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 benefit plans their employers provide, and make well informed decisions about their healthcare and benefit 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 the American Institute of Certified Public Accountants' Statement of Position (SOP) No. 97-2, "Software Revenue Recognition" (SOP 97-2), 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 per Emerging Issues Task Force (EITF) Issue No. 00-3, "Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity's Hardware". 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 SFAS 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 SOP 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 SFAS 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 $823,000 of expense over a weighted average of 1.7 years for all unvested options outstanding at June 30, 2009.

RESULTS OF OPERATIONS

Comparison of the Three Months Ended June 30, 2009 with the Three Months Ended
June 30, 2008.

Revenues (numbers in table in thousands)



                                         Three Months Ended
                                              June 30,             $           %
                                          2009         2008     Change       Change
     Licensing                         $    6,528    $  6,330   $   198         3.1 %
     Product                                  340         316        24         7.6 %
     Professional services and other          204         543      (339 )     (62.4 )%

     Total net revenues                $    7,072    $  7,189      (117 )      (1.6 )%

Total net revenues decreased $117,000, or 1.6%, to $7,072,000 for the three months ended June 30, 2009 compared to the three months ended June 30, 2008. For the three months ended June 30, 2009, 92.3% of our total net revenues came from the licensing of our health information services and benefits technology solutions.

Licensing revenues increased $198,000, or 3.1%, to $6,528,000 for the three months ended June 30, 2009 compared to the three months ended June 30, 2008. 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, fluctuations in licensing revenue are 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 an increase in new customer contracts exceeding contract cancellations from our benefits technology solutions and an increase in usage based revenue from our health information services.

Revenues from product sales increased $24,000, or 7.6%, to $340,000 for the three months ended June 30, 2009 compared to the three months ended June 30, 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're currently in the process of deploying our online product, A.D.A.M Interactive Anatomy (AIA). With the deployment of AIA and future online educational products, we will begin to shift our revenue from one-time product sales to a recurring license model.

Professional services and other revenue decreased $339,000, or 62.4%, to $204,000 for the three months ended June 30, 2009 compared to the three months ended June 30, 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.

Operating Costs and Expenses (numbers in table in thousands)



                                          Three Months Ended
                                               June 30,             $           %
                                           2009         2008     Change       Change
    Cost of revenues                    $    1,064    $    921   $   143        15.5 %
    Cost of revenues - amortization            512         465        47        10.1 %
    Product and content development          1,445       1,197       248        20.7 %
    Sales and marketing                      1,831       2,157      (326 )     (15.1 )%
    General and administrative               1,161       1,298      (137 )     (10.6 )%
    Restructuring costs                      1,408          -      1,408          -

    Total operating cost and expenses   $    7,421    $  6,038   $ 1,383        22.9 %

Cost of revenues increased $143,000, or 15.5%, to $1,064,000 for the three months ended June 30, 2009 compared to the three months ended June 30, 2008. Cost of revenues consists primarily of costs associated with personnel support for our products and services, distribution license fees and royalties. The increase is primarily attributable to the cost of additional personnel to increase the level of service to our customers.

Cost of revenues - amortization increased $47,000, or 10.1%, to $512,000 for the three months ended June 30, 2009 compared to the three months ended June 30, 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 capitalized software development projects.

Product and content development expenses increased $248,000, or 20.7%, to $1,445,000 for the three months ended June 30, 2009 compared to the three months ended June 30, 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 additional development and support efforts used to enhance our products that were not capitalizable for the three months ended June 30, 2009 compared to the three months ended June 30, 2008.

Sales and marketing expenses decreased $326,000, or 15.1%, to $1,831,000 for the three months ended June 30, 2009 compared to the three months ended June 30, 2008. Sales and marketing expenses include personnel costs, and their related travel and support costs, and the costs of our marketing and public relations programs. This decrease in expense is the result of lower sales commission and salary costs and related sales overhead expenses.

General and administrative expenses decreased $137,000, or 10.6%, to $1,161,000 for the three months ended June 30, 2009 compared to the three months ended June 30, 2008. This decrease 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 and controls as well as improved collection which led to lower bad debt expense.

Restructuring costs were $1,408,000 for the three months ended June 30, 2009. Based on the current real estate market conditions, we revised our estimate of sublease rental income from offices included in our 2008 Facility Consolidation Program. This is described in further detail in Note 12 of notes to our consolidated financial statements.

Operating profit decreased $1,500,000 to a $349,000 loss for the three months ended June 30, 2009 compared to a $1,151,000 profit for the three months ended June 30, 2008.

Other Expenses and Income

Interest expense was $117,000 and $346,000 for the three months ended June 30, 2009 and 2008, respectively. This decrease in interest expense was primarily due to the reduction of debt from $14,000,000 at June 30, 2008 to $9,000,000 at June 30, 2009 along with a reduction in the borrowing cost from our debt refinancing that occurred on December 31, 2008.

