the Company
           (incorporated by reference to Exhibit 3.1).
     4.2   Amended and Restated By-Laws of the Company (incorporated by 
           reference to Exhibit 3.2).
    *4.3   Specimen Common Stock Certificate
    *4.4   Form of Option Certificate relating to the Company's 1992 Stock
           Option Plan 
    *4.5   Form of Warrants to Purchase shares of Common Stock, dated April 
           through  November 1994
    *4.6   Warrant issued to The Robinson-Humphrey Company on May 23, 1995
   *10.1   Amended and Restated 1992 Stock Option Plan
   *10.2   401(k) Adoption Agreement and Trust.
   *10.3   Employment Agreement between the Company and Robert S. Cramer, Jr.,
           dated December 21, 1994.
   *10.4   Employment Agreement between the Company and Gregory M. Swayne, dated
           December 19, 1994.
   *10.5   Publishing Agreement by and between Williams & Wilkins and the
           Company, dated February 22, 1994
  *+10.6   Software Distribution Agreement between Broderbund Software, Inc. and
           the Company, dated as of June 1, 1994, as amended by Amendment No. 1,
           dated as of November 1, 1994.
  *+10.7   Software Reseller Agreement among the Company, Addison Wesley 
           Longman, through its Addison Wesley/Benjamin Cummings Group Sales 
           Force Division, Benjamin/Cummings, and Addison Wesley Publishers 
           Ltd., dated as of August 4, 1994.
  *+10.8   Software Reseller Agreement among the Company and Addison Wesley
           Longman, through its Addison Wesley School Division, dated as of
           February 9, 1995.
  *+10.9   Software Reseller Agreement between Churchill Livingstone, Inc. and
           the Company, dated as of May 8, 1995.
 ***10.10  Amendment to Software  Reseller  Agreement between  Churchill  
           Livingstone,  Inc. and the Company, dated as of December 23, 1996
   *10.11  Localization Agreement between Sunflowers Interactive Entertainment,
           a wholly-owned subsidiary 
</TABLE>

                                       24
<PAGE>   25

<TABLE>
<S>        <C>
           of BOMICO, and the Company, dated June 28, 1995.
  *10.12   Software Reseller Agreement between BOMICO UNTERHALTUNGSSOFT-
           UND-HARDWARE VERTRIEBS GMBH and the Company, dated June 28, 1995.
  *10.13   Distribution Agreement with Ingram Micro, dated August 10, 1995
 **10.14   Addendum dated January 19, 1996 to Distribution Agreement with Ingram
           Micro, dated August 10, 1995.
  *10.15   Vendor Agreement between ABCO Distributors, Inc. and the Company,
           dated August 10, 1994.
 **10.16   Publishing/Developer  Agreement by and between J.S.K., Inc. and the
           Company,  dated as of November 30, 1995.
 **10.17   Localization Agreement between ZEMI Corp. and the Company dated
           June 7, 1996.
***10.18   Letter Agreement with Mindscape, Inc., dated February 26, 1997, 
           setting forth distribution terms.
   10.19   Licensing and Distribution Agreement between Mindscape, Inc. and the
           Company dated June 13, 1997.
   10.20   Asset Purchase and Sale agreement between Mosby, Inc. and the Company
           dated October 16, 1998. 
   10.21   Copyright  License Agreement between Kainos Laboratories, Inc. and 
           the Company, dated December 29, 1997
   10.22   License Agreement between CNN Newssource, Inc. and the Company dated
           January 15, 1998.
   10.23   Sublease Agreement between UltimateCom of Atlanta, L.L.C. and the 
           Company, dated January 15, 1998
    23.1   Consent of Price Waterhouse LLP
    27.1   Restated Financial Data Schedule - March 31, 1998 (for SEC use only)
    27.2   Restated Financial Data Schedule - December 31, 1997
    27.3   Restated Financial Data Schedule - September 30, 1997
    27.4   Restated Financial Data Schedule - June 30, 1997
    27.5   Restated Financial Data Schedule - March 31, 1997
    27.6   Restated Financial Data Schedule - March 31, 1997
</TABLE>

---------------
*     Incorporated by reference to the Company's Registration Statement on 
      Form S-1, File No. 33-96864, dated September 12, 1995, as amended).
**    Incorporated by reference to the Company's Annual Report on Form 10-K for
      the fiscal year ended March 31, 1996.
***   Incorporated by reference to the Company's Annual Report on Form 10-K for
      the fiscal year ended March 31, 1997.
+     The Company has been granted confidential treatment of portions of this
      Exhibit. Accordingly, portions thereof have been omitted and filed
      separately.


(B) REPORTS ON FORM 8-K

    No reports on Form 8-K have been filed with the Securities and Exchange
Commission during the fourth quarter of fiscal 1998.


                                       25
<PAGE>   26
SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.


                            A.D.A.M. SOFTWARE, INC.

                           (Registrant)



                            By: /s/ Robert S. Cramer, Jr. 
                               --------------------------------------------
                               Robert S. Cramer, Jr.
                               Chairman of the Board, Co-Founder, Chief
                               Executive Officer, and Director
                               Date:  June 26, 1998


         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated, on June 26, 1998.

