<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
                   (NO FEE REQUIRED EFFECTIVE OCTOBER 7, 1996)

                    FOR THE FISCAL YEAR ENDED MARCH 31, 1997

                                       OR

      [ ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
              THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

                  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 $6,785,278 at June 26, 1997 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 4,901,897 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

    None.



<PAGE>   2

TABLE OF CONTENTS

<TABLE>
<CAPTION>

PART I                                                                                            Page
                                                                                                  ----
<S>               <C>                                                                             <C>
    Item   1.     Business                                                                         1
    Item   2.     Properties                                                                      13 
    Item   3.     Legal Proceedings                                                               13 
    Item   4.     Submission of Matters to a Vote of Security Holders                             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                                         16 
    Item   8.     Financial Statements and Supplementary Data                                     23 
    Item   9.     Changes in and Disagreements With Accountants on
                      Accounting and Financial Disclosures                                        23

PART III
    Item   10.    Directors and Executive Officers of the Registrant                              24 
    Item   11.    Executive Compensation                                                          27 
    Item   12.    Security Ownership of Certain Beneficial Owners
                      and Management                                                              30  
    Item   13.    Certain Relationships and Related Transactions                                  31  

PART IV
    Item   14.    Exhibits, Financial Statement Schedules and Reports
                      on Form 8-K                                                                 33

SIGNATURES
</TABLE>


                                       ii

<PAGE>   3

PART I

ITEM 1.   BUSINESS

General

     A.D.A.M. Software, Inc. ("the Company" or "A.D.A.M.") creates, publishes
and markets educational multimedia software products, services, content and
Internet-ready applications that provide anatomical, medical, scientific and
health-related information for the academic, consumer and professional markets.
A.D.A.M. products use the Company's proprietary Image Database, which currently
contains approximately 70 gigabytes of visual anatomical and medical content in
the form of illustrations, animations, three-dimensional ("3-D") models and
interactive, dissectible imagery.

     The Company creates educational multimedia software products with varying
levels of content, functionality and price for the academic, consumer and
professional markets. The A.D.A.M. Scholar Series includes products for the
medical school, undergraduate and allied health institutional and student
markets. The A.D.A.M. At School Series serves the K-12 market and the A.D.A.M.
At Home Series includes products for children and adult consumers. The newly
created A.D.A.M. Interactive Healthcare and Legal Divisions sell A.D.A.M.
products from the various educational product lines into the professional
markets, which include healthcare, pharmaceutical and legal markets. A.D.A.M.
also licenses its content and provides custom development services.

     A.D.A.M. Software has taken significant steps during the fiscal year ended
March 31, 1997 ("fiscal 1997") to restructure its business model, including
licensing the retail distribution rights for its consumer product line and
completing development of its new flagship product, A.D.A.M. Interactive Anatomy
("AIA"), to serve the higher education and healthcare professional markets.

    The Company was incorporated as a Georgia corporation and commenced
operations in March 1990. The Company was organized by the management of
Medical-Legal Illustrations, Inc. ("MLI"), a predecessor company, which was
founded in 1984 and merged into the Company effective June 30, 1992. MLI, which
produced customized medical illustrations, operated as a division of the Company
until March 31, 1994, when the Company made the strategic decision to
discontinue its customized medical illustration business.

STRATEGY

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

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



                                       1
<PAGE>   4

-    Develop and Enhance High Quality, Market-Driven Products and Services. The
     Company offers a range of educational multimedia software products and has
     a large Image Database from which to develop new products, license content
     and create custom projects. The newly released A.D.A.M. Interactive Anatomy
     ("AIA") also provides for new libraries of content and functionality to be
     added or plugged in to the core AIA foundation module. Because of the
     Company's unique vertical integration, potential users may become aware of
     the Company and its products at home, in school or in a professional
     environment. They then may choose to stay abreast of new products and new
     content and/or functionality libraries through the Company's web-site or
     other avenues. Importantly, as many of the Company's current users in the
     academic market are preparing for a healthcare-related career, the Company
     believes it is well positioned to continue to provide content and products
     to this next generation of healthcare professionals.

-    Further Establish the "A.D.A.M." Brand Name as a Recognized Leader in
     Anatomical and Medical Content. Management of the Company believes that the
     established brand name recognition for "A.D.A.M." across the Company's
     various markets is an important element of the Company's long-term goal.
     The Company continues to invest significant time and resources in these new
     content and functionality libraries and believes that these investments
     create a strong competitive advantage while enhancing customer satisfaction
     and building a loyal customer base.


-    Open New Professional Markets for A.D.A.M. Products and Content. The
     professional markets, consisting of healthcare, pharmaceutical and legal
     markets, are new, large opportunities for the Company to deploy its
     products and content. The Company intends to market its products and
     content to gain a growing presence among this new set of potential
     customers. The Company's goal is for doctors to use A.D.A.M. products for
     patient education and informed consent, pharmaceutical companies to use
     A.D.A.M. products to train their sales force in anatomy and physiology and
     lawyers to use A.D.A.M. products as demonstrative evidence in settlement
     and trial negotiations.

-    Maintain Tight Controls on Expenses and Employee Headcount. The Company
     intends to vigorously monitor and control expenses and employee headcount
     as it moves forward. The Company has produced an expanded product line that
     it believes is well positioned to meet the needs of its various markets. In
     addition, the decision to outsource consumer distribution allows the
     Company to reduce sales and marketing expenses. Furthermore, the Company
     completed a major restructuring in fiscal 1997 and, as a result, has
     significantly reduced headcount and operating costs.

PRODUCTS

General

     The Company creates educational multimedia software products with varying
levels of content, functionality and price for the academic, consumer and
professional markets. The A.D.A.M. Scholar Series includes products for the
medical school, undergraduate and allied health institutional and student
markets. The A.D.A.M. At School Series serves the K-12 market and the A.D.A.M.
At Home Series includes products for children and adult consumers. The


                                        2


<PAGE>   5


newly created A.D.A.M. Interactive Healthcare and Legal Divisions sell A.D.A.M.
products from the various educational product lines into the professional
markets. A.D.A.M. also licenses its content and provides custom development
services. The Company's products are provided on CD-ROM disks that can be used
on Apple Macintosh or Windows-based multimedia PC's.

     All of the Company's products incorporate images from the A.D.A.M. Image
Database. The initial database was assembled by a team of master degreed medical
illustrators, anatomists, commercial illustrators, multimedia experts and
software engineers over a three and one-half year period. Each year the Company
creates additional content, placing recent emphasis on 3-D models. Currently,
the A.D.A.M. Image Database contains approximately 70 gigabytes of visual
anatomical and medical content in the form of illustrations, animations, 3-D
models and interactive, dissectible imagery. Many A.D.A.M. images have been
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.

     The Company's educational multimedia software products have received
significant media and professional recognition, including five 1997 Software
Publishers Association Codie awards for Best Education Program, Best Education
Upgrade, Best Comprehensive School Software Program, Best Simulation Software
Program and Best Curriculum Software for Secondary/Post Secondary Schools.
Additionally, the Company received two 1996 Software Publishers Association
Codie awards for Best Curriculum-Based Education Program and Best Education
Program for Middle Schools, and two 1995 Software Publishers Association Codie
Awards for Best Overall Education Program and Best Home Learning Program. The
Codie Awards are sponsored annually by the Software Publishers Association
("SPA"), an industry trade group consisting of most software publishers. In
1997, 1996 and 1995, over 1,000, 900 and 680 products, respectively, were
entered into the Codie competition. One award is given in each of a number of
categories and winners are selected via ballot by SPA member companies.


A.D.A.M. SCHOLAR SERIES PRODUCTS

     A.D.A.M. Interactive Anatomy ("AIA"), the Company's new flagship product
released in the first fiscal quarter of 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. Also, one-button Internet Access provides solutions for
distance learning as well as offering seamless integration of the Internet and
its capabilities.

     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., which were designed for the undergraduate health sciences
curriculum and completed during fiscal 1997. Each module is designed to
complement A.D.A.M. Standard, integrating anatomical


                                        3


<PAGE>   6


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 on this vital system of the body. The module includes: Anatomy
     Review-Respiratory Structures, Pulmonary Ventilation, Gas Exchange, Gas
     Transport and Control of Respiration.

-    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 with 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. The Anatomy Review includes key features of: The
     Nephron, Tubular Segments and Associated Blood Vessels and Renal Corpuscle.


     A.D.A.M. Practice Practical ("APP") is a new program that 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 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 exploration of each system of the human body.

     A.D.A.M. Standard is designed primarily for undergraduate institutions with
health science programs. It is the intermediate-level application in the
A.D.A.M. Scholar Series and


                                        4


<PAGE>   7

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
exploration of each system of the human body.

     CD-ROM Animation Books include A.D.A.M. Trauma, A.D.A.M. Obstetrics and
Gynecology and A.D.A.M. Orthopedic and are intended primarily for the graduate
education and professional markets. A.D.A.M. Trauma contains a set of
interactive animations, patient education documents and accompanying tools for
simulating typical head, back and burn injuries. A.D.A.M. Obstetrics and
Gynecology offers a selection of birth and gynecological procedures for
anatomy/medical instruction, physicians' reference and patient communication.
A.D.A.M. Orthopedic contains a series of animations of various surgical
procedures for anatomy of the lower limbs.

     The A.D.A.M. Scholar Series products contributed approximately 44.7%, 57.2%
and 73.0% of net revenues in fiscal 1997, fiscal 1996 and fiscal 1995,
respectively. The Company anticipates that it will continue to devote resources
to developing products for the academic market.

A.D.A.M. AT HOME SERIES PRODUCTS

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

     A.D.A.M. The Inside Story is a consumer "edutainment" product designed for
use by all members of the family which provides A.D.A.M. anatomy 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.

     Nine Month Miracle is a consumer "edutainment" product designed for use by
all members of the family interested in pregnancy. Nine Month Miracle contains
accurate and informative 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
emotional 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.



                                        5


<PAGE>   8


     Life's Greatest Mysteries is a consumer "edutainment" product designed for
use by all members of the family that provides an interactive exploration of the
myths, mysteries and curiosities of the human body. Using detailed animations
and a simple "Q&A" format, a live entertaining 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.

     Physician's Home Assistant and Pediatric Home Assistant, licensed by
A.D.A.M. Software in Fall 1996, are easy-to-use symptom analysis tools and
medical reference guides intent on creating an informed patient. These products
offers extensive disease, nutrition, surgery, medical record, drug side-effect
and interaction databases. The product was developed and produced by Applied
Medical Informatics, now owned by Mosby Consumer Health, and A.D.A.M. Software
serves as its exclusive distributor to the retail marketplace.

     The A.D.A.M. At Home Series products contributed approximately 43.1%, 39.3%
and 21.0% of net revenues in fiscal 1997, fiscal 1996 and fiscal 1995,
respectively. Because of changes in the retail market and the outsourcing of
consumer distribution, the Company has decided to discontinue further
development of consumer titles that would be solely funded by the Company.

