GENERAL

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 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, 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.

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.

• 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. 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 Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed" ("SFAS 86"). 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, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). 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.

In accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), 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

On January 1, 2006, we adopted SFAS 123(R) using the modified prospective application transition approach method. We expect to incur approximately $668,000 of expense over a weighted average of 1.4 years for all unvested options outstanding at March 31, 2009.

RESULTS OF OPERATIONS

Comparison of the Three Months Ended March 31, 2009 with the Three Months Ended
March 31, 2008.

Revenues (numbers in table in thousands)



                                          Three Months Ended
                                              March 31,             $          %
                                           2009         2008     Change      Change
      Licensing                         $    6,176    $  6,429   $  (253 )     (3.9 )%
      Product                                  215         241       (26 )    (10.9 )%
      Professional services and other          278         453      (175 )    (38.6 )%

      Total Net Revenues                $    6,669    $  7,123   $  (454 )     (6.4 )%

Total net revenues decreased 6.4%, or $454,000, to $6,669,000 for the three months ended March 31, 2009 compared to the three months ended March 31, 2008. For the three months ended March 31, 2009, 92.6% of our total net 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 decrease in licensing revenue is a result of an increase in contract cancellations exceeding new customer contracts from our benefits technology solutions, and a decrease in usage based revenue from our health information services.

Revenues from product sales decreased by 10.9%, or $26,000, to $215,000 for the three months ended March 31, 2009 compared to the three months ended March 31, 2008. 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 currently investing in new product development of online solutions to meet the current market requirements.

Professional services and other revenue decreased $175,000, or 38.6%, to $278,000 for the three months ended March 31, 2009 compared to the three months ended March 31, 2008. 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. The decrease was primarily due to a shift away from direct to consumer products to focus on our employer and broker solutions. We also saw a decrease in one-time medical image sales compared to last year.

Operating Costs and Expenses (numbers in table in thousands)



                                           Three Months Ended
                                               March 31,             $           %
                                            2009         2008      Change      Change
     Cost of revenues                    $     1,115    $   946   $    169       17.9 %
     Cost of revenues - amortization             463        482        (19 )     (3.9 )%
     Product and content development           1,045        991         54        5.4 %
     Sales and marketing                       1,947      2,118       (171 )     (8.1 )%
     General and administrative                1,083      1,295       (212 )    (16.4 )%
     Goodwill impairment                      13,940         -      13,940

     Total Operating Cost and Expenses   $    19,593    $ 5,832   $ 13,761      236.0 %

Cost of revenues consists primarily of costs associated with personnel support for our products and services, distribution license fees and royalties. Cost of revenues increased $169,000, or 17.9%, to $1,115,000 for the three months ended March 31, 2009 compared to the three months ended March 31, 2008. The increase is primarily attributable to the cost of additional personnel to increase the level of service to our customers.

Cost of revenues - amortization decreased $19,000, or 3.9%, to $463,000 for the three months ended March 31, 2009 compared to the three months ended March 31, 2008. Cost of revenues - amortization consists of costs associated with amortization of capitalized customer lists, software product, and content development costs. We see fluctuations in amortization costs from period to period based on the timing of capital projects.

Product and content development expenses increased $54,000, or 5.4%, to $1,045,000 for the three months ended March 31, 2009 compared to the three months ended March 31, 2008. Product and content development expenses consist of salary and costs associated with engineering and developing our product and service offerings. This increase is due to lower capitalized project spending of $269,000, being offset by a decrease of total spending of $215,000 for the three months ended March 31, 2009 compared to the three months ended March 31, 2008.

Sales and marketing expenses decreased 8.1%, or $171,000, to $1,947,000 for the three months ended March 31, 2009 compared to the three months ended March 31, 2008. Sales and marketing expenses include the personnel costs and their related travel and support costs and the costs of our marketing and public relations programs. The decrease was related to savings we made in our direct to consumer products.

General and administrative expenses decreased 16.4%, or $212,000, to $1,083,000 for the three months ended March 31, 2009 compared to the three months ended March 31, 2008. This reduction in expense is due to a reduction in personnel in the general and administrative area resulting from our prior efforts to streamline and automate internal processes, controls and the consolidation of certain functions between OnlineBenefits and A.D.A.M.