<TABLE>
<CAPTION>

                  Signature                                 Title                      
                  ---------                                 -----                      
                                                                                       
<S>                                          <C> 
/s/ Robert S. Cramer, Jr.                    Chairman of the Board, Co-Founder, Chief  
-----------------------------------          Executive Officer, and Director (Principal
Robert S. Cramer, Jr.                        Executive Officer)                        
                                                                                       
                                                                                       
                                                                                       
/s/ Gregory M. Swayne                        Vice-Chairman, Co-Founder and Director    
-----------------------------------                                                    
Gregory M. Swayne                                                                      
                                                                                       
                                                                                       
                                                                                       
/s/ Michael S. Fisher                        Director of Finance/Administration        
-----------------------------------          (Principal Financial Officer)             
Michael S. Fisher                                                                      
                                                                                       
                                                                                       
                                                                                       
/s/ Sally D. Elliott                         Director                                  
-----------------------------------                                                    
Sally D. Elliott                                                                       
                                                                                       
                                                                                       
                                                                                       
                                             Director                                  
-----------------------------------                                                    
Dr. Anthony J. Gatti                                                                   
                                                                                       
                                                                                       
                                                                                       
/s/ Daniel S. Howe                           Director                                  
-----------------------------------                                                    
Daniel S. Howe                                                                         
                                                                                       
                                                                                       
                                                                                       
                                             Director                                  
-----------------------------------                                                    
Hamilton Jordan                                                                        
                                                                                       
                                                                                       
                                                                                       
                                             Director                                  
-----------------------------------                                                    
David O'Connor                                                                         



                                                         
/s/ John W. McClaugherty                     Director    
-----------------------------------                      
John W. McClaugherty                                     
                                                         
                                                         
                                                         
                                             Director    
-----------------------------------                      
Francis J. Tedesco, M.D.                                 
                                            
</TABLE>


                                       7
<PAGE>   27


                        REPORT OF INDEPENDENT ACCOUNTANTS



To the Board of Directors and Shareholders of
A.D.A.M Software, Inc.

In our opinion, the financial statements listed in the index appearing under
Item 14(a)(1) and (2) on page 24 present fairly, in all material respects, the
financial position of A.D.A.M. Software, Inc., at March 31, 1998 and 1997, and
the results of its operations and its cash flows for each of the three years in
the period ended March 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.


                                        PRICE WATERHOUSE LLP


Atlanta, Georgia
May 22, 1998

                                      F-1

<PAGE>   28
A.D.A.M. SOFTWARE, INC.
Balance Sheets
(In thousands, except share data)
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                           MARCH 31,
                                                                    -----------------------
                                                                      1998           1997
                                                                      ----           ----
<S>                                                                 <C>            <C>     
ASSETS
Current assets
   Cash and cash equivalents                                        $    704       $  2,422
   Short-term investments                                              7,664          8,546
   Accounts receivable, net of allowances of $162
      and $459                                                         1,239            638
   Inventories                                                           467            375
   Prepaids and other                                                    124            108
                                                                    --------       --------
          Total current assets                                        10,198         12,089

Property and equipment, net                                              496            729
Software development costs, net                                          689            487
Restricted certificates of deposit                                       517            357
                                                                    --------       --------

          Total assets                                              $ 11,900       $ 13,662
                                                                    ========       ========

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
   Accounts payable                                                 $    318       $    434
   Accrued liabilities                                                   375            562
   Accrued compensation and employee benefits                            247            259
   Accrued restructuring costs                                            --            189
   Deferred rent                                                         209            173
   Deferred revenue                                                       38            490
                                                                    --------       --------
          Total current liabilities                                    1,187          2,107
                                                                    --------       --------

Commitments and contingencies

Shareholders' equity
   Preferred stock, no par value; 9,062,500 shares authorized;
      no shares issued and outstanding                                    --             --
   Common stock, $0.01 par value; 20,000,000 shares
      authorized; 5,274,647 shares issued and outstanding                 52             52
   Common stock warrants                                                 135            135
   Additional paid-in capital                                         33,883         33,883
   Treasury stock at cost, 602,550 shares                             (1,420)            --
   Accumulated deficit                                               (21,937)       (22,515)
                                                                    --------       --------
                                                                      10,713         11,555
                                                                    --------       --------

          Total liabilities and shareholders' equity                $ 11,900       $ 13,662
                                                                    ========       ========
</TABLE>


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

                                      F-2
<PAGE>   29
A.D.A.M. SOFTWARE, INC.
Statement of Operations
(In thousands, except share data)
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                              YEAR ENDED MARCH 31,
                                                     --------------------------------------
                                                       1998           1997           1996
                                                       ----           ----           ----
<S>                                                  <C>            <C>            <C>     
Net revenues                                         $  6,888       $  4,591       $  6,447

Cost and expenses
   Cost of revenues                                     1,178          1,280          1,491
   Sales and marketing                                  2,778          4,494          4,090
   Product development                                  1,512          2,260          2,847
   General and administrative                           1,293          2,369          2,008
   Restructuring charge                                    --            490             --
                                                     --------       --------       --------
                                                        6,761         10,893         10,436
                                                     --------       --------       --------

        Operating income (loss)                           127         (6,302)        (3,989)

Interest expense                                           (3)            (8)          (317)
Interest income                                           529            869            415
                                                     --------       --------       --------
        Income (loss) before income taxes and
          extraordinary item                              653         (5,441)        (3,891)

Income taxes                                              (75)            --             --
                                                     --------       --------       --------
        Income (loss) before extraordinary item           578         (5,441)        (3,891)

   Extraordinary loss on extinguishment of debt
      (net of income tax benefit of $29)                   --             --            (46)
                                                     --------       --------       --------

        Net income (loss)                            $    578       $ (5,441)      $ (3,937)
                                                     ========       ========       ========

Basic net income (loss) per share
      Income (loss) before extraordinary item        $   0.12       $  (1.03)      $  (1.13)
      Extraordinary item                                   --             --           (.01)
                                                     --------       --------       --------

      Basic net income (loss) per share              $   0.12       $  (1.03)      $  (1.14)
                                                     ========       ========       ========

        Weighted average shares outstanding             4,916          5,258          3,673
                                                     ========       ========       ========