A.D.A.M. AT SCHOOL SERIES PRODUCTS

     In fiscal 1997, the Company created the A.D.A.M. At School series to serve
the K-12 market. The A.D.A.M. At School series products accounted for
approximately 10.2% of net revenues in fiscal 1997. Sales of these products were
included in the A.D.A.M. Scholar Series products during prior fiscal years.

     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, which 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 permit 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.



                                        6


<PAGE>   9

    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 study of
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. The A.D.A.M. At Home Series - School Editions accounted for
approximately 3.8% of net revenues in fiscal 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 senior
management of the Company for possible 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, each product concept is evaluated for return on investment,
sales potential and overall strategic value. The completed analysis from this
stage is then presented to senior management of the Company for final product
development decisions.

    Once accepted 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 also 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. It is during this stage that the Company's designers,
illustrators, programmers and other creative talent become actively involved in
developing the product. 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, the results of which are
integrated back into the design specifications. In addition to the functionality
and testing, management believes it is important for the Company to continually
market test products at several other levels. Since the Company is producing
information products, it is necessary to constantly assess the accuracy of the
content, which includes 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.



                                        7


<PAGE>   10



    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.

SERVICES

    The Company uses its Image Database to create custom services 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.

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 and
broaden product distribution. In fiscal 1997, the Company licensed its consumer
product line to Mindscape, Inc. for distribution into the retail market,
relieving the Company of sales, marketing and distribution responsibilities in
the consumer market. During fiscal 1997, the Company had one distributor that
accounted for more than 10% of net revenues.

    In the academic market, the Company markets its products through both direct
and indirect channels. The Company employs approximately five direct telesales
representatives and two field sales people, and has a network of value added
resellers and catalog resellers to sell its institutional products. In addition,
the Company works non-exclusively with Churchill Livingstone USA, Addison Wesley
Longman, Williams and Wilkins and various educational distributors in addressing
the student 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. 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 the academic market, the Company ended the exclusivity attributes of its
relationship with Churchill Livingstone UK at the end of fiscal 1997 for the
higher education European market in order to work with various country-specific
educational resellers and publishers to market and sell its educational
products. 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. Revenues


                                        8


<PAGE>   11
from such relationships were immaterial in fiscal 1997. International revenues
comprised 15.4%, 15.2% and 28.6% of the Company's total net revenues in fiscal
1997, fiscal 1996 and fiscal 1995, respectively.

    The Company has designated two employees to pursue the professional markets
including healthcare, pharmaceutical, and legal. The Company sales, marketing
and distribution evolves around building awareness of A.D.A.M.'s products,
attending industry events, establishing relationships with prospective companies
and customers and doing thorough market research. The Company intends to employ
both a direct and indirect sales strategy in the professional market.

STRATEGIC ALLIANCES

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

    Addison Wesley Longman Publishing Company, a subsidiary of Pearson PLC

    Addison Wesley Longman, Inc.("AWL") is a major publisher for the
undergraduate market for science, health science, nursing and allied health. 
AWL is a shareholder of the Company and has product development and
distribution relationships with the Company. The Company and AWL (through their
subsidiary Benjamin/Cummings) 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 AWL focused on the
student market.

    Mindscape, Inc., a subsidiary of Pearson, PLC

    In March 1997, A.D.A.M.Software, Inc. and Mindscape, Inc. entered into a
worldwide distribution agreement for distribution of A.D.A.M.'s consumer
products into the retail marketplace. The agreement provided Mindscape with
exclusive distribution rights for English language consumer products in retail,
other equipment manufacturers and direct mail, and non-exclusive in other areas
including K-12 and on-line.

ANATOMICAL REVIEW BOARD

    The Company has established an Anatomical Review Board composed of
individuals with expertise in the fields of anatomy, biology and medicine to
assist 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 with respect to content accuracy and testing reliance of the
Company's products and product development candidates.

    As of March 31, 1997 the members of the Anatomical Review Board were as
follows:




                                        9


<PAGE>   12
<TABLE>
<CAPTION>

     Name                                                Affiliation
     ----                                                -----------
     <S>                                             <C>
     Anne Agur, B.Sc. (OT), M.Sc. ................   Associate Professor, Anatomy and Cell
                                                     Biology, University of Toronto, Faculty of
                                                     Medicine

     Arthur W. English, Ph.D......................   Professor of Anatomy, Emory University
                                                     School of Medicine

     Keith L. Moore, Ph.D.........................   Professor, Anatomy and Cell Biology,
                                                     University of Toronto, Faculty of Medicine

     Wojciech (Albert) Pawlina, M.D...............   Assistant Professor, Anatomy and Cell
                                                     Biology, University of Florida College of
                                                     Medicine

     Vick Williams, M.D., Ph.D....................   Professor, Cellular and Structural Biology,
                                                     University of Texas Health Science Center at
                                                     San Antonio

     Kyle W. Peterson, Ph.D.........................  Professor of Anatomy, Emory University
                                                     School of Medicine

     John V. Urbas, B.S., M.S., Ph.D. .............  Heinrich-Heine-Rin65, Germany

</TABLE>

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
its trademarks "A.D.A.M.," "SCHOLAR SERIES," "NINE MONTH MIRACLE," and 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


                                       10


<PAGE>   13

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
licenses 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 included in its products,
including video, photographs, music and text, from various third parties that is
incorporated in its products. 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 on 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


                                       11


<PAGE>   14

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. Since the
Company has not previously sold to these markets, the Company expects
professional sales to grow fairly slowly.

    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, most 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, 1997, the Company employed 58 persons. Of these, 19 were
engaged primarily in product development, 17 in sales, seven in marketing and 15
in finance and administration. The Company currently employs eight 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.

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
Exchange Act. 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.


                                       12


<PAGE>   15

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. Management of the Company believes
that the Company's current facilities will be adequate through at least 1998. 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 was filed in Fulton County
Superior Court in Atlanta, Georgia by an owner of 1,000 shares of A.D.A.M.
common stock against the Company and certain of its then officers and directors
(Robert S. Cramer, Jr., Curtis A. Cain, Gregory M. Swayne, Holcombe P. Green,
Jr. and John W. McClaugherty). 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. 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 1997.




                                       13

<PAGE>   16

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 since the
Company's initial public offering, which was consummated on November 10, 1995.

<TABLE>
<CAPTION>

                                                                      High           Low
                                                                      ----           ---

     <S>                                                            <C>             <C>
     FISCAL 1996
     Fiscal Third Quarter (commencing
       November 10, 1995) ..................................        $14-1/8         $4-3/8
     Fourth Quarter ........................................           7             4-1/2
                                                                           
     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 (through June 23, 1997) .................         2-5/16          1-3/4
</TABLE>


    At June 27, 1997 there were approximately 214 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. To date, the Company has incurred losses and 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>   17

ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>


                                                                   Fiscal Year Ended March 31,
                                                    ---------------------------------------------------------
                                                      1997         1996        1995        1994        1993
                                                    --------     --------     -------     -------     -------
                                                             (in thousands, except per share amounts)

<S>                                                 <C>          <C>          <C>         <C>         <C>    
STATEMENT OF OPERATIONS:
   Net revenues                                     $  4,591     $  6,447     $ 5,742     $ 2,813     $   976

   Cost and expenses:
      Cost of revenues                                 1,280        1,491         791         293         114
      Sales and marketing                              4,494        4,090       3,666       1,965       1,141
      Product development                              2,260        2,847       2,401       1,759       1,023
      General and administrative                       2,369        2,008       1,774       1,554       1,200
      Restructuring charge                               490         --          --          --          --
                                                    --------     --------     -------     -------     -------

        Total costs and expenses                      10,893       10,436       8,632       5,571       3,478
                                                    --------     --------     -------     -------     -------

      Operating loss                                  (6,302)      (3,989)     (2,890)     (2,758)     (2,502)
   Interest expense                                       (8)        (317)       (383)        (90)       (117)
   Interest income                                       869          415          43          64           3
                                                    --------     --------     -------     -------     -------

      Loss from continuing operations                 (5,441)      (3,891)     (3,230)     (2,784)     (2,616)
   Loss from discontinued operations                    --           --          --          (400)       (185)
                                                    --------     --------     -------     -------     -------

      Loss before extraordinary item                  (5,441)      (3,891)     (3,230)     (3,184)     (2,801)
   Extraordinary loss from early extinguishment
      of debt, net of income tax benefit of $29         --            (46)       --          --          --

        Net loss                                    $ (5,441)    $ (3,937)    $(3,230)    $(3,184)    $(2,801)
                                                    ========     ========     =======     =======     =======

   Net loss per share from continuing operations    $  (1.03)    $  (1.13)    $ (1.22)    $ (1.11)    $ (1.35)

   Net loss per share                                  (1.03)       (1.14)      (1.22)      (1.27)      (1.44)

   Weighted average number of common shares
      and share equivalents outstanding                5,258        3,673       2,694       2,510       1,939
                                                    ========     ========     =======     =======     =======
</TABLE>

<TABLE>
<CAPTION>
                                                                          As of March 31,
                                                      -------------------------------------------------------
                                                       1997         1996        1995         1994        1993
                                                      ------       ------       -----       -----       -----
                                                                         (in thousands)

<S>                                                   <C>          <C>          <C>         <C>         <C>  
BALANCE SHEET DATA:
   Cash and cash equivalents                           2,422        5,352         940         716         348
   Working capital (deficiency)                        9,982       15,354      (1,736)       (593)       (550)
   Total assets                                       13,662       18,871       4,247       3,632       1,340
   Short-term debt                                      --            250       2,530         284         480
   Long-term debt                                       --           --           298         336         546
   Convertible Preferred Stock                          --           --         2,022        --          --
   Total shareholders' equity (deficit)               11,555       16,896      (1,943)     (1,284)       (653)

</TABLE>



                                       15
<PAGE>   18





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.") creates, publishes and
markets educational multimedia software products, services, content and
Internet-ready applications that provide anatomical, medical, scientific and
health-related information for the academic, consumer and professional markets.
The Company sells its products into the academic markets through alliances with
distributors and by direct sales and marketing activities. As of March 1997
consumer distribution has been outsourced to Mindscape, Inc. 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. 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 related obligations are fulfilled.

    The Company's first 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
multimedia capabilities into 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 have a
lower unit price, higher cost of goods sold as a percent of price and lower
gross margin. The average net revenues received by the Company were
approximately $24.00 per unit for the 189,000 units of software sold in fiscal
1997 as compared to approximately $50.00 per unit for the 129,000 units of
software sold in fiscal 1996 and approximately $101.00 per unit for the 56,700
units of software sold in fiscal 1995. The 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, has resulted in lower gross margins and
higher costs of revenue as a percentage of net revenue. However, the Company
does not expect these trends to continue due to the release in the first quarter
of fiscal 1998 of a new, flagship product to the academic market with a retail
price of $1,295.00, as well as a less costly means by which to sell its consumer
products, specifically, the distribution agreement reached with Mindscape, Inc.
in March 1997.

