**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

----

 

**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,  2004** |
| ** **     | **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**(State of incorporation) | ** ** | **58-1878070**(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)of the Act:

**None**

 

Securities registered under Section 12(g)of the Act:

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

 

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 thisForm 10-KSB or any amendment to this Form 10-KSB. o

 

The revenuesfor the year ended December 31, 2004, the most recent fiscal year, were$8,433,166.

 

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 7,2005 (based on the closing sale price of the Registrant’s common stock, asreported on the Nasdaq SmallCap Market on such date) was $53,030,459.  There were 7,891,419 shares of common stockoutstanding on March 7, 2005.

 

TransitionalSmall Business Disclosure Format Yes oNo ý

 

 

----

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions ofthe registrant’s proxy statement for its 2005 Annual Meeting of Shareholdersare incorporated herein by reference in response to Part III of this Form10-KSB.

 

2

----

 

**TABLE OFCONTENTS**

 
| **PART I.**    | ** **                                                                                                      | ** ** |
|----------------|-----------------------------------------------------------------------------------------------------------------|------------|
| Item 1.        | Business                                                                                                        |       |
| Item 2.        | Properties                                                                                                      |       |
| 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 of  Financial Condition and Results of Operations                     |       |
| Item 7.        | Financial Statements                                                                                            |       |
| Item 8.        | Changes In and Disagreements with  Accountants on Accounting and Financial Disclosures                          |       |
| Item 8A.       | Controls and Procedures                                                                                         |       |
| Item 8B.       | Other Information                                                                                               |       |
|           |                                                                                                            |       |
| **PART  III.** | ** **                                                                                                      | ** ** |
| Item 9.        | Directors and Executive Officers of the  Registrant                                                             |       |
| 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                                                                          |       |

 

3

----

 

**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.,may constitute “forward-looking statements” under the Private SecuritiesLitigation Reform Act of 1995. When used in this report, the words “believes,” “expects,”“estimates,” “intends,” “will” and similar expressions are intended to identifyforward-looking statements. Statements regarding future events and developmentsand our future performance, as well as our expectations, beliefs, plans,intentions, estimates or projections relating to the future, are forward-lookingstatements within the meaning of these laws. 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 ability tocontain our operating expenses. All forward-looking statements are subject tocertain 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.****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 to thosewho play an active and ongoing role in their personal health management. Ourhealth 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 the informationin our products. We add to our content library when needed, such as whenimportant health issues arise or when our customers request specific productsto support their product and service offerings. Our health information isaccredited by URAC, an industry leading accreditation organization, and we area 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:

 

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

 

•                  Over40,000 catalogued medical illustrations that we have developed;

 

•                  Thousandsof web-enabled animations depicting disease states and other medicalconditions, 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 

 

4

----

 

management vendors,health-oriented Internet websites, healthcare technology companies andemployers. Our products can be incorporated into a customer’s website, imbeddedin healthcare applications such as an electronic medical record or diseasemanagement applications, contained in a printed or CD-ROM format, or combinedwith other products that may be offered to a healthcare consumer.

 

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

 

•                  Toincrease the utilization of their products and services; and

 

•                  Toimprove health 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 the healthcareconsumer. We also work with some of the leading companies in the healthcareindustry to integrate our health information into applications such aselectronic 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 by theCenter for Healthcare Strategy, low health literacy is estimated to cost theU.S. healthcare industry approximately $32 to $58 billion a year. The directmedical cost impact of low health literacy results in additional hospital andoffice visits, longer hospital stays, increased number of medical tests andprocedures and additional prescriptions. It spans ethnic boundaries and socialclasses and is estimated to impact nearly one in three people in the U.S. Ourproducts take advantage of various educational techniques, such as the use ofvisual aids and interactive media, which allow healthcare organizations toreach consumers at multiple reading levels. The use of visuals has been provento assist in the understanding and retention of complex information, and wehave been at the forefront of providing visually engaging, interactive healthinformation 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 the healthcaremarkets. This is a result of our increased sales and marketing focus, thedevelopment of additional sales channels into the healthcare market and ourproduct development strategy healthcare. We also believe that the quality,depth and breadth of our product line, as well as the technology we havedeveloped in our content management infrastructure allows us to competefavorably in the markets we serve.

 

**Markets**

 

We market our products to the healthcareindustry, to Internet websites and to educational institutions and students.

 

*HealthcareIndustry*

 

Our productstarget a broad range of businesses in the healthcare industry including healthcareproviders, health plans and employers, healthcare technology companies, healthand wellness companies and pharmaceutical organizations.

 

*HealthcareProviders.*Healthcare providers include hospitals andhospital systems and large physician practice groups that are providing healthcareservices to consumers. We believe our primary revenue opportunities are withthe approximately 2,000 hospital facilities in the U.S. that exceed 250 beds.There are two underlying reasons why we believe this market is important:

 

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

 

5

----

 

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

 

*HealthPlans and Employers.* Health plans and employers are actively looking for operational andproductivity improvements through the effective use of health information. Webelieve that our products are well suited to assist these types oforganizations in two important aspects:

 

•                  Therecognition and 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 offering toserve as a driver for advertising revenue. While we still derive a portion ofour 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 educational institutions,the K through 12 market and the allied health education areas that may include medicaltechnology, dental, nursing and EMT. Historically, we have serviced this marketwith our CD-ROM products. We continue to experience a revenue stream from thesale of these CD-ROM products although we have seen a decline in our educationrevenues as our CD-ROM products have begun to age. We began shipping a majorupgrade to our flagship educational product in 2004, A.D.A.M. InteractiveAnatomy 4.0, and we expect that this release will allow us to expand our salesefforts in the educational markets. We also believe that the educational marketis an important and complementary extension of 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.

