0001104659-06-075012.txt : 20061114 0001104659-06-075012.hdr.sgml : 20061114 20061114155736 ACCESSION NUMBER: 0001104659-06-075012 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20060930 FILED AS OF DATE: 20061114 DATE AS OF CHANGE: 20061114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADAM INC CENTRAL INDEX KEY: 0000863650 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 581878070 STATE OF INCORPORATION: GA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-26962 FILM NUMBER: 061214937 BUSINESS ADDRESS: STREET 1: 1600 RIVEREDGE PARKWAY STREET 2: STE 800 CITY: ATLANTA STATE: GA ZIP: 30328 BUSINESS PHONE: 7709800888 MAIL ADDRESS: STREET 1: 1600 RIVEREDGE PKWY STREET 2: STE 800 CITY: ATLANTA STATE: GA ZIP: 30328 FORMER COMPANY: FORMER CONFORMED NAME: A D A M SOFTWARE INC DATE OF NAME CHANGE: 19950919 10-Q 1 a06-22036_110q.htm QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(D)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the quarterly period ended September 30, 2006

	OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the transition period from

Commission File Number 0-26962

A.D.A.M., INC.

(Exact Name of Registrant as Specified in its Charter)

Georgia		58-1878070
(State or other jurisdiction of		(IRS Employer Identification No.)
incorporation or organization)

1600 RiverEdge Parkway, Suite 100
Atlanta, Georgia 30328-4696
(Address of Principal Executive Offices, Zip Code)

N/A
(Former Name or Former Address, if changed since last report)

Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) YES o NO x

As of November 9, 2006 there were 9,258,221 shares of the Registrant’s common stock, par value $.01 per share, outstanding.

A.D.A.M., Inc.
Index
Form 10-Q for the Quarter Ended September 30, 2006

Part I—Financial Information

ITEM 1.	Consolidated Financial Statements

	Consolidated Balance Sheets at September 30, 2006 (unaudited) and December 31, 2005

	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2006 and 2005 (unaudited)

	Consolidated Statement of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2006 (unaudited)

	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005 (unaudited)

	Notes to Consolidated Financial Statements (unaudited)

ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk

ITEM 4.	Controls and Procedures

	Part II-Other Information
ITEM 1A.	Risk Factors

ITEM 6.	Exhibits

PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

A.D.A.M., Inc.

Consolidated Balance Sheets

(In thousands, except share data)

	(Unaudited) September 30, 2006			December 31, 2005
Assets
Current assets
Cash & cash equivalents	$	4,285		$	2,816
Short term investments	2,743			7,861
Accounts receivable, net of allowances of $255 and $147, respectively	3,175			1,840
Restricted cash	—			25
Inventories	76			68
Prepaids and other current assets	3,104			463
Deferred financing costs, net	342			—
Deferred tax assets	—			221
Total current assets	13,725			13,294
Property and equipment, net	799			268
Intangible assets, net	10,208			953
Goodwill	31,262			2,043
Other assets	202			43
Deferred financing costs, net	933			—
Deferred tax assets, net of current portion	2,031			5,279
Total assets	$	59,160		$	21,880

Liabilities and Shareholders’ Equity
Current liabilities
Accounts payables and accrued expenses	$	3,073		$	1,055
Deferred revenue	4,900			3,643
Note payable	1,500			—
Capital lease obligations – current portion	157			20
Deferred tax	65			—
Total current liabilities	9,695			4,718
Capital lease obligations, net of current portion	138			18
Other liabilities	1,396			—
Long-term debt	25,000			—
Total liabilities	36,229			4,736
Commitments and contingencies
Shareholders’ equity
Common stock, $.01 par value; 20,000,000 shares authorized; 9,250,304 shares issued and 8,980,545 shares outstanding at 9/30/2006 and 8,482,772 shares issued and 8,213,013 shares outstanding at 12/31/2005	92			85
Treasury stock, at cost, 269,759 shares	(1,088		)	(1,088		)
Additional paid-in capital	53,965			50,350
Unrealized loss on investments	(11		)	(11		)
Accumulated deficit	(30,027		)	(32,192		)
Total shareholders’ equity	22,931			17,144
Total liabilities and shareholders’ equity	$	59,160		$	21,880

The accompanying notes are an integral part of these consolidated financial statements.