Diluted net income (loss) per share
      Income (loss) before extraordinary item        $   0.12       $  (1.03)      $  (1.13)
      Extraordinary item                                   --             --           (.01)
                                                     --------       --------       --------

      Diluted net income (loss) per share            $   0.12       $  (1.03)      $  (1.14)
                                                     ========       ========       ========

        Weighted average shares outstanding             4,959          5,258          3,673
                                                     ========       ========       ========
</TABLE>


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


                                      F-3
<PAGE>   30
A.D.A.M. SOFTWARE, INC.
Statement of Changes in Shareholders's Equity
(In thousands, except share data)
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                               COMMON STOCK         ADDITIONAL    COMMON
                                          -----------------------     PAID-IN      STOCK      ACCUMULATED    TREASURY
                                            SHARES       AMOUNT       CAPITAL     WARRANTS      DEFICIT        STOCK        TOTAL
                                          ----------   ----------   ----------   ----------   -----------   ----------   ----------
<S>                                       <C>          <C>          <C>          <C>          <C>           <C>          <C>        
BALANCE AT MARCH 31, 1995                  2,696,887   $       27   $   10,168   $       --   $  (12,138)   $       --   $   (1,943)
Issuance of common stock                   1,558,600           15       16,489           --           --            --       16,504
Retirement of common shares                 (125,000)          (1)                                  (999)           --       (1,000)
Accretion of discount on mandatorily
  redeemable convertible preferred stock          --           --         (244)          --           --            --         (244)
Conversion of mandatorily redeemable
  convertible preferred stock                762,500            8        6,186           --           --            --        6,194
Exercise of common stock options             341,660            3        1,184           --           --            --        1,187
Issuance of common stock warrants                 --           --           --          135           --            --          135
Net loss                                          --           --           --           --       (3,937)           --       (3,937)
                                          ----------   ----------   ----------   ----------   ----------    ----------   ----------

BALANCE AT MARCH 31, 1996                  5,234,647           52       33,783          135      (17,074)           --       16,896
Exercise of common stock options              40,000           --          100           --           --            --          100
Net loss                                          --           --           --           --       (5,441)           --       (5,441)
                                          ----------   ----------   ----------   ----------   ----------    ----------   ----------

BALANCE AT MARCH 31, 1997                  5,274,647           52       33,883          135      (22,515)           --       11,555

Repurchase of stock                               --           --           --           --           --        (1,420)      (1,420)
Net income                                        --           --           --           --          578            --          578
                                          ----------   ----------   ----------   ----------   ----------    ----------   ----------

BALANCE AT MARCH 31, 1998                  5,274,647   $       52   $   33,883   $      135   $  (21,937)   $   (1,420)  $   10,713
                                          ==========   ==========   ==========   ==========   ==========    ==========   ==========
</TABLE>

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



                                      F-4
<PAGE>   31
A.D.A.M. SOFTWARE, INC.
Statement of Cash Flows
(In thousands)
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                            YEAR ENDED MARCH 31,
                                                                  ----------------------------------------
                                                                     1998            1997          1996
                                                                     ----            ----          ----
<S>                                                                <C>            <C>            <C>      
Cash flows from operating activities
   Net income (loss)                                               $    578       $ (5,441)      $ (3,937)
   Adjustments to reconcile net income (loss) to
      net cash used in operating activities
        Depreciation and amortization                                   707            576            796
        Accretion                                                        --             --           (118)
        Loss on extinguishment of debt                                                                 75
        Changes in assets and liabilities
          Accounts receivable                                          (601)          (190)           576
          Inventories                                                   (92)            58           (263)
          Prepaids and other assets                                     (16)             7           (115)
          Accounts payable                                             (116)           (92)           129
          Accrued liabilities                                          (187)           (52)           168
          Accrued interest                                               --           (158)           (13)
          Accrued compensation and employee benefits                    (12)            77             52
          Accrued restructuring costs                                  (189)           189             --
          Deferred rent                                                  36            (72)            49
          Deferred revenue                                             (452)           490             --
          Third party advances                                           --           (250)            --
                                                                   --------       --------       --------
             Net cash used in operating activities                     (344)        (4,858)        (2,601)
                                                                   --------       --------       --------

Cash flows from investing activities
   Purchases of short-term investments                              (32,116)       (29,363)       (20,803)
   Proceeds from sale of short-term investments                      32,998         31,798         10,000
   Purchases of property and equipment                                 (134)          (297)          (315)
   Redemption of restricted certificate of deposit                       --            191            183
   Software development costs                                          (542)          (501)           (93)
                                                                   --------       --------       --------
             Net cash provided (used) in investing activities           206          1,828        (11,028)
                                                                   --------       --------       --------

Cash flows from financing activities
   Proceeds from issuance of common stock, net of
      issuance costs, and exercise of options                            --            100         17,691
   Repurchase of common stock                                            --             --         (1,000)
   Proceeds from issuance of mandatorily redeemable
      preferred stock, net of issuance costs                             --             --          3,928
   Purchase of treasury shares                                       (1,420)            --             --
   Restricted certificate of deposit                                   (160)            --             --
   Repayments of notes payable                                           --             --         (2,578)
                                                                   --------       --------       --------
             Net cash provided by financing activities               (1,580)           100         18,041
                                                                   --------       --------       --------

(Decrease) increase in cash and cash equivalents                     (1,718)        (2,930)         4,412
Cash and cash equivalents, beginning of period                        2,422          5,352            940
                                                                   --------       --------       --------

Cash and cash equivalents, end of period                           $    704       $  2,422       $  5,352
                                                                   ========       ========       ========
</TABLE>

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


                                      F-5
<PAGE>   32
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

1.     DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         A.D.A.M. Software, Inc. (A.D.A.M. or the Company) creates, publishes
         and markets educational multimedia software products that provide
         anatomical, medical, scientific and health-related information for the
         academic, professional, and consumer markets. The Company sells its
         products into the academic and consumer markets through alliances with
         distributors and original equipment manufacturers (OEMs) and by direct
         sales and marketing activities. A.D.A.M.(R) products incorporate
         internally developed, original medical illustrations with text, audio,
         photography, animation and video in easy-to-use, interactive software
         applications.

