**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-KSB**

 
| **(Mark One)** |
|----------------|
| **ý**     | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE  SECURITIES EXCHANGE ACT OF 1934** |
| ** **     | ** ** |
| ** **     | **For the fiscal year ended December 31,  2005** |
| ** **     | ** ** |
| ** **     | **OR** |
| ** **     | ** ** |
| **o**          | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| ** **     | ** ** |
| ** **     | **For the transition period from** |

 

**CommissionFile Number 0-26962**

 

**A.D.A.M., INC.**

(Exact name of registrant asspecified in its charter)

 

| **Georgia**               | ** ** | **58-1878070**                     |
|---------------------------|------------|------------------------------------|
| (State of  incorporation) |       | (IRS  Employer Identification No.) |

 

**1600RiverEdge Parkway, Suite 100**

**Atlanta,Georgia 30328**

(Address of Principal ExecutiveOffices, Zip Code)

 

Issuer’s telephone number,including area code:

**(770) 980-0888**

 

Securities registered under Section 12(b) ofthe Act:

**None**

 

Securities registered under Section 12(g) ofthe Act:

 
| ** ** | ** ** | **Title of each class** | ** ** | ** ** | ** ** |
|------------|------------|----------------------------------------|------------|------------|------------|
|       |       | Common  Stock, par value $.01          |       |       |       |

 

Check whetherthe issuer is not required to file reports pursuant to Section13 or 15(d) ofthe Exchange Act.

 

Check whetherthe issuer (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes ýNo o

 

Check if thereis no disclosure of delinquent filers in response to Item 405 ofRegulation S-B is not contained in this form, and no disclosure will becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-KSBor any amendment to this Form 10-KSB. ý

 

Indicate bycheck mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes oNo ý

 

The revenuesfor the year ended December 31, 2005, the most recent fiscal year, were $10,053,484.

 

The aggregatemarket value of the common equity held by non-affiliates of the Registrant(assuming for these purposes, but without conceding, that all executiveofficers and directors are “affiliates” of the Registrant) as of March 7, 2006(based on the closing sale price of the Registrant’s common stock, as reportedon the Nasdaq SmallCap Market on such date) was $82,975,532. There were 8,590,294shares of common stock outstanding on March 7, 2006.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions ofthe registrant’s proxy statement for its 2006 Annual Meeting of Shareholdersare incorporated herein by reference in response to Part III of this Form 10-KSB.

 

TransitionalSmall Business Disclosure Format Yes oNo ý

 

 

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**TABLE OFCONTENTS**

 
| **PART I.**   | ** **                                                                                                                  | ** ** |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------|------------|
| Item 1.            | Description of Business                                                                                                     |       |
| Item 2.            | Description of Property                                                                                                     |       |
| Item 3.            | Legal Proceedings                                                                                                           |       |
| Item 4.            | Submission of Matters to a Vote of Security  Holders                                                                        |       |
|               |                                                                                                                        |       |
| **PART II.**  | ** **                                                                                                                  | ** ** |
| Item 5.            | Market for Common Equity, Related  Stockholder Matters, and Small Business Issuer Purchases of Equity Securities            |       |
| Item 6.            | Management’s Discussion and Analysis or  plan of Operation                                                             |       |
| Item 7.            | Financial Statements                                                                                                        |       |
| Item 8.            | Changes In and Disagreements with  Accountants on Accounting and Financial Disclosure                                       |       |
| Item 8A.           | Controls and Procedures                                                                                                     |       |
| Item 8B.           | Other Information                                                                                                           |       |
|               |                                                                                                                        |       |
| **PART III.** | ** **                                                                                                                  | ** ** |
| Item 9.            | Directors, Executive Officers, Promoters  and Control Persons; Compliance with Section 16(a) of the Exchange  Act |       |
| Item 10.           | Executive Compensation                                                                                                      |       |
| Item 11.           | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                             |       |
| Item 12.           | Certain Relationships and Related  Transactions                                                                             |       |
| Item 13.           | Exhibits                                                                                                                    |       |
| Item 14.           | Principal Accountant Fees and Services                                                                                      |       |

 

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**PART I.**

 

**DisclosureRegarding Forward Looking Statements**

 

Certain statements made in thisreport, and other written or oral statements made by or on behalf of A.D.A.M., Inc.,may constitute “forward-looking statements” under the Private SecuritiesLitigation Reform Act of 1995, which represent the expectations or beliefsof, including, but not limited to, statements concerning the issuer’soperations, performance, financial condition and growth. For this purpose, anystatements contained in this Report that are not statements of historical fact may bedeemed forward-looking statements. Without limiting the generality of theforegoing, when used in this report, the word “believes,” “expects,” “estimates,”“intends,” “will,” “may,” “anticipate,” “could,” “should,” “can,” or “continue”or the negative or other variations thereof or comparable terminology areintended to identify forward-looking statements. Examples of such statements inthis report include descriptions of our plans and strategies with respect todeveloping certain market opportunities, our overall business plan, our plansto develop additional strategic partnerships, our intention to develop ourproducts and platform technologies, our continuing growth and our abilityto contain our operating expenses. All forward-looking statements are subjectto certain risks and uncertainties that could cause actual events to differmaterially from those projected, including those described under the caption “FactorsAffecting Future Performance” in Item 1 of this Report. We believe that theseforward-looking statements are reasonable; however, you should not place unduereliance on such statements. These statements are based on current expectationsand speak only as of the date of such statements. We undertake no obligation topublicly update or revise any forward-looking statement, whether as a result offuture events, new information or otherwise.

 

**ITEM 1. DESCRIPTION OF BUSINESS**

 

**Overview**

 

We specialize in the creationand delivery of interactive health content and applications that can be used bya broad range of healthcare consumers – from those with low health literacy tothose who play an active and ongoing role in their personal health management.Our health information can be used for learning about general health concerns,specific diseases, medical conditions and treatments, surgical procedures, druginformation, specialty health subjects such as women’s and children’s health,nutrition, alternative medicine and more. Our health applications, such as ourHealth Risk Assessment library, allow consumers to learn more about theirhealth by providing them with relevant feedback regarding their healthcondition to help in making better decisions.

 

Our health content productsmeet rigorous editorial and quality assurance standards. We use an extensivenetwork of physicians and specialists who continually review and update theinformation in our products. We add to our content library when needed, such aswhen important health issues arise or when our customers request specificproducts to support their product and service offerings. Our health informationis accredited by URAC, an industry leading accreditation organization, and weare a founding member of Hi-Ethics, a coalition of the most widely referencedhealth websites and information providers committed to developing industrystandards for the quality of consumer health information.

 

We believe that our healthinformation products, applications and technology are unique in the industry.One of our most valuable strengths, and competitive advantages, is a large,proprietary content library and content management system. This libraryincludes:

 

•                  More than 4,000health reference articles on disease, conditions, symptoms, surgeries,nutrition and medical tests;

 

•                  Over 40,000catalogued medical illustrations that we have developed;

 

•                  Thousands ofweb-enabled animations depicting disease states and other medical conditions,many of which are broadcast quality;

 

•                  Interactivetools that enhance and complement the functionality of our health contentproducts;

 

•                  Uniquetechnology for viewing the anatomy of the human body; and

 

•                  Proprietarycontent management and delivery technology that allow us to deliver our contentproducts to a customer’s specification efficiently and cost effectively as wellas providing them with tools that assist in the integration and maintenance ofthe content on their web sites.

 

We sell ourhealth content products and healthcare related applications primarily throughannual licensing agreements to many different types of healthcare andhealth-related organizations including hospitals, health plans, integrators,pharmaceutical companies, care management vendors, health-oriented Internetwebsites, healthcare technology companies and employers. Our 

 

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products can be incorporatedinto a customer’s website, imbedded in healthcare applications such as anelectronic medical record or disease management applications, contained in a printedor CD-ROM format, or combined with other products that may be offered to ahealthcare consumer.

 

Healthcareorganizations can use our products and technology primarily in two ways:

 

•                  To increase theutilization of their products and services; and

 

•                  To improvehealth outcomes and manage the appropriateness of care.

 

In both of these applications,we believe that health content plays a vital role in helping theseorganizations achieve their business objectives, while adding value for thehealthcare consumer. We also work with some of the leading companies in thehealthcare industry to integrate our health information into applications suchas electronic medical records and care management applications where specifichealth information relating to a patient or plan member’s condition ordiagnosis can be made available to them through a secure, personalized websiteor “patient or member portal.”

 

Our content products are alsodesigned to address the proliferation of low health literacy — the inability toread, understand or act on health information. According to a recent study bythe Center for Healthcare Strategy, low health literacy is estimated to costthe U.S. healthcare industry approximately $32 to $58 billion a year. Thedirect medical cost impact of low health literacy results in additionalhospital and office visits, longer hospital stays, increased number of medicaltests and procedures and additional prescriptions. It spans ethnic boundariesand social classes and is estimated to impact nearly one in three people in theU.S. Our products take advantage of various educational techniques, such as theuse of visual aids and interactive media, which allow healthcare organizationsto reach consumers at multiple reading levels. The use of visuals has beenproven to assist in the understanding and retention of complex information, andwe have been at the forefront of providing visually engaging, interactivehealth information for over a decade. Our extensive collection of medicalillustrations, graphics and animations are carefully put into our products sothat healthcare consumers can better understand and retain the information theyare reading.

 

Our products can also bedelivered to consumers in a variety of formats — from print to electronicdelivery. We have also translated several of our core content products,including the Health Illustrated Encyclopedia, into Spanish. The ability tooffer these products in Spanish is important to us, as we recognize thetremendous growth of the U.S. Hispanic population and the effects of limitedEnglish proficiency within the healthcare system.

