This analysis of our results of operations should be read in conjunction with the accompanying consolidated financial statements, including notes thereto, contained in Item 8 of this Report. This Report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act, and
Section 21E of the Exchange Act. Statements that are predictive in nature and that depend upon or refer to future events or conditions are forward-looking statements. Although we believe that these statements are based upon reasonable expectations, we can give no assurance that their goals will be achieved. Please refer to the discussion of forward-looking statements included in Part I of this Report.

Overview

We provide online information and technology solutions for employers, benefits brokers, healthcare organizations and online media companies. For the end users of our solutions-general consumers, employees, patients, and health plan members-our products and services help people to better understand their health, better understand the benefits plans their employers provide, and make well informed decisions about their healthcare and benefits selections. In addition, we help people understand the relationship between their benefits and the costs associated with them. This connection between financial understanding and benefits choice and use of benefits is increasingly important as consumers are assuming more of the financial responsibilities for their healthcare.

Our proprietary health information products are derived from what we believe to be one of the largest continually enhanced online consumer health reference information libraries available. The information we provide which is web-based, includes information on diseases, symptoms, treatments, surgical procedures, specialty medicine and topics, and alternative medicine. Our content is enhanced with visuals, animations and other new media that provides a graphically rich environment to promote learning retention and interactivity. In addition, we offer a number of health-related applications, such as health risk assessments and other decision support applications that are used by consumers to make informed healthcare decisions.

Our primary product for benefits brokers and employers is Benergy ™, a co-branded, web-based portal for employees that communicates benefits and other company sponsored information, improves benefits education and selection, automates benefits enrollment, manages healthcare financial accounts such as Flexible Spending Accounts, and provides health content and decision support tools to aid in health education and awareness. The tools, information and services offered through Benergy automate and streamline many important human resources (HR) functions so that employers can optimize their time and reduce administrative costs-while providing employees with a high level of access to pertinent benefits and health information. Benefits brokers consider Benergy to be an important part of their service offering to their employer clients. Brokers make available to their clients a Benergy site that is populated with that employer's specific benefits plan information. In many instances they manage the Benergy site on behalf of their employer client, providing a deeper level of client service.

In addition to Benergy, we offer benefits brokers a comprehensive agency management system called AgencyWare. With AgencyWare, brokers can manage the entire employer client lifecycle-moving prospects through each phase of the sales process, sending requests for proposals (RFP's), preparing client presentations, managing client renewals and commissions, tracking customer service issues and organizing client data. We also offer brokers other tools that improve their communication with their respective clients.

We sell our health information products primarily through multi-year licensing agreements to many different types of healthcare and health-related organizations including hospitals, health plans, system integrators, pharmaceutical companies, health-oriented Internet websites, healthcare technology companies and employers. Our health content solutions are used by our customers as part of their Web initiatives, imbedded in healthcare applications such as an electronic medical record or disease management applications, contained in a printed or CD-ROM format, or combined with other products that may be offered to a healthcare consumer.

We sell our Benergy and broker management system primarily through annual licensing agreements with group insurance brokers. Our brokers pay us a minimum annual fee for a predetermined number of end user licenses to Benergy. We also offer additional products in addition to the base Benergy product, such as online enrollment, which often times is sold by us directly to the employer. The annual license agreements typically provide for a minimum monthly financial commitment and additional fees, if usage exceeds the minimum.

We sell our educational products, professional services and other services based on customer needs and each transaction is generally sold on an individual order basis, and revenue recognized as the product or service is delivered.

Information regarding each of our service markets appears in Item 1 of this Report, under the caption "Overview of our Business."

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, intangible assets, income taxes and contingencies. 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 derive revenues from the following sources: (1) electronically delivered software, which includes software license and post contract customer support (PCS) revenue, (2) hosted software, which includes software license, hosting and PCS revenue, (3) professional services and (4) product sales. 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) collectability is reasonably assured. When a contract includes multiple elements, such as software and 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.

Electronically delivered software, which includes software license and PCS revenue, is recognized in accordance with Statement of Position No. 97-2, "Software Revenue Recognition," with the entire amount recognized ratably over the term of the license agreement.

Hosted software, which includes software license, hosting and PCS revenue, is recognized using GAAP principles for service revenue recognition as per Emerging Issues Task Force (EITF) Issue No. 00-3. The entire amount of revenue is recognized ratably over the term of the license agreement, which matches the service that is being provided.

Professional service revenues are generally recognized upon completion and acceptance by the customer. For revenue arrangements in which we sell through a reseller, we recognize revenue only after an agreement has been finalized between the customer and our authorized reseller and the content has been delivered to the customer by the reseller.

Product sales revenues are generally recognized at the time title passes to customers, distributors or resellers.

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. 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. The allowance for returns in prior years has not been significant.

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 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 revenues 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 revenues 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.

• 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 accompanying 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.

• Stock-based Compensation

We previously accounted for stock-based compensation expense under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Under Accounting Principles Board Opinion No. 25, we would not have recognized any compensation cost, because our options were granted at market value. On January 1, 2006, we adopted SFAS No. 123R using the modified prospective application transition approach method. We expect to incur approximately $822,000 of expense over a weighted average of 1.6 years for all unvested options outstanding at December 31, 2008.