         USE OF ESTIMATES

         The preparation of financial statements in conformity with generally
         accepted accounting principles requires management to make estimates
         and assumptions that affect the reported amounts of assets and
         liabilities and disclosure of contingent assets and liabilities at the
         date of the financial statements and the reported amounts of net
         revenues and expenses during the reporting period. Actual results could
         differ from those estimates.

         REVENUE RECOGNITION

         Revenues are primarily derived from the sale of software products and
         from royalty agreements. Revenue from product sales is generally
         recognized at the time of shipment to customers, distributors or
         resellers or, in the case of consignment arrangements, at the time of
         shipment from the consignee to its customers. Revenues from royalty
         agreements are recognized as earned based upon performance or product
         shipment. Allowances for estimated returns are provided at the time of
         sale. The Company evaluates the adequacy of allowances for returns and
         doubtful accounts primarily based upon its evaluation of historical and
         expected sales experience and by channel of distribution. The estimates
         determined for reserves for returns and allowances are based upon
         information available at the reporting date. To the extent the future
         market, sell through experience, channels of distribution and general
         economic conditions change, the estimated reserves required for returns
         and allowances may also change. Payments received in advance of
         shipments are recorded as deferred revenue in the accompanying balance
         sheet and are recognized as revenue when the related software is
         shipped.

         CONCENTRATION OF CREDIT RISK

         Financial instruments that potentially subject the Company to
         concentration of credit risk consist primarily of marketable securities
         and trade receivables. The Company restricts investment of marketable
         securities to short-term investment grade securities and direct or
         guaranteed obligations of the United States government.

         At March 31, 1998, the Company had a receivable due from one customer
         of $300,000. In addition, total sales to that customer were
         approximately 10.9% of net revenues during fiscal 1998.

         At March 31, 1997, the Company had receivables from each of two major
         distributors of approximately $269,000 and $137,000, respectively.
         Total sales to these distributors were approximately 16% and 3%,
         respectively, of net revenues during fiscal 1997.

                                      F-6

<PAGE>   33
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS

-------------------------------------------------------------------------------

         FAIR VALUE OF FINANCIAL INSTRUMENTS

         The carrying amounts of the Company's financial instruments, including
         cash and cash equivalents, accounts receivable, accounts payable,
         accrued compensation and other accrued liabilities, approximate fair
         value due to their short maturities.

         INVENTORIES

         Inventories consist principally of computer software media and related
         shipping materials and are stated at the lower of cost or market. Cost
         is determined using the first-in, first-out method.

         PROPERTY AND EQUIPMENT

         Property and equipment are recorded at cost, less accumulated
         depreciation and amortization. Depreciation and amortization are
         provided using the straight-line method for financial reporting
         purposes and accelerated methods for income tax purposes over the
         estimated useful lives of three to five years.

         SOFTWARE DEVELOPMENT COSTS

         Capitalized software development costs consist principally of salaries
         and certain other expenses directly related to development and
         modifications of software products capitalized in accordance with the
         provisions of Statement of Financial Accounting Standards (SFAS) No.
         86, "Accounting for the Costs of Computer Software to be Sold, Leased,
         or Otherwise Marketed". Capitalization of such costs begins when a
         working model has been produced as evidenced by completion of design,
         planning, coding and testing such that the product meets its design
         specifications and has thereby established technological feasibility as
         defined in SFAS No. 86. Capitalization of such costs ends when the
         resulting product is available for general release to the public.
         Amortization of capitalized software development costs is provided at
         the greater of the ratio of current product revenue to the total of
         current and anticipated product revenue or on a straight-line basis
         over the estimated economic life of the software, which the Company has
         determined to be in the range of eighteen to twenty-four months. It is
         reasonably possible that those estimates of anticipated product
         revenues, the remaining estimated economic life of the product, or both
         will be reduced significantly in the near term due to changing
         technologies. As a result, the carrying amount of capitalized software
         costs may be reduced materially in the near term.

         RESTRICTED CERTIFICATES OF DEPOSIT

         In connection with the Company's noncancelable operating leases for its
         office space and telephone system, the Company is required to purchase
         certificates of deposit with a bank securing letters of credit
         guaranteeing payments under the leases (see Note 13). The certificates
         of deposit mature subsequent to March 31, 1999, bear interest at an
         average rate of approximately 5.50% and are carried at cost which
         approximates market.

         INCOME TAXES

         The Company accounts for income taxes utilizing the liability method
         and deferred income taxes are determined based on the estimated future
         tax effects of differences between the financial reporting and income
         tax basis of assets and liabilities given the provisions of the enacted
         tax laws. A valuation allowance is provided against deferred tax assets
         for which it is more likely than not that the asset will not be
         realized.

                                      F-7

<PAGE>   34
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

         STOCK-BASED COMPENSATION

         The Company has chosen to continue to account for stock-based
         compensation using the intrinsic value method prescribed in Accounting
         Principles Board Opinion No. 25, "Accounting for Stock Issued to
         Employees," and related Interpretations and to elect the disclosure
         option of SFAS No. 123, "Accounting for Stock-Based Compensation".
         Accordingly, compensation cost for stock options issued to employees is
         measured as the excess, if any, of the quoted market price of the
         Company's stock at the date of the grant over the amount an employee
         must pay to acquire the stock.