 

6

----

 

The followingchart summarizes our primary products and the typical customers of thoseproducts:

 
| **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 content is organized by topic or  condition and is enhanced with graphical illustrations. Also, available in  Spanish. |
|                                    |       |                                                                                                                                 |       |                                                                                                                                                                                                                                                                                                                                                 |
| In-Depth Disease and  Condition Reports |       | Hospitals, health plans,  disease management companies, physicians, and medical libraries.                                           |       | Available as a library or  individually by topic. Generally sold with the Health Illustrated  Encyclopedia. The In-Depth Reports provide the reader a much deeper  understanding of the subject. Typically targeted to the 8th grade  reading level.                                                                                                 |
|                                    |       |                                                                                                                                 |       |                                                                                                                                                                                                                                                                                                                                                 |
| Consumer ACCESS                         |       | Hospitals, health plans and  Internet websites catering to alternative medicine, physicians, spas and  health fitness organizations. |       | ACCESS provides medically  reviewed information on the integration of alternative therapies with  traditional medicine. Includes approximately 170 health conditions, 120 herbs  and supplements, 20 monographs on complementary treatments, and 1,600 drug monographs.                                                                              |

 

7

----

 
| **PRODUCT**                             | ** ** | **CUSTOMER**                                                                                                                   | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                                                                                                          |
|-----------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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. |
|                                    |       |                                                                                                                           |       |                                                                                                                                                                                                                                                                                                                                                     |
| 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. Also available in Spanish.                                                                                                                                                                                                         |
|                                    |       |                                                                                                                           |       |                                                                                                                                                                                                                                                                                                                                                     |
| 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 condition and lifestyle-specific.                                                                                                                                                                                                              |
|                                    |       |                                                                                                                           |       |                                                                                                                                                                                                                                                                                                                                                     |
| 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 (student version). |       | A 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. At Home Series 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.                                                                                                                                                                                    |

 

8

----

 

 

We offer our customers variouscustom and professional services including medical illustration, multimedia andanimation development and engineering. Our ability to provide customers withthese types of professional services is an important component to our positionas a full-service solution provider. We believe that in order to providefull-service solutions to our customers, we must provide flexibility in the wayour products are configured and 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 contentplatform handles the management and workflow associated with our electronicassets. The publishing components of our system allow us to deliver products toour customers more efficiently and with more accuracy. Our system also allowsus to customize our product content offerings for customers with minimaldevelopment costs. Our TransADAM integration application, made available toeach of our license customers, allows them to then manage the integration andupdating process 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 betweeninformation and 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 new customersand 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.*Medicalwriters, health practitioners and medical illustrators develop our content.Previously published content is reviewed and internally evaluated forcompleteness and relevancy. Also, textual content is evaluated for enhancementwith new and appropriate visuals.

 

9

----

 

•                  *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.

 

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-focused healthcarestrategy. We have several other important relationships that provide us withincreased visibility in our markets. Those relationships include resellers thatsell to the hospital market and healthcare technology companies that haveintegrated certain content components from us. We believe that developing morethird-party distribution will continue to be an important driver for futurerevenues.

 

**Manufacturing**

 

The production of our softwareproducts includes CD-ROM pressing, assembly of purchased product components,printing of product packaging and user manuals and shipping of finished goods,all of which is performed by third-party vendors in accordance with ourspecifications and forecasts. We believe that there are alternate sources foreach of these services that could be implemented without material delay, ifnecessary.

 

**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 and third-partynondisclosure agreements to protect our proprietary rights. We have obtainedU.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 with Kataken Seiko K.K.  We are also the owner of a number of domainname registrations**.**

 

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.

 

10

----

 

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 thatthird parties 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.

 

•                  Publishers and distributors of traditional offline media, including those targeting healthcare professionals, such as Thompson, Walters 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 operating histories,greater brand recognition and larger customer bases. We believe othercompetitive factors in our markets include ease of implementation and use,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;

 

•                  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, 2004, we had 38 employees. Of these employees, 19 wereengaged primarily in editorial management and product development, 11 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.

 

11

----

 

•                  Althoughwe reported net income for 2003 and 2004, we have incurred substantial lossesin the past. We experienced losses of $1,530,000 in 2002, income of $1,597,000in 2001 and losses of $7,854,000 in 2000. We cannot offer any assurance that wewill be able to sustain profitability in the future.

 

•                  Wemay be unable to obtain sufficient capital to pursue our growth and marketdevelopment strategies, which would hurt our financial results*.* We can offer no assurance that our revenues will besufficient to cover our expenses or that capital will be available to us onsatisfactory terms or at all, to fund any shortfall in these costs andrevenues.

 

•                  Wemay be unable to compete effectively with other providers of healthcareinformation, which could cause our growth and market development strategies tobe unsuccessful. The market for providing healthcare information is intenselycompetitive, and competition could increase in the future. As this marketdevelops, we expect our sensitivity to competitive pressures to be especiallystrong as we continue to attract and retain customers. We may not be able tocompete effectively against these companies, and if we fail to competeeffectively we may suffer reduced gross margins and loss of market share.

 

•                  Somecompetitors have advantages over us because of their longer operatinghistories, greater name recognition, or greater financial, technical andmarketing resources. As a result, they may be able to adapt more quickly to newor emerging technologies and changes in customer requirements. They could alsodevote greater resources to the promotion and sale of their products orservices. Furthermore, mergers and acquisitions among other companies couldintensify our existing competition or create new competitors.

 

•                  Wecan offer no assurance that the loss of any significant license customer willnot materially adversely affect our business.

 

•                  Weface technological challenges in our ability to deliver customized informationin the rapidly changing healthcare industry, which may limit our ability tomaintain existing customers or attract new customers*.*We believe that health information will become more customized to an individual’spersonal health management needs. As a result, we will need to have adequatetechnology infrastructure that will allow us to deliver in a cost effectivemanner portions of our content assets based on each customer’s requirements.

 

•                  Wemay be unable to successfully identify, acquire, manage or integratecomplementary businesses*.* Our long-termgrowth strategy may include acquiring businesses with complementary products,technologies or professional services. Moving forward, we may not be successfulin acquiring other complementary businesses or assimilating their personnel andoperations. These difficulties could disrupt our ongoing business, distract ourmanagement and employees, increase our expenses and adversely affect ourresults of operations. Future acquisitions may also cause us to incur expensessuch as in-process research and development expenses, which may negativelyaffect our earnings. We cannot be certain that we will successfully overcomethese risks with respect to any future acquisitions. In addition, we havehistorically paid a portion of the consideration for some of our acquisitionsby issuing common stock. The issuance of additional common stock or othersecurities convertible into common stock in connection with future acquisitionswould dilute the ownership interests of our existing shareholders.

 

•                  Wemay be unable to attract new personnel, which would adversely affectimplementation 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.