A.D.A.M., Inc.

Consolidated Statements of Operations

(In thousands, except per share data)
(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
Revenues, net:
Licensing	$	3,915		$	1,961		$	8,152		$	5,597
Product	368			581			1,110			1,460
Professional services and other	190			178			408			490
Total revenues, net	4,473			2,720			9,670			7,547

Cost of Revenues:
Cost of revenues	587			279			1,208			891
Cost of revenues - amortization	257			173			634			533
Total cost of revenues	844			452			1,842			1,424
Gross profit	3,629			2,268			7,828			6,123

Operating expenses:
Product and content development	874			441			1,584			1,103
Sales and marketing	801			508			1,690			1,363
General and administrative	1,274			608			2,472			1,893
Total operating expenses	2,949			1,557			5,746			4,359

Operating income	680			711			2,082			1,764

Interest expense	372			8			376			27
Interest income	(178		)	(109		)	(459		)	(230		)

Income before income taxes	486			812			2,165			1,967
Income tax benefit	—			(5,600		)	—			(5,600		)

Net income	$	486		$	6,412		$	2,165		$	7,567
Basic net income per common share	$	0.06		$	0.79		$	0.26		$	0.94
Basic weighted average number of common shares outstanding	8,711			8,168			8,487			8,084
Diluted net income per common share	$	0.05		$	0.67		$	0.21		$	0.80
Diluted weighted average number of common shares outstanding	10,096			9,533			10,079			9,422

The accompanying notes are an integral part of these consolidated financial statements.

A.D.A.M., Inc.

Consolidated Statement of Changes in Shareholders’ Equity

(In thousands, except share data)
(Unaudited)

											Accumulated
									Additional		Other
	Common Stock			Treasury Stock					Paid-in		Comprehensive			Accumulated
	Shares	Amount		Shares		Amount			Capital		Income/(Loss)			Deficit			Total
Balance at December 31, 2005	8,482,772	$	85	(269,759	)	$	(1,088	)	$	50,350	$	(11	)	$	(32,192	)	$	17,144
Comprehensive income:
Net income	—	—		—		—			—		—			2,165			2,165
Unrealized gain (loss) on investments	—	—		—		—			—		—			—			—
Total comprehensive income																	2,165
Stock-based compensation expense	—	—		—		—			120		—			—			120
Common shares issued related to OBI acquisition	529,100	5		—		—			2,995		—			—			3,000
Exercise of common stock options	238,432	2		—		—			500		—			—			502
Balance at September 30, 2006	9,250,304	$	92	(269,759	)	$	(1,088	)	$	53,965	$	(11	)	$	(30,027	)	$	22,931

The accompanying notes are an integral part of these consolidated financial statements.

A.D.A.M., Inc.

Consolidated Statements of Cash Flows

(In thousands)
(Unaudited)