Due to the decline in our common stock price, we performed additional goodwill impairment testing as of March 31, 2009 and recorded a non-cash goodwill impairment charge of $13,940,000. This is described in further detail in Note 4 of notes to our consolidated financial statements. We performed our annual goodwill impairment testing during the fourth quarters of fiscal year 2008 and 2007, and did not record an impairment loss on goodwill for either of those periods.

Operating profit decreased $14,215,000 to a $12,924,000 loss for the three months ended March 31, 2009 compared to a $1,291,000 profit for the three months ended March 31, 2008. This decrease is primarily related to the non-cash goodwill impairment charge of $13,940,000.

Other Expenses and Income

Interest expense was $121,000 and $472,000 for the three months ended March 31, 2009 and 2008, respectively. This decrease in interest expense was primarily due to the reduction of debt from $15,000,000 at March 31, 2008 to $9,500,000 at March 31, 2009.

Interest income was $2,000 and $24,000 for the three months ended March 31, 2009 and 2008, respectively.

We recognized a loss on the sale of interest bearing short-term investments of $296,000 during the three months ended March 31, 2008 as short term investments of $2,716,000 were sold during the quarter.

Net Income

As a result of the factors described above, net income decreased $13,590,000, to a net loss of $13,043,000 for the three months ended March 31, 2009 compared to net income of $547,000 for the three months ended March 31, 2008.

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2009, we had current assets of $6,100,000, including cash and cash equivalents of $2,552,000, and $10,645,000 in current liabilities, or a negative working capital of $4,545,000. Working capital includes $5,758,000 in deferred revenue for which we have already received payment. While we are obligated to provide services related to those payments, in the future, we will not receive additional payments related to those services. Excluding the deferred revenue, working capital would have been $1,213,000. Our working capital is affected by the timing of each period end in relation to items such as payments received from customers, payments made to vendors, and internal payroll and billing cycles, as well as the seasonality within our business. Accordingly, our working capital, and its impact on cash flow from operations, can fluctuate materially from period to period. We use working capital to finance ongoing operations, fund the development and introduction of new business strategies and internally developed software, acquire complementary businesses and acquire capital equipment.

Cash provided by operating activities was $2,134,000 during the three months ended March 31, 2009, as compared to cash provided of $967,000 during the three months ended March 31, 2008. This $1,167,000 increase was due primarily to the increase in cash received from the collection of accounts receivable of $1,235,000.

Cash used in investing activities was $428,000 during the three months ended March 31, 2009, as compared to cash provided of $1,941,000 during the three months ended March 31, 2008. This $2,369,000 decrease was primarily due to proceeds received during the three months ended March 31, 2008, from the sale of short term investments of $2,716,000, offset by a $269,000 reduction of cash used in software product and content development costs.

Cash used in financing activities was $531,000 during the three months ended March 31, 2009, as compared to $4,799,000 during the three months ended March 31, 2008. The $4,268,000 decrease in cash used was primarily due to the $500,000 in payments made in the three months ended March 31, 2009, related to the payoff of long-term debt associated with the OnlineBenefits acquisition, versus the $5,000,000 in payments made in the three months ended March 31, 2008. In addition, proceeds from the exercise of common stock options decreased $230,000.

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements made in this report, and other written or oral statements made by or on behalf of A.D.A.M., may constitute "forward-looking statements" within the meaning of the federal securities laws. When used in this report, the words "believes," "expects," "estimates," "intends" and similar expressions are intended to identify forward-looking statements. Statements regarding future events and developments and our future performance, as well as our expectations, beliefs, plans, intentions, estimates or projections relating to the future, are forward-looking statements within the meaning of these laws. Examples of such statements in this report include descriptions of our plans and strategies with respect to developing certain market opportunities, our overall business plan, our plans to develop additional strategic partnerships, our intention to develop certain platform technologies and our continuing growth. All forward-looking statements are subject to certain risks and uncertainties that could cause actual events to differ materially from those projected. We believe that these forward-looking statements are reasonable; however, you should not place undue reliance on such statements. These statements are based on current expectations and speak only as of the date of such statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of future events, new information or otherwise.