 

•                  Ourstock price is extremely volatile and could decline significantly*.* Since our initial public offering in 1995, there has beensignificant volatility in the price of our common stock. This volatility hasoften been unrelated to our operating performance. There can be no assurancethat the market price of our common stock will be maintained or that the volumeof trading in our shares will not decrease. Furthermore, following periods ofvolatility in the market price of a company’s securities, securities classaction claims frequently are brought against the subject company. To the extentthat the 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.

 

•                  Wemust comply with Section 404 of the Sarbanes-Oxley Act which will requireus to increase our expenses associated with the development and testing of ourinternal controls. There can be no assurance that we will not 

 

12

----

 

have significantdeficiencies or material weaknesses in our internal controls or that we willnot encounter higher than anticipated expenses associated with compliance thatmay adversely affect our share price.

 

•                  Wehave adopted certain anti-takeover provisions that may deter a takeover. Ourarticles of incorporation and bylaws contain provisions that may deter atakeover, including a takeover on terms that many of our shareholders mightconsider favorable, such as: the authority of our board of directors to issuecommon stock and preferred stock and to determine the price, rights (includingvoting rights), preferences, privileges and restrictions of each series ofpreferred stock, without any vote or action by our shareholders; the existenceof large amounts of authorized but unissued common stock and preferred stock;staggered, three-year terms for our board of directors; and advance noticerequirements for board of directors nominations and for shareholder proposals.The rights and preferences of any series of preferred stock could include apreference over the common stock on the distribution of our assets upon aliquidation or sale of our company, preferential dividends, redemption rights,the right to elect one or more directors and other voting rights. The rights ofthe holders of any series of preferred stock that may be issued in the futuremay adversely affect the rights of the holders of the common stock. We have nocurrent plans to issue preferred stock. In addition, certain provisions ofGeorgia law and our stock option plan may also discourage, delay or prevent achange in control of our company or unsolicited acquisition proposals.

 

•                  Asignificant number of unissued shares are available for future sale and couldadversely affect the market price of our common stock. If our shareholders,option holders, or warrant holders exercise their rights to sell substantialamounts of our common shares in the public market, the market price of ourcommon stock could fall. Given the unpredictable transaction volumes for ourcommon stock, the sale of a significant amount of these shares at any giventime could cause the market price of our common stock to decline or otherwisebe highly volatile. Such sales could also make it more difficult for us to sellequity or equity-related securities in the future at a time and price when wedeem conditions to be more favorable.

 

•                  OurStock Purchase Agreement with Fusion Capital Fund II, LLC may result insignificant dilution of our other shareholders. On May 22, 2002, weentered into a Common Stock Purchase Agreement with Fusion Capital Fund II,LLC. Pursuant to this agreement, Fusion Capital has agreed to purchase up to anaggregate of $12,000,000 of our common stock. We have the right to sell up to$15,000 of common stock per trading day under this agreement with FusionCapital unless our stock price equals or exceeds $7.00, in which case the dailyamount may be increased at our option. Fusion Capital is not obligated topurchase any shares of our common stock on any trading days that the marketprice of our common stock is less than $1.00. Sales of our common stock underthis agreement would dilute the ownership of shareholders other than FusionCapital Fund II, LLC. As of December 31, 2003, we had sold 486,566 sharesfor $733,000 under this agreement. During the year ended December 31,2004, there were no transactions 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 on commonhealth conditions and diseases called WELL-CONNECTEDTM. This library of over 100reports was originally developed by an experienced team of medical writers andeditors and is reviewed for accuracy by a board of physicians with facultypositions at Harvard Medical School and Massachusetts General Hospital. Eachreport 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 as A.D.A.M. Software, Inc. We changed ourname to adam.com, Inc. in 1999 and to A.D.A.M., Inc. in 2001. We are headquarteredin Atlanta, Georgia.

 

13

----

 

**ITEM 2.****PROPERTIES**

 

Our headquarters are located in approximately 12,000 square feet ofleased office space in Atlanta, Georgia. This lease extends through April 2008.We sublease approximately 500 square feet of this space to a company whoseChairman is our Chief Executive Officer. Beginning March 1, 2005, we will becollecting $1,200 for monthly lease payments and other shared services. Wesublease an additional 500 square feet of this space to a company whose ChiefExecutive Officer is a director of A.D.A.M. for monthly lease payments of $785.

 

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

 

**ITEM 3.****LEGAL PROCEEDINGS**

 

We are not party to any legalproceedings.

 

**ITEM 4.****SUBMISSION OF MATTERS TO A VOTEOF SECURITY HOLDERS**

 

No matters were submitted to a vote of security holders during the lastquarter of 2004.

 

14

----

 

**PART II.**

 

**ITEM 5.****MARKET FOR COMMON EQUITY,RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITYSECURITIES**

 

**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** | ** ** |
|------------------------------------------------|------------|----------|------------|---------|------------|
|                                           |       |     |       |    |       |
| **Twelve Months Ended December 31, 2003** |       |     |       |    |       |
| Quarter ended March 31, 2003              |       | $        | 1.30       |    | $          | 0.35 |   |
| Quarter ended June 30, 2003               |       | $        | 1.74       |    | $          | 0.80 |   |
| Quarter ended September 30, 2003          |       | $        | 2.19       |    | $          | 1.12 |   |
| Quarter ended December 31, 2003           |       | $        | 2.69       |    | $          | 1.42 |   |
|                                           |       |     |       |    |       |
| **Twelve Months 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 |   |

 

At March 7, 2005 there were 148 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**

 

On September 1, 2004, we entered into a Restricted Common StockPurchase Agreement with James T. Atenhan and Victor P. Thompson (each a “Purchaser”and collectively, the “Purchasers”) in connection with a consulting agreementwe entered into with a financial services firm controlled by the Purchasers.Each Purchaser purchased 25,000 shares of our common stock at a purchase priceof $1.70 per share. The purchase price of our common stock was discounted fromthe $2.40 market price on the date we entered into the agreement. The offer andsale of the shares to the Purchasers was exempt from the registrationrequirements of the Securities Act of 1933 (the “Act”) pursuant to Rule 506 andSection 4(2) of the Act. In connection with the sales, we complied withthe informational requirements of Regulation D, did not conduct any generalsolicitation or advertising, and complied with the requirements of Regulation Drelating to the restrictions on the transferability of the shares issued.