RESULTS OF OPERATIONS

Year ended December 31, 2008 compared to year ended December 31, 2007

Revenues (numbers in table in thousands)

                                           Year Ended
                                          December 31,
                                         2008       2007      $ Change      % Change
     A.D.A.M., Inc. Consolidated
     Licensing                         $ 25,395   $ 23,563   $    1,832          7.8 %
     Product                              1,182      1,642         (460 )      (28.0 )%
     Professional services and other      2,280      2,673         (393 )      (14.7 )%

     Total Net Revenues                $ 28,857   $ 27,878   $      979          3.5 %

Total net revenues increased 3.5%, or $979,000, to $28,857,000, for the year ended December 31, 2008 compared to the year ended December 31, 2007. For the periods shown above, over 85% of those revenues came from the licensing of our health information services and benefits technology solutions.

Licensing revenues are recognized on a monthly basis, either based on usage, expiration of monthly minimums, or on a straight-line basis over the life of the contract. Therefore, fluctuation in licensing revenue is due to new contracts, customer usage levels or contract terminations. We annualize each contract's committed value and use changes to that value, from new sales or terminations, to calculate a net client retention rate.

Our increase in licensing revenue is a result of new customer contracts and client retention from our health information products. We derive those revenues primarily from healthcare organizations and healthcare information technology companies. The increase in new customer contracts is a result of the increased staffing in sales and marketing personnel, product enhancements, and an increase in the demand for online consumer-focused health information.

Revenues from product sales decreased by 28.0%, or $460,000, to $1,182,000 for the year ended December 31, 2008 compared to the year ended December 31, 2007. Our product revenues consist primarily of CD-based product sales to the educational market. Revenues were lower in this area due to a market shift from CD-based products to online solutions. We are planning to invest in new product development of online solutions to meet the current market requirements.

Professional services and other revenue decreased $393,000, or 14.7%, to $2,280,000 for the year ended December 31, 2008 compared to the year ended December 31, 2007. Professional services and other revenue are derived from products such as custom implementation services, flexible spending account services, direct to consumer products, and sales of nonrecurring products such as books, publications, and medical images. In the fourth quarter last year, we recorded over $350,000 in revenue for a professional services engagement that was nonrecurring.

Operating Costs and Expenses (numbers in table in thousands)



                                            Year Ended
                                           December 31,
                                         2008         2007        $ Change      % Change
   A.D.A.M., Inc. Consolidated
   Cost of revenues                    $  4,201     $  5,092     $     (891 )      (17.5 )%
   Cost of revenues-amortization          1,699        1,477            222         15.0 %
   Product and content development        6,022        5,820            202          3.5 %
   Development capitalization            (1,725 )     (1,154 )         (571 )       49.5 %
   Sales and marketing                    8,961        6,026          2,935         48.7 %
   General and administrative             7,897        5,858          2,039         34.8 %

   Total Operating Cost and Expenses   $ 27,055     $ 23,119     $    3,936         17.0 %

Cost of revenues consists primarily of costs associated with royalties, distribution license fees, and personnel support for our products and services. Cost of revenues decreased $891,000, or 17.5%, to $4,201,000 for the year ended December 31, 2008 compared to the year ended December 31, 2007. This decrease is primarily the result of lower royalty costs from the elimination or expiration of certain royalty agreements related to our healthcare products.

Cost of revenues-amortization increased $222,000, or 15%, to $1,699,000 for the year ended December 31, 2008 compared to the year ended December 31, 2007. Cost of revenues-amortization consists of costs associated with amortization of capitalized customer lists, software product, and content development costs. Cost of revenues-amortization for customer lists and software product related to the acquisition of OnlineBenefits was $753,000 for the year ended December 31, 2008 and 2007. The amortization increases primarily relate to new benefit technology product releases and other product enhancements that were made in the second half of 2007.

Product and content development expenses increased $202,000, or 3.5%, to $6,022,000 for the year ended December 31, 2008 compared to the year ended December 31, 2007. Product and content development expenses consist of salary and costs associated with engineering and developing our product and service offerings. Development capitalization increased $571,000, or 49.5%, for the year ended December 31, 2008 compared to the year ended December 31, 2007. This increase in development is due to investments to enhance the functionality of our broker and employer solution products. Due to the increase in capitalization, the net expense decreased $369,000 for the year ended December 31, 2008 compared to the same period in the prior year.

Sales and marketing expenses increased 48.7%, or $2,935,000, to $8,961,000 for the year ended December 31, 2008 compared to the year ended December 31, 2007. Sales and marketing expenses include the personnel costs of sales and marketing personnel and their related travel and support costs and the costs of our marketing and public relations programs. This increase is primarily attributable to the hiring of additional sales and customer relations personnel and related expenses in order to expand our sales presence, pursue additional market opportunities, and enhance our customer service levels.