	Nine Months Ended
	September 30, 2006			September 30, 2005
Cash flows from operating activities
Net income	$	2,165		$	7,567
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	765			670
Stock compensation for services	—			23
Stock option compensation expense	120			158
Other, net	(19		)	(15		)
Deferred income taxes	—			(5,600		)
Changes in assets and liabilities, net of effects from acquisition:
Accounts receivable	(110		)	549
Inventories	(8		)	29
Prepaids and other assets	(61		)	(168		)
Accounts payable and accrued expenses	(223		)	(54		)
Other liabilities	153			—
Deferred revenue	(327		)	4
Net cash provided by operating activities	2,455			3,163
Cash flows from investing activities
Acquisition of subsidiary, net of cash acquired of $1,548.	(29,353		)	—
Purchases of property and equipment	(113		)	(222		)
Repayments on notes receivable	—			192
Net change in restricted time deposits	24			47
Software product and content development costs	(589		)	(293		)
Maturities and reclassifications of investments	2,055			2,226
Net sale proceeds (purchase) of investments available-for-sale	3,063			(6,800		)
Net cash used by investing activities	(24,913		)	(4,850		)
Cash flows from financing activities
Proceeds from issuance of term note	20,000			—
Proceeds from issuance of convertible notes	5,000			—
Payment of financing costs	(1,339		)	—
Proceeds from exercise of common stock options and warrants	502			679
Repurchase of common stock to be held as treasury stock	—			(496		)
Repayments on capital leases	(236		)	(12		)
Net cash provided by financing activities	23,927			171
Increase (decrease) in cash and cash equivalents	1,469			(1,516		)
Cash and cash equivalents, beginning of period	2,816			3,242
Cash and cash equivalents, end of period	$	4,285		$	1,726

Interest paid	$	1,350		$	3
Supplemental disclosures of noncash transactions:
Assets acquired and liabilities assumed related to the acquisition of Online Benefits:
Working capital other than cash	$	3,741		$	—
Property, plant, and equipment	549			—
Intangibles	9,300			—
Goodwill	29,200
Long-term assets	157			—
Current liabilities	(5,459		)	—
Noncurrent liabilities	(1,601		)	—
Deferred income tax liabilities	(3,534		)	—
Less: issuance of common stock related to the acquisition	(3,000		)	—
Cash paid to acquire Online Benefits	$	29,353		$	—

The accompanying notes are an integral part of these consolidated financial statements.

A.D.A.M., Inc.

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2006

1. BUSINESS AND BASIS OF PRESENTATION

Business

We provide high-quality health information and benefits management solutions to healthcare organizations, employers, consumers, and educational institutions. With an industry-leading employee and human resources (HR) benefits management platform and one of the largest consumer health information libraries in the world, A.D.A.M. products empower consumers to get smart about their health and wellness, manage their personal benefits and health account finances, while helping organizations reduce the costs of healthcare and benefits administration.

Our highly illustrated and interactive health content can be used for learning about general health concerns, specific diseases, medical conditions and treatments, surgical procedures, drug information, wellness topics, alternative medicine and more. We also develop a number of decision support products such as our Health Risk Assessment library and DecisionAssist tools that guide consumers in making good healthcare decisions by better understanding their health condition and needs. Our content products and decision support tools are sold primarily through annual licensing agreements to a variety of healthcare and health-related organizations including hospitals, health plans, integrators, pharmaceutical companies, care management vendors, health-oriented Internet websites, and healthcare technology companies. Our content products can be incorporated into a customer’s website, embedded in healthcare applications such as a care management or disease management application, delivered in a printed or CD-ROM format, or combined with other products that may be offered to a healthcare consumer.

Our HR benefits management solutions include Benergy, an award-winning employer and employee self-service portal to administer, learn about, enroll in, and manage benefits. Benergy reduces costs by automating many HR and benefits tasks, and serves as a communication vehicle between employer and employee. With A.D.A.M.’s high-quality health content and tools, this solution also serves as a health management platform ideal for consumer driven health plans. Benergy is distributed primarily to the small to mid-size employer market through annual licensing agreements with insurance brokers, payroll service providers, and benefits consultants.

In addition to solutions for employers and employees, we also offer products and services for the insurance broker market, including flexible spending account (FSA) administration, Agencyware, an insurance agency management system and Client Community, a dedicated web portal for insurance brokers to interact with their HR customers and prospects.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and the general instructions to Form 10-Q. Accordingly, certain information and footnotes required by GAAP for complete financial statements may be condensed or omitted. These interim financial statements should be read in conjunction with our audited financial statements and notes thereto included in our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2005. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from those estimates.