    The Company has experienced substantial losses since its inception
resulting in an accumulated deficit of approximately $22.5 million as of March
31, 1997. For the fiscal years ended March 31, 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 Company has successfully
implemented its restructuring Plan (the "Plan")


                                       16

<PAGE>   19






during fiscal 1997, and will be better able to bring costs in line with
anticipated revenues in order to approach profitability. 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 noncancelable leases was gross rental payments due
through the end of the lease plus broker's commission less expected rental
receipts from subleasing the space. The lease was for additional space on
another floor in the same office building as the Company's headquarters. The
Company is currently able to locate all employees on one floor, and does not
anticipate a need for additional capacity in the foreseeable future. The cost
benefits due to reduction of personnel have been largely realized in the third
and fourth quarters of fiscal 1997, and the lease termination will be realized
after March 31, 1997.

    At March 31, 1997, the Company had net operating loss carryforwards
available for tax purposes of approximately $19.9 million, which will expire in
years 2007 through 2012. 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,     ------------------ 
                                       --------------------------      1996 TO    1995 TO 
                                       1997       1996       1995       1997       1996 
                                       ----       ----       ----       ----       ---- 
<S>                                     <C>        <C>        <C>      <C>        <C>  
Net revenues                            100%       100%       100%     (28.5)%    12.3%
Costs and expenses:
   Cost of revenues                    27.9       23.1       13.8      (14.2)     88.5
   Sales and marketing                 97.9       63.4       63.8        9.9      11.6
   Product development                 49.2       44.2       41.8      (20.6)     18.6
   General and administration          51.6       31.1       30.9       18.0      13.2
   Restructuring charge                10.7       --         --          N/A       N/A
                                     ------      -----      ----- 

          Total costs and expenses    237.3      161.8      150.3
                                     ------      -----      ----- 

Operating loss                       (137.3)     (61.8)     (50.3)
</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.

                                       17

<PAGE>   20
<TABLE>
<CAPTION>

                                  FISCAL YEAR ENDED MARCH 31,
                                  ---------------------------
                                   1997      1996      1995
                                   ----      ----      ----

<S>                               <C>       <C>       <C>   
Academic                          $2,523    $3,688    $4,194
Consumer                           1,978     2,533     1,207
Professional                        --        --        --
Other revenues                        90       226       341
                                  ------    ------    ------

     Net revenues                 $4,591    $6,447    $5,742
                                  ======    ======    ======
</TABLE>


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,
have not resulted in significant increases in unit shipments of those titles,
adversely affecting 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.

    The Company believes that anticipated future revenue growth will depend on,
among other things, its ability to successfully introduce its new flagship
academic product, A.D.A.M. Interactive Anatomy, and other planned products to
the marketplace. Additionally, the extent of competition, unit pricing trends,
the demand for its software in the academic, consumer


                                       18

<PAGE>   21


and professional markets and the performance of the Company's strategic partners
in 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 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 1995, 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 have not resulted 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 is 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 is 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 costs to continue in fiscal 1998 and expects to recover defense
costs from its insurance carrier in the event of a favorable adjudication. The
decrease in premises rental cost as a result of the restructuring will be
realized beginning April 1, 1997.

    During the second quarter of fiscal 1997, the Company implemented a
restructuring Plan (the "Plan") designed to enhance overall competitiveness,
productivity and efficiency


                                       19

<PAGE>   22


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 is
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 is due
mainly to development costs related to ADAM Interactive Anatomy. During fiscal
1996 and fiscal 1995, the majority of the 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 has
a deferred liability at March 31, 1997 which it expects to recognize as income
during the first and second quarters of fiscal 1998.

Fiscal 1996 Compared to Fiscal 1995

    Total net revenues increased 12.3% to $6,447,000 in fiscal 1996 compared to
$5,742,000 in fiscal 1995 as a result of increased sales of the Company's
products to the consumer market, partially offset by a decline in revenues from
the academic market. Total unit shipments of the Company's products increased to
approximately 129,000 units in fiscal 1996 from approximately 56,700 units in
fiscal 1995 due to a continued shift in the Company's product mix toward higher
volume, lower priced consumer products.

    Net revenues from the academic market decreased 12.1% to $3,688,000 in
fiscal 1996 from $4,194,000 in fiscal 1995 due primarily to a significant
reduction of revenues from strategic partners during the fourth quarter of
fiscal 1996. The decrease was further impacted by the Company's aggressive
policy on price protection resulting in an increase in an allowance of
approximately $315,000 in the fourth quarter for anticipated price reductions on
several academic products. As a percent of total net revenues, net revenues from
the academic market decreased to 57.2% in fiscal 1996 compared to 73.0% in
fiscal 1995.

    Net revenues from the consumer market increased 109.9% to $2,533,000 in
fiscal 1996 from $1,207,000 in fiscal 1995 due primarily to a full year of
continued sales of A.D.A.M.


                                       20

<PAGE>   23

The Inside Story and the Company's introduction of its second consumer title
Nine Month Miracle in April 1995. The Company's third consumer title, Life's
Greatest Mysteries, which was launched in October 1995, experienced lower than
expected sales during the Company's fourth quarter of fiscal 1996. As a percent
of total net revenues, net revenues from the consumer market increased to 39.3%
in fiscal 1996 compared to 21.0% in fiscal 1995.

    Cost of revenues increased 88.5% to $1,491,000 in fiscal 1996 compared
to $791,000 in fiscal 1995. Cost of revenues, which includes the cost of
support, packaging, documentation, royalties, and amortization of capitalized
software development costs, increased primarily from increases in net revenues,
specifically in the consumer market and an increase in amortization of
capitalized product. As a percent of total net revenues, cost of revenues
increased to 23.1% in fiscal 1996 compared to 13.8% in fiscal 1995 due to the
above factors, as well as a shift in the Company's product mix towards higher
volume, lower priced consumer products.

    Sale and marketing expenses increased 11.6% to $4,090,000 in fiscal 1996
from $3,666,000 in fiscal 1995, primarily as a result of increased marketing
expenses relating to the introduction of Nine Month Miracle and Life's  
Greatest Mysteries in the consumer market. As a percentage of total net
revenues, sales and marketing expenses decreased slightly to 63.4% in fiscal
1996 from 63.8% in fiscal 1995.

    Product development costs increased 18.6% to $2,847,000 in fiscal 1996 from
$2,401,000 in fiscal 1995 due primarily to an increase in consulting costs
related to product development activity and a $356,000 reduction in the amount
of development costs capitalized for fiscal 1996 compared to fiscal 1995. The
reduction in capitalized development costs was due to focus on development of
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, resulting in lower capitalized costs as compared to mostly academic
products developed in the prior year, which drew upon a more established content
and core technology base. As a percentage of total net revenues, product
development expenses increased to 44.2% in fiscal 1996 from 41.8% in fiscal
1995. Total expenditures for product development, including capitalized
expenses, increased to $2,940,000 in fiscal 1996 compared to $2,850,000 in
fiscal 1995. The Company capitalized product development expenses of $93,000 and
$449,000 in fiscal 1996 and fiscal 1995, respectively which represented 3.2% and
15.8% of total expenditure for product development in these respective periods.
Amortization of capitalized product development cost totaled $356,000 and
$119,000 in fiscal 1996 and 1995, respectively, and is charged to and included
in cost of revenues described above.

    General and administrative expenses increased 13.2% to $2,008,000 in fiscal
1996 from $1,774,000 in fiscal 1995 primarily as a result of increased
consulting and professional fees associated with being a public company. As a
percentage of total net revenues, general and administrative expenses increased
to 31.1% in fiscal 1996 from 30.9% in fiscal 1995.



                                       21
<PAGE>   24


LIQUIDITY AND CAPITAL RESOURCES

    At March 31, 1997 the Company had cash and cash equivalents of $2,422,000,
short-term investments of $8,546,000, and working capital of $9,982,000. Cash
used in operating activities was $4,858,000 in fiscal 1997, $2,601,000 in fiscal
1996 and $3,504,000 in fiscal 1995, principally as a result of net losses for
these periods.

    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 1998.

    During April 1997 the Board of Directors adopted a stock repurchase program.
The program authorizes 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. 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. As of June 27, 1997 the
Company has repurchased 372,750 shares of Common Stock on the open market for an
average price of approximately $1.95 per common share for an aggregate purchase
price of approximately $729,000. Repurchased shares represent approximately 6.9%
of the shares of Common Stock issued and 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.



                                       22

<PAGE>   25

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


                                       23

<PAGE>   26

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

<TABLE>
<CAPTION>

NAME                                     AGE                POSITIONS WITH THE COMPANY
----                                     ---                --------------------------

<S>                                      <C>                <C>                                        
Robert S. Cramer, Jr.                    36                 Chairman of the Board, Co-Founder, Chief
                                                            Executive Officer

Gregory M. Swayne                        39                 Co-Founder, Vice-Chairman, Vice President of
                                                            Production and Director

Sally D. Elliott                         44                 Director

Anthony J. Gatti, M.D.                   49                 Director

Daniel S. Howe                           37                 Director

J. Larry Jones                           56                 Director

John W. McClaugherty                     38                 Director

Francis J. Tedesco, M.D.                 53                 Director

Michael S. Fisher                        34                 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. In 1989, Mr. Cramer served as an
Executive Editor and Co-Publisher of Atlanta Computer Spectrum, a regional
technology publication he helped to create. Also, 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.

             SALLY D. ELLIOTT. Ms. Elliott has been a Director of the Company
since June 1993. Ms. Elliott has served since June 1991 as President of the
Consumer Publishing Group, Addison Wesley Longman, Inc., formerly known as
Benjamin/Cummings Publishing Company, Inc. ("Benjamin/Cummings"), a publisher
of college textbooks and a subsidiary of Addison Wesley


                                       24

<PAGE>   27


Longman, a minority shareholder of the Company and an indirect subsidiary of
Pearson PLC ("Addison Wesley Longman"), a minority shareholder of the Company.
Prior thereto, Ms. Elliott served as General Manager of Benjamin/Cummings from
June 1989 to June 1991 and Editorial Director of Benjamin/Cummings from June
1987 to June 1989. Ms. Elliott is also a director of Addison Wesley Longman.

             ANTHONY J. GATTI. Dr. Gatti has been a Director of the Company
since May 1993. Dr. Gatti has been a doctor of podiatric medicine in private
practice since 1974. He is President and a director of National Podiatry
Management, a preferred provider organization offering podiatry services to
major health providers, and a director of several other national and state
podiatric medicine groups.

             DANIEL S. HOWE. Mr. Howe has been a Director of the Company since
December, 1996. Mr. Howe is President of DSH Enterprises, Inc., a real estate
development and investment company and has served in that capacity since January
1990.