General and administrative expenses increased 34.8%, or $2,039,000, to $7,897,000 for the year ended December 31, 2008 compared to the year ended December 31, 2007. The fourth quarter 2008 includes $3,006,000 of costs associated with a facility consolidation and a loan refinance. This expense was offset by reduced personnel in the general and administrative area resulting from our prior efforts to streamline and automate internal processes costs, controls and the consolidation of certain functions between Online Benefits and
A.D.A.M. In the fourth quarter of 2007, we recorded severance expense of $529,000.

Operating profit decreased $2,957,000 to $1,802,000 for the year ended December 31, 2008 compared to an operating profit of $4,759,000 for the year ended December 31, 2007. This decrease is directly related to the facility consolidation and refinance of the Capital Source Loan.

Other Expenses and Income

Interest expense was $1,495,000 and $2,565,000 for the years ended December 31, 2008 and 2007, respectively. This decrease in interest expense was primarily due to the pay down of debt from $20,000,000 at December 31, 2007 to $10,000,000 at December 31, 2008.

Interest income was $27,000 and $235,000 for the years ended December 31, 2008 and 2007, respectively. These decreases were primarily due to the decrease in cash associated with the advance payments on the Capital Source Loan.

We recognized a loss on the sale of interest bearing short-term investments of $296,000 during the year ended December 31, 2008 as short term investments of $2,716,000 were sold. A portion of these funds were used to make a $5,000,000 early payment on the Capital Source Loan.

Net Income

As a result of the factors described above, net income decreased $3,901,000 to $38,000 for the year ended December 31, 2008, compared to $3,939,000 for the year ended December 31 2007.

Year ended December 31, 2007 compared to year ended December 31, 2006

Revenues (numbers in table in thousands)

                                             Year Ended
                                            December 31,
                                           2007       2006     $ Change    % Change
       A.D.A.M., Inc. Consolidated
       Licensing                         $ 23,563   $ 13,818   $   9,745       70.5 %
       Product                              1,642      1,594          48        3.0 %
       Professional services and other      2,673      1,093       1,580      144.6 %

       Total Net Revenues                $ 27,878   $ 16,505   $  11,373       68.9 %

A.D.A.M. acquired OnlineBenefits on August 14, 2006 and, accordingly, the results of OnlineBenefits are included in the consolidated operating results subsequent to the acquisition. In order to facilitate the review of the year to year results, the tables below show the results of just the A.D.A.M. operating units and excludes the amounts reported by OnlineBenefits.

Results of A.D.A.M. operating units excluding OnlineBenefits

                                                Year Ended
                                               December 31,
                                              2007       2006      $ Change    % Change
  A.D.A.M., Inc. excluding OnlineBenefits
  Licensing                                 $ 10,111   $  8,817   $    1,294       14.7 %
  Product                                      1,642      1,594           48        3.0 %
  Professional services and other                828        650          178       27.4 %

  Total Net Revenues                        $ 12,581   $ 11,061   $    1,520       13.7 %

Total net revenues increased 68.9%, or $11,373,000, to $27,878,000 for the year ended December 31, 2007 from $16,505,000 for the year ended December 31, 2006. Revenues from OnlineBenefits in 2007 accounted for $9,853,000 of the net increase. Excluding the results of OnlineBenefits, total revenue increased $1,520,000 or 13.7% from 2006 to 2007.

Licensing revenues increased 70.5%, or $9,745,000, to $23,563,000 for the year ended December 31, 2007 from $13,818,000 for the year ended December 31, 2006. Licensing revenues are derived from licensing our products primarily to healthcare organizations, technology companies, benefit brokers, employers, and internet customers. OnlineBenefits licensing revenue from benefit brokers and employers accounted for $8,451,000 of the total $9,745,000 increase in licensing revenue for 2007.

Excluding the results of OnlineBenefits, licensing revenue increased 14.7%, or $1,294,000, to $10,111,000, for the year ended December 31, 2007 from $8,817,000 for the year ended December 31, 2006. This growth was from increased revenue in internet, provider, and technology customers. The internet market increased $676,000 to $1,869,000, provider companies increased $279,000 to $4,172,000, and the technology market increased $153,000 to $720,000 in 2007. As a percent of total revenues, revenues from licensing were 80.4% in 2007 compared to 79.7% in 2006.

Revenues from product sales increased 3.0%, or $48,000, to $1,642,000 for the year ended December 31, 2007 from $1,594,000 for the year ended December 31, 2006. The product revenues consist primarily of product sales to the educational market. This increase in 2007 was attributable to an increase in average sale price. As a percent of total revenues, revenues from product sales were 5.9% in 2007 compared to 9.7% in 2006.

Professional services and other revenue are derived from products such as flexible spending account services, direct to consumer products, custom implementation services, and sales of nonrecurring products such as books, subscriptions, and images. The revenue growth of 144.6%, or $1,580,000, for the year ended December 31, 2007 was mainly attributable to the results of OnlineBenefits and its related administrative service provider business. The professional services and other revenues accounted for approximately 9.6% of total revenues for 2007 compared to 6.6% in 2006.

Operating Costs and Expenses (numbers in table in thousands)



. . .