In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Certain amounts previously reported have been reclassified for comparative purposes to conform with current period presentation.

Operating results for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006 or any future period.

2. STOCK-BASED COMPENSATION

On January 14, 1999, certain option grants were canceled at the election of their holders and then replaced that day on a one-for-one basis with new options with an exercise price equal to the closing market price that day, $5.25. These options are accounted for in accordance with FASB Interpretation No. 44 (“FIN 44”), “Accounting for Certain Transactions involving Stock Compensation (an interpretation of APB 25)”, which provides guidance on the accounting for certain stock option transactions and subsequent amendments to stock option transactions. FIN 44 requires compensation cost for these variably priced options to be recorded to the extent that the current market price exceeds the options’ grant price. The expense is to be adjusted for increases or decreases in the intrinsic value of the modified awards in subsequent periods and until the awards have been exercised, forfeited, or expired. We had 173,149 and 224,638 variably priced options outstanding at September 30, 2006 and December 31, 2005, respectively, all of which had fully vested by January 2002 and are accounted for under FIN 44. There were 51,489 variably priced options exercised in the nine months ended September 30, 2006, all during the first three months of 2006. We recorded stock-based compensation expense of $133,000 and stock-based compensation benefit $44,000 for the three and nine months ended September 30, 2006, respectively. For the three and nine months ended September 30, 2005, we recorded stock-based compensation expense of $2,000 and $158,000, respectively.

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-Based Compensation.” Statement 123(R) supersedes APB Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees,” and amends FASB Statement No. 95, “Statement of Cash Flows.” The approach to accounting for share-based payments in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values and no longer allows pro forma disclosure as an alternative to financial statement recognition.

Effective January 1, 2006, we adopted Statement 123(R) using the modified prospective method and, therefore, reflect compensation expense in accordance with the SFAS 123(R) transition provisions. Under the modified prospective method, prior periods are not restated to reflect the impact of adopting the new standard at earlier dates.

As a result of the adoption of Statement 123(R), we recorded $122,000 and $164,000 of stock-based compensation expense for the three and nine months ended September 30, 2006 related to our employee stock options, not including those variable options described above. Had we continued to account for these options under APB 25 we would have recorded no such expense. After recording the expense through September 30, 2006, there remained approximately $2,264,000 of unrecognized compensation cost related to unvested employee stock options to be recognized over the next 3.4 years.

We used the Black-Scholes method (which models the value over time of financial instruments) to estimate the fair value at grant date of the options. The Black-Scholes method uses several assumptions to value an option. We used the following assumptions:

· Expected Dividend Yield - because we do not currently pay dividends, our expected dividend yield is zero.

· Expected Volatility in Stock Price – reflects the historical change in our stock price over the expected term of the stock option.

· Risk-free Interest Rate – reflects the average rate on the treasury bond with maturity equal to the expected term of the option.

· Expected Life of Stock Awards – reflects the simplified method to calculate an expected life based on the midpoint between the vesting date and the end of the contractual term of the stock award.

The weighted-average assumptions used in the option pricing model for stock option grants were as follows:

Nine Months Ended September 30,	2006
Expected Dividend Yield	—
Expected Volatility in Stock Price	73.58		%
Risk-Free Interest Rate	4.73		%
Expected Life of Stock Awards	3.5 years
Weighted Average Fair Value at Grant Date	$	3.02

Had we determined employee compensation costs using a fair value based methodology at the grant date for our stock options under SFAS 123(R) in 2005 as well, our pro forma consolidated net income for the year ago quarter and year-to-year date would have been as follows (in thousands, except per share data):

	Three Months Ended			Nine Months Ended
	September 30,			September 30,
	2005			2005

Net income as reported	$	6,412		$	7,567
Add stock-based compensation expense included in reported net income	2			158
Deduct total stock-based compensation determined under fair-value based methods for all employee awards	(30		)	(261		)