 

15

----

 

**ITEM 6.****MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**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 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 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 our productdevelopment strategy. We also believe that the quality, depth and breadth ofour product line, as well as the technology we have developed in our contentmanagement infrastructure allows us to compete favorably in the markets weserve.  Information regarding each of ourservice markets appears in Item 1 of 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 

 

16

 

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. 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.

 

17

 

•                  *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.

 

•                  *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.

 

•                  *Variable Stock Options*

 

InMarch 2000, the FASB issued Financial Interpretations No. 44 (“FIN 44”), “Accountingfor Certain Transactions involving Stock Compensation (an interpretation of APBOpinion No. 25).” This opinion provides guidance on the accounting for certainstock option transactions and subsequent amendments to stock optiontransactions. FIN 44 was effective July 1, 2000, but certain conclusionscover specific events that occur after either December 15, 1998 or January 12,2000. We have from time to time granted stock options to our employees topurchase shares of our common stock. Certain of these options were canceled atthe option of their holders on January 14, 1999, and then replaced thatday on a one-for-one basis with new options with an exercise price equal to theclosing market price that day.

 

Theadoption of FIN 44 did not have a material impact on our financial position orresults of operations. This interpretation requires variable accountingtreatment for options that have been modified from their original terms.Accordingly, compensation cost shall be adjusted for increases or decreases inthe intrinsic value of the modified awards in subsequent periods and until theawards have been exercised, forfeited, or expired. As of December 31, 2004,we have 231,438 outstanding options with an exercise price of $5.25 that areconsidered variable under this interpretation. Because the stock price from theeffective date of July 1, 2000 through December 31, 2004 has beenbelow $5.25, we had not recorded any compensation cost related to the re-pricedoptions issued on January 14, 1999. On March 7, 2005, the closingprice of our common stock was $6.98.  Shouldour stock price remain above $5.25 our operating results will be affected untilthe stock options are either exercised or forfeited and could adversely affectany reporting period in which the variable accounting is required. Any chargesthat result from these variable options would be non-cash operating expensesand will be reported on a separate line item. See “Recent Developments”

 

18

 

**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,” andamends FASB Statement No. 95, “Statement of Cash Flows.” The approach toaccounting 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 no longerallows pro forma disclosure as an alternative to financial statementrecognition. We will be required to adopt Statement 123(R) at the beginning ofits quarter ending March 31, 2006.

 

We will adopt SFAS 123(R) using the modified prospective method andreflect compensation expense in accordance with the SFAS 123(R) transitionprovisions.  Under the modifiedprospective method, prior periods are not restated to reflect the impact ofadopting the new standard at earlier dates. Pro forma disclosures regarding the effect on our net income and netincome per common share in 2004 and 2003, had we applied the fair value methodof accounting for share-based compensation as prescribed by SFAS 123, arecontained in the “Stock-based employee compensation” section of Note1.  Based on share-based compensationgranted through December 31, 2004 and the fair values previouslycalculated under SFAS 123, we project we will record an immaterial amount ofadditional compensation expense in 2006 related to stock options upon theadoption of SFAS 123R compared to the existing accounting method under APBOpinion No. 25.  We are still evaluatingthe impact this new standard will have on our Stock Incentive Plan.

 

**SelectedFinancial Data**

 

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

 
| ** **                                                                                   | ** ** | **Twelve Months Ended   December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                                   | ** ** | **(In thousands, except per share  data)**  | ** ** |
| **STATEMENT  OF OPERATIONS DATA:**                                                           |       |                                        |       |   |   |   |   |   |   |   |   |
| Net revenues                                                                                 |       | $                                           | 8,433      |   | $ | 7,889 |   | $ | 8,924 |   | $ | 8,946 |   | $ | 8,621 |   |
| Costs and  expenses:                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Costs of  revenues                                                                           |       | 1,717                                       |       | 1,668 |   | 1,478 |   | 1,588 |   | 742 |   |
| General and  administrative                                                                  |       | 1,497                                       |       | 1,774 |   | 2,451 |   | 2,156 |   | 3,323 |   |
| Product and  content development                                                             |       | 1,414                                       |       | 1,375 |   | 2,476 |   | 2,243 |   | 4,091 |   |
| Sales and  marketing                                                                         |       | 1,704                                       |       | 1,743 |   | 2,782 |   | 1,961 |   | 2,958 |   |
| Depreciation  and amortization                                                               |       | 562                                         |       | 767 |   | 909 |   | 820 |   | 2,410 |   |
| Restructuring                                                                                |       | —                                      |       | — |   | — |   | — |   | 733 |   |
| Total costs  and expenses                                                                    |       | 6,894                                       |       | 7,327 |   | 10,096 |   | 8,768 |   | 14,257 |   |
| Operating  income (loss)                                                                     |       | 1,539                                       |       | 562 |   | (1,172 | ) | 178 |   | (5,636 | ) |
| Interest  income (expense), net                                                              |       | 82                                          |       | 46 |   | 66 |   | 99 |   | (987 | ) |
| Realized  loss and impairment of investment securities                                       |       | —                                      |       | — |   | (176 | ) | (146 | ) | (1,105 | ) |
| Realized  gain on sale of assets, net                                                        |       | —                                      |       | — |   | — |   | 1,808 |   | — |   |
| Income  (loss) before income taxes, minority interest and equity in net losses of  affiliate |       | $                                           | 1,621      |   | $ | 608 |   | $ | (1,282 | ) | $ | 1,939 |   | $ | (7,728 | ) |
| Income taxes                                                                                 |       | —                                      |       | — |   | — |   | — |   | — |   |
| Income  (loss) before minority interest and equity in net losses of affiliate                |       | $                                           | 1,621      |   | $ | 608 |   | $ | (1,282 | ) | $ | 1,939 |   | $ | (7,728 | ) |
| Minority  interest in consolidated subsidiary                                                |       | —                                      |       | — |   | — |   | — |   | — |   |
| Equity in  net losses of affiliate                                                           |       | —                                      |       | — |   | (248 | ) | (342 | ) | (126 | ) |
|                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Net income  (loss)                                                                           |       | $                                           | 1,621      |   | $ | 608 |   | $ | (1,530 | ) | $ | 1,597 |   | $ | (7,854 | ) |
|                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic net  income (loss) per share                                                           |       | $                                           | 0.21       |   | $ | 0.08 |   | $ | (0.22 | ) | $ | 0.25 |   | $ | (1.42 | ) |
|                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Weighted  average number of common shares and share equivalents outstanding, basic           |       | 7,879                                       |       | 7,306 |   | 7,107 |   | 6,453 |   | 5,536 |   |
|                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Diluted net  income (loss) per share                                                         |       | $                                           | 0.19       |   | $ | 0.07 |   | $ | (0.22 | ) | $ | 0.24 |   | $ | (1.42 | ) |
|                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Weighted  average number of common shares and share equivalents outstanding, diluted         |       | 8,742                                       |       | 8,169 |   | 7,107 |   | 6,555 |   | 5,536 |   |