             J. LARRY JONES. Mr. Jones has been a director of the Company since
August 1995. In 1988, Mr. Jones became a director and President, Educational
Publishing Division, of Addison Wesley Longman, became President of Addison
Wesley Longman in October 1992, Chief Executive Officer of Addison Wesley
Longman in October 1994 and Chairman of the Board of Addison Wesley Longman in
January 1995.

             JOHN W. MCCLAUGHERTY. Mr. McClaugherty, a co-founder of the
Company, has served as a Director of the Company since its inception in March
1990. Currently, Mr. McClaugherty serves as President of J.S.K., Inc., a medical
illustration company. Mr. McClaugherty served as Chief Executive Officer of the
Company from its inception until March 1994. Prior thereto, Mr. McClaugherty was
the Vice President of Sales and Marketing and a director of MLI, predecessor to
the Company, from March 1985 until March 1990. Since 1994, Mr. McClaugherty has
served as President of J.S.K., Inc., a provider of medical illustrations to the
legal profession and a licensee of the Company. See "Certain Transactions."

             FRANCIS J. TEDESCO. Dr. Tedesco has been a Director of the Company
since July 1996. He has served as Chief Executive Officer of Health Sciences
University and as President of the Medical College of Georgia ("MCG") since
1988, and has been a Professor of Medicine at MCG since 1981. He also is a
consultant to Dwight David Eisenhower Medical Center -- Fort Gordon, Georgia;
Veterans Administration Medical Center --Augusta, Georgia and Walter Reed Army
Medical Center -- Washington, D.C. Prior to coming to MCG in 1978, Dr. Tedesco
held academic appointments beginning in 1971 at the Hospital of the University
of Pennsylvania; Washington University School of Medicine, St. Louis, Missouri;
and University of Miami School of Medicine. Dr. Tedesco currently serves on the
Board of Directors and is Vice President of the Georgia Division of the American
Cancer Society, and he is a director of URO Health, a medical products
manufacturer.

             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 eligible and has satisfied all requirements for
CPA certification.



                                       25

<PAGE>   28



SECTION 16(A)  BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

    Section 16(a) of the Exchange Act requires executive officers and directors
of the Company and persons who beneficially own more than ten percent of the
Company's Common Stock to file with the Securities and Exchange Commission
certain reports, and to furnish copies thereof to the Company, with respect to
each such person's beneficial ownership of the Company's equity securities.
Based solely upon a review of the copies of such reports furnished to the
Company and certain representations of such persons, all such persons have
complied with the applicable reporting requirements, except for Michael Fisher
who inadvertently filed his Form 3 approximately one month late.


                                       26

<PAGE>   29

ITEM 11.  EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

             The table below sets forth certain information relating to the
compensation earned during fiscal 1997 and the fiscal year ended March 31, 1996
("fiscal 1996") and the fiscal year ended March 31, 1995 ("fiscal 1995") by the
Chief Executive Officer and all executive officers that received salary and
bonus in excess of $100,000 for fiscal 1997 (the "Named Executive Officers").
<TABLE>
<CAPTION>


                                                                                                                     LONG-TERM
                                                                     ANNUAL COMPENSATION                            COMPENSATION
                                                                     -------------------                            ------------
                                                                                                  SECURITIES            ALL
                                                   FISCAL                                         UNDERLYING           OTHER
NAME AND PRINCIPAL POSITIONS                        YEAR          SALARY($)         BONUS($)       OPTIONS(#)       COMPENSATION
----------------------------                        ----          ---------         --------       ----------       ------------
<S>                                                 <C>           <C>               <C>              <C>             <C>        
Robert S. Cramer, Jr                                1997          $155,000             --              --            $  2,111(1)
(Chairman of the Board                              1996          $128,750             --            75,000          $  2,140(1)
of Directors, Chief Executive                       1995          $126,583          $ 4,500          20,000              --
Officer, Co-Founder and Director)

Gregory M. Swayne                                   1997          $155,000             --              --            $  4,185(1)
(Vice-Chairman, Vice                                1996          $128,750          $ 9,000          75,000          $  4,245(1)
President of Production and Director)               1995          $126,583          $ 4,500          20,000              --

Curtis A. Cain (2)                                  1997          $ 76,973             --              --            $330,000(3)
(Former Chief Executive Officer)                    1996          $135,000          $12,340          90,000              --
                                                    1995          $113,333          $ 9,500          20,000              --

Robert A. DiProva (4)                               1997          $100,625             --              --            $ 60,000(5)
(Former Chief Financial Officer)                    1996          $ 72,083          $12,340          33,000              --


David Tranberg (6)                                  1997          $132,494             --             5,000          $ 80,000(5)
(Former Vice-President of Sales                     1996          $ 23,872             --            30,000              --
Marketing)
</TABLE>

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

(1)          Represents life insurance premiums paid on behalf of such executive
             officers.
(2)          Mr. Cain ceased to be an employee of the Company effective
             September 4, 1997.
(3)          Represents lump sum severance payment of $150,000 plus $180,000
             payable in twelve equal monthly installments through September
             1997.
(4)          Mr. DiProva ceased to be an employee of the Company effective   
             February 15, 1997. Mr. Diprova joined the Company in September, 
             1995, and therefore received no compensation for fiscal 1995.   
(5)          Represents lump sum severance payment.
(6)          Mr. Tranberg ceased to be an employee of the Company effective  
             March 31, 1997. Mr. Tranberg joined the Company in January 1996,
             and therefor received no compensation for fiscal 1995.          
                                                                

OPTION GRANTS IN LAST FISCAL YEAR

           The following table provides information regarding stock options
granted to the Named Executive Officers during fiscal 1997.



                                       27

<PAGE>   30

<TABLE>
<CAPTION>

                                                INDIVIDUAL GRANTS                           POTENTIAL REALIZABLE
                            NUMBER OF                                                         VALUE AT ASSUMED
                           SECURITIES        % OF TOTAL                                     ANNUAL RATES OF STOCK
                           UNDERLYING      OPTIONS GRANTED  EXERCISE OR                       PRICE APPRECIATION
                             OPTIONS        TO EMPLOYEES    BASE PRICE     EXPIRATION           FOR OPTION TERM
NAME                       GRANTED (#)     IN FISCAL YEAR    ($/SHARE)        DATE        5% ($)(1)         10%($)(1)
----                       -----------     --------------    ---------        ----        ---------         ---------
                                                                                         
<S>                            <C>               <C>           <C>            <C>          <C>              <C>    
Robert S. Cramer, Jr            --               --             --               --           --               --
Gregory M. Swayne               --               --             --               --           --               --
Curtis A. Cain (3)              --               --             --               --           --               --
Robert A. DiProva (4)          5,000             6.0%          $2.50            (2)        $ 7,075          $17,930
                               5,000             6.0%          $2.25          3/25/02      $ 7,075          $17,930
David Tranberg (5)             5,000             6.0%          $2.50            (2)        $ 7,075          $17,930
</TABLE>


(1)          The potential realizable value portion of the foregoing table
             illustrates value that might be realized upon exercise of the
             options immediately prior to the expiration of their term, assuming
             the specified compounded rates of appreciation on the Common Stock
             over the term of the options. These numbers do not take into
             account plan provisions providing for termination of the option
             following termination of employment or nontransferability.
(2)          Forfeited in connection with such officer's cessation of
             employment.
(3)          Mr. Cain ceased to be an employee of the Company effective
             September 4, 1997.
(4)          Mr. DiProva ceased to be an employee of the Company effective
             February 15, 1997.
(5)          Mr. Tranberg ceased to be an employee of the Company effective
             March 31, 1997.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES

    The following table shows the number and value of exercisable and
unexercisable options held by the Company's Named Executive Officers as of the
end of fiscal 1997. Value is determined as the difference between exercise price
and fair market value. No stock appreciation rights were outstanding in fiscal
1997.
<TABLE>
<CAPTION>

                                                                   NUMBER OF UNEXERCISED
                                          SHARES         VALUE       OPTIONS AT FISCAL
                                         ACQUIRED      REALIZED        YEAR-END (#)
                                      ON EXERCISE(#)   ($)(1)    EXERCISABLE/UNEXERCISABLE
                                                                 -------------------------
<S>                                       <C>           <C>          <C>           
Robert S. Cramer, Jr ..............       20,000        $5,000       150,000/50,000(2)
Gregory M. Swayne .................         --            --          150,000/50,000
Curtis A. Cain ....................         --            --             None/None
Robert A. DiProva .................         --            --            5,000/None
David Tranberg ....................         --            --             None/None

</TABLE>
-------------------
(1)          Based on the difference between the fair market value of the
             Company's Common Stock at the date of exercise, less the exercise
             price.
(2)          Does not include warrants to purchase 42,938 shares of Common Stock
             issued in connection with Subordinated Bridge Notes.


                                       28

<PAGE>   31


EMPLOYMENT AGREEMENTS

    The Company has entered into employment agreements with Messrs. Cramer
and Swayne. Each agreement expires on December 31, 1997 (the "Expiration Date")
and is automatically renewable for successive one-year periods unless written
notice of non-renewal is given by either party. Each agreement also may be
terminated by the Company with or without cause or upon the employee's death or
inability to perform his duties on account of a disability for a period of
twelve consecutive months or by the employee. If any agreement is terminated
prior to the Expiration Date for any reason, except by the employee, by the
Company for cause or upon the employee's death or disability, the Company must
continue to pay the employee's base salary and bonus either (i) for the period
from the date of termination through the Expiration Date if the agreement is
terminated prior to the first anniversary thereof or (ii) for the two year
period following the date of termination if the agreement is terminated after
the first anniversary thereof. If the agreement is terminated because of the
death or disability of the employee, the Company must pay the employee or his
beneficiaries his base salary and bonus for a period of one year following the
date of termination; provided, however, that, in the case of termination for
disability, the Company may elect, in lieu of making such payments, to provide
the employee with disability insurance coverage. The agreements provide for a
minimum base salary of $120,000 for each of Messrs. Cramer and Swayne, and for
annual discretionary bonuses. Each agreement also contains a two year
noncompetition, customer and employee nonsolicitation and confidentiality
provision. In addition, the Company has executed Employee Confidentiality,
Nondisclosure and Noncompetition Agreements with all of its employees.

COMPENSATION OF DIRECTORS

     To date, Directors have not received cash compensation for their services
as directors of the Company. In April 1997, the non-employee directors of the
Company were granted the following options to purchase Common Stock: Messrs.
McClaugherty and Gatti: 3,000 options; Messrs. Tedesco and Howe: 10,000 options.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     During fiscal 1997, the Compensation Committee of the Company consisted of
Mssrs. Cramer, Jones, and Howe. During fiscal 1997, the Company sold
approximately $11,000 of product to Addison Wesley Longman. Mr. Jones is a
director of Addison Wesley Longman. Additionally, the Company had royalty
revenues of approximately $134,000 related to Benjamin/Cummings Publishing
Company, Inc., a subsidiary of Addison Wesley Longman. The Company purchased
approximately $22,000 of product from Benjamin/Cummings during fiscal 1997 and
paid royalty expense to Benjamin/Cummings of approximately $70,000.