Pro forma net income	$	6,384		$	7,464
Basic net income per share
As reported	$	0.79		$	0.94
Pro forma	$	0.78		$	0.92

Diluted net income per share
As reported	$	0.67		$	0.80
Pro forma	$	0.67		$	0.79

In 2002, our Board of Directors adopted and our shareholders approved our 2002 Stock Incentive Plan, under which we have reserved 1,500,000 shares of common stock pursuant to the grant of incentive or non-qualified stock options to full-time employees and key persons. Options are granted at an exercise price as determined by our Board of Directors, which may not be less than the fair market value of our common stock at the date of the grant, and the options generally vest ratably over a three-year period. Options granted under the Plan generally expire ten years from the date of grant.

The following table summarizes stock option activity for the nine months ended September 30, 2006:

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
			Exercise		Contractual	Intrinsic
	Shares		Price		Life (years)	Value ($000)
Outstanding at December 31, 2005	2,818,331		$	3.81	5.32

Granted	762,500		5.50
Exercised	(238,432	)	2.11
Canceled or expired	(8,200	)	7.96

Outstanding at September 30, 2006	3,334,199		4.30		3.90	10,602
Exercisable	2,542,532		3.95		4.50	9,376

Intrinsic value was calculated by multiplying the number of options times the amount by which the Company’s market price at September 30, 2006 exceeded the strike price for each option. The market price at September 30, 2006 was $6.99.

3. ACQUISITION OF ONLINE BENEFITS, INC. AND SUBSIDIARIES

On August 14, 2006, A.D.A.M acquired all of the outstanding capital stock of Online Benefits, Inc. and Subsidiaries (Online Benefits) from the shareholders thereof, for an aggregate purchase price of $33,901,000, which is comprised of $29,500,000 in cash, 529,100 shares of the Company’s common stock having a value of $3,000,000, and $1,401,000 in transaction costs pursuant to the Agreement and Plan of Merger dated as of August 14, 2006.

The acquisition of Online Benefits was made to expand the Company’s distribution and customer base. The results of operations of Online Benefits are included in the accompanying consolidated financial statements of the Company commencing on August 14, 2006.

The allocation of the purchase price consideration paid at closing to the assets acquired and liabilities assumed was based upon estimates of the fair market value of the acquired assets and assumed liabilities in accordance with FAS 141. The fair values assigned to the intangibles acquired were formulated based on an independent third-party evaluation.

The purchase price of the acquisition is set forth below (in thousands):

Issuance of common stock	$	3,000
Cash paid	29,500
Total consideration paid to sellers	32,500
Additional cash paid for transaction costs	1,401
Total purchase price	33,901
Less: noncash item of issuance of common stock	(3,000		)
Less: cash acquired in the acquisition	(1,548		)
Net cash paid for acquisition	$	29,353

In addition, the Company established escrow deposit accounts related to the acquisition of Online Benefits, which have been recorded on the accompanying consolidated balance sheet in prepaids and other current assets.

The estimate of the fair value of the assets acquired and liabilities assumed is set forth below (in thousands):

Assets acquired:
Current assets	$	5,289
Property and equipment	549
Intangible asset – customer list	8,800
Intangible asset – technology	500
Long-term assets	157
Total assets acquired	15,295

Liabilities assumed:
Current liabilities	(5,459		)
Non-current liabilities	(1,601		)
Deferred tax liabilities	(3,534		)
Total liabilities assumed	(10,594		)
Net assets acquired	4,701

Costs in excess of net assets acquired (recorded goodwill)	29,200
Total fair value of net assets acquired and goodwill	$	33,901

The following unaudited combined pro forma financial information presents the results of operations of the Company as if the acquisition had occurred at the beginning of each of the periods presented. Adjustments to the combined financial information related to the acquisition that affect the results of operations include the interest expense associated with the debt issued in conjunction with the acquisition and amortization of the fair value of intangible assets. This pro forma information does not purport to be indicative of what would have occurred had the acquisition occurred as of January 1, 2006 and 2005 or of results of operations that may occur in the future.