 

19

----

 
| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                         | ** ** | **(In thousands)**    | ** ** |
| **BALANCE  SHEET DATA:**                           |       |                  |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and short-term investments |       | $                     | 5,968      |   | $ | 4,554 |   | $ | 2,220 |   | $ | 2,878 |   | $ | 1,666 |   |
| Accounts  receivable-net                           |       | 2,112                 |       | 1,407 |   | 1,288 |   | 1,949 |   | 1,046 |   |
| Total  current assets                              |       | 8,624                 |       | 6,355 |   | 3,838 |   | 5,436 |   | 3,259 |   |
| Goodwill                                           |       | 2,043                 |       | 2,043 |   | 2,043 |   | 1,474 |   | — |   |
| Total assets                                       |       | 13,244                |       | 10,496 |   | 8,691 |   | 9,861 |   | 6,817 |   |
| Deferred revenue                                   |       | 3,615                 |       | 2,295 |   | 1,916 |   | 1,621 |   | 2,479 |   |
| Short-term  debt                                   |       | 17                    |       | 11 |   | 19 |   | 34 |   | 188 |   |
| Total  current liabilities                         |       | 4,358                 |       | 2,940 |   | 2,632 |   | 2,680 |   | 4,162 |   |
| Total  liabilities                                 |       | 4,395                 |       | 2,976 |   | 2,679 |   | 2,688 |   | 4,162 |   |
| Total  shareholders’ equity                   |       | 8,849                 |       | 7,520 |   | 6,012 |   | 7,173 |   | 2,655 |   |
| Working  capital (deficiency)                      |       | 4,266                 |       | 3,415 |   | 1,206 |   | 2,756 |   | (903 | ) |
|                                                    |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Quarterly Financial Information**

 

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

 
| ** **                 | ** ** | **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 |   |
| Earning per  share basic   |       | $                                          | 0.03       |   | $ | 0.04 |   | $ | 0.05 |   | $ | 0.09 |   |
| Earning per  share diluted |       | $                                          | 0.03       |   | $ | 0.04 |   | $ | 0.05 |   | $ | 0.07 |   |

 
| ** **                 | ** ** | **2003**                                   | ** ** |
|----------------------------|------------|--------------------------------------------|------------|
| ** **                 | ** ** | **Three  Months Ended**                    | ** ** |
| ** **                 | ** ** | **March 31**                          | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ** **                 | ** ** | **(In  thousands, except per share data)** | ** ** |
|                       |       |                                       |       |   |   |   |   |   |   |
| Operating  revenues        |       | $                                          | 2,344      |   | $ | 1,934 |   | $ | 1,873 |   | $ | 1,738 |   |
| Operating  income          |       | 288                                        |       | 113 |   | 76 |   | 85 |   |
| Net income                 |       | 299                                        |       | 126 |   | 86 |   | 97 |   |
| Earning per share basic    |       | $                                          | 0.04       |   | $ | 0.02 |   | $ | 0.01 |   | $ | 0.01 |   |
| Earning per  share diluted |       | $                                          | 0.04       |   | $ | 0.02 |   | $ | 0.01 |   | $ | 0.01 |   |

 

**Results of Operations**

 

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

 
| ** **                      | ** ** | **Twelve Months  ended  December 31, 2004** | ** ** | **Twelve Months  ended  December 31, 2003** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
|                            |       |                                             |       |                                             |       |
| Net revenues                    |       | 100                                              | %          | 100                                              | %          |
| Cost and expenses:              |       |                                             |       |                                             |       |
| Cost of revenues                |       | 20.4                                             |       | 21.1                                             |       |
| General and administrative      |       | 17.7                                             |       | 22.5                                             |       |
| Product and content development |       | 16.8                                             |       | 17.4                                             |       |
| Sales and marketing             |       | 20.2                                             |       | 22.1                                             |       |
| Depreciation and amortization   |       | 6.7                                              |       | 9.7                                              |       |
| Total costs and expenses        |       | 81.8                                             |       | 92.8                                             |       |
|                            |       |                                             |       |                                             |       |
| Operating income                |       | 18.2                                             | %          | 7.2                                              | %          |

 

**Twelve months ended December 31, 2004 compared to twelve monthsended December 31, 2003**

 

20

----

 

**Revenues**

 

Totalnet revenues increased $544,000, or 6.9%, to $8,433,000 for 2004 compared to $7,889,000for 2003.

 

Revenuesfrom the healthcare industry increased $1,475,000, or 34.9%, to $5,706,000 for2004 compared to $4,231,000 for 2003. This increase in revenues was attributableto healthcare licensing revenue. We have undertaken technological initiativesto enable our content products to be used in broader applications within the healthcareindustry such as electronic medical records and other point-of-careapplications. We believe we are well positioned in the market as the demand forhealth information grows and as content becomes an increasingly importantdriver for business growth within the healthcare industry. As a percent oftotal revenues, revenues from the healthcare industry increased to 67.7% for2004 compared to 53.6% for 2003.

 

Revenuesfrom the Internet market decreased $860,000, or 39.3%, to $1,326,000 for 2004compared to $2,186,000 for 2003. This decrease was primarily due to theexpiration of alicense agreement with WebMD Corp., which accounted forapproximately 26% of Internet market revenues during 2003.  Our concentration on expanding our presencein the healthcare market also contributed to decline in Internet revenues.  As a percent of total net revenues, revenuesfrom the Internet market decreased to 15.7% during 2004 compared to 27.7% for2003.