                                       29

<PAGE>   32


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

    The following table sets forth the beneficial ownership of shares of Common
Stock as of June 27, 1997 for (i) directors of the Company, (ii) the Named
Executive Officers, including three individuals who are no longer employed by
the Company, (iii) the directors and executive officers of the Company as a
group and (iv) each person who is a shareholder of the Company holding more than
a 5% interest in the Company. Unless otherwise indicated in the footnotes, all
of such interests are owned directly, and the indicated person or entity has
sole voting and disposition power. The number of shares represents (a) the
number of shares of Common Stock the person beneficially owns plus (b) the
number of shares issuable upon exercise of currently exercisable options and
warrants.
<TABLE>
<CAPTION>

                                                                    NUMBER
                                                                   OF SHARES
  NAME AND ADDRESS OF                                            BENEFICIALLY
  BENEFICIAL OWNER                                                   OWNED                       PERCENT OF CLASS(1)
  ----------------                                               ------------                    -------------------

<S>                                                                 <C>                               <C>  
Robert S. Cramer, Jr.(2)................................              683,557                         13.6%
Gregory M. Swayne.(3)...................................              332,854                          6.7
Curtis A. Cain..........................................                2,000                          *
Robert A. DiProva (4)...................................                5,500                          *
David Tranberg..........................................                2,000                          *
Sally D. Elliott(5).....................................                   --                          --
Daniel S. Howe (6)......................................               21,000                          *
Dr. Anthony J. Gatti(7).................................              205,000                          4.2
J. Larry Jones (8)......................................              700,000                         14.3
John W. McClaugherty....................................               26,202                          *
Francis J. Tedesco, M.D.................................                   --                          --
Addison Wesley Longman..................................              700,000                         14.3
James D. Oelschlager(9).................................              418,750                          8.5
Firestone Tire and Rubber Master Trust(10)                            356,250                          7.2
All executive officers and directors as a group
  (9 persons)(11).......................................            1,963,430                         40.1%
</TABLE>

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

*    Less than 1%.

(1)  Assumes 4,901,897 shares outstanding, excluding shares held in treasury by
     the Company. Except as indicated in the footnotes set forth below, the 
     persons named in the table, to the Company's knowledge, have sole voting 
     and investment power with respect to all shares of Common Stock shown as 
     beneficially owned by them. The number of shares shown as owned by, and 
     the voting power of, individual shareholders include shares which are not
     currently outstanding but which such shareholders are entitled to acquire 
     or will be entitled to acquire within 60 days. Suchshares are deemed to be
     outstanding for the purpose of computing the percentage of outstanding 
     Common Stock owned by the particular shareholder, but are not deemed to 
     be outstanding for the purpose of computing the percentage ownership of 
     any other person.
(2)  Includes 95,500 shares issuable upon exercise of outstanding options and
     42,938 shares issuable upon exercise of outstanding warrants, and 90,666
     shares held in trust for Mr. Cramer's children, for which Mr. Cramer
     disclaims beneficial ownership.
(3)  Includes 95,500 shares issuable upon exercise of outstanding options.
(4)  Mr. DiProva ceased to be an employee of the Company effective February 15,
     1997.


                                       30

<PAGE>   33

     Includes 5,000 shares issuable upon exercise of outstanding options.
(5)  Ms. Elliott is a director of Addison Wesley Longman.
(6)  Represents 3,000 shares issuable upon exercise of outstanding options and
     18,000 shares issuable upon exercise of outstanding warrants.
(7)  Includes 108,500 shares jointly held by Dr. Gatti and his wife. Dr. Gatti
     shares voting and dispositive power with respect to the 108,500 shares and
     disclaims beneficial ownership of such shares. Includes 70,250 shares held
     by Anthony J. Gatti, D.P.M., P.C. Money Pension Plan of which Dr. Gatti is
     Trustee and over which Dr. Gatti holds sole voting and dispositive power.
     Dr. Gatti disclaims beneficial ownership of such shares. Includes 16,250
     shares held by Anthony J. Gatti, D.P.M., P.C. Profit Sharing Plan, of which
     Dr. Gatti is Trustee and over which Dr. Gatti holds sole voting and
     dispositive power. Dr. Gatti disclaims beneficial ownership of such shares.
     Includes 5,000 shares issuable upon exercise of outstanding options.
(8)  Mr. Jones, chief executive officer and director of Addison Wesley Longman,
     disclaims beneficial ownership of these shares. Mr. Jones' address is c/o
     A.D.A.M. Software, Inc., 1600 RiverEdge Parkway, Suite 800, Atlanta,
     Georgia 30328.
(9)  Includes 356,250 shares held by the Firestone Tire and Rubber Master Trust
     (the "Firestone Trust"), for which Oak Associates, of which Mr. Oelschlager
     is President, is the fund manager. Includes 12,500 shares held by the Oak
     Associates Profit Sharing Plan and Trust, of which Mr. Oelschlager is the
     trustee. Mr. Oelschlager's address is c/o Oak Associates, 3875 Embassy
     Parkway, Suite 250, Akron, Ohio 44333. The information included in the
     table is based on statements filed with the Securities and Exchange
     Commission pursuant to Section 13(d) or 13(g) of the Securities Exchange
     Act of 1934, as amended.
(10) The Firestone Trust's address is Chemical Bank, as trustee for Firestone
     Rubber and Tire Master Trust (R.D. 4615504) c/o Oak Associates, 3875
     Embassy Parkway, Suite 250, Akron, Ohio 44333. The information included in
     the table is based on statements filed with the Securities and Exchange
     Commission pursuant to Section 13(d) or 13(g) of the Securities Exchange
     Act of 1934, as amended.
(11) Includes, for each director and executive officer, his or her respective
     shares issuable upon exercise of outstanding options and warrants.


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     On March 31, 1994, the Company entered into a license agreement (the
"MLI License Agreement") with J.S.K., Inc. ("JSK"), a company controlled by Mr.
McClaugherty, a Director of the Company, pursuant to which JSK was granted the
right to use the A.D.A.M. Image Database to produce printed customized medical
illustrations and videotapes for use by lawyers as demonstrative evidence pieces
for a two-year term in return for a fixed fee. JSK was also granted a license to
use the "Medical-Legal Illustrations" service mark for a two-year term. The
Company continues to hold all legal title in the A.D.A.M. Image Database and
owns all copyright interest in illustrations and videotapes produced by JSK
pursuant to the MLI License Agreement. The MLI License Agreement was amended on
August 30, 1995 to extend the initial term to July 7, 1997 and to fix the
monthly license fee payable to the Company at $6,200 per month. The Company also
authorized JSK to act as a reseller of the Company's products pursuant to a
Reseller Agreement dated April 24, 1994. During fiscal 1997, the Company sold
approximately $64,000 of product to JSK pursuant to the Reseller Agreement. JSK
paid the Company approximately $68,000 in licensing and rental fees during
fiscal 1997 pursuant to the MLI License Agreement.

                                       31

<PAGE>   34






     During fiscal 1997, the Company sold approximately $11,000 of product to
Addison Wesley Longman. Ms. Elliot and Mr. Jones are directors of Addison Wesley
Longman. Additionally, the Company had royalty revenues of approximately
$134,000 related to Benjamin/Cummings Publishing Company, Inc., a subsidiary of
Addison Wesley Longman. The Company purchased approximately $22,000 of product
from Benjamin/Cummings during fiscal 1997 and paid royalty expense to
Benjamin/Cummings of approximately $70,000.

     It is the Company's policy that all future transactions, if any, with
affiliated parties will be approved by the disinterested members of the
Company's Board of Directors (or a committee thereof) or by the shareholders of
the Company.

                                       32

<PAGE>   35


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, 1997 and 1996                                          F-2 
              Statement of Operations for the three years ended March 31, 1997                  F-3
              Statement of Changes in Shareholders' Equity for the
                 three years ended March 31, 1997                                               F-4
              Statement of Cash Flows for the three years ended March 31, 1997                  F-5
              Notes to Financial Statements                                                     F-6


       (2)    Financial Statement Schedule:
              For the three years ended March 31, 1997
                 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    Convertible Preferred Stock Purchase Agreement by and between the
         Company and certain investors dated as of August 30, 1995.
*10.2    ADAM/McClaugherty Termination-Redemption Agreement between the Company
         and John W. McClaugherty, dated August 30, 1995.
*10.3    Amended and Restated 1992 Stock Option Plan
*10.4    401(k) Adoption Agreement and Trust.
*10.5    Employment Agreement between the Company and Robert S. Cramer, Jr.,
         dated December 21, 1994.
*10.6    Employment Agreement between the Company and Gregory M. Swayne, dated

</TABLE>

                                       33

<PAGE>   36

<TABLE>
<S>      <C>
         December 19, 1994.
  10.7   Severance Agreement between the Company and Curtis A. Cain, dated
         September 3, 1996.
  10.8   Severance Agreement between the Company and Robert A. DiProva, dated
         January 20, 1997.
 *10.9   Publishing Agreement by and between Williams & Wilkins and the Company,
         dated February 22, 1994
 *10.10  License Agreement by and between J.S.K., Inc. and the Company, dated
         April 1, 1994, as amended on August 30, 1995.
 *10.11  Software Reseller Agreement between J.S.K., Inc. and the Company, dated
         April 29, 1994, as amended on August 30, 1995.
*+10.12  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.
*+10.13  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.
*+10.14  Software Reseller Agreement among the Company and Addison Wesley
         Longman, through its Addison Wesley School Division, dated as of
         February 9, 1995.
*+10.15  Software Reseller Agreement between Churchill Livingstone, Inc. and the
         Company, dated as of May 8, 1995.
  10.16  Amendment to Software Reseller Agreement between Churchill Livingstone,
         Inc. and the Company, dated as of December 23, 1996
 *10.17  Localization Agreement between Sunflowers Interactive Entertainment, a
         wholly- owned subsidiary of BOMICO, and the Company, dated June 28,
         1995.
 *10.18  Software Reseller Agreement between BOMICO UNTERHALTUNGSSOFT-UND-
         HARDWARE VERTRIEBS GMBH and the Company, dated June 28, 1995.
 *10.19  Distribution Agreement with Ingram Micro, dated August 10, 1995
**10.20  Addendum dated January 19, 1996 to Distribution Agreement with Ingram
         Micro, dated August 10, 1995.
 *10.21  Vendor Agreement between ABCO Distributors, Inc. and the Company, dated
         August 10, 1994.
**10.22  Publishing/Developer Agreement by and between J.S.K., Inc. and the
         Company, dated as of November 30, 1995.
**10.23  Localization Agreement between ZEMI Corp. and the Company dated June 7,
         1996.
  10.24  Letter Agreement with Mindscape, Inc., dated February 26, 1997, setting
         forth distribution terms.
  23.1   Consent of Price Waterhouse LLP
  27.1   Financial Data Schedule (for SEC use only) 
</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.
+        The Company has been granted confidential treatment of portions of this
         Exhibit. Accordingly, portions thereof have been omitted and filed
         separately.