Interest income was $3,000 and $5,000 for the three months ended June 30, 2009 and 2008, respectively.

Net Income

As a result of the factors described above, net income decreased $1,273,000, to a net loss of $463,000 for the three months ended June 30, 2009 compared to net income of $810,000 for the three months ended June 30, 2008.

Comparison of the Six Months Ended June 30, 2009 with the Six Months Ended
June 30, 2008.

Revenues (numbers in table in thousands)



                                          Six Months Ended
                                              June 30,            $           %
                                          2009        2008     Change       Change
      Licensing                         $  12,704   $ 12,759   $   (55 )      (0.4 )%
      Product                                 555        557        (2 )      (0.4 )%
      Professional services and other         482        996      (514 )     (51.6 )%

      Total net revenues                $  13,741   $ 14,312      (571 )      (4.0 )%

Total net revenues decreased $571,000, or 4.0%, to $13,741,000 for the six months ended June 30, 2009 compared to the six months ended June 30, 2008. For the six months ended June 30, 2009, 92.5% of our total net revenues came from the licensing of our health information services and benefits technology solutions.

Licensing revenues decreased $55,000, or 0.4%, to $12,704,000 for the six months ended June 30, 2009 compared to the six months ended June 30, 2008. 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 contract cancellations and a decrease in usage based revenue exceeding new customer contracts from our benefits technology solutions.

Revenues from product sales decreased by $2,000, or 0.4%, to $555,000 for the six months ended June 30, 2009 compared to the six months ended June 30, 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're currently in the process of deploying our online product, A.D.A.M Interactive Anatomy (AIA). With the deployment of AIA and future online educational products, we will begin to shift our revenue from one-time product sales to a recurring license model.

Professional services and other revenue decreased $514,000, or 51.6%, to $482,000 for the six months ended June 30, 2009 compared to the six months ended June 30, 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.

Operating Costs and Expenses (numbers in table in thousands)



                                           Six Months Ended
                                               June 30,            $            %
                                           2009        2008      Change       Change
     Cost of revenues                    $   2,179   $  1,867   $    312        16.7 %
     Cost of revenues - amortization           975        947         28         3.0 %
     Product and content development         2,490      2,188        302        13.8 %
     Sales and marketing                     3,778      4,274       (496 )     (11.6 )%
     General and administrative              2,244      2,593       (349 )     (13.5 )%
     Goodwill impairment                    13,940         -      13,940          -
     Restructuring costs                     1,408         -       1,408          -

     Total operating cost and expenses   $  27,014   $ 11,869   $ 15,145       127.6 %

Cost of revenues increased $312,000, or 16.7%, to $2,179,000 for the six months ended June 30, 2009 compared to the six months ended June 30, 2008. Cost of revenues consists primarily of costs associated with personnel support for our products and services, distribution license fees and royalties. The increase is primarily attributable to the cost of additional personnel to increase the level of service to our customers.

Cost of revenues - amortization increased $28,000, or 3.0%, to $975,000 for the six months ended June 30, 2009 compared to the six months ended June 30, 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 $302,000, or 13.8%, to $2,490,000 for the six months ended June 30, 2009 compared to the six months ended June 30, 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 $264,000 coupled with a decrease in total spending of $38,000 for the six months ended June 30, 2009 compared to the six months ended June 30, 2008.

Sales and marketing expenses decreased $496,000, or 11.6%, to $3,778,000 for the six months ended June 30, 2009 compared to the six months ended June 30, 2008. Sales and marketing expenses include personnel costs and their related travel and support costs and the costs of our marketing and public relations programs. This decrease in expense is the result of lower sales commission and salary costs and related sales overhead expenses.

General and administrative expenses decreased $349,000, or 13.5%, to $2,244,000 for the six months ended June 30, 2009 compared to the six months ended June 30, 2008. This decrease 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 and controls.

Due to the decline in our common stock price, we performed additional goodwill impairment testing during the first quarter of 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.

Restructuring costs were $1,408,000 for the six months ended June 30, 2009. Based on the current real estate market conditions, we revised our estimate of sublease rental income from offices included in our 2008 Facility Consolidation Program. This is described in further detail in Note 12 of notes to our consolidated financial statements.

Operating profit decreased $15,716,000 to a $13,273,000 loss for the six months ended June 30, 2009 compared to a $2,443,000 profit for the six months ended June 30, 2008.

Other Expenses and Income

Interest expense was $238,000 and $818,000 for the six months ended June 30, 2009 and 2008, respectively. This decrease in interest expense was primarily due to the reduction of debt from $14,000,000 at June 30, 2008 to $9,000,000 at June 30, 2009 along with a reduction in the borrowing cost from our debt refinancing that occurred on December 31, 2008.

Interest income was $5,000 and $29,000 for the six months ended June 30, 2009 and 2008, respectively.

We recognized a loss on the sale of interest bearing short-term investments of $296,000 during the six months ended June 30, 2008 as short term investments of $2,716,000 were sold during the year.

Net Income

. . .