 

Revenuesfrom the education market decreased $58,000, or 4.1%, to $1,367,000 for 2004compared to $1,425,000 for 2003. This decrease was primarily attributable to a decrease of $256,000 ofsubscription products revenue.  Of thisdecrease in subscription products revenue, $136,000 was due to the effects ofthe transfer of the IMC Consult Newsletter subscription rights to anotherpublisher and $100,000 was due to the reclassification of the Well-Connectedsubscription customer base from the educational market to the healthcaremarket. Also contributing to the overall education market revenue decrease was a$122,000 decrease in sales of our CD-ROM based products, primarily due to anaging product line.  This decrease inrevenues was offset by $304,000 of new revenues from the 2004 release of amajor upgrade of our flagship product for education, A.D.A.M. InteractiveAnatomy 4.0.  Other CD-ROM sales were down slightly,$30,000, while education license agreements and royalties further offset theeducation revenue decrease by $38,000 and $12,000, respectively.  As a percent of total net revenues,net revenues from the education market decreased to 16.2% for 2004 compared to 18.1%for 2003.

 

**Operating Expenses**

 

Costof revenues increased $49,000, or 2.9%, to $1,717,000 for 2004 compared to $1,668,000for 2003. 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. Thisincrease was primarily the result of a $51,000 increase of cost of goods soldfor our CD-ROM based products and a $54,000 net increase in distributionlicense fees from the sales of our Spanish language products, the sales of ourthird party licensing agreement products, and royalty expenses. This increasewas offset by a $37,000 decrease in software product and content developmentamortization due to certain capitalized products and content being fullyamortized (net of a $242,000 increase in amortization due to the completion ofnew products, including the Family Health Guide, during 2004) and a $21,000 decrease related to our IMC newsletterdue to the transfer of subscription rights to another publisher. As a percent of total net revenues,cost of revenues decreased to 20.4% for 2004 compared to 21.1% for 2003.

 

Generaland administrative expenses decreased $277,000, or 15.6%, to $1,497,000 for 2004from $1,774,000 for 2003. This decrease was primarily attributable to a $74,000decrease in investor relations expenses, a $73,000 decrease in legal andaccounting expenses, a $60,000 decrease in our general insurance expense, a$45,000 decrease in bad debt expense, a $35,000 decrease in general andadministrative overhead expenses related to the closing of our Boston office, a$30,000 decrease in equipment and furniture leasing expenses, and a $9,000decrease in our rent expense. This decrease was offset by a $22,000 increase intax and license expenses, a $20,000 increase in salary expenses and a $9,000increase in overall general and administrative expenses. As a percent of totalrevenues, general and administrative expenses decreased to 17.8% for 2004compared to 22.5% for 2003.

 

Productand content development costs increased $39,000, or 2.8%, to $1,414,000 for 2004from $1,375,000 for 2003. This increase was primarily attributableto a $72,000 increase in consulting expenses, a $15,000 increase in contentacquisition expenses and a $10,000 increase in salary expenses. This increasewas offset by a $44,000 decrease in research and development expenses whichwere capitalized during 2004, a $9,000 decrease in third party licenseexpenses, and a $4,000 decrease in overall product and content developmentexpenses. As a percent of total revenues, product and content development costsdecreased to 16.8% for 2004 compared to 17.4% for 2003.

 

21

----

 

Salesand marketing expenses decreased $39,000, or 2.2%, to $1,704,000 for 2004 from$1,743,000 for 2003. Thisdecrease was primarily attributable to a $70,000 decrease in commission andbonus expenses, a $34,000 decrease in salary expenses, a $14,000 decrease in overallsales and marketing expenses and a $12,000 decrease in travel expenses. Thisdecrease was offset by a $61,000 increase in consulting expenses relating tothe upgrade of A.D.A.M.Interactive Anatomy, a $17,000increase in trade show expenses and a $16,000 increase in advertising expense.As a percent of total revenues, sales and marketing expenses decreased to 20.2%for 2004 compared to 22.1% for 2003.

 

Depreciationand amortization expenses decreased $205,000, or 26.7%, to $562,000 for 2004from $767,000 for 2003.  This decrease was attributable to a $173,000net decrease of purchased contract and content acquisition amortization and a$32,000 decrease in depreciation of assets.  As a percent of total revenues, depreciationand amortization expenses decreased to 6.7% for 2004 compared to 9.7% for 2003.

 

**Other Expenses and Income**

 

Interestincome, net, increased $36,000, or 78.3%, to $82,000 for 2004, as compared tointerest income of $46,000 for 2003. This increase was primarily attributableto the purchase of investment funds and additional time deposits during theyear.

 

For 2004 and 2003, no provision was made for income taxes, as we hadsufficient net operating loss carry forwards to offset taxable income. Wecurrently meet the requirements for the small corporation exemption forAlternative Minimum Tax purposes. As of December 31, 2004, we continue tomaintain a valuation allowance against our total net deferred tax assetbalance.

 

As a result of the above, we had net income of $1,621,000, or $0.21 pershare (basic), for 2004 compared to a net income of $608,000, or $0.08 pershare (basic) for 2003.

 

**Liquidity and Capital Resources**

 

Asof December 31, 2004, we had cash of $3,242,000, short-term investments of$2,726,000 and working capital of $4,266,000.

 

Cash provided by operating activities increased to $3,445,000 during2004 as compared to cash provided by operating activities of $2,130,000 during2003. This increase is due mainly to our increase in both net income and deferredrevenue.  This increase was slightlyoffset by the increase in our accounts receivable balance at December 31,2004 as compared to December 31, 2003.

 

Cash used in investing activities was $4,393,000 during 2004 ascompared to cash used in investing activities of $624,000 during 2003. During2004, we purchased approximately $2,726,000 of short term investments (seetable below) and a $1,000,000 long-term bond. We had no such purchases in 2003. Additionally, during 2004, our purchases of property and equipmentincreased $16,000 as compared to 2003.

 

Cashused in financing activities increased to $364,000 during 2004 as compared tocash provided by financing activities of $828,000 during 2003. The primaryfinancing activity impacting cash flows in 2004 the repurchase of shares of ourcommon stock for $592,000 offset by a $609,000 net decrease in proceeds fromthe sale of common stock and the exercise of stock options.

 

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.