                                       34

<PAGE>   37


(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 1997.



                                       35

<PAGE>   38
                      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 33 present fairly, in all material respects, the
financial position of A.D.A.M. Software, Inc., at March 31, 1997 and 1996, and
the results of its operations and its cash flows for each of the three years in
the period ended March 31, 1997, 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 6, 1997





                                    F - 1

<PAGE>   39


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

BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                                                MARCH 31,
                                                                            ---------------
                                                                            1997       1996
                                                                            ----       ----
                         ASSETS
<S>                                                                      <C>         <C>     
Current assets
   Cash and cash equivalents                                             $  2,422    $  5,352
   Short-term investments                                                   8,546      10,981
   Accounts receivable, net of allowances of $459
      and $766                                                                638         448
   Inventories                                                                375         433
   Prepaids and other                                                         108         115
                                                                         --------    --------
           Total current assets                                            12,089      17,329

Property and equipment, net                                                   729         889
Software development costs, net                                               487         105
Restricted certificate of deposit                                             357         548
                                                                         --------    --------
                                                                         $ 13,662    $ 18,871
                                                                         ========    ========


LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
   Accounts payable                                                      $    434    $    526
   Accrued liabilities                                                        562         614
   Accrued interest                                                            --         158
   Accrued compensation and employee benefits                                 259         182
   Accrued restructuring costs                                                189          --
   Deferred rent                                                              173         245
   Deferred revenue                                                           490          --
   Third party advances                                                        --         250
                                                                         --------    --------
           Total current liabilities                                        2,107       1,975

Long-term obligations                                                          --          --
                                                                         --------    --------
           Total liabilities                                                2,107       1,975
                                                                         --------    --------


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;
      5,274,677 and 5,234,647 shares issued and outstanding                    52          52
   Common stock warrants                                                      135         135
   Additional paid-in capital                                              33,883      33,783
   Accumulated deficit                                                    (22,515)    (17,074)
                                                                         --------    --------
                                                                           11,555      16,896
Commitments and contingencies (Note 13)

                                                                         --------    --------
                                                                         $ 13,662    $ 18,871
                                                                         ========    ========
</TABLE>



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

                                      F - 2

<PAGE>   40


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

STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>

                                                                           Year ended March 31,
                                                                    -------------------------------
                                                                        1997       1996       1995
                                                                        ----       ----       ----

<S>                                                                 <C>         <C>         <C>    
Net revenues                                                        $  4,591    $  6,447    $ 5,742
                                                                    --------    --------    -------

Cost and expenses
   Cost of revenues                                                    1,280       1,491        791
   Sales and marketing                                                 4,494       4,090      3,666
   Product development                                                 2,260       2,847      2,401
   General and administrative                                          2,369       2,008      1,774
   Restructuring charge                                                  490          --         --
                                                                    --------    --------    -------
                                                                      10,893      10,436      8,632
                                                                    --------    --------    -------
        Operating loss                                                (6,302)     (3,989)    (2,890)

Interest expense                                                          (8)       (317)      (383)
Interest income                                                          869         415         43
                                                                    --------    --------    -------
        Loss and extraordinary items before income taxes              (5,441)     (3,891)    (3,230)

Income taxes                                                              --          --         --
                                                                    --------    --------    -------
        Loss before extraordinary item                                (5,441)     (3,891)    (3,230)

   Extraordinary loss on extinguishment of debt
      (net of  income tax benefit of $29)                                 --         (46)        --
                                                                    --------    --------    -------
        Net loss                                                    $ (5,441)   $ (3,937)   $(3,230)
                                                                    ========    ========    ======= 

Net loss per common share and common share equivalent
   Loss before extraordinary item                                   $  (1.03)   $  (1.13)   $ (1.22)
   Loss from extraordinary item                                           --        (.01)        --
                                                                    --------    --------    -------
Net loss per common share                                           $  (1.03)   $  (1.14)   $ (1.22)
                                                                    ========    ========    ======= 


Weighted average number of common shares and
   common share equivalents outstanding                                5,258       3,673      2,694
                                                                    ========    ========    ======= 

Unaudited pro forma and supplemental earnings per share
   Pro forma net loss per common share                                          $   (.99)   $ (1.17)
                                                                                ========    ======= 

   Pro forma weighted average number of common
      shares outstanding                                                           3,962      2,766
                                                                                ========    ======= 

   Supplemental pro forma net loss per common share                             $   (.92)          
                                                                                ========           

   Supplemental pro forma weighted average number of
      common shares outstanding                                                    4,055           
                                                                                ========           

</TABLE>


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

                                      F - 3

<PAGE>   41


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

STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY 
(IN THOUSANDS, EXCEPT SHARE DATA)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>

                                                                        
                                                  COMMON STOCK          ADDITIONAL    COMMON               
                                             ---------------------       PAID-IN      STOCK     ACCUMULATED
                                              SHARES        AMOUNT       CAPITAL     WARRANTS      DEFICIT        TOTAL
                                              ------        ------       -------     --------      -------        -----
<S>                                          <C>            <C>       <C>            <C>        <C>           <C>      
BALANCE AT MARCH 31, 1994                    2,687,254      $  27     $   10,165     $     -    $   (8,908)   $   1,284
Net loss                                             -          -              -           -        (3,230)      (3,230)
Accretion of discount on mandatorily
   redeemable convertible preferred stock            -          -            (47)          -             -          (47)
Notes receivable received for
   stock options exercised                           -          -            (43)          -             -          (43)
Exercise of common stock options                 9,633          -             93           -             -           93
                                             ---------      -----     ----------     -------    ----------    ---------

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
Net loss                                             -          -              -           -        (3,937)      (3,937)
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
                                             ---------      -----     ----------     -------    ----------    ---------

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

BALANCE AT MARCH 31, 1997                    5,274,647      $  52     $   33,883     $   135    $  (22,515)   $  11,555
                                             =========      =====     ==========     =======    ==========    =========
</TABLE>


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

                                      F - 4

<PAGE>   42


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

STATEMENT OF CASH FLOWS
(In thousands)
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>

                                                                                   YEAR ENDED MARCH 31,
                                                                          ---------------------------------------
                                                                             1997          1996          1995
                                                                             ----          ----          ----
<S>                                                                       <C>           <C>           <C>        
Cash flows from operating activities
   Net loss                                                               $   (5,441)   $   (3,937)   $   (3,230)
   Adjustments to reconcile net loss to net cash used
      in operating activities
        Depreciation and amortization                                            576           796           562
        Accretion                                                                  -          (118)            -
        Loss on extinguishment of debt                                                          75             -
        Changes in assets and liabilities
           (Increase) decrease in accounts receivable                           (190)          576          (477)
           Decrease (increase) in inventories                                     58          (263)          (14)
           Decrease (increase) in prepaids and other assets                        7          (115)            -
           (Decrease ) increase in accounts payable                              (92)          129          (141)
           (Decrease ) increase in accrued liabilities                           (52)          168          (499)
           (Decrease) increase in accrued interest                              (158)          (13)          132
           Increase in accrued compensation and
              employee benefits                                                   77            52            26
           Increase in accrued restructuring costs                               189             -             -
           (Decrease) increase in deferred rent                                  (72)           49           137
           Increase in deferred revenue                                          490             -             -
           Decrease in third party advances                                     (250)            -             -
                                                                          ----------    ----------    ---------- 
              Net cash used in operating activities                           (4,858)       (2,601)       (3,504)
                                                                          ----------    ----------    ---------- 


Cash flows from investing activities
   Purchases of short-term investments                                       (29,363)      (20,803)            -
   Proceeds from sale of short-term investments                               31,798        10,000             -
   Purchases of property and equipment                                          (297)         (315)         (180)
   Redemption of restricted certificate of deposit                               191           183           167
   Software development costs                                                   (501)          (93)         (449)
                                                                          ----------    ----------    ---------- 
              Net cash used in investing activities                            1,828       (11,028)         (462)
                                                                          ----------    ----------    ---------- 


Cash flows from financing activities
   Proceeds from issuance of common stock, net of
      issuance costs, and exercise of options                                    100        17,691             7
   Repurchase of common stock                                                      -        (1,000)            -
   Proceeds from issuance of mandatorily redeemable
      preferred stock, net of issuance costs                                       -         3,928         1,975
   Proceeds from issuance of subordinated debt                                     -             -         2,244
   Borrowings under line of credit                                                 -             -           291
   Repayments under line of credit                                                 -             -          (291)
   Repayments of notes payable                                                     -        (2,578)          (36)
                                                                          ----------    ----------    ---------- 
              Net cash provided by financing activities                          100        18,041         4,190
                                                                          ----------    ----------    ---------- 


(Decrease) increase in cash and cash equivalents                              (2,930)        4,412           224
Cash and cash equivalents, beginning of period                                 5,352           940           716
                                                                          ----------    ----------    ---------- 
Cash and cash equivalents, end of period                                  $    2,422    $    5,352    $      940
                                                                          ==========    ==========    ==========
</TABLE>




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

                                      F - 5

<PAGE>   43


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 their customers. 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. Revenues
      from royalty agreements are recognized as earned based upon performance or
      product shipment. 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.

      A significant portion of the Company's revenues and related receivables
      are from major distributors. At March 31, 1997, the Company had
      receivables from each of two major

                                      F - 6

<PAGE>   44


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

      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.

      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 ranges from 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 CERTIFICATE OF DEPOSIT
      In connection with the Company's noncancelable operating lease for its
      office space, the Company is required to purchase certificates of deposit
      with a bank securing a letter of credit guaranteeing rental payments under
      the lease (see Note 13). The certificate of deposit matures May 27, 1997,
      bears interest at 4.75% and is carried at cost which approximates market.


                                      F - 7

<PAGE>   45


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

      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
 .
      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 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.

      LOSS PER COMMON SHARE
      Net loss per share is computed using the weighted average number of common
      shares and common share equivalents outstanding during 1997, 1996 and
      1995. The 1996 and 1995 loss per common share gives effect to the
      accretion of discount on mandatorily redeemable preferred stock. The
      Company's stock options and warrants are excluded from the calculation of
      loss per common share due to their anti-dilutive effect.

      PRO FORMA NET LOSS PER COMMON SHARE (UNAUDITED)
      Pro forma net loss per common share has been included to give effect to
      the conversion of the Company's outstanding Convertible Preferred Stock
      upon consummation of the initial public offering (see Notes 8 and 9).

      Pro forma net loss per common share is computed using the weighted average
      number of common shares and common share equivalents outstanding during
      1996 and 1995. The number of pro forma weighted average shares outstanding
      during 1996 and 1995 is based on the number of weighted average shares
      outstanding in each period after giving effect to the estimated number of
      additional shares (289,000 in fiscal 1996 and 72,000 in fiscal 1995) that
      would have been outstanding upon conversion of the mandatorily redeemable
      preferred stock. The Company's stock options and warrants are excluded
      from the 1996 and 1995 calculation of pro forma net loss per common share
      due to their anti-dilutive effect.