	For the Three Months Ended,					For the Nine Months Ended,
	September 30, 2006			September 30, 2005		September 30, 2006			September 30, 2005
Revenues	$	6,072		$	5,981	$	17,939		$	17,107
Operating income	542			889		2,206			1,963
Net income (loss)	(443		)	5,768		(187		)	5,303
Basic net income (loss) per common share	(0.05		)	0.66		(0.02		)	0.62
Diluted net income (loss) per common share	(0.05		)	0.57		(0.02		)	0.53

4. DEBT

Note Payable

Effective August 14, 2006, the Company assumed a debt of $1,500,000 in conjunction with the acquisition of Online Benefits.

Per the original agreement between the lender and Online Benefits, payments of principal and interest were to commence on the third anniversary date (August 2004) to the extent Online Benefits received revenue share payments through that date, and again on the fourth anniversary date (if principal and interest remained unpaid) to the extent Online Benefits received revenue share payments in the previous twelve-month period. No revenue share payments have been received through September 30, 2006. Also, at September 30, 2006, since the Company had senior obligations outstanding, no payments were due on this note.

This debt was secured by a first priority lien on the software product Online Benefits developed under the Joint Development Agreement and a second priority lien on all other assets of Online Benefits so long as any Senior Obligations, as defined, were outstanding after which this debt would be secured by all the assets of Online Benefits.

The debt bears interest at the rate of 8% per annum, compounded quarterly, and payable annually in arrears, increasing to 12% upon the occurrence of an Event of Default, as defined. Online Benefits paid interest due on the August 31, 2002 anniversary date; however, it made no annual interest payments subsequent to that date due to the agreement between the parties. The lender has now claimed the debt is in default, and, therefore, the Company has shown the outstanding balance as current on the accompanying consolidated balance sheet. Under the terms of the Loan Agreement and an Intercreditor Agreement between Online Benefits, the third party lender and Note holders, the third party lender is precluded from taking any action to accelerate payment of obligations under this debt. Accrued interest, at the 8% rate per annum, amounted to approximately $556,000 at September 30, 2006.

Long-term debt

In conjunction with the acquisition of Online Benefits, the Company entered into a credit agreement (Credit Agreement) with Capital Source Finance LLC (Lender). The Credit Agreement, with related balances at September 30, 2006, is summarized below (numbers in column are in thousands):

$2,000,000 revolver with Lender - principal repayable in full in August 2011; interest at LIBOR plus 4% or the prime rate (8.25% at September 30, 2006) plus 2.75%, payable quarterly in arrears; revolver unused facility fee of 0.5% per annum of the average daily balance of the unused portion, payable monthly in arrears	$	—

$20,000,000 term loan with Lender - principal repayable in quarterly installments of varying amounts ($1.0 million from December 2007 through September 2008, $1.25 million through September 2010, and $1.5 million through September 2011), interest same as revolver; prepayment premium of either 2% (prior to first anniversary) or 1% (between first and second anniversary) of prepaid amount	20,000

$5,000,000 convertible note with Lender - principal repayable in full in August 2011; interest at LIBOR plus 2.5% or the prime rate plus 1.25%, payable quarterly in arrears; prepayment premium same as term loan; all or any portion of the principal balance is convertible at the option of the Lender into common stock of the Company at a conversion price per share as defined in the agreement	5,000
	$	25,000

In connection with the Credit Agreement, the Company entered into a Conversion and Registration Rights Agreement dated as of August 14, 2006, which specifies terms applicable to the conversion of the convertible note and provides the Lender with certain registration rights with respect to the shares issuable on conversion of the convertible note.