 

22

----

 

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 June 15, 2004 we also purchased along-term bond in the amount of $1,000,000. The bond matures on July 15, 2006 and earns interest at an annualrate of approximately 4.50%. Interest is paid to us on a semi-annualbasis.  At December 31, 2004, theamortized cost of the bond approximated fair value.

 

On February 15,2003, we entered into a Restricted Common Stock Purchase Agreement with JamesT. Atenhan and Victor P. Thompson (each a “Purchaser”) in connection with aconsulting agreement with a financial services firm controlled by thePurchasers. Each Purchaser purchased 37,500 shares of our common stock at apurchase price of $.40 per share. The purchase price of our common stock wasdiscounted from the $.78 market price on the date we entered into theagreement. In connection with the sale, we recorded deferred compensation forservices of $28,500. This deferred compensation expense was expensed over thesix-month service period.

 

On August 1,2003, we entered into a second Restricted Common Stock Purchase Agreement withthe Purchasers in connection with a twelve-month extension of the consulting agreement.Each Purchaser purchased 38,889 shares of our common stock at a purchase priceof $.90 per share. The purchase price of our common stock was discounted fromthe $1.86 market price on the date we entered into the agreement. In connectionwith the sale, we recorded deferred compensation for services of $74,667. Thisdeferred compensation expense was expensed over the twelve-month service period.

 

On September 1,2004, we extended the consulting agreement for another twelve months andentered into a third Restricted Common Stock Purchase Agreement with thePurchasers. Each Purchaser purchased 25,000 shares of our common stock at apurchase price of $1.70 per share. The purchase price was discounted from the$2.40 market price on the date we entered into the agreement. In connectionwith the sale, we recorded deferred compensation expense for services of$35,000. This deferred compensation expense is being expensed over thetwelve-month service period beginning September 1, 2004.  As of December 31, 2004, the remainingdeferred compensation expense for services was approximately $23,000.

 

On May 22, 2002, weentered into a Common Stock Purchase Agreement with Fusion Capital Fund II,LLC. Pursuant to this agreement, Fusion Capital agreed to purchase up to anaggregate of $12,000,000 of our common stock. We have the right to sell up to$15,000 of our common stock per trading day under this agreement unless ourstock price equals or exceeds $7.00, in which case the daily amount may beincreased at our option. Fusion Capital is not obligated to purchase any sharesof our common stock on any trading days that the market price of our commonstock is less than $1.00. Since we registered 3,500,000 shares for sale toFusion Capital pursuant to the agreement, the selling price of our common stockto Fusion Capital will have to average at least $3.43 per share for us toreceive the maximum proceeds of $12,000,000 without registering additionalshares of common stock, which we have the right but not the obligation to do.Assuming a purchase price of $1.00 per share and the purchase by Fusion Capitalof the full 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 FusionCapital (19.99% of our outstanding shares as of May 22, 2002, the date ofthe agreement, exclusive of the 160,000 shares issued to Fusion Capital as acommitment fee), we would first be required to seek shareholder approval of theagreement in order to be in compliance with Nasdaq rules. We may, but shall beunder no obligation to, request our shareholders to approve the transactioncontemplated by the agreement. We may terminate the agreement at any time, andFusion Capital may terminate the agreement at any time after approximately40 months following the date the purchase obligation under the agreementbecame effective. During the year ended December 31, 2003, we sold 486,566shares for aggregate proceeds of $733,000 under this agreement.  During the year ended December 31, 2004,there were no transactions under this agreement.

 

23

----

 

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 warrants were issued in conjunctionwith the issuance of notes on December 31, 1999 and are exercisable at anytime at the election of the holders, expiring at various dates through December 31,2005. During 2004 50,000 warrants at an exercise price of $11.11 per shareexpired.

 

On May 30, 2001, we received afull-recourse promissory note from our Chief Executive Officer for approximately$341,000 (the “Exercise Note”) for the exercise of 150,000 options at $1.94 pershare and a $50,000 promissory note (the “Tax Note”) in connection with a loanto our Chief Executive Officer to pay taxes related to the stock exercise. Thenotes accrue interest of 6.25% per annum and are due in full on or beforeMay 29, 2006. Part of the Exercise Note, $291,000, is secured by 150,000shares of our common stock and is recorded in shareholders’ equity. At December 312004 and 2003, $291,000 of principal was owed under the Exercise Note and$39,000 of principal was owed under the Tax Note.  At December 31, 2004, there was also$21,000 in accrued interest outstanding. Bonuses accruing under the Chief Executive Officer’s employmentagreement will be used to repay the notes (see paragraph below).

 

On October 1, 2002, we entered into anemployment agreement with our Chief Executive Officer, which was amended on March 17,2004. The employment agreement as amended provides for bonuses in an aggregateamount of approximately $289,000 through May 2006. Under the terms of theagreement, these bonuses will be paid by reducing the amounts outstanding underthe Exercise Note and Tax Note. During the year ended December 31, 2003,our Chief Executive Officer earned bonus payments totaling $78,866 under theagreement which were applied towards accrued interest and the outstanding NoteReceivable balance.  At December 31,2004 we had accrued bonuses to our Chief Executive Officer in the amount of$61,340, which will be applied as payment in May 2005 first to any accruedinterest and then to the outstanding Note Receivable balance. At December 31,2004, an additional approximately $149,000 of bonuses remained to be accrued andpaid under this agreement.

 

We have also entered into certain agreementsto license content for our services from various unrelated third parties. Wealso have contractual obligations at December 31, 2004, relating to realestate, capital and operating lease arrangements.