      SUPPLEMENTAL PRO FORMA NET LOSS PER COMMON SHARE (UNAUDITED)
      Supplemental pro forma net loss per common share for 1996 is computed
      using the pro forma weighted average number of shares of common stock and
      common stock equivalents increased by the estimated number of additional
      shares to repay certain indebtedness. This payment was

                                      F - 8

<PAGE>   46


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

      effected after consummation of the initial public offering. Pro forma net
      loss is decreased to give effect to the reduction in interest costs of
      approximately $187,000 in fiscal 1996.

      RECENT ACCOUNTING PRONOUNCEMENT
      In February 1997, the Financial Accounting Standards Board issued SFAS
      128, "Earnings per Share". SFAS 128 will be effective for financial
      statements for periods ending after December 31, 1997, including interim
      periods, and establishes standards for computing and presenting earnings
      per share. In its financial statements for the year ending March 31, 1998,
      the Company will make the required disclosures of basic and diluted
      earnings per share, as applicable, and provide a reconciliation of the
      numerator and denominator of its basic and diluted earnings per share
      computations. All prior period earnings per share data will be restated by
      the Company in the period of adoption of SFAS 128, which is not expected
      to have a material effect on the presentation of the Company's earnings
      (loss) per common share data.


2.    MARKETABLE SECURITIES

      On March 31, 1997 and 1996, 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. Held-to-maturity securities at March 31, 1997 included the
      following (in thousands):
<TABLE>
<CAPTION>
                                                                                                             GROSS
                                                                               AMORTIZED        FAIR       UNREALIZED
                                                                                 COST           VALUE      GAIN/(LOSS)
                                                                                 ----           -----      -----------
<S>                                                                             <C>             <C>             <C>
AMEX Commercial Paper, face value of
      $1,000,000, interest at 5.24% due April 1, 1997                           $  999          $  999          $--

Ford Motor Credit Paper, face value of
      $1,000,000, interest at 5.23%, due April 2, 1997                             999             995          (4)


Ford Motor Credit Paper, face value of
      $1,000,000, interest at 5.22%, due April 28, 1997                          1,013           1,013          --

Northwest Financial Commercial Paper, face value
      of $1,000,000, interest at 5.21%, due May 13,
      1997                                                                       1,010           1,009          (1)

John Deere Commercial Paper, face value of
      $1,000,000, interest at 5.24%, due May 14, 1997                            1,010           1,009          (1)

</TABLE>

                                      F - 9

<PAGE>   47


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
<TABLE>
      <S>                                                                             <C>             <C>               <C>
      GE Capital Commercial Paper, face value of
            $500,000, interest at 5.27%, due May 22, 1997                                505              505            --

      AMEX Commercial Paper, face value of
            $1,000,000, interest at 5.15%, due June 24, 1997                           1,005            1,004            (1)

      GE Capital Commercial Paper, face value of
            $1,000,000, interest at 5.45%, due June 24, 1997                           1,001            1,003             2

      GE Capital Commercial Paper, face value of
            $1,000,000, interest at 5.22%, due June 27, 1997                           1,004            1,004            --
                                                                                      ------          -------           ---
                                                                                      $8,546          $ 8,541           $(5)
                                                                                      ======          =======           ===
</TABLE>


      Net unrealized losses on held-to-maturity securities have not been
      recognized in the accompanying financial statements. There were no
      realized gains or losses for the years ended March 31, 1997, 1996 and
      1995.


3.    INVENTORIES

      The components of inventory are summarized as follows (in thousands):
<TABLE>
<CAPTION>
                                                   MARCH 31,
                                              ------------------
                                              1997          1996
                                              ----          ----
 
      <S>                                     <C>           <C> 
      Raw materials                           $158          $274
      Finished goods                           217           159
                                              ----          ----
                                              $375          $433
                                              ====          ====
</TABLE>



4.    PROPERTY AND EQUIPMENT

      Property and equipment is summarized as follows (in thousands):
<TABLE>
<CAPTION>
                                                                                     MARCH 31,
                                                                              ----------------------
                                                                              1997              1996
                                                                              ----              ----

       <S>                                                                   <C>               <C>    
       Computers                                                             $ 1,260           $ 1,073
       Equipment                                                                 271               257
       Furniture and fixtures                                                    528               545
       Leasehold improvements                                                    151               167
                                                                             -------           -------
                                                                               2,210             2,042
       Less - Accumulated depreciation and amortization                       (1,481)           (1,153)
                                                                             -------           -------
                                                                             $   729           $   889
                                                                             =======           =======
</TABLE>



                                     F - 10

<PAGE>   48


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

      Depreciation and amortization of property and equipment totaled
      approximately $457,000, $440,000 and $443,000 for 1997, 1996 and 1995,
      respectively.


5.    PRODUCT DEVELOPMENT EXPENDITURES

      Product development expenditures are summarized as follows (in thousands):
<TABLE>
<CAPTION>

                                                                    YEAR ENDED MARCH 31,
                                                         -----------------------------------------
                                                         1997              1996               1995
                                                         ----              ----               ----

       <S>                                              <C>               <C>               <C>    
       Total development expenditures                   $ 2,761           $ 2,940           $ 2,850
       Less: Additions to capitalized software
          development, prior to amortization               (501)              (93)             (449)
                                                        -------           -------           -------
       Product development expense                      $ 2,260           $ 2,847           $ 2,401
                                                        =======           =======           =======
</TABLE>



      The activity in the capitalized software development account is summarized
      as follows (in thousands):
<TABLE>
<CAPTION>
                                                                      YEAR ENDED MARCH 31,
                                                               ------------------------------------
                                                               1997           1996             1995
                                                               ----           ----             ----
       <S>                                                    <C>             <C>             <C>  
       Balance at beginning of year, net                      $ 105           $ 368           $  38
       Additions                                                501              93             449
       Amortization expense                                    (119)           (356)           (119)
                                                              -----           -----           -----
       Balance at end of year, net                            $ 487           $ 105           $ 368
                                                              =====           =====           =====
</TABLE>


      Capitalized software development costs of approximately $469,000, $-0- and
      $140,000 at March 31, 1997, 1996 and 1995, respectively, were not subject
      to amortization as products were not available for general release.


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 fiscal 1997.


                                     F - 11

<PAGE>   49


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

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


7.    INCOME TAXES

      At March 31, 1997, the Company had net operating loss and general business
      credit carryforwards available for tax purposes of approximately
      $19,912,000 and $150,000, respectively, which will expire in years 2007
      through 2012. 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 preownership change net operating
      loss carryforwards.

      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 loss before income taxes and extraordinary item as a result of
      the following (in thousands):
<TABLE>
<CAPTION>

                                                                                   YEAR ENDED MARCH 31,
                                                                      --------------------------------------------
                                                                        1997              1996              1995
                                                                        ----              ----              ----
       <S>                                                            <C>               <C>               <C>     
       Federal tax benefit loss before income
          taxes and extraordinary item at statutory
          federal income tax rate                                     $(1,850)          $(1,319)          $(1,098)

       (Increase) decrease due to:
          Change in valuation allowance                                 2,042             1,430             1,264
          State taxes                                                    (255)             (117)             (128)
          Research and development credits                                (38)              (12)              (51)
          Other                                                           101                18                13
                                                                      -------           -------           ------- 
                                                                      $     -          $      -           $     -
                                                                      =======           =======           ======= 

</TABLE>



                                     F - 12

<PAGE>   50


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

      The components of the Company's deferred tax assets and liabilities are as
      follows (in thousands):
<TABLE>
<CAPTION>
                                                            MARCH 31,
                                                      ----------------------
                                                      1997              1996
                                                      ----              ----
       <S>                                          <C>               <C>    
       Deferred tax assets
          Fixed assets                              $    --           $    23
          Accrued expenses                              229                94
          Deferred revenue                              186                --
          Allowance for doubtful accounts               174               286
          Research and development credits              150               111
          Net operating loss carryforwards            7,559             5,609
                                                    -------           -------
                                                      8,298             6,123
                                                    -------           -------
       Deferred tax liabilities
          Software development cost                    (185)              (40)
          Fixed assets                                   12                --
                                                    -------           -------
                                                       (173)              (40)
                                                    -------           -------

       Net deferred tax asset before
          valuation allowance                         8,125             6,083

       Valuation allowance                           (8,125)           (6,083)
                                                    -------           -------
                                                    $     -           $     -
                                                    =======           =======
</TABLE>


      Net tax assets increased approximately $2,042,000 for the year ended March
      31, 1997, primarily due to an increase in net operating loss
      carryforwards. Due to the existence of continuing losses, the Company
      recorded a corresponding increase in the valuation allowance of
      $2,042,000. Management's estimate of the valuation allowance could be
      effected in the near term based on taxable income generated in future
      years.


8.    MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK

      During fiscal 1996 and 1995, the Company issued 500,000 shares and 262,500
      shares, respectively, of Series A mandatorily redeemable convertible
      preferred stock (Convertible Preferred Stock) at $8.00 per share. The
      Convertible Preferred Stock was convertible into a like number of shares
      of the Company's common stock. The call features of the Convertible
      Preferred Stock allowed for redemption by the Company of the stock
      beginning on the fifth anniversary of the initial issuance of the
      Convertible Preferred Stock, and on each anniversary thereafter. Holders
      of the Convertible Preferred Stock could redeem the stock beginning on the
      fifth anniversary of the initial issuance of the Convertible Preferred
      Stock. The redemption price included a guaranteed annual return of 10% per
      share and the conversion feature expired on the

                                     F - 13

<PAGE>   51


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

      tenth anniversary of the initial issuance of the Convertible Preferred
      Stock. Accretion of the discount on the Convertible Preferred Stock was
      recorded as a charge to additional paid-in capital and a credit to the
      Convertible Preferred Stock account.

      Upon consummation of the initial public offering discussed in Note 9, the
      762,500 shares were automatically converted into an equal number of common
      shares.


9.    SHAREHOLDERS' EQUITY

      In November 1995, the Company completed an initial public offering (the
      Offering) of 2,000,000 shares of its common stock comprised of 1,558,600
      newly-issued Company shares and 441,400 shares sold by selling
      shareholders. Employees and certain shareholders exercised 191,200 options
      and sold the shares obtained as part of the Offering. The Company used a
      portion of the proceeds from the offering to repay indebtedness and for
      general corporate purposes.


10.   COMMON STOCK, OPTIONS AND WARRANTS

      A.D.A.M. has two stock option plans 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 as estimated by the 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 have been exercised or expired. No
      further grants under the 1991 Option Plan are authorized.

      In addition to the options granted under A.D.A.M.'s incentive and
      non-qualified stock option plans, A.D.A.M. also 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 are immediately exercisable and expire five years from the date of
      grant with the exception of 17,000 and 2,000 options granted during fiscal
      1997 and 1996, respectively, which vest one year from the date of grant
      and 6,000 and 5,000 options granted during fiscal 1996 and 1995,
      respectively, which expire ten years from the date of grant.