 

Over the past several years wehave seen a significant shift in our ability to secure new business in thehealthcare markets. This is a result of our increased sales and marketingfocus, the development of additional sales channels into the healthcare marketand our product development strategy. We also believe that the quality, depthand breadth of our product line, as well as the technology we have developed inour content management infrastructure allows us to compete favorably in themarkets we serve.

 

**Markets**

 

We market our products to thehealthcare industry, to Internet websites and to educational institutions andstudents.

 

*HealthcareIndustry*

 

Our productstarget a broad range of businesses in the healthcare industry includinghealthcare providers, health plans and employers, healthcare technologycompanies, health and wellness companies and pharmaceutical organizations.

 

*HealthcareProviders*Healthcare providers include hospitalsand hospital systems and large physician practice groups that are providinghealthcare services to consumers. We believe our primary revenue opportunitiesare with the approximately 2,000 hospital facilities in the U.S. that exceed250 beds. There are two underlying reasons why we believe this market isimportant:

 

•                  Healthcareproviders are seeking to enhance their websites with content, tools andservices that can increase utilization of their services and support theirservice line efforts; and

 

•                  Healthcareproviders are evolving their websites to offer more personalized servicesincluding the use of health information as part of patient education,informed consent, physician loyalty programs and risk management.

 

*HealthPlans and Employers* Health plans and employers areactively looking for operational and productivity improvements through theeffective use of health information. We believe that our products are wellsuited to assist these types of organizations in two important aspects:

 

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•                  The recognitionand identification of disease for early health intervention; and

 

•                  Demandmanagement of health plan members and employees to seek health interventionwhen appropriate or as necessary.

 

*PharmaceuticalOrganizations* The relaxation of pharmaceuticalmarketing regulations by the Food and Drug Administration in 1997, has led tothe proliferation of Direct to Consumer (“DTC”) advertising by thepharmaceutical companies. The increase in DTC marketing has created newopportunities for us as we leverage our ability to customize our healthinformation products to support these marketing efforts. Currently, severalleading pharmaceutical organizations license our content products, and webelieve there is potential to expand these relationships.

 

*HealthcareTechnology Companies* Healthcare applicationdevelopers such as electronic medical record vendors, system integrators,medical device companies, and disease management application developers can useour content at point-of-care or within the workflow of their care management orcare delivery systems to deliver relevant health information to patients.

 

*Health andWellness Companies*We also market our products andservices to organizations that are developing health and wellness programs forconsumers that address specific medical condition management such as diabetes,lifestyle or behavioral change programs such as diet and weight loss, or riskassessment such as organizations who provide health risk assessment programs.These programs may also be sold directly to employers, or they may becontracted to a health plan to provide such services to the plan’s clients.

 

*InternetWebsites*

 

This marketincludes large Internet and media-related websites that host a variety ofconsumer-oriented content and services. These websites generally use our healthcontent either exclusively or as part of a larger health channel offeringto serve as a driver for advertising revenue. While we still derive a portionof our revenues and continue to explore ways in which to expand our presence inthis market, the number of license agreements we have completed has diminishedas the larger websites continue to grow and the number of smaller, morespecialized health sites have either ceased operations or have been acquired.We continue to pursue qualified opportunities in this market as they becomeavailable. We also attempt to leverage existing relationships to provide morecontent products and professional services.

 

*EducationalInstitutions and Students*

 

The educationmarket includes higher education such as undergraduate educationalinstitutions, the K through 12 market and the allied health education areasthat may include medical technology, dental, nursing and EMT. Historically,we have serviced this market with our CD-ROM products. We continue toexperience a revenue stream from the sale of these CD-ROM products although wehave seen a decline in our education revenues as our CD-ROM products have begunto age. We began shipping a major upgrade to our flagship educational productin 2004, A.D.A.M. Interactive Anatomy 4.0, and we expect that this release willallow us to expand our sales efforts in the educational markets. We alsobelieve that the educational market is an important and complementary extensionof our broader product strategy in healthcare.

 

**Productsand Services**

 

We offer a comprehensiveportfolio of informative, Web-enabled products that are designed to explaincomplex medical issues in a way that can be easily understood by healthcareconsumers at a variety of reading and learning levels. We have also developed anumber of educational CD-ROM products that are sold primarily to the K through12, higher education and allied health markets, including our flagship softwareproduct for higher education, A.D.A.M. Interactive Anatomy 4.0.

 

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The following chart summarizesour primary products and the typical customers of those products:

 
| **PRODUCT**                                        | ** ** | **CUSTOMER**                                                                                                                         | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|----------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Health Illustrated  Encyclopedia                   |       | Hospitals, health plans,  consumer-oriented websites, health and wellness companies and employers.                                   |       | A general health reference  product containing approximately 3,600 unique articles relating to diseases  and health conditions, medical tests, symptoms, injuries, treatment options,  surgical procedures and nutrition. The articles are organized by topic or  condition and enhanced with graphical illustrations. The Encyclopedia is also  available in Spanish and in a smaller “Community Hospital” edition with 1,800  articles. |
|                                               |       |                                                                                                                                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| In-Depth Disease and Condition  Reports            |       | Hospitals, health plans,  disease management companies, physicians, and medical libraries.                                           |       | Reports that provide readers  with a much deeper understanding of the subject and are typically targeted to  the 8th grade reading level. These are available as a library or  individually by topic and are generally sold with the Health Illustrated  Encyclopedia.                                                                                                                                                                              |
|                                               |       |                                                                                                                                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| Complementary &  Alternative              |       | Hospitals, health plans and  Internet websites catering to alternative medicine, physicians, spas and  health fitness organizations. |       | Medically reviewed  information on the integration of alternative therapies with traditional  medicine. Topics cover approximately 170 health conditions, 120 herbs and supplements,  and 20 monographs on complementary treatments.                                                                                                                                                                                                                |
|                                               |       |                                                                                                                                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| Care Guides                                        |       | Hospitals, health plans,  consumer-oriented websites, health and wellness companies and employers.                                   |       | Comprehensive patient care  guides on common health conditions such as Asthma, Allergies, Diabetes Type 1  and 2, High Blood Pressure and High Cholesterol, Low Back Pain and others.  Designed for ease of use, each guide contains “key points”, supplemental  reading, and information to help patients make educated healthcare decisions.                                                                                            |
|                                               |       |                                                                                                                                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| Health & Wellness Decision Support  Suite |       | Employers, benefit brokers,  health plans.                                                                                           |       | An end-to-end content  solution for employees and health plan members to assess, evaluate and manage  their health. Includes a comprehensive A.D.A.M. health library and decision  support tools.                                                                                                                                                                                                                                                   |
|                                               |       |                                                                                                                                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| A.D.A.M. Illustrated Family Health  Guide          |       | Health plans, employers                                                                                                              |       | An illustrated home health  book for consumers. Contains over 300 pages on conditions, first aid,  and healthy living.                                                                                                                                                                                                                                                                                                                         |
|                                               |       |                                                                                                                                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| QuickSheets                                        |       | Hospitals                                                                                                                            |       | Illustrated patient education  handouts on diseases, surgeries and other topics. Healthcare professionals  can access QuickSheets from their intranet and either, print or email them in  English and Spanish.                                                                                                                                                                                                                                      |
|                                               |       |                                                                                                                                 |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| Pregnancy Health Center                            |       | Hospitals supporting  maternity service line, health plans, employers and specialty websites.                                        |       | Provides topical health  information and interactive tools addressing pregnancy, from pre-conception  to post-partum. This information is also available in Spanish.                                                                                                                                                                                                                                                                                |

 

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| **PRODUCT**                       | ** ** | **CUSTOMER**                                                                                                  | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                             |
|-----------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Surgeries and Procedures          |       | Hospitals, health plans,  physician practices and Internet websites.                                          |       | A web-based product that  explains various surgeries and medical procedures using step-by-step, easy to  understand language supplemented by medical illustrations, diagrams and  imagery. Also available in Spanish.                                       |
|                              |       |                                                                                                          |       |                                                                                                                                                                                                                                                        |
| Health Risk Assessment  Library   |       | Hospitals, health plans,  consumer-oriented websites, health and wellness companies and employers.            |       | A library of interactive  health risk assessments that includes assessments for general health as well  as conditions and lifestyles. Also available is back-end reporting  capabilities for administrators to identify population risks and trends.        |
|                              |       |                                                                                                          |       |                                                                                                                                                                                                                                                        |
| TransADAM                         |       | All license customers.                                                                                        |       | A proprietary transformation  and deployment application that processes A.D.A.M. content to a client  specified location. TransADAM provides the ability to synchronize the client’s  customized library with A.D.A.M. at client-determined intervals. |
|                              |       |                                                                                                          |       |                                                                                                                                                                                                                                                        |
| A.D.A.M. Interactive Anatomy  4.0 |       | Undergraduate and allied  health educational institutions and undergraduate anatomy and physiology  students. |       | A DVD-ROM & CD-ROM  product that simulates human anatomical dissection of both male and  female bodies. More than 22,000 anatomical structures can be identified.                                                                             |
|                              |       |                                                                                                          |       |                                                                                                                                                                                                                                                        |
| A.D.A.M. School Editions          |       | K-12 teachers and students.                                                                                   |       | A series of CD-ROM  products including A.D.A.M. The Inside Story, Nine Month Miracle and Life’s  Greatest Mysteries coupled with curriculum guides for teachers.                                                                                  |

 

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We offer our customers various custom and professional servicesincluding medical illustration, multimedia and animation development andengineering. Our ability to provide customers with these types of professionalservices is an important component to our position as a full-service solutionprovider. We believe that in order to provide full-service solutions to ourcustomers, we must provide flexibility in the way our products are configuredand delivered.