In addition to the above terms, there is a provision for a prepayment of 50% excess cash flow, as defined in the Credit Agreement. The Credit Agreement is secured by (i) a first lien on all existing and future tangible and intangible assets and personal property and equity stock of the Company and any existing and future subsidiaries, and (ii) a pledge of 100% of the Company’s subsidiaries capital stock. The Credit Agreement contains other customary financial covenants.

5. INVESTMENTS

Our investments are classified as available-for-sale and are therefore recorded at fair value based on current market rates. Changes in the fair value are included in the equity section of our balance sheet and reported in our Consolidated Statement of Changes in Shareholders’ Equity.

Our short-term investments at September 30, 2006 included the following (in thousands):

Description	Balance		Purchased	Maturity	Yield at 9/30/2006
Mutual Funds
- AIM Floating Fund	$	440	10/14/05	10/14/06	5.53	%
- AIM Floating Fund	1,123		11/15/05	11/15/06	5.53	%
- AIM Floating Fund	337		12/16/05	12/16/06	5.53	%
- AIM Floating Fund	843		1/18/06	1/18/07	5.53	%
Total Short-term Investments	$	2,743

At December 31, 2005, our short-term investments included the following (in thousands):

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

Total Short-term Investments	$	7,861

6. COMPREHENSIVE INCOME

During the three and nine months ended September 30, 2006, we reported comprehensive income of $486,000 and $2,165,000, respectively. During the three and nine months ended September 30, 2005, we reported comprehensive income of $6,419,000 and $7,561,000 respectively.

7. INTANGIBLE ASSETS

Intangible assets consist of purchased intellectual content, purchased customer list and contracts, capitalized software product and content development costs to be sold, leased or otherwise marketed, and software development costs for internal use software.

Capitalized software product and content development costs to be sold, leased or otherwise marketed consist principally of salaries and certain other expenses directly related to the development and modifications of software products and content. Amortization of capitalized software product and content development costs is provided at 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 economic life of the software, which we have determined to generally be two years.

We expense costs incurred in the preliminary project planning stage and thereafter capitalize costs incurred in developing or obtaining internal use software. Costs, such as maintenance and training, are expensed as incurred. Capitalized costs are amortized over their estimated useful life, generally three years.

Intangible assets are summarized as follows (in thousands):

	Estimated amortizable	September 30,			December 31,
	lives (years)	2006			2005
Intangible Assets:
Capitalized software products and content to be sold, leased or otherwise marketed	2 – 3	$	4,364		$	3,351
Software developed for internal use	3	339			263
Purchased intellectual content	3	1,431			1,431
Purchased customer contracts	2	333			333
Purchased customer list	15	8,800			—

Intangible assets, gross		15,267			5,378

Accumulated amortization:
Capitalized software products and content to be sold, leased or otherwise marketed		(3,037		)	(2,559		)
Software developed for internal use		(181		)	(102		)
Purchased intellectual content		(1,431		)	(1,431		)
Purchased customer contracts		(333		)	(333		)
Customer list		(77		)	—

Accumulated amortization		(5,059		)	(4,425		)

Intangible assets, net		$	10,208		$	953

Amortization expense, related to intangibles, for the three and nine months ended September 30, 2006 was $257,000 and $634,000, respectively. For the three and nine months ended September 30, 2005, total amortization expense was $186,000 and $590,000, respectively, including $173,000 and $532,000, respectively, for amortization of capitalized software reported in cost of revenues. The remaining $13,000 and $58,000 of amortization for the three and nine months ended September, 2005, respectively, was related to purchased intellectual content and customer contracts which were fully amortized in 2005.

For the three and nine months ended September 30, 2006, additions to intangibles, with the exception of the intangibles related to the acquisition discussed in Note 13, were approximately $231,000 and $589,000 and were related to software development.