         EARNINGS PER SHARE

         In fiscal 1998, the Company adopted SFAS No. 128, "Earnings Per Share".
         The computation of basic earnings per share is based on the weighted
         average number of common shares outstanding during the period. The
         computation of diluted earnings per share is based on the weighted
         average number of common shares outstanding plus, when their effect is
         dilutive, potential common stock consisting of shares subject to stock
         options, stock warrants and convertible notes. As of March 31, 1998
         potential common stock shares of 43,620 have been included in computing
         diluted earnings per share.

         The basic and diluted loss per share for fiscal 1996 gives effect to
         the accretion of a discount on previously outstanding mandatorily
         redeemable preferred stock (Note 8).

2.     MARKETABLE SECURITIES

         On March 31, 1998 and 1997, the Company held investments in marketable
         securities which it classified as held-to-maturity. Held-to-maturity
         securities represent those securities that the Company has both the
         positive intent and ability to hold to maturity and are carried at
         amortized cost. Securities with a maturity date within one year are
         classified as short-term investments and are stated at cost plus
         accrued interest.

                                      F-8

<PAGE>   35
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS

-------------------------------------------------------------------------------

         Held-to-maturity securities at March 31, 1998 included the following
         (in thousands):

<TABLE>
<CAPTION>

                                                                                 GROSS
                                                        AMORTIZED     FAIR     UNREALIZED
                                                          COST        VALUE    GAIN/(LOSS)
                                                        ---------    ------    -----------
         <S>                                            <C>          <C>       <C>
         General Motors Commercial Paper, face
            value of $1,012,000, interest at 5.37%,
            due April 24, 1998                           $1,008      $1,008      $   --

         Merrill Lynch Commercial Paper, face
            value of $3,145,000, interest at 5.37%,
            due May 22, 1998                              3,121       3,121          --

         Merrill Lynch Commercial Paper, face
            value of $300,000, interest at 5.16%,
            due May 22, 1998                                298         298          --

         Toshiba Commercial Paper, face
            value of $1,500,000, interest at 5.50%,
            due June 9, 1998                              1,484       1,484          --

         Atlantis One Commercial Paper, face
            value of $1,774,000, interest at 5.46%,
            due June 18, 1998                             1,753       1,753          --
                                                         ------      ------      ------

                                                         $7,664      $7,664      $   --
                                                         ------      ------      ------
</TABLE>

         There were no realized gains or losses for the years ended March 31,
         1998, 1997 and 1996.

3.       INVENTORIES

         The components of inventory are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                                    MARCH 31,
                                                              -------------------
                                                              1998           1997
                                                              ----           ----
         <S>                                                  <C>            <C>
         Raw materials                                        $256           $158
         Finished goods                                        211            217
                                                              ----           ----
                                                              $467           $375
                                                              ----           ----
</TABLE>

                                      F-9
<PAGE>   36
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

4.       PROPERTY AND EQUIPMENT

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

         Depreciation and amortization of property and equipment totaled
         approximately $367,000, $457,000 and $440,000 for the years ended March
         31, 1998, 1997 and 1996, respectively.

<TABLE>
<CAPTION>
                                                                      MARCH 31,
                                                               ---------------------
                                                                 1998          1997
                                                                 ----          ----
         <S>                                                   <C>           <C>
         Computers                                             $ 1,194       $ 1,260
         Equipment                                                 299           271
         Furniture and fixtures                                    507           528
         Leasehold improvements                                    156           151
                                                               -------       -------
                                                                 2,156         2,210
         Less - Accumulated depreciation and amortization       (1,660)       (1,481)
                                                               -------       -------
                                                               $   496       $   729
                                                               -------       -------
</TABLE>


5.       PRODUCT DEVELOPMENT EXPENDITURES

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


<TABLE>
<CAPTION>
                                                              YEAR ENDED MARCH 31,
                                                      -----------------------------------
                                                        1998          1997          1996
                                                        ----          ----          ----
         <S>                                          <C>           <C>           <C>
         Total development expenditures               $ 2,054       $ 2,761       $ 2,940
         Less: Additions to capitalized software
           development, prior to amortization            (542)         (501)          (93)
                                                      -------       -------       -------

         Product development expense                  $ 1,512       $ 2,260       $ 2,847
                                                      =======       =======       =======
</TABLE>


         The activity in the capitalized software development account is
         summarized as follows (in thousands):


<TABLE>
<CAPTION>
                                                     YEAR ENDED MARCH 31,
                                                -----------------------------
                                                 1998        1997        1996
                                                 ----        ----        ----
         <S>                                    <C>         <C>         <C>
         Balance at beginning of year, net      $ 487       $ 105       $ 368
         Additions                                542         501          93
         Amortization expense                    (340)       (119)       (356)
                                                -----       -----       -----

         Balance at end of year, net            $ 689       $ 487       $ 105
                                                =====       =====       =====
</TABLE>

                                      F-10
<PAGE>   37
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

6.       DEBT

         During fiscal 1996, the Company maintained a line of credit with a
         bank. At March 31, 1996, borrowings of $450,000 were available under
         the line of credit agreement through May 1996 bearing interest at prime
         (8.25% at March 31, 1996) plus 1% with an annual renewal fee of 1% of
         the unused line of credit. The line of credit was collateralized by
         substantially all of the Company's assets. The Company terminated the
         line of credit agreement during the year ended March 31, 1997.

         At March 31, 1996, the Company had unsecured advances of $250,000 plus
         accrued interest payable due to a third party. The advances were paid
         in full during the year ended March 31, 1997.