 

**CustomerSupport and Client Services**

 

We believe that a high level ofcustomer support is necessary to attract and retain customers and we thereforeprovide several levels of customer support for both our CD-ROM and licensecustomers. We provide toll-free telephone technical support for our CD-ROMcustomers and, through our client services team we maintain direct and ongoingrelationships with our license customers for technical support, integrationissues, content updates, maintenance and general account management.

 

**Platform,Product and Content Development**

 

Our proprietary content platform handlesthe management and workflow associated with our electronic assets. Thepublishing components of our system allow us to deliver products to ourcustomers more efficiently and with more accuracy. Our system also allows us tocustomize our product content offerings for customers with minimal developmentcosts. Our TransADAM integration application, made available to each of ourlicense customers, allows them to then manage the integration and updatingprocess of our content on their websites.

 

We have also implemented theuse of the National Library of Medicine’s Unified Medical Language System (“UMLS”).The use of the UMLS assists in the development of systems that help healthcareorganizations integrate data across a wide variety of information systems suchas electronic medical records and other decision support applications. The UMLSallows us to output any of our health content to any number of standard medicaltaxonomies such as ICD-9, CPT, MeSH and SnoMed. We believe that providing ourcustomers with data in this fashion will allow them to easily integrate ourcontent into their own systems creating an “actionable” environment between informationand related services.

 

With the capabilities of ourcontent management system, and through the development of additional content,products and technologies, we expect to expand our licensing network with newcustomers and derive additional revenues from our current license customers.

 

We provide our productsdirectly to our customers through File Transfer Protocol (FTP), CD-ROM,Application Service Provider and web services. Our platform technology andservers are located in a secure data center with built-in redundancies at ourcorporate offices in Atlanta, Georgia.

 

**EditorialExcellence**

 

We believe that our healthinformation products are developed and maintained to the highest degree ofcompleteness, relevancy and medical accuracy. Our editorial process is dividedinto five areas:

 

•                  *Development.*Medical writers, health practitioners andmedical illustrators develop our content. Previously published content isreviewed and internally evaluated for completeness and relevancy. Also, textualcontent is evaluated for enhancement with new and appropriate visuals.

 

•                  *Review.*We have developed an extensive network of reviewersthat evaluate the accuracy of the text and visual content. Our network consistsof physicians who are specialists in their field that provide input on themedical accuracy, relevancy and completeness of the information.

 

•                  *Editorial.*Our editorial staff reviews all content, bothtextual and visual, for grammar, style and consistency. A content qualityassurance check is also performed.

 

•                  *Production.*The content is indexed, stored in a datamanagement environment, coded and tagged for presentation. Another level oftechnical and content quality assurance checks are also performed during thisstep.

 

•                  *Publication.*This is the stage where we publish the contentor product to our customers. Our health information is regularly updated and,in most cases, this update cycle is repeated quarterly.

 

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We are also a founding memberof Hi-Ethics (Health Internet Ethics), a non-profit organization dedicated toproviding consumers the highest standards for privacy, security, credibilityand reliability of health information via the Internet. Since 2002, our chiefmedical officer, Dr. Alan Greene, has served as President of Hi-Ethics.

 

**Sales andMarketing**

 

We market our products andservices through a direct sales force, our reseller network, and consultinggroups that provide professional services such as web strategy and integrationto our target markets. We also participate in industry trade shows andconferences.

 

We have also establishedcertain strategic relationships in order to expand the sales and distributionof our products. For example, we have partnered with Hispanicare, a division ofDrTango, Inc., an organization that has translated several of our contentproducts into Spanish and resells them as part of a Hispanic-focusedhealthcare strategy. We have several other important relationships that provideus with increased visibility in our markets. Those relationships includeresellers that sell to the hospital market, employers, and healthcaretechnology companies that have integrated certain content components from us.We believe that developing more third-party distribution will continue to be animportant driver for future revenues.

 

**Manufacturing**

 

The production of our softwareproducts includes CD-ROM/DVD-ROM pressing, assembly of purchased productcomponents, printing of product packaging and user manuals and shipping offinished goods, all of which is performed by third-party vendors in accordancewith our specifications and forecasts. We believe that there are alternatesources for each of these services that could be implemented without materialdelay, if necessary.

 

**ProprietaryRights and Licenses**

 

We regard our softwarepublications and content assets as proprietary. We rely primarily on acombination of copyright, trademark and trade secret laws, employee andthird-party nondisclosure agreements to protect our proprietary rights. We haveobtained U.S. federal registrations of the trademarks and the logos for the “A.D.A.M.”marks, as well as numerous other trademarks, which identify our products. Wehave also obtained registrations of the “A.D.A.M.” trademark in Australia,Austria, Benelux, Canada, Chile, China, Denmark, France, Germany, India,Ireland, Italy, New Zealand, South Africa, Sweden, Switzerland and Taiwan andwe have a pending application to register the mark in Malaysia. We haveacquired and are using a number of registered and unregistered trademarks toidentify our products. We use the “A.D.A.M.” mark in Japan under license withKataken Seiko K.K. We are also the owner of a number of domain nameregistrations**.**

 

We have applied for and/orobtained numerous U.S. Copyright Registrations for our software, publicationand content products, including *Health IllustratedEncyclopedia, A.D.A.M. Interactive Anatomy,*and *PregnancyHealth Center*. We do not currently hold any patents or have anypatent applications pending. There can be no assurance that these protectionswill be adequate to protect the intellectual property rights or that ourcompetitors will not independently develop technologies that are substantiallyequivalent or superior to our technologies. We further believe that due to therapid pace of innovation within the multimedia and software industries, factorssuch as the technological and creative skills of our personnel and the qualityof the content of our products are as important in establishing and maintaininga leadership position within the industry as the various legal protections forour technology.

 

We believe that our products,trademarks and other proprietary rights do not infringe upon the proprietaryrights of third parties and to date no third party has filed an infringementclaim against us. However, as the number of products in our industry increasesand the functionality of these products overlap, content providers may becomeincreasingly subject to infringement claims. There can be no assurance that thirdparties will not assert infringement claims against us in the future withrespect to current or future products, trademarks or other works of A.D.A.M. orthat any assertion will not require us to enter into royalty arrangements orresult in costly litigation.

 

**Competition**

 

The market in which we operateis highly competitive and continually evolving. There are a number of healthcontent service providers offering products in various pre-packaged andcustomized ways, including:

 

•                  Online content providers and aggregators, targeting the healthcare industry or health conscious consumer, such as WebMD Corporation.

 

•                  Public sector and non-profit organizations that provide healthcare information without advertising or commercial sponsorships such as the American Medical Association, the Mayo Clinic and Healthwise, Inc.

 

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•                  Publishers and distributors of traditional offline media, including those targeting healthcare professionals, such as Thompson, Wolters Kluwers and others.

 

•                  Health and wellness program providers such as Health Dialog that are offering integrated health and wellness management services.

 

•                  Traditional disease management providers such as American Healthways and SHPS.

 

Some of our competitors havegreater technical, product development, marketing, financial and otherresources than we do. These organizations may have longer operatinghistories, greater brand recognition and larger customer bases. We believeother competitive factors in our markets include ease of implementation anduse, pricing, features and quality of customer support.

 

We believe ourprincipal competitive advantages in our markets are:

 

•                  Ownership of all our A.D.A.M.-labeled electronic assets;

 

•                  Depth and breadth of product line with versatile market applications;

 

•                  Rigorous editorial review processes;

 

•                  Proprietary content management, delivery and integration technologies; and

 

•                  Unique visual content assets that require specialized knowledge and training to create.

 

**Employees**

 

Asof December 31, 2005, we had 40 employees. Of these employees, 18 wereengaged primarily in editorial management and product development, 12 in salesand marketing and 8 in finance and administration.

 

Ouremployees are not covered by a collective bargaining agreement and we haveexperienced no work stoppages. We consider our employee relations to be good.We believe that our future growth and success will depend upon our ability toretain and continue to attract highly skilled and motivated personnel in allareas of our operations.

 

**Factors Affecting Future Performance**

 

Youshould carefully consider each of the following factors along with all of theother information in this Report. The risks and uncertainties described beloware not the only ones we will face. Additional risks and uncertainties notpresently known to us or that we currently believe to be immaterial may alsoadversely affect our business. If any of the following risks and uncertaintiesdevelop into actual events, our business, financial condition or results ofoperations could be materially adversely affected. If that happens, the tradingprices of our common stock could decline significantly.

 

•                  Although we reported net income for several mostrecent years, we have also incurred substantial losses in the past. We cannotoffer any assurance that our current performance is a guarantee of futureprofitability.

 

•                  We may be unable to obtain sufficient capitalto pursue our growth and market development strategies, which would hurt our financialresults. We can offer no assurance that our revenues will be sufficient tocover our expenses or that capital will be available to us on satisfactoryterms or at all, to fund any shortfall in these costs and revenues.

 

•                  We may be unable to compete effectively withother providers of healthcare information, which could cause our growth andmarket development strategies to be unsuccessful. The market for providinghealthcare information is intensely competitive, and competition could increasein the future. As this market develops, we expect our sensitivity tocompetitive pressures to be especially strong as we continue to attract andretain customers. We may not be able to compete effectively against thesecompanies, and if we fail to compete effectively we may suffer reducedgross margins and loss of market share.

 

•                  Some competitors have advantages over us because oftheir longer operating histories, greater name recognition, or greaterfinancial, technical and marketing resources. As a result, they may beable to adapt more quickly to new or emerging technologies and changes incustomer requirements. They could also devote greater resources to thepromotion and sale of

 

10

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theirproducts or services. Furthermore, mergers and acquisitions among othercompanies could intensify our existing competition or create new competitors.

 

•                  We can offer no assurance that the loss of anysignificant license customer will not materially adversely affect our business.