      Additionally, in June 1993, the Company issued options to purchase 245,000
      shares of its common stock to an investor at $11.11 per share. These
      options expired in June 1995 without exercise. In August 1995, the Company
      issued options to purchase 64,658 shares of its common stock to an
      investor at $11.11 per share. These options expired in August 1996 without
      exercise.


                                     F - 14

<PAGE>   52


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

      Transactions related to stock options for the three years ended March 31,
1997 are as follows:
<TABLE>
<CAPTION>

                                                                                                OPTION PRICE
                                                                                SHARES            PER SHARE
                                                                                ------            ---------
      <S>                                                                      <C>            <C>
      Outstanding at March 31, 1994                                            1,446,427      $   2.00-11.11

         Granted                                                                 151,900          8.00-11.11
         Exercised                                                                (9,633)          3.00-7.00
         Canceled or expired                                                     (93,067)         5.00-11.11
                                                                               ---------      --------------
      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
                                                                               =========      ==============
</TABLE>


      The options outstanding at March 31, 1997 for 444,523 shares are
      exercisable at prices ranging from $2.25 to $12.00 per share for a total
      exercise value of approximately $2,985,000. 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 - 15

<PAGE>   53


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

11.   STOCK COMPENSATION

      The Company has adopted the disclosure only provisions of SFAS 123,
      "Accounting for Stock-Based Compensation." Accordingly, no compensation
      cost has been recognized for options issued to employees under the stock
      option plan. 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 1997 and 1996 consistent with the provisions of
      SFAS 123, the Company's net loss and loss per share would have been
      changed to the pro forma amounts indicated below (in thousands, except per
      share amounts):
<TABLE>
<CAPTION>
                                                                 1997           1996

         <S>                                               <C>             <C>         
         Net loss            As reported                   $     (5,441)   $    (3,937)
                             Pro forma                           (5,566)        (4,395)

         Net loss per share
            Primary          As reported                   $      (1.03)   $     (1.14)
                             Pro forma                            (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 1997 and 1996,
      respectively: dividend yield of 0% for all years; expected volatility of
      56% for all years; risk-free interest rate of 5.88% and 6.22%; 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, 1997 and 1996 and changes during the years ending on those dates is
      presented below:
<TABLE>
<CAPTION>
                                                                         1997                        1996
                                                                 ----------------------       ----------------------
                                                                               WEIGHTED                     WEIGHTED
                                                                                AVERAGE                     AVERAGE
                                                                               EXERCISE                     EXERCISE
               OPTIONS                                            SHARES         PRICE         SHARES        PRICE

     <S>                                                        <C>           <C>            <C>          <C>      
     Outstanding at beginning of year                            1,129,735    $   6.20        1,495,627   $    5.85
     Granted                                                        83,400        2.41          449,758       17.11
     Exercised                                                     (40,000)       2.41         (341,660)       3.48
     Forfeited                                                    (551,108)       6.75         (473,990)       7.28
                                                                ----------                   ----------
     Outstanding at end of year                                    622,027        6.03        1,129,735        6.20
                                                                ==========                   ==========

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

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



                                     F - 16

<PAGE>   54


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

      The following table summarizes information about stock options outstanding
at March 31, 1997:
<TABLE>
<CAPTION>

                                                              OPTIONS OUTSTANDING               OPTIONS EXERCISABLE
                                                   -----------------------------------      -----------------------
                                                                 WEIGHTED
                                                                  AVERAGE     WEIGHTED                     WEIGHTED
                                                     NUMBER      REMAINING     AVERAGE        NUMBER        AVERAGE
                  RANGE OF                         OUTSTANDING  CONTRACTUAL   EXERCISE      EXERCISABLE    EXERCISE
               EXERCISE PRICES                     AT 3/31/97      LIFE         PRICE       AT 3/31/97       PRICE

              <S>                                    <C>        <C>            <C>             <C>        <C>         
              $  2.25 to 2.50                         66,800    7.3 years      $  2.36          10,000    $   2.25
              $  4.75 to 7.00                        289,459    4.7               5.80         284,792        5.82
              $  8.00 to 12.00                       265,768    8.6               8.84         149,731        9.08
                                                     -------                                   -------
              $  2.25 to 12.00                       622,027    6.6               6.73         444,523        6.84
                                                     =======                                   =======
</TABLE>



12.   RELATED PARTY TRANSACTIONS

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

      During fiscal 1997 and 1996, the 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 conjunction with the initial
      public offering discussed in Note 9.

      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 bearing interest at 15%, payable in quarterly
      instalments, were 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 initial public
      offering discussed in Note 9. The related warrants are outstanding as of
      March 31, 1997.



                                     F - 17

<PAGE>   55


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

13.   COMMITMENTS AND CONTINGENCIES

      The Company leases office space and equipment under noncancelable lease
      agreements expiring on various dates through 2002. At March 31, 1997,
      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>       
                  1998                                               401
                  1999                                               481
                  2000                                               463
                  2001                                               463
                  2002                                               463
                  Thereafter                                         116
                                                              ----------
                                                              $    2,387
                                                              ==========
</TABLE>



      Rent expense for the years ended March 31, 1997, 1996 and 1995 was
      approximately $640,000, $663,000 and $670,000, respectively.

      The Company is required to secure rental payments under the office space
      lease agreement with a letter of credit supported by certificates of
      deposit. The amount of the certificates of deposit securing the letter of
      credit decreases over the term of the lease.

      During December 1994, the Company entered into employment agreements with
      certain officers of the Company. Each agreement expires on December 31,
      1997 (the Expiration Date) and is automatically renewable for successive
      one-year periods unless written notice of non-renewal is given by either
      party. If the agreements are terminated without cause, the Company will be
      obligated to pay certain amounts as specified by the agreements. One
      agreement was terminated during fiscal 1997 in conjunction with the
      restructuring discussed in Note 16. Amounts remaining to be paid under the
      terminated agreement at March 31, 1997 are approximately $75,000 and are
      included in accrued restructuring in the accompanying balance sheet.

      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.

                                     F - 18

<PAGE>   56


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------


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 1997, 1996 and 1995 were
      approximately $-0-, $329,000 and $252,000, respectively.

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

                                                                                     YEAR ENDED MARCH 31,
                                                                                 ----------------------------        

                                                                                 1997      1996          1995
                                                                                 ----      ----          ----

      <S>                                                                          <C>  <C>           <C>
      Notes receivable taken for stock options exercised                           -             -    $    43
      Additions to common stock through decreases in
         accrued liabilities                                                       -             -    $    43
      Convertible Preferred Stock accretion                                        -    $      244    $    47
      Conversion of 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 periods
      ended March 31, 1997, 1996 and 1995, the Company had net revenue from
      international sales of approximately $709,000, $983,000 and $1,645,000,
      respectively. A summary of revenues by geographic area is as follows (in
      thousands):
<TABLE>
<CAPTION>

                                                                                   YEAR ENDED MARCH 31,
                                                                            ---------------------------------
                                                                            1997           1996          1995
                                                                            ----           ----          ----

           <S>                                                            <C>           <C>           <C>       
           United States                                                  $    3,882    $    5,464    $    4,097
           Europe                                                                474           359           633
           Pacific Rim and Asia                                                  119           370           791
           Other                                                                 116           254           221
                                                                          ----------    ----------    ----------
                                                                          $    4,591    $    6,447    $    5,742
                                                                          ==========    ==========    ==========
</TABLE>


      No geographic region within Europe accounted for more than 10% of total
      sales during the three year period ended March 31, 1997.



                                     F - 19

<PAGE>   57


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

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

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 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
      is approximately $189,000.


17.   SUBSEQUENT EVENT

      During April 1997, the Board of Directors adopted a stock repurchase
      program. The program authorizes 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. 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.

      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.






                                     F - 20

<PAGE>   58



                                                                     SCHEDULE II


                                A.D.A.M. SOFTWARE
                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS



                        FOR THE YEAR ENDED MARCH 31, 1997
                             (THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>

                                                  BALANCE AT                                          BALANCE AT
                                                   BEGINNING        CHARGED TO          ACCOUNTS          END
                                                      OF             COSTS AND           WRITTEN          OF
     DESCRIPTION                                    PERIOD           EXPENSES              OFF          PERIOD
     -----------                                    ------           --------              ---          ------

<S>                                             <C>                 <C>                <C>            <C>       
Allowance for Doubtful Accounts                 $       766         $        79        $     386      $      459
                                                ===========         ===========        =========      ==========
</TABLE>



                        FOR THE YEAR ENDED MARCH 31, 1996
                             (THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>

                                                  BALANCE AT                                          BALANCE AT
                                                   BEGINNING        CHARGED TO          ACCOUNTS          END
                                                      OF             COSTS AND           WRITTEN          OF
     DESCRIPTION                                    PERIOD           EXPENSES              OFF          PERIOD
     -----------                                    ------           --------              ---          ------

<S>                                             <C>                 <C>                <C>            <C>       
Allowance for Doubtful Accounts                 $       110         $       687        $      31      $      766
                                                ===========         ===========        =========      ==========
</TABLE>



                        FOR THE YEAR ENDED MARCH 31, 1995
                             (THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>

                                                  BALANCE AT                                          BALANCE AT
                                                   BEGINNING        CHARGED TO          ACCOUNTS          END
                                                      OF             COSTS AND           WRITTEN          OF
     DESCRIPTION                                    PERIOD           EXPENSES              OFF          PERIOD
     -----------                                    ------           --------              ---          ------

<S>                                             <C>                 <C>                <C>            <C>       
Allowance for Doubtful Accounts                 $        51         $        53        $      (6)     $      110
                                                ===========         ===========        =========      ==========
</TABLE>




<PAGE>   59



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 27, 1997

    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 27, 1997.
<TABLE>
<CAPTION>


                  Signature                                                 Title
                  ---------                                                 -----

           <S>                                              <C>
           Robert S. Cramer, Jr.                            Chairman of the Board, Co-Founder, Chief
           ---------------------------                      Executive Officer, and Director (Principal
           Robert S. Cramer, Jr.                            Executive Officer)                        


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


           Michael S. Fisher                                Director of Finance/Administration
           ---------------------------                      (Principal Financial Officer)
           Michael S. Fisher                                


           John W. McClaugherty                             Director
           ---------------------------
           John W. McClaugherty


           Sally D. Elliott                                 Director
           ---------------------------
           Sally D. Elliott


                                                            Director
           ---------------------------
           Dr. Anthony J. Gatti


                                                            Director
           ---------------------------
           J. Larry Jones



           Daniel S. Howe                                   Director
           ---------------------------
           Daniel S. Howe


           Francis J. Tedesco, M.D.                         Director
           ---------------------------
           Francis J. Tedesco, M.D.
</TABLE>