7.       INCOME TAXES

         
                                      F-11
<PAGE>   38
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

         The provision for income taxes differs from the amount computed by
         applying the applicable U.S. statutory federal income tax rate of 34
         percent to income (loss) before income taxes and extraordinary item as
         a result of the following (in thousands):

<TABLE>
<CAPTION>
                                                                YEAR ENDED MARCH 31,
                                                        -----------------------------------
                                                          1998          1997          1996
                                                          ----          ----          ----
         <S>                                            <C>           <C>           <C>
         Federal tax provision (benefit) on income
           (loss) before income taxes and
           extraordinary item at statutory federal
           income tax rate                              $   222       $(1,850)      $(1,319)

         (Increase) decrease due to:
           Change in valuation allowance                   (205)        2,042         1,430
           State taxes                                       26          (255)         (117)
           Research and development credits                 (37)          (38)          (12)
           Foreign taxes withheld                            75            --            --
           Other                                             (6)          101            18
                                                        -------       -------       -------
                                                        $    75       $    --       $    --
                                                        -------       -------       -------


</TABLE>

         The components of the Company's deferred tax assets and liabilities are
         as follows (in thousands):

<TABLE>
<CAPTION>
                                                                    MARCH 31,
                                                             ---------------------
                                                               1998          1997
                                                               ----          ----
         <S>                                                 <C>           <C>
         Deferred tax assets
           Accrued expenses                                  $   201       $   229
           Deferred revenue                                        1           186
           Allowance for doubtful accounts                        17           174
           Fixed assets                                          104            12
           Research and development credits                      173           150
           Net operating loss carryforwards                    7,262         7,133
                                                             -------       -------
                                                               7,758         7,884
                                                             -------       -------
         Deferred tax liabilities                        
           Software development costs                           (264)         (185)
                                                             -------       -------
                                                                (264)         (185)
                                                             -------       -------
         Net deferred tax asset before                   
           valuation allowance                                 7,494         7,699
                                                         
         Valuation allowance                                  (7,494)       (7,699)
                                                             -------       -------
                                                         
                                                             $    --       $    --
                                                             =======       =======
</TABLE>

         At March 31, 1998, the Company had net operating loss and general
         business credit carryforwards available for tax purposes of
         approximately $19,100,000 and $173,000, respectively, which will expire
         in years 2007 through 2013. Under the Tax Reform Act of 1986, the
         amounts of, and the benefit from, net operating loss carryforwards may
         be impaired or limited in certain circumstances, including ownership
         changes (as defined by the Internal Revenue Service). 

         At March 31, 1998 and 1997, the Company has recorded a valuation
         allowance equal to its net deferred tax assets as management believes
         it is more likely than not that the net deferred tax assets will not be
         realized. Management's estimate of the valuation allowance could be
         effected in the near term based on taxable income generated in future
         periods.

                                      F-12
<PAGE>   39
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

8.       MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK

         Upon consummation of the Company's initial public offering in November
         1995, 762,500 shares of Series A mandatorily redeemable convertible
         preferred stock (Convertible Preferred Stock) were automatically
         converted into an equal number of common stock shares. During the year
         ended March 31, 1996, accretion of the discount on the Convertible
         Preferred Stock of $244,000 was recorded as a charge to additional
         paid-in capital and a credit to the Convertible Preferred Stock
         account.

9.       TREASURY STOCK

         In April 1997, the Company's Board of Directors adopted a stock
         repurchase program. The program authorized repurchase of the Company's
         common stock from time to time In open market transactions on the
         Nasdaq Stock market. During the year, the Company repurchased common
         stock at various times during fiscal 1998 with an aggregate cost for
         all shares purchased of $1.4 million. The Company used cash on hand to
         fund the repurchase program, and the repurchased stock is held as
         treasury stock.

10.      COMMON STOCK OPTIONS AND WARRANTS

         The Company. has two stock option plans (the 1992 Option Plan and the
         1991 Option Plan) under which the Company may grant incentive or
         non-qualified stock options to full-time employees and key persons.
         Options are granted at an exercise price which is not less than fair
         market value of the Company's common stock as determined by the
         Company's Board of Directors and vest ratably over a three-year period.
         Options granted under the 1992 Option Plan expire ten years from the
         date of grant. As of March 31, 1997, all options granted under the 1991
         Option Plan were exercised or expired. No further grants under the 1991
         Option Plan are authorized.

         In addition to the options granted under the 1992 and 1991 Option
         Plans, the Company has granted options to purchase shares of its common
         stock to certain employees, directors and consultants in connection
         with their association with the Company. These options vest from
         immediate to ratably over three years and have terms from five to ten
         years.

                                      F-13
<PAGE>   40
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

         The following table summarizes stock option activity for the three
         years ended March 31, 1998:


<TABLE>
<CAPTION>
                                                                                  OPTION PRICE
                                                                  SHARES            PER SHARE
                                                               -------------     ---------------
   <S>                                                         <C>               <C>    
   Outstanding at March 31, 1995                                  1,495,627      $  2.00 - 11.11

      Granted                                                       449,758         4.75 - 12.00
      Exercised                                                    (341,660)        2.00 -  7.00
      Canceled or expired                                          (473,990)        3.00 - 11.11
                                                               -------------     ---------------
   Outstanding at March 31, 1996                                  1,129,735         2.00 - 12.00

      Granted                                                        83,400         2.25 -  2.50
      Exercised                                                     (40,000)        2.00 -  3.00
      Canceled or expired                                          (551,108)        2.38 - 11.11
                                                               -------------     ---------------
   Outstanding at March 31, 1997                                    622,027         2.25 - 12.00

      Granted                                                       515,600         2.00 - 10.00
      Exercised                                                           -                    -
      Canceled or expired                                          (173,300)        2.00 - 11.11
                                                               -------------     ---------------

   Outstanding at March 31, 1998                                    964,327      $  2.00 - 12.00
                                                               =============     ===============
</TABLE>

         The Company has reserved 1,400,000 shares of common stock for issuance
         under the 1992 Option Plan.