 

•                  We face technological challenges in our ability todeliver customized information in the rapidly changing healthcare industry,which may limit our ability to maintain existing customers or attract newcustomers. We believe that health information will become more customized to anindividual’s personal health management needs. As a result, we will need tohave adequate technology infrastructure that will allow us to deliver in a costeffective manner portions of our content assets based on each customer’srequirements.

 

•                  We may be unable to successfully identify,acquire, manage or integrate complementary businesses. Our long-term growthstrategy may include acquiring businesses with complementary products,technologies or professional services. Moving forward, we may not besuccessful in acquiring other complementary businesses or assimilating theirpersonnel and operations. These difficulties could disrupt our ongoingbusiness, distract our management and employees, increase our expenses andadversely affect our results of operations. Future acquisitions may alsocause us to incur expenses such as in-process research and developmentexpenses, which may negatively affect our earnings. We cannot be certainthat we will successfully overcome these risks with respect to any futureacquisitions. In addition, we have historically paid a portion of theconsideration for some of our acquisitions by issuing common stock. Theissuance of additional common stock or other securities convertible into commonstock in connection with future acquisitions would dilute the ownershipinterests of our existing shareholders.

 

•                  We may be unable to attract new personnel,which would adversely affect implementation of our overall business strategy.In order to promote the development of our target markets, we will need toidentify, attract and retain software engineers, web designers, sales andmarketing professionals and other key personnel. We will compete with othercompanies both within and outside our markets for such employees and we may beunable to attract these employees. If we do not succeed in attracting thesetypes of new employees, we may be unable to fully implement our growth andmarket development strategies and our business will suffer.

 

•                  Our stock price is extremely volatile and coulddecline significantly*.* Since ourinitial public offering in 1995, there has been significant volatility in theprice of our common stock. This volatility has often been unrelated to ouroperating performance. There can be no assurance that the market price of ourcommon stock will be maintained or that the volume of trading in our shareswill not decrease. Furthermore, following periods of volatility in the marketprice of a company’s securities, securities class actionclaims frequently are brought against the subject company. To the extent thatthe market price of our shares falls dramatically in any period of time,shareholders may bring claims, with or without merit, against us. Suchlitigation would be expensive to defend and would divert management attentionand resources regardless of outcome.

 

•                  We must comply with Section 404 of the Sarbanes-OxleyAct which will require us to increase our expenses associated with thedevelopment and testing of our internal controls. There can be no assurancethat we will not have significant deficiencies or material weaknesses in ourinternal controls or that we will not encounter higher than anticipatedexpenses associated with compliance that may adversely affect our shareprice.

 

•                  We have adopted certain anti-takeover provisionsthat may deter a takeover. Our articles of incorporation and bylawscontain provisions that may deter a takeover, including a takeover onterms that many of our shareholders might consider favorable, such as: the authorityof our board of directors to issue common stock and preferred stock and todetermine the price, rights (including voting rights), preferences, privilegesand restrictions of each series of preferred stock, without any vote oraction by our shareholders; the existence of large amounts of authorized butunissued common stock and preferred stock; staggered, three-year terms for ourboard of directors; and advance notice requirements for board of directorsnominations and for shareholder proposals. The rights and preferences of any series ofpreferred stock could include a preference over the common stock on thedistribution of our assets upon a liquidation or sale of our company,preferential dividends, redemption rights, the right to elect one or moredirectors and other voting rights. The rights of the holders of any series ofpreferred stock that may be issued in the future may adversely affectthe rights of the holders of the common stock. We have no current plans toissue preferred stock. In addition, certain provisions of Georgia law and ourstock option plan may also discourage, delay or prevent a change incontrol of our company or unsolicited acquisition proposals.

 

•                  A significant number of unissued shares areavailable for future sale and could adversely affect the market price of ourcommon stock. If our shareholders, option holders, or warrant holders exercisetheir rights to sell substantial amounts of our common shares in the publicmarket, the market price of our common stock could fall. Given theunpredictable transaction volumes for our common stock, the sale of asignificant amount of these shares at any given time could cause the marketprice of our common stock to decline or otherwise be highly volatile. Suchsales could also make it more difficult for us to sell equity or equity-relatedsecurities in the future at a time and price when we deem conditions to be morefavorable.

 

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•                  Our Stock Purchase Agreement with Fusion CapitalFund II, LLC may result in significant dilution of our other shareholders.On May 22, 2002, we entered into a Common Stock Purchase Agreement withFusion Capital Fund II, LLC. Pursuant to this agreement, Fusion Capital hasagreed to purchase up to an aggregate of $12,000,000 of our common stock. Wehave the right to sell up to $15,000 of common stock per trading day under thisagreement with Fusion Capital unless our stock price equals or exceeds $7.00,in which case the daily amount may be increased at our option. FusionCapital is not obligated to purchase any shares of our common stock on anytrading days that the market price of our common stock is less than $1.00.Sales of our common stock under this agreement would dilute the ownership ofshareholders other than Fusion Capital Fund II, LLC. As of December 31,2003, we had sold 486,566 shares for $733,000 under this agreement. Since thattime and through December 31, 2005, there have been no furthertransactions under this agreement.

 

**Acquisitions**

 

In December 2001, we acquired Integrative Medicine Communications, Inc.(“IMC”), a leading developer and licensor of health content in thecomplementary and alternative medicine (“CAM”) field. Their product, known asAccess, is a comprehensive, web-enabled database of medical conditions, andherbal and supplemental monographs, that are designed for use by consumers.

 

In February 2002, we acquired Nidus Information Services, Inc.(“Nidus”), a privately held provider of in-depth patient education reports oncommon health conditions and diseases called WELL-CONNECTEDTM. This library ofover 100 reports was originally developed by an experienced team of medicalwriters and editors and is reviewed for accuracy by a board of physicians withfaculty positions at Harvard Medical School and Massachusetts General Hospital.Each report is distinguished from other information sources by its detail ofinformation, quality and currency, its evidence-based approach, and rigorouseditorial review. The reports are available through print or web subscriptionsand through licensing agreements. They are sold primarily to healthcareorganizations, Internet portals, health content resellers and medicallibraries.

 

We have included the results of these acquisitions in our consolidatedfinancial statements from the date of acquisition.

 

**Corporate Information**

 

We were incorporated in 1990 under the laws of the State of Georgia asA.D.A.M. Software, Inc. We changed our name to adam.com, Inc. in 1999and to A.D.A.M., Inc. in 2001. We are headquartered in Atlanta, Georgia.

 

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**ITEM2. DESCRIPTION OF PROPERTY**

 

Our headquartersare located in approximately 12,000 square feet of leased office space inAtlanta, Georgia. This lease extends through April 2008. We currently subleaseapproximately 500 square feet of this space to a company whose Chairman is alsoour Chairman. We collect $1,200 monthly for lease payments and other shared services.Additionally, until the third quarter of 2005, we sublet on a month to monthbasis at $586 per month, 500 square feet of this space to a company whose ChiefExecutive Officer is a director of A.D.A.M. On September 1, 2005 thatcompany delivered a 30 day written notice for the termination of the lease.

 

If additional facilities are required, we believe that suitablefacilities will be available at market rates.

 

**ITEM3. LEGAL PROCEEDINGS**

 

We are not party to any legalproceedings.

 

**ITEM 4. SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS**

 

No matters were submitted to a vote of security holders during the lastquarter of 2005.

 

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**PART II.**

 

**ITEM 5. MARKET FOR COMMONEQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OFEQUITY SECIRITIES**

 

**Market Price Information**

 

Our common stock is listed on the Nasdaq SmallCap Market, where it hastraded since it was transferred from the Nasdaq National Market on January 31,2003. The following table sets forth the high and low sales price of our commonstock for each quarter during the last two years, as reported by the NasdaqStock Market:

 
| ** **                             | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------------------------------|------------|----------|------------|---------|------------|
|                                   |       |     |       |    |       |
| **Year Ended December 31, 2004**  |       |     |       |    |       |
| Quarter ended March 31,  2004     |       | $        | 2.60       |    | $          | 1.69 |   |
| Quarter ended June 30,  2004      |       | $        | 2.36       |    | $          | 1.85 |   |
| Quarter ended September 30,  2004 |       | $        | 3.00       |    | $          | 2.00 |   |
| Quarter ended December 31,  2004  |       | $        | 4.72       |    | $          | 2.76 |   |
|                                   |       |     |       |    |       |
| **Year Ended December 31, 2005**  |       |     |       |    |       |
| Quarter ended March 31,  2005     |       | $        | 7.34       |    | $          | 3.92 |   |
| Quarter ended June 30,  2005      |       | $        | 7.10       |    | $          | 4.48 |   |
| Quarter ended September 30,  2005 |       | $        | 6.42       |    | $          | 5.45 |   |
| Quarter ended December 31,  2005  |       | $        | 10.01      |    | $          | 5.58 |   |

 

At March 7, 2006 there were 140 recordholders of our common stock.

 

We have never paid or declared any cash dividends on our common stockand we do not intend to pay dividends on our common stock in the near future.We presently expect to retain any future earnings to fund continuingdevelopment and growth of our business. Our payment of dividends in the futureis subject to the discretion of our board of directors and will depend on ourearnings, financial condition, capital requirements and other relevant factors.

 

**Recent Sales of Unregistered Securities;Stock Repurchases in the Fourth Quarter**

 

None.