 

Total payments due and estimated underlicense payments and real estate, operating and capital leases and total bonusamounts due under an employment agreement are listed below:

 
| **Year** | ** ** | **License  Agreements** | ** ** | **Annual  Bonus** | ** ** | **Real Estate  Leases** | ** ** | **Other Operating   Leases** | ** ** | **Capital Leases** | ** ** | **Total** | ** ** |
|----------|------------|-------------------------|------------|-------------------|------------|-------------------------|------------|------------------------------|------------|--------------------|------------|-----------|------------|
|     |       |                    |       |              |       |                    |       |                         |       |               |       |      |       |
| 2005     |       | $                       | 100,000    |              | $          | 105,000                 |       | $                            | 229,000    |               | $          | 1,000     |       | $ | 24,000 |   | $ | 459,000 |   |
| 2006     |       | 0                       |       | 105,000           |       | 234,000                 |       | 1,000                        |       | 24,000             |       | 364,000   |       |
| 2007     |       | 0                       |       | 0                 |       | 239,000                 |       | 1,000                        |       | 19,000             |       | 259,000   |       |
| 2008     |       | 0                       |       | 0                 |       | 182,000                 |       | 0                            |       | 0                  |       | 182,000   |       |
|          |            |                         |            |                   |            |                         |            |                              |            |                    |            |           |            |  |  |  |  |  |  |

 

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 to acceleratedevelopment 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 to certainlimitations on our operations, including limitations on the payment ofdividends. If adequate funds are not available or not available on acceptable terms,we may be unable to take advantage of acquisition opportunities, develop orenhance services and products or respond to competitive pressures, any of whichcould have a material adverse effect on our business, financial condition andresults of operations.

 

We do not have any material off-balance sheetarrangements.

 

**Recent Developments**

 

*Variable stock options* (see the CriticalAccounting Policies and Estimates section of Item 6 above).

Asmentioned above, in the event our stock price goes above $5.25 we willrecognize compensation expense for each variable stock option outstanding.  On March 7, 2005 the closing stock pricewas $6.98.   Accordingly, as of 

 

24

----

 

March 7,2005 the total compensation expense during the first quarter ending March 31,2005 related to the variable stock options was approximately $400,000 for thefirst quarter of 2005.

 

**ITEM 7.****FINANCIAL STATEMENTS**

 

Thefollowing financial statements are filed as Exhibit 99.1 to this Report and incorporatedherein by reference.

 
| Report  of Independent Registered Public Accounting Firm - Tauber & Balser, P.C.                                  |
|-----------------------------------------------------------------------------------------------------------------------|
| Report  of Independent Registered Public Accounting Firm – PricewaterhouseCoopers LLP                            |
| Consolidated Balance  Sheets at December 31, 2004 and 2003                                                       |
| Consolidated  Statements of Operations for the years ended December 31, 2004 and 2003                            |
| Consolidated  Statements of Changes in Shareholders’ Equity for the years ended December 31,  2004 and 2003 |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2004 and 2003                            |
| Notes to  Consolidated Financial Statements                                                                           |

 

**ITEM 8.****CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES**

 

Not Applicable

 

**ITEM 8A.****CONTROLS AND PROCEDURES**

 

Anevaluation was performed under the supervision and with the participation ofour management, including our Chief Executive Officer, or CEO, and ChiefOperating Officer (our acting Chief Financial Officer), or COO, of theeffectiveness of our disclosure controls and procedures as of December 31,2004. Based on that evaluation, our management, including the CEO and COO,concluded that our disclosure controls and procedures are effective to ensurethat information required to be disclosed by us in reports that we file orsubmit under the Securities Exchange Act is recorded, processed, summarized andreported as specified in the SEC’s rules and forms.

 

Duringthe fourth quarter of 2004, 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.

 

**ITEM 8B.****OTHER INFORMATION**

 

NotApplicable.

 

25

----

 

**PART III.**

 

**ITEM 9.****DIRECTORS AND EXECUTIVE OFFICERSOF THE REGISTRANT**

 

Theinformation required by this Item is incorporated herein by reference to ourproxy statement for our 2005 Annual Meeting of Shareholders.

 

**ITEM 10.****EXECUTIVE COMPENSATION**

 

Theinformation required by this Item is incorporated herein by reference to ourproxy statement for our 2005 Annual Meeting of Shareholders.

 

**ITEM 11.****SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

Theinformation required by this Item is incorporated herein by reference to ourproxy statement for our 2005 Annual Meeting of Shareholders.

 

**ITEM 12.****CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS**

 

Theinformation required by this Item is incorporated herein by reference to ourproxy statement for our 2005 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 ACCOUNTANT FEES ANDSERVICES**

 

Theinformation required by this Item is incorporated herein by reference to ourproxy statement for our 2005 Annual Meeting of Shareholders.

 

26

----

 

**SIGNATURES**

 

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

 
| Date:  March 29, 2005 | A.D.A.M., INC.  (Registrant) |
|----------------------------|-----------------------------------|
|                       | By:                               | /s/ Robert S. Cramer, Jr. |
|                       |                              | Robert S. Cramer, Jr.*Chairman of the Board and  Chief Executive Officer (principal executive officer)* |
|                       |                              |   |
|                       | By                                | /s/ Kevin S. Noland |
|                       |                              | Kevin S. Noland*President, Chief Operating Officer and Corporate  Secretary  (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 29, 2005.

 
| **Signature**                | ** ** | **Title**                                          |
|------------------------------|------------|----------------------------------------------------|
|                         |       |                                               |
|                         |       |                                               |
| /s/ Robert S. Cramer, Jr.    |       | Chairman  of the Board and Chief Executive Officer |
| 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.            |       |                                               |

 

27

----

 

**EXHIBIT INDEX**

 

Thefollowing exhibits are filed as part of, or are incorporated by reference into,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            |       | Amended  and Restated Employment Agreement between the Company and Robert S. Cramer,  dated October 1, 2002 (the “Cramer Employment Agreement”) (incorporated  by reference to the Company’s Annual Report on Form 10-KSB for the fiscal  year ended December 31, 2002) |
| 10.3.1          |       | Letter  agreement regarding calculation of bonus payments under the Cramer Employment  Agreement (incorporated by reference to the Company’s Annual Report on Form  10-K for the fiscal year ended December 31, 2003)                                                                  |
| 10.3.2          |       | First  Amendment to Amended and Restated Employment Agreement between the Company  and Robert S. Cramer (incroporated by reference to Exhibit 10.1 of the Form  8-K filed by the Company on March 18, 2005)                                                                                      |
| 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)                                                                                                            |
| 10.5            |       | 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)                                                                                                                                                                                      |
| 23.2            |       | Consent  Of Independent Registered Public Accounting Firm — PricewaterhouseCoopers LLP  (filed herewith)                                                                                                                                                                                    |
| 31.1            |       | Certification  of Principal Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 (filed herewith)                                                                                                                                                                   |
| 31.2            |       | Certification  of Principal Financial 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)                                                                                                                                                                                                                                                           |

 

28

----