         During 1995, the Company issued subordinated notes payable that
         included 112,188 warrants exercisable into a like number of common
         shares for $8.00 per share. During the first six months of fiscal 1996,
         the maturity of $1,650,000 aggregate principal amount of subordinated
         notes was extended for an additional year in exchange for the issuance
         of 82,500 warrants. The warrants are exercisable beginning on the first
         anniversary of the date of the issuance of the notes and expire five
         years thereafter. During May 1995, an additional 19,375 warrants were
         issued to the placement agent for the Convertible Preferred Stock. The
         warrants are exercisable on the first anniversary of the date of
         issuance and expire five years thereafter.

                                      F-14
<PAGE>   41
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

11.      STOCK COMPENSATION

         The Company has adopted the disclosure only provisions of SFAS No. 123,
         "Accounting for Stock-Based Compensation ("SFAS 123")". Accordingly, no
         compensation cost has been recognized for options issued to employees
         under the Company's stock option plans. Had compensation cost for the
         Company's stock option grants described in Note 10 been determined
         based on the fair value at the grant date for awards in fiscal
         1998,1997 and 1996 consistent with the provisions of SFAS 123, the
         Company's net income (loss) and income (loss) per share would have been
         changed to the pro forma amounts indicated below (in thousands, except
         per share amounts):


<TABLE>
<CAPTION>


                                                                  1998            1997         1996
                                                                  ----            ----         ----
<S>                                     <C>                    <C>             <C>          <C>   
Net income (loss)
                                        As reported            $      578      $  (5,441)   $ (3,937)
                                        Pro forma                     380         (5,566)     (4,395)
Basic and diluted net income
   (loss) per share
                                        As reported            $      .12      $   (1.03)   $  (1.14)
                                        Pro forma                     .07          (1.05)      (1.19)

</TABLE>

         The fair value of each option grant is estimated on the date of grant
         using the Black-Scholes option-pricing model with the following
         weighted-average assumptions used for grants in fiscal 1998, 1997 and
         1996, respectively: dividend yield of 0% for all years; expected
         volatility of 56% for all years; average risk-free interest rates of
         6.01%, 6.22% and 5.88%; and expected life of 3.5 years for all years.

         A summary of the status of the Company's stock option grants as of
         March 31, 1998, 1997 and 1996 and changes during the years ending on
         those dates is presented below:

<TABLE>
<CAPTION>

                                                  1998                          1997                           1996
                                       ----------------------------  ----------------------------   --------------------------
                                                       Weighted                       Weighted                       Weighted
                                                        Average                       Average                        Average
                                                       Exercise                       Exercise                       Exercise
                                         Shares          Price          Shares         Price           Shares         Price
                                       ------------  --------------  -------------  -------------   -------------  -----------
<S>                                    <C>           <C>             <C>             <C>             <C>             <C>
Outstanding at beginning of year           622,027     $  6.03         1,129,735     $  6.20         1,495,627       $  5.85
   Granted                                 515,600        4.96            83,400        2.41           449,758         17.11
   Exercised                                     -           -           (40,000)       2.41          (341,660)         3.48
   Forfeited                              (173,300)       3.48          (551,108)       6.75          (473,990)         7.28
                                       -----------                   -----------                   ----------- 

   Outstanding at end of year              964,327        5.75           622,027        6.03         1,129,735          6.20
                                       ===========                   ===========                   =========== 

   Options exercisable at end
      of year                              370,039                       444,523                       670,835

   Weighted-average fair value
      of options granted during
       the year                        $       .95                   $      1.18                   $      4.44
</TABLE>

                                      F-15
<PAGE>   42
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

         The following table summarizes information about stock options
         outstanding at March 31, 1998: 

<TABLE>
<CAPTION>
                                        OPTIONS OUTSTANDING                           OPTIONS EXERCISABLE
                         ----------------------------------------------------    ----------------------------
                                              WEIGHTED
                                               AVERAGE          WEIGHTED                            WEIGHTED
                             NUMBER           REMAINING          AVERAGE            NUMBER           AVERAGE
   RANGE OF               OUTSTANDING        CONTRACTUAL        EXERCISE         EXERCISABLE        EXERCISE
EXERCISE PRICE             AT 3/31/98           LIFE              PRICE           AT 3/31/98          PRICE
<S>                       <C>                <C>               <C>               <C>                <C>   
 
$ 2.00 to   2.94                289,200       7.9  years       $   2.27               39,900        $ 2.29
$ 4.75 to   7.00                298,360       5.7                  6.00              176,727          5.12
$ 8.00 to  12.00                376,767       7.3                  8.88              153,412          9.06
                         --------------                                            ---------
$ 2.00 to  12.00                964,327       7.0                  6.01              370,039          6.45
                         ==============                                            =========
</TABLE>

         In April 1997, the Company granted non-qualified stock options to two
         officers of the Company to acquire 120,000 shares each of the Company's
         common stock. The vesting period for 60,000 of the options granted to
         each officer is one-third per year for three years. The vesting period
         of the remaining 60,000 options granted to each officer is one-third
         per year for three years or, if the Company's stock price reaches
         certain targets, vesting will occur in blocks of 20,000 options for
         each target price met. The exercise price for the first 20,000 options
         granted to each officer is $5.00 per share. The exercise price for the
         remaining options increases by $1.00 for each block of 20,000 options.

12.      RELATED PARTY TRANSACTIONS

         During fiscal 1998 and 1997, the Company sold approximately $17,000 and
         $11,000, respectively, of product to Addison Wesley Longman, Inc., a
         shareholder in the Company. During fiscal 1998, 1997 and 1996, the
         Company sold approximately $42,000, $-0- and $308,000, respectively, of
         product to Benjamin/Cummings (BC), a subsidiary of a shareholder of the
         Company. The Company earned royalty revenues of approximately $217,000,
         $134,000 and $93,000, related to BC during fiscal 1998,1997 and 1996,
         respectively. Additionally, the Company purchased approximately
         $43,000, $22,000 and $30,000 of product from BC during fiscal 1998,
         1997 and 1996, respectively, and paid royalty expense to BC of
         approximately $215,000, $70,000 and $47,000, respectively.