 

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**ITEM 6. MANAGEMENT’S DISCUSSIONAND ANALYSIS OR PLAN OF OPERATION**

 

**The following discussion should be read inconjunction with the consolidated financial statements and notes theretopresented elsewhere in this Annual Report on Form 10-KSB.**

 

**Overview**

 

We specialize in the creation anddelivery of interactive health content and applications that can be used by abroad range of healthcare consumers – from those with low health literacy tothose who play an active and ongoing role in their personal health management.Our health information can be used for learning about general health concerns,specific diseases, medical conditions and treatments, surgical procedures, druginformation, specialty health subjects such as women’s health and children’shealth, nutrition, alternative medicine and more. Our health applications, suchas our Health Risk Assessment library, allow consumers to learn more abouttheir health by providing them with relevant feedback regarding their healthcondition to help in making better decisions.

 

We sell our health contentproducts and healthcare related applications primarily through annual licensingagreements to many different types of healthcare and health-relatedorganizations including hospitals, health plans, integrators, pharmaceuticalcompanies, care management vendors, health-oriented Internet websites, healthcaretechnology companies and employers. Our products can be incorporated into acustomer’s website, imbedded in healthcare applications such as an electronicmedical record or disease management applications, contained in a printed or CD-ROMformat, or combined with other products that may be offered to a healthcareconsumer.

 

Over the past several years wehave seen a significant shift in our ability to secure new business in the healthcaremarket. This is a result of our increased sales and marketing focus, thedevelopment of additional sales channels into the healthcare market and ourproduct development strategy. We also believe that the quality, depth andbreadth of our product line, as well as the technology we have developed in ourcontent management infrastructure allows us to compete favorably in the marketswe serve. Information regarding each of our service markets appears in Item 1of this Report, under the caption “Markets.”

 

**Critical Accounting Policies and Estimates**

 

Discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the amounts reported in the consolidated financial statements and the accompanying notes. On an on-going basis, we evaluate our estimates, including those related to product returns, product and content development expenses, bad debts, inventories, intangible assets, income taxes, contingencies and litigation. We base our estimates on experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

 

•                  *Revenue Recognition*

 

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” as amended by SAB 101A and 101B and as revised by SAB 104, “Revenue Recognition” and Statement of Position No. 97-2, “Software Revenue Recognition.” Accordingly, we recognize revenue when: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured.

 

We generate revenues mainly in two ways – Internet-based licensing and shipped product sales. Internet revenues consist primarily of license fees that usually consist of an annual, up-front fee that is initially recorded as deferred revenue. This revenue is recognized ratably over the term of the license agreement beginning after delivery has occurred, upon customer acceptance, when we have determined that the fees from the agreement are fixed and determinable, and there are no significant return or acceptance provisions. When a contract includes multiple elements, such as services, the entire fee is allocated to each respective element, based on vendor specific objective evidence of fair value, and recognized when the revenue criteria for each element is met. Service revenues are generally recognized upon completion and acceptance by the customer. For Internet revenue arrangements in which we sell through a reseller, we do not recognize any revenue until an agreement has been finalized between the customer and our authorized reseller and the content has been delivered to the customer by the reseller. Revenue is not recognized under any circumstances unless collectibility is reasonably assured. Shipped product revenues represent the sales of software products and revenues earned under certain royalty agreements. 

 

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Revenues from product sales are generally recognized at the time title passes to customers, distributors or resellers. Revenues from royalty agreements are recognized as earned based upon performance or product shipment.

 

•                  *Sales Returns Allowances and Allowance for Doubtful Accounts*

 

Significant management judgments and estimates must be made in connection with establishing the sales returns and other allowances in any accounting period. Management must make estimates of potential future product returns related to current period product revenue. Allowances for estimated product returns are provided at the time of sale. We evaluate the adequacy of allowances for returns primarily based upon our evaluation of historical and expected sales experience and by channel of distribution. The judgments and estimates of management may have a material effect on the amount and timing of our revenue for any given period.

 

Similarly, management must make estimates of the uncollectability of accounts receivable. Management specifically analyzes accounts receivable and historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

 

•                  *Capitalized Software Product and Content Development Costs*

 

We capitalize software product and content development costs in accordance with Financial and Accounting Standards Board (“FASB”) Statement No. 86 (“FAS 86”), “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” This statement specifies that costs incurred internally in creating a computer software product shall be charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of all planning, designing, and testing activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements. We cease capitalization of internally developed software when the product is made available for general release to customers and thereafter, any maintenance and customer support is charged to expense when related revenue is recognized or when those costs are incurred. We amortize such capitalized costs as cost of sales on a product-by-product basis using 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 life of the software, which we have determined to generally be two years. We continually evaluate the recoverability of capitalized costs and if the successes of new product releases are less than we anticipate then a write-down of capitalized costs may be made which could adversely affect our results in the reporting period in which the write-down occurs.

 

We also capitalize internal software development costs in accordance with the American Institute of Certified Public Accountants Statement of Position 98-1 (“SOP 98-1”), “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” This statement specifies that computer software development costs for computer software intended for internal use occurs in three stages: (1) the preliminary project stage, where costs are expensed as incurred, (2) the application development stage, where costs are capitalized, and (3) the post-implementation or operation stage, where again costs are expensed as incurred. We cease capitalization of developed software for internal use when the software is ready for its intended use and placed in service. We amortize such capitalized costs as cost of sales on a product-by-product basis using the straight-line method over a period of three years. We continually evaluate the usability of the products that make up our capitalized costs and if certain circumstances arise such as the introduction of new technology in the marketplace that management intends to use in place of the capitalized project, then a write-down of capitalized costs may be made which could adversely affect our results in the reporting period in which the write-down occurs.

 

•                  *Inventory*

 

We record reserves for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

 

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•                  *Goodwill and Intangible Assets*

 

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, we evaluate goodwill and intangible assets for impairment on an annual basis. Additionally, goodwill is tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of an entity below its carrying value. These events or circumstances would include a significant change in the business climate, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business or other factors. The carrying value of goodwill is evaluated in relation to the operating performance and estimated future discounted cash flows of the entity.

 

•                  *Income Taxes*

 

As part of the process of preparing our consolidated financial statements we are required to estimate our taxes in each of the jurisdictions in which we operate. This process involves management estimating the actual tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and U.S. GAAP purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. During 2005 we reversed a portion of the valuation allowance which had previously reserved against the entire balance of our deferred tax asset.

 

**Recent Accounting Pronouncements**

 

On December 16, 2004, the Financial Accounting Standards Board(FASB) issued FASB Statement No. 123 (revised 2004), “Share-Based Payment,”which is a revision of FASB Statement No. 123, “Accounting for Stock-BasedCompensation.”  Statement 123(R)supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,”and amends FASB Statement No. 95, “Statement of Cash Flows.” The approachto accounting for share-based payments in Statement 123(R) is similar to theapproach described in Statement 123. However, Statement 123(R) requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the financial statements based on their fair values and nolonger allows pro forma disclosure as an alternative to financial statementrecognition.

 

We will adopt Statement 123(R) at the beginning of our first quarterending March 31, 2006 using the modified prospective method and reflectcompensation expense in accordance with the SFAS 123(R) transition provisions. Underthe modified prospective method, prior periods are not restated to reflect theimpact of adopting the new standard at earlier dates. Pro forma disclosuresregarding the effect on our net income and net income per common share in 2004 and2005, had we applied the fair value method of accounting for share-basedcompensation as prescribed by SFAS 123, are contained in the “Stock-basedemployee compensation” section of Note 1 to our Consolidated FinancialStatements. Based on share-based compensation granted through December 31,2005 and the fair values previously calculated under SFAS 123, we project wewill record an immaterial amount of additional compensation expense in 2006 relatedto stock options upon the adoption of SFAS 123R compared to the existingaccounting method under APB Opinion No. 25. We will continue to evaluatethe impact this new standard will have on our Stock Incentive Plan.

 

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**Selected Financial Data**

 

Thefollowing selected financial data should be read in conjunction with theConsolidated Financial Statements and Notes thereto.

 
| ** **                                                                | ** ** | **Year Ended   December 31,**                       | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                | ** ** | **(In thousands, except per share data)** | ** ** |
| **STATEMENT  OF OPERATIONS DATA:**                                        |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net revenues                                                              |       | $                                                                  | 10,054     |   | $ | 8,433 |   | $ | 7,889 |   | $ | 8,924 |   | $ | 8,946 |   |
| Costs and  expenses:                                                      |       |                                                               |       |   |   |   |   |   |   |   |   |
| Costs of  revenues                                                        |       | 2,063                                                              |       | 1,717 |   | 1,668 |   | 1,478 |   | 1,588 |   |
| General and  administrative                                               |       | 3,096                                                              |       | 1,691 |   | 1,774 |   | 2,451 |   | 2,156 |   |
| Product and  content development                                          |       | 1,456                                                              |       | 1,321 |   | 1,375 |   | 2,476 |   | 2,243 |   |
| Sales and  marketing                                                      |       | 1,965                                                              |       | 1,603 |   | 1,743 |   | 2,782 |   | 1,961 |   |
| Depreciation  and amortization                                            |       | 185                                                                |       | 562 |   | 767 |   | 909 |   | 820 |   |
| Total costs  and expenses                                                 |       | 8,765                                                              |       | 6,894 |   | 7,327 |   | 10,096 |   | 8,768 |   |
| Operating  income (loss)                                                  |       | 1,289                                                              |       | 1,539 |   | 562 |   | (1,172 | ) | 178 |   |
| Interest  income (expense), net                                           |       | 313                                                                |       | 82 |   | 46 |   | 66 |   | 99 |   |
| Realized  loss and impairment of investment securities                    |       | (40                                                                | )          | — |   | — |   | (176 | ) | (146 | ) |
| Realized  gain on sale of assets, net                                     |       | —                                                             |       | — |   | — |   | — |   | 1,808 |   |
| Income  (loss) before income taxes, and equity in net losses of affiliate |       | $                                                                  | 1,562      |   | $ | 1,621 |   | $ | 608 |   | $ | (1,282 | ) | $ | 1,939 |   |
| Income tax  benefit, deferred                                             |       | 5,500                                                              |       | — |   | — |   | — |   | — |   |
| Income  (loss) before equity in net losses of affiliate                   |       | $                                                                  | 7,062      |   | $ | 1,621 |   | $ | 608 |   | $ | (1,282 | ) | $ | 1,939 |   |
| Equity in  net losses of affiliate                                        |       | —                                                             |       | — |   | — |   | (248 | ) | (342 | ) |
|                                                                      |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net income  (loss)                                                        |       | $                                                                  | 7,062      |   | $ | 1,621 |   | $ | 608 |   | $ | (1,530 | ) | $ | 1,597 |   |
|                                                                      |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic net  income (loss) per share                                        |       | $                                                                  | 0.87       |   | $ | 0.21 |   | $ | 0.08 |   | $ | (0.22 | ) | $ | 0.25 |   |
|                                                                      |       |                                                               |       |   |   |   |   |   |   |   |   |
| Weighted  average number of common shares outstanding, basic              |       | 8,108                                                              |       | 7,879 |   | 7,306 |   | 7,107 |   | 6,453 |   |
|                                                                      |       |                                                               |       |   |   |   |   |   |   |   |   |
| Diluted net  income (loss) per share                                      |       | $                                                                  | 0.75       |   | $ | 0.19 |   | $ | 0.07 |   | $ | (0.22 | ) | $ | 0.24 |   |
|                                                                      |       |                                                               |       |   |   |   |   |   |   |   |   |
| Weighted  average number of common shares outstanding, diluted            |       | 9,468                                                              |       | 8,742 |   | 8,169 |   | 7,107 |   | 6,555 |   |

 
| ** **                                         | ** ** | **December 31,**   | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                         | ** ** | **(In thousands)** | ** ** |
| **BALANCE SHEET DATA:**                            |       |                    |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and short-term investments |       | $                       | 10,677     |   | $ | 5,968 |   | $ | 4,554 |   | $ | 2,220 |   | $ | 2,878 |   |
| Accounts  receivable, net                          |       | 1,840                   |       | 2,112 |   | 1,407 |   | 1,288 |   | 1,949 |   |
| Current  portion of deferred tax asset             |       | 221                     |       | — |   | — |   | — |   | — |   |
| Total  current assets                              |       | 13,294                  |       | 8,624 |   | 6,355 |   | 3,838 |   | 5,436 |   |
| Deferred tax  asset, net of current portion        |       | 5,279                   |       | — |   | — |   | — |   | — |   |
| Goodwill                                           |       | 2,043                   |       | 2,043 |   | 2,043 |   | 2,043 |   | 1,474 |   |
| Total assets                                       |       | 21,880                  |       | 13,244 |   | 10,496 |   | 8,691 |   | 9,861 |   |
| Deferred  revenue                                  |       | 3,643                   |       | 3,615 |   | 2,295 |   | 1,916 |   | 1,621 |   |
| Short-term  debt                                   |       | 20                      |       | 17 |   | 11 |   | 19 |   | 34 |   |
| Total  current liabilities                         |       | 4,718                   |       | 4,358 |   | 2,940 |   | 2,632 |   | 2,680 |   |
| Total  liabilities                                 |       | 4,736                   |       | 4,395 |   | 2,976 |   | 2,679 |   | 2,688 |   |
| Total  shareholders’ equity                   |       | 17,144                  |       | 8,849 |   | 7,520 |   | 6,012 |   | 7,173 |   |
| Working  capital                                   |       | 8,576                   |       | 4,266 |   | 3,415 |   | 1,206 |   | 2,756 |   |
|                                                    |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Quarterly Financial Information**

 

The following tables set forthsummary earnings data for each quarter of the last two years:

 
| ** **                  | ** ** | **2005**                                                           | ** ** |
|-----------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                  | ** ** | **Three Months Ended**                                   | ** ** |
| ** **                  | ** ** | **March 31**                                                  | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ** **                  | ** ** | **(In thousands, except per share data)** | ** ** |
|                        |       |                                                               |       |   |   |   |   |   |   |
| Operating revenues          |       | $                                                                  | 2,338      |   | $ | 2,489 |   | $ | 2,720 |   | $ | 2,507 |   |
| Operating income (loss)     |       | 472                                                                |       | 581 |   | 711 |   | (475 | ) |
| Net income (loss)           |       | 508                                                                |       | 647 |   | 6,412 |   | (505 | ) |
| Earnings per share, basic   |       | $                                                                  | 0.06       |   | $ | 0.08 |   | $ | 0.79 |   | $ | (0.06 | ) |
| Earnings per share, diluted |       | $                                                                  | 0.06       |   | $ | 0.07 |   | $ | 0.67 |   | $ | (0.05 | ) |

 
| ** **                  | ** ** | **2004**                                                           | ** ** |
|-----------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                  | ** ** | **Three Months Ended**                                   | ** ** |
| ** **                  | ** ** | **March 31**                                                  | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ** **                  | ** ** | **(In thousands, except per share data)** | ** ** |
|                        |       |                                                               |       |   |   |   |   |   |   |
| Operating revenues          |       | $                                                                  | 1,751      |   | $ | 1,933 |   | $ | 2,278 |   | $ | 2,471 |   |
| Operating income            |       | 209                                                                |       | 305 |   | 380 |   | 645 |   |
| Net income                  |       | 224                                                                |       | 315 |   | 405 |   | 676 |   |
| Earnings per share, basic   |       | $                                                                  | 0.03       |   | $ | 0.04 |   | $ | 0.05 |   | $ | 0.09 |   |
| Earnings per share, diluted |       | $                                                                  | 0.03       |   | $ | 0.04 |   | $ | 0.05 |   | $ | 0.07 |   |

 

**Results of Operations**

 

Thefollowing table sets forth for the periods indicated the percentages of our netrevenues represented by each indicated line item.

 
| ** **                      | ** ** | **Year  ended  December 31, 2005** | ** ** | **Year  ended  December 31, 2004** | ** ** |
|---------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
|                            |       |                                         |       |                                         |       |
| Net revenues                    |       | 100                                          | %          | 100                                          | %          |
| Cost and  expenses:             |       |                                         |       |                                         |       |
| Cost of revenues                |       | 20.5                                         |       | 20.4                                         |       |
| General and administrative      |       | 30.8                                         |       | 20.0                                         |       |
| Product and content development |       | 14.6                                         |       | 15.7                                         |       |
| Sales and marketing             |       | 19.5                                         |       | 19.0                                         |       |
| Depreciation and amortization   |       | 1.8                                          |       | 6.7                                          |       |
| Total costs and expenses        |       | 87.2                                         |       | 81.8                                         |       |
|                            |       |                                         |       |                                         |       |
| Operating income                |       | 12.8                                         | %          | 18.2                                         | %          |

 

**Year ended December 31, 2005 compared to year ended December 31,2004**

 

**Revenues**

 

Totalnet revenues increased $1,621,000, or 19.2%, to $10,054,000 for 2005 comparedto $8,433,000 for 2004.

 

Licensingrevenues increased $1,027,000, or 15.6%, to $7,598,000 for 2005 compared to $6,571,000for 2004. Our licensing revenues are derived from licensing our products tomainly healthcare, technology and internet customers. This increase isprimarily due to the success of our efforts to increase the presence of ourlicensed product in the healthcare markets. We realized increases in revenuesof $684,000 from hospitals, providers and other healthcare companies, $296,000from the managed care and payer companies, $115,000 from pharmaceuticalcompanies and $45,000 from technology related companies. These were offset by a$107,000 decrease in revenues from the internet market. As a percent of totalrevenues, revenues from the licensing agreements decreased to 75.6% for 2005 comparedto 77.9% for 2004.

 

Revenuesfrom the education market increased $447,000, or 35.1%, to $1,720,000 for 2005 comparedto $1,273,000 for 2004. This was mainly due to a $469,000 increase in sales of thenew version of our flagship product for education A.D.A.M. Interactive Anatomy 4.0which was released in the third quarter of 2004. As a percent of total netrevenues, net revenues from the education 

 

19

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marketincreased to 17.1% for 2005 compared to 15.1% for 2004.

 

**Operating Expenses**

 

Costof revenues increased $346,000, or 20.2%, to $2,063,000 for 2005 compared to $1,717,000for 2004. Cost of revenues includes shipped product components, packaging andshipping costs, newsletter printing costs, distribution license fees,royalties, and amortization of capitalized software product and contentdevelopment costs. This increase was primarily the result of a $120,000increase in software product and content development amortization, a $100,000increase in royalties, a $10,000 increase in third party licensing, and an$11,000 increase in subscription cost. This increase was offset by a $58,000decrease in shipping costs, and an $11,000 decrease in subscription costs. Asa percent of total net revenues, cost of revenues was to 20.5% for 2005 and 20.4%for 2004.

 

Generaland administrative expenses increased $1,405,000, or 83.1%, to $3,096,000 for 2005from $1,691,000 for 2004. This increase was primarily attributable to a $644,000increase in stock compensation expense related to our variably priced stockoptions, a $520,000 increase in salaries and related benefits, payroll taxesand hiring costs, a $149,000 increase in consulting fees and temporary laborfor various projects including Sarbanes Oxley related work, a $26,000 increasein bad debt expense, a $41,000 increase in legal and accounting fees, a $23,000increase in dues and fees, and a $15,000 increase in travel costs. Theseincreases were partially offset by a $46,000 decrease in investor relations, a$7,000 decrease in computer and office supplies, and a $12,000 decrease inother miscellaneous general and administrative costs. As a percent of totalrevenues, general and administrative expenses increased to 30.8% for 2005 comparedto 20.0% for 2004.