         During fiscal 1997 and 1996, J.S.K., Inc. (JSK), whose president is a
         director and shareholder of the Company, paid the Company approximately
         $68,000 and $86,000 in licensing and rental fees, respectively.
         Additionally, during fiscal 1996, the Company sold approximately
         $64,000 of product to JSK.

         During fiscal 1996, an officer and shareholder of the Company borrowed
         $25,000 as evidenced by a Promissory Note which bore interest at 12%
         per annum. The Promissory Note was repaid in November 1995.

         During fiscal 1995, the Company issued subordinated debt in the amount
         of $718,750 and $600,000 to an officer and shareholder of the Company
         and to other entities operated by a director of the Company,
         respectively. The subordinated notes payable 


                                      F-16
<PAGE>   43
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

         bore interest at 15%, were payable in quarterly instalments, and due on
         varying maturity dates from May 2, 1996 through November 29, 1996. The
         subordinated notes payable issued during fiscal 1995 included 35,938
         and 17,500 warrants exercisable into an equal number of shares of
         common stock for $8.00 per share. The warrants are exercisable
         beginning on the first anniversary date of the issuance of the notes
         and expire five years thereafter. During fiscal 1996, the Company
         repaid the subordinated debt with proceeds from the Company's initial
         public offering. The related warrants remain outstanding at March 31,
         1998.

13.      COMMITMENTS AND CONTINGENCIES

         The Company leases office space and equipment under noncancelable lease
         agreements expiring on various dates through 2002. At March 31, 1998,
         future minimum rentals for noncancelable leases with terms in excess of
         one year were as follows (in thousands): 

<TABLE>
<CAPTION>
                                                                        MINIMUM
      YEAR ENDING                                                        ANNUAL
        MARCH 31                                                        RENTALS
        --------                                                        -------
      <S>                                                              <C>    
         1999                                                          $     524
         2000                                                                522
         2001                                                                522
         2002                                                                522
         2003                                                                175
                                                                       ---------
         Thereafter                                                    $   2,265
                                                                       =========
</TABLE>

         Rent expense for the years ended March 31, 1998, 1997 and 1996 was
         approximately $417,000, $640,000 and $663,000, respectively.

         On April 25, 1996 the Company and certain of its officers and directors
         were named in a class action lawsuit. The complaint alleges violations
         of Section 11, 12(2) and 15 of the Securities Act of 1933, violations
         of the Georgia Securities Act and negligent misrepresentation arising
         out of alleged disclosure deficiencies in connection with the Company's
         initial public offering which was completed on November 10, 1995. The
         complaint seeks compensatory damages and reimbursements for plaintiff's
         fees and expenses. The Company and its officers and directors are
         vigorously defending against the allegations. The Company cannot
         estimate the impact of the outcome of the lawsuit on the financial
         condition or results of operations.

14.      SUPPLEMENTAL CASH FLOW INFORMATION

         Cash and cash equivalents include cash on hand and on deposit and
         highly liquid investments with an original maturity of three months or
         less. Cash payments for interest during fiscal years 1998, 1997 and
         1996 were approximately $ -0-, $-0- and $329,000, respectively.

                                      F-17
<PAGE>   44

A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------


         Noncash investing and financing activities having an impact on the
         balance sheet are as follows:


<TABLE>
<CAPTION>
                                                                             YEAR ENDED MARCH 31,
                                                                  ---------------------------------------
                                                                      1998           1997            1996
                                                                      ----           ----            ----
<S>                                                               <C>             <C>             <C>    
Convertible Preferred Stock accretion                             $      -        $     -         $   244
Conversion of Convertible Preferred Stock                                -              -           6,194
Issuance of common stock warrants                                        -              -             135
</TABLE>

15.      PRODUCT SALES

         The Company exports its products through agreements with international
         and domestic distributors which grant territorial rights. During the
         years ended March 31, 1998, 1997 and 1996, the Company had net revenue
         from international sales of approximately $1,643,00, $709,000 and
         $983,000, respectively. A summary of revenues by geographic area is as
         follows (in thousands): 



<TABLE>
<CAPTION>

                                                                      YEAR ENDED MARCH 31,
                                                           -------------------------------------------
                                                               1998           1997           1996
                                                               ----           ----           ----
      <S>                                                  <C>               <C>             <C>    
      United States                                        $      5,245      $   3,882       $    5,464
      Europe                                                        371            474              359
      Pacific Rim and Asia                                        1,003            119              370
      Other                                                         269            116              254
                                                           ------------      ---------       ----------
                                                           $      6,888      $   4,591       $    6,447
                                                           ============      =========       ==========
</TABLE>

         No geographic region within Europe accounted for more than 10% of
         total sales during the three year period ended March 31, 1998.

16.      RESTRUCTURING

         During the second quarter of fiscal 1997, the Company implemented a
         restructuring Plan (the Plan) designed to enhance overall
         competitiveness, productivity and efficiency through the reduction of
         overhead costs. The Plan resulted in a pre-tax charge of approximately
         $490,000. The charge principally reflects severance costs resulting
         from realignments throughout the Company, including workforce
         reductions of 29 employees, employee termination costs and costs
         associated with non-cancelable leases net of estimated sublease rental
         income. Total payments of approximately $301,000, primarily related to
         severance agreements were made subsequent to the implementation of the
         Plan. There are no accrued restructuring costs remaining at March 31,
         1998.

                                      F-18