 

Productand content development costs increased $135,000, or 10.2%, to $1,456,000 for 2005from $1,321,000 for 2004. This increase was primarily attributableto $237,000 decrease in the amount of software development costs capitalized, an$8,000 increase in third party software licensing fees, a $5,000 increase incontinuing education and training costs for our employees, and a $3,000increase in both travel costs and dues and fees. Partially offsetting theseincreases was a $103,000 decrease in consulting costs, an $11,000 decrease incommissions and bonuses, a $5,000 decrease in computer related supplies, and a$4,000 decrease in payroll taxes. As a percent of total revenues, product andcontent development costs decreased to 14.6% for 2005 compared to 15.7% for2004.

 

Salesand marketing expenses increased $362,000, or 22.6%, to $1,965,000 for 2005from $1,603,000 for 2004. Driving this increase was a $195,000 increase insalaries and related payroll taxes, an $84,000 increase in advertising andmarketing related costs, and an $80,000 increase in consulting fees. As apercent of total revenues, sales and marketing expenses were 19.5% for 2005compared to 19.0% for 2004.

 

Depreciationand amortization expenses decreased $377,000, or 67.1%, to $185,000 for 2005 from$562,000 for 2004. This is due to the full depreciation and amortization ofcertain fixed assets and intangible assets during 2004 and the first half of2005. As a percent of total revenues, depreciation and amortization expensesdecreased to 1.8% for 2005 compared to 6.7% for 2004.

 

**Other Expenses and Income**

 

Interestand investment income, net, increased $191,000, or 232.9%, to $273,000 for 2005,as compared to interest income of $82,000 for 2004. This increase wasattributable to an increase in the amount of invested funds and higher interestand dividend yields.

 

In the third quarter of 2005 we realized an income tax benefit of$5,600,000 due to the reversal of a portion of our deferred tax asset valuationallowance. In the fourth quarter of 2005 we offset this benefit with a $100,000deferred income tax expense (see Note 15 to the condensed consolidatedfinancial statements.) For 2004 no provision was recorded for income taxes aswe had sufficient net operating loss carry forwards to offset taxable incomeand we had fully reserved our deferred tax asset.

 

As a result of the above, we had net income of $7,062,000, or $0.87 pershare (basic), for 2005 compared to a net income of $1,621,000, or $0.21 pershare (basic) for 2004.

 

**Liquidity and Capital Resources**

 

Asof December 31, 2005, we had cash and cash equivalents of $2,816,000,short-term investments of $7,861,000 and working capital of $8,576,000.

 

Cash provided by operating activities increased to $3,976,000 during 2005as compared to cash provided by operating activities of $3,445,000 during 2004.This $531,000 increase is due mainly to our increase in net income (net of non-cashrelated add-backs such as depreciation and amortization, deferred income taxes,and variable stock based compensation expense), an increase in accountsreceivable, and a decrease in accounts payable balances. These were offset bythe increase in our deferred tax asset balance at December 31, 2005 ascompared to December 31, 2004.

 

Cash used in investing activities was $4,798,000 during 2005 ascompared to cash used in investing activities of $4,393,000 during 

 

20

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2004, an increase of $405,000. During 2005 compared to 2004, we increasedour invested funds and restricted time deposits by $536,000. Additionally, during2005, we had a $103,000 increase in purchases of property and equipmentcompared to 2004. These increases in use of cash were offset by a $236,000 decreasein software product and content development costs.

 

Cashprovided by financing activities was $396,000 during 2005 as compared to cash usedin financing activities of $364,000 during 2004. The primary sources of this$760,000 increase in financing cash were an additional $545,000 in proceedsfrom the sale of stock and exercise of stock options and warrants, and a$125,000 net cash increase from the repayment of a stock subscriptionreceivable. Additionally, in 2005 we used $496,000 to repurchase shares of ourcommon stock compared to $592,000 in 2004.

 

We also use working capital to financeongoing operations, fund the development and introduction of new businessstrategies and internally developed software, acquire complementary businessesand acquire capital equipment.

 

Our short-term investments at December 31, 2005 included thefollowing (in thousands):

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

 

During 2005, we transferred the classification of our marketable debtsecurities from held-to-maturity to available-for-sale as we no longer have thepositive intent to hold these investments to maturity. As such, our investmentsare recorded at fair value based on current market rates. Changes in the fairvalue are included in the equity section of our balance sheet and reportedin our Consolidated Statements of Changes in Shareholders’ Equity.

 

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

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

 

At December 31, 2004, the cost of the above investmentsapproximated fair value.

 

On September 1, 2004, we entered into a Restricted Common StockPurchase Agreement with James T. Atenhan and Victor P. Thompson (each a “Purchaser”)in connection with a twelve month extension of the consulting agreement with afinancial services firm controlled by the Purchasers. Under the agreement, eachPurchaser purchased 25,000 shares of our common stock at a purchase price of$1.70 per share. The purchase price was discounted from the $2.40 market priceon the date we entered into the agreement. In connection with the sale, werecorded deferred compensation expense for services of $35,000. This deferredcompensation was expensed over the twelve-month service period which ended August 31,2005.

 

21

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On May 22, 2002, we entered into aCommon Stock Purchase Agreement with Fusion Capital Fund II, LLC. Pursuant tothis agreement, Fusion Capital agreed to purchase up to an aggregate of$12,000,000 of our common stock. We have the right to sell up to $15,000 of ourcommon stock per trading day under this agreement unless our stock price equalsor exceeds $7.00, in which case the daily amount may be increased at ouroption. Fusion Capital is not obligated to purchase any shares of our commonstock on any trading days that the market price of our common stock is lessthan $1.00. Since we registered 3,500,000 shares for sale to Fusion Capitalpursuant to the agreement, the selling price of our common stock to FusionCapital will have to average at least $3.43 per share for us to receive themaximum proceeds of $12,000,000 without registering additional shares of commonstock, which we have the right but not the obligation to do. Assuming apurchase price of $1.00 per share and the purchase by Fusion Capital of thefull 3,500,000 shares under the agreement, proceeds to us would be $3,500,000.If we decided to sell more than the 1,352,100 shares to Fusion Capital (19.99%of our outstanding shares as of May 22, 2002, the date of the agreement,exclusive of the 160,000 shares issued to Fusion Capital as a commitment fee),we would first be required to seek shareholder approval of the agreement inorder to be in compliance with Nasdaq rules. We may, but shall be under noobligation to, request our shareholders to approve the transaction contemplatedby the agreement. We may terminate the agreement at any time, and FusionCapital may terminate the agreement at any time after August 2005,approximately 40 months following the date the purchase obligation underthe agreement became effective. During the year ended December 31, 2003,we sold 486,566 shares for aggregate proceeds of $733,000 under this agreement.Since that time and through December 31, 2005, there have been nofurther transactions under this agreement.

 

22

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

 

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

 

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

 

We have also entered into certain agreementsto license content for our services from various unrelated third parties. Wealso have contractual obligations at December 31, 2005, relating to realestate, capital and operating lease arrangements.

 

Total payments due and estimated underlicense payments and real estate, operating and capital leases are listedbelow:

 
| **Year** | ** ** | **License  Agreements** | ** ** | **Real Estate  Leases** | ** ** | **Other Operating  Leases** | ** ** | **Capital Leases** | ** ** | **Total** | ** ** |
|----------|------------|-------------------------|------------|------------------------------|------------|----------------------------------|------------|-------------------------|------------|-----------|------------|
|     |       |                    |       |                         |       |                             |       |                    |       |      |       |
| 2006     |       | $                       | 114,000    |                         | $          | 234,000                          |       | $                       | 17,000     |      | $          | 24,000 |   | $ | 389,000 |   |
| 2007     |       | —                  |       | 239,000                      |       | 21,000                           |       | 19,000                  |       | 279,000   |       |
| 2008     |       | —                  |       | 182,000                      |       | 5,000                            |       | —                  |       | 187,000   |       |
|          |            |                         |            |                              |            |                                  |            |                         |            |           |            |  |  |  |  |  |

 

We believe that cash and short-terminvestments, together with anticipated cash flows from operations, will besufficient to meet our working capital needs for the next twelve months.However, we may be required to raise additional funds in order toaccelerate development of new and existing services and products, to respond tocompetitive pressures or to possibly acquire complementary products, businessesor technologies. There can be no assurance that any required additionalfinancing will be available on terms favorable to us, or at all. If additionalfunds are raised by the issuance of equity securities, our shareholders wouldexperience dilution of their ownership interest and these securities may haverights senior to those of the holders of the common stock. If additional fundsare raised by the issuance of debt securities, we may be subject tocertain limitations on our operations, including limitations on the payment ofdividends. If adequate funds are not available or not available on acceptableterms, we may be unable to take advantage of acquisition opportunities,develop or enhance services and products or respond to competitive pressures,any of which could have a material adverse effect on our business, financialcondition and results of operations.

 

We do not have any material off-balance sheetarrangements.

 

**Recent Developments**

 

In September 2005, we received a demand notice from a former resellerrequesting $237,000 plus interest and certain attorney fees relating to allegedunderpayments of royalties. We filed a breach of contract counter claim fordamages up to $500,000 relating to non-performance of the reseller agreement.Both of these matters have been settled through arbitration and in February 2006we made a $100,000 settlement payment to fully relieve us from any furtherclaims related to this matter.

 

In January 2006, our Board of Directors appointed Kevin S. Noland,our then Chief Operating Officer, to the Chief Executive Officer position. Mr. Nolandmaintains his title as President of the Company. Robert Cramer, who had heldthe CEO title for the past ten years, continues to serve as our Chairman of theBoard of Directors. In accordance with his current employment agreement Mr. Cramer’sbonuses due from the Company and his notes due to the Company have been fullysatisfied through a one time lump sum bonus payment made in December 2005.The company filed a Form 8K in January 2006 further detailing thistransaction.

 

23

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**ITEM 7. FINANCIAL STATEMENTS**

 

Thefollowing financial statements are filed as Exhibit 99.1 to this Reportand incorporated herein by reference.

 
| Report of Independent Registered Public Accounting Firm -  Tauber & Balser, P.C.                            |   |
|----------------------------------------------------------------------------------------------------------------------|--------|
| Consolidated Balance Sheets at December 31, 2005 and  2004                                                      |   |
| Consolidated Statements of Operations for the years ended  December 31, 2005 and 2004                           |   |
| Consolidated Statements of Changes in Shareholders’  Equity for the years ended December 31, 2005 and 2004 |   |
| Consolidated Statements of Cash Flows for the years ended  December 31, 2005 and 2004                           |   |
| Notes to Consolidated Financial Statements                                                                           |   |

 

**ITEM 8. CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

Not Applicable

 

**ITEM8A. CONTROLS AND PROCEDURES**

 

An evaluation was performed under thesupervision and with the participation of our management, including our ChiefExecutive Officer (who is also our acting Chief Financial Officer), of theeffectiveness of our disclosure controls and procedures as ofDecember 31, 2005. Disclosure controls andprocedures are procedures designed with the objective of ensuring thatinformation required to be disclosed by us in reports that we file or submitunder the Securities Exchange Act is recorded, processed, summarized andreported as specified in the SEC’s rules and forms. Based on that evaluation,our management, including the CEO, concluded that our disclosure controls andprocedures were effective as of the end of the period covered by this report,with the exception of the existence of certain material weaknesses existing inthe Company’s internal control over financial reporting as discussed below.

 

As of December 31, 2005, the Company hadcertain material weaknesses in its internal control over financial reporting.Internal controls over financial reporting are processes designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. The material weaknesses noted relatedto the following: (1) accrual of current period accounts payable invoicesreceived after year-end, (2) proper authorization of product shipments tocustomers at year-end, and (3) insufficient communication between sales andaccounting personnel relating to sales arrangements outside of the Company’sstandard terms.

 

Duringthe fourth quarter of 2005, there were no changes in our internal control overfinancial reporting that have materially affected, or that are reasonablylikely to materially affect, our internal control over financial reporting.During the first quarter of 2006, to improve the Company’s controls in responseto the material weaknesses discovered, management has hired additional keyaccounting personnel to effectively manage the Company’s financial closeprocess, including the review of accruals at each period end, as well as implementingadditional controls over the authorization of sales terms and products shipped.

 

**ITEM 8B. OTHER INFORMATION**

 

NotApplicable.

 

24

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**PART III.**

 

**ITEM 9. DIRECTORS, EXECUTIVEOFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OFTHE EXCHANCE ACT**

 

Theinformation required by this Item is incorporated herein by reference to ourproxy statement for our 2006 Annual Meeting of Shareholders.

 

**ITEM 10. EXECUTIVE COMPENSATION**

 

Theinformation required by this Item is incorporated herein by reference to ourproxy statement for our 2006 Annual Meeting of Shareholders.

 

**ITEM 11. SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

Theinformation required by this Item is incorporated herein by reference to ourproxy statement for our 2006 Annual Meeting of Shareholders.

 

**ITEM 12. CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS**

 

Theinformation required by this Item is incorporated herein by reference to ourproxy statement for our 2006 Annual Meeting of Shareholders.

 

**ITEM 13. EXHIBITS**

 

Thelist of exhibits filed with this report appears immediately following thesignature page of this report and is incorporated herein by reference.

 

**ITEM 14. PRINCIPAL ACCOUNTANTFEES AND SERVICES**

 

Theinformation required by this Item is incorporated herein by reference to ourproxy statement for our 2006 Annual Meeting of Shareholders.

 

25

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 

 
| Date:  March 30, 2006 | A.D.A.M., INC.  (Registrant) |
|----------------------------|-----------------------------------|
|                       |                              |   |
|                       |                              |   |
|                       | By                                | /s/ Kevin S. Noland |
|                       |                              | Kevin S. Noland*President, Chief Executive Officer and Corporate  Secretary  (principal executive officer and acting principal financial and accounting  officer)* |

 

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities indicated, on March 30, 2006.

 
| **Signature**                  | ** ** | **Title**                           |
|--------------------------------|------------|-------------------------------------|
|                           |       |                                |
|                           |       |                                |
| /s/ Robert S. Cramer, Jr. |       | Chairman  of the Board of Directors |
| Robert S. Cramer, Jr.     |       |                                |
|                           |       |                                |
|                           |       |                                |
| /s/ Clay Scarborough           |       | Director                            |
| Clay Scarborough               |       |                                |
|                           |       |                                |
|                           |       |                                |
| /s/ Daniel S. Howe             |       | Director                            |
| Daniel S. Howe                 |       |                                |
|                           |       |                                |
|                           |       |                                |
| /s/ John W. McClaugherty       |       | Director                            |
| John W. McClaugherty           |       |                                |
|                           |       |                                |
|                           |       |                                |
| /s/ Francis J. Tedesco, M.D.   |       | Director                            |
| Francis J. Tedesco, M.D.       |       |                                |
|                           |       |                                |
|                           |       |                                |
| /s/ Mark Kishel, M.D.          |       | Director                            |
| Mark Kishel, M.D.              |       |                                |

 

26

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**EXHIBIT INDEX**

 

Thefollowing exhibits are filed as part of, or are incorporated by referenceinto, this report on Form 10-KSB:

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                           |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                                                                                                                                                                |
| 3.1                  |       | Articles  of Incorporation (incorporated by reference to Exhibit 3.1 of the  Company’s Quarterly Report on Form 10-Q for the quarter ended September 30,  1999)                                                                                                       |
| 3.2                  |       | Amendment  to the Articles of Incorporation (incorporated by reference to Exhibit 3.2  of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30,  1999)                                                                                      |
| 3.3                  |       | Amended  and Restated By-Laws (incorporated by reference to the Company’s Registration  Statement on Form S-1, File No. 33-96864, dated September 12,  1995, as amended)                                                                                              |
| 10.1                 |       | Amended  and Restated 1992 Stock Option Plan (incorporated by reference to the Company’s  Registration Statement on Form S-1, File No. 33-96864, dated September 12,  1995, as amended)                                                                               |
| 10.2                 |       | 401(k)  Adoption Agreement and Trust (incorporated by reference to the Company’s  Registration Statement on Form S-1, File No. 33-96864, dated September 12,  1995, as amended)                                                                                       |
| 10.3                 |       | Second Amended and Restated  Employment Agreement between the Company and Robert S. Cramer (incorporated  by reference to the Company’s Quarterly Report on Form 10-QSB for the quarter  ended March 31, 2005)                                                                  |
| 10.3.1               |       | Amendment to the Second  Amended and Restated Employment Agreement between the Company and Robert S. Cramer  (filed herewith)                                                                                                                                                             |
| 10.3.2               |       | Second Amendment to Second  Amended and Restated Employment Agreement between  the Company and Robert S. Cramer (filed herewith)                                                                                                                                                          |
| 10.4                 |       | Employment  Agreement between the Company and Kevin S. Noland., dated December 21,  2001 (incorporated by reference to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 31, 2001)                                                         |
| 10.4.1               |       | First  Amendment to Employment Agreement between the Company and Kevin S. Noland  (incorporated by reference to Exhibit 10.2 of the Form 8-K filed by  the Company on March 18, 2005)                                                                                      |
| 10.4.2               |       | Modification  to Compensation Arrangements with Kevin S. Noland (incorporated by reference  to the Company’s Quarterly Report on Form 10-QSB for the quarter ended  September 30, 2005)                                                                                              |
| 10.4.3               |       | Second  Amendment to Employment Agreement between the Company and Kevin S. Noland  (filed herewith)                                                                                                                                                                                       |
| 10.4.4               |       | Third  Amendment to Employment Agreement between the Company and Kevin S. Noland  (filed herewith)                                                                                                                                                                                        |
| 10.5                 |       | Bridge  Note and Warrant Purchase Agreement between Union Street Partners, L.P and  Robert S. Cramer, Jr. and the Company dated December 31, 1999  (incorporated by reference to the Company’s Annual Report on Form 10-K  for the year ended December 31, 1999) |
| 10.6                 |       | Registration  Rights Agreement between Union Street Partners, L.P and Robert S. Cramer, Jr.  and the Company dated December 31, 1999 (incorporated by reference to  the Company’s Annual Report on Form 10-K for the year ended December 31,  1999)              |
| 10.7                 |       | Common  Stock Purchase Agreement dated May 22, 2003 between the Company and  Fusion Capital Fund II, LLC (incorporated by reference to the Company’s  Registration Statement of Form S-3, File No. 333-45294, dated September 7,  2000, as amended)              |
| 10.8                 |       | 2002  Stock Incentive Plan (incorporated by reference to the Company’s definitive  proxy statement filed on May 24, 2002 in connection with its 2002 Annual  Meeting of Shareholders)                                                                                           |
| 14.1                 |       | Code  of Ethics for Senior Officers (filed herewith)                                                                                                                                                                                                                                      |
| 21.1                 |       | Subsidiaries  of the Company (filed herewith)                                                                                                                                                                                                                                             |
| 23.1                 |       | Consent  Of Independent Registered Public Accounting Firm — Tauber & Balser  P.C. (filed herewith)                                                                                                                                                                          |
| 31.1                 |       | Certification  of Principal Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 (filed herewith)                                                                                                                                                            |
| 32.1                 |       | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed  herewith)                                                                                                                                                                                           |
| 99.1                 |       | Financial  Statements (filed herewith)                                                                                                                                                                                                                                                    |

 

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