8. NET INCOME PER COMMON SHARE

We compute basic net income per share by dividing net income by the weighted average number of common shares outstanding for each period. Diluted net income per share is based upon the addition of the effect of common stock equivalents (stock options, warrants and convertible debt) to the denominator of the basic net income per share calculation using the treasury stock method if their effect is dilutive. The computation of net income per share for the three and nine months ended September 30, 2006 and 2005 is as follows (in thousands, except per share data):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005

Net income	$	486	$	6,412	$	2,165	$	7,567
Weighted average common shares outstanding - basic	8,711		8,168		8,487		8,084
Weighted average common share equivalents (stock options, warrants and convertible debt)	1,385		1,365		1,592		1,338
Weighted average common shares outstanding - diluted	10,096		9,533		10,079		9,422
Net income per share:
Basic	$	0.06	$	0.79	$	0.26	$	0.94
Diluted	$	0.05	$	0.67	$	0.21	$	0.80

Anti-dilutive stock options, warrants outstanding and convertible debt	829		535		564		545

9. NON-CONSOLIDATED AFFILIATE

We have one non-consolidated affiliate, ThePort Network, Inc. (formerly ThePort.com, Inc.) (“ThePort”). As of September 30, 2006, we had an approximate 32% voting interest in ThePort and this investment was accounted for under the equity method. As of September 30, 2006 and December 31, 2005, the carrying value of this investment was $0. We have no future obligations to fund ThePort.

10. RELATED PARTY TRANSACTIONS

Investment and Sublease with BeBetter Networks, Inc.

At September 30, 2006 and December 31, 2005, we had a 2% investment in BeBetter Networks, Inc. (“BeBetter”). As of September 30, 2006 and December 31, 2005, our Chairman of the Board of Directors held an approximate 2% voting interest in this company. We account for the investment under the cost method, as we have less than a 20% ownership and do not exercise significant influence over the investee.

At September 30, 2006 and December 31, 2005, the carrying value of our investment in BeBetter was $0. We have no plans to make additional investments in BeBetter in the future.

In September 2005, BeBetter vacated the space we had been subleasing to them on a month to month basis at $585 per month.

Investment and Sublease with ThePort Network, Inc.

As of September 30, 2006 and December 31, 2005, we held an approximate 32% voting interest in ThePort Network, Inc. (“ThePort”). Our Chairman of the Board of Directors, who also currently serves as the Chairman of the Board of Directors of ThePort, held an approximate 7% voting interest in ThePort at September 30, 2006 and

December 31, 2005 and held a convertible note from and made loans to ThePort in the amount of approximately $1,519,000 and $1,369,000 at September 30, 2006 and December 31, 2005, respectively. Two of our other directors also own equity interests in ThePort. The investment is being accounted for under the equity method (see Note 1 to the financial statements included in our Annual Report on Form 10-KSB).

At September 30, 2006 and December 31, 2005, the carrying value of our investment in ThePort was $0. We have not adjusted our investment below zero for our share of ThePort’s losses since then and through September 30, 2006, as we have not provided or committed to provide any additional financial support to ThePort.

In September 2006, ThePort vacated the space we had been subleasing to them on a month to month basis at $1,200 per month.

11. COMMITMENTS AND CONTINGENCIES

Leases

We lease office space and equipment under non-cancelable lease agreements expiring on various dates through 2008. We also have capital lease commitments for certain equipment. Additionally, we have entered into certain agreements to license content for our services from various unrelated third parties. Total payments due and estimated under license agreements and real estate, operating and capital leases for the remainder of 2006 and beyond are listed below (in thousands):

	License		Real Estate		Other Operating		Capital
	Agreements		Leases		Leases		Lease

2006	$	81	$	393	$	58	$	48
2007	—		1,600		187		164
2008	—		1,594		72		95
2009	—		1,465		46		25
2010	—		1,530		27		—
Thereafter	—		784		4		—
Total future minimum lease payments and payments under license agreements	$	81	$	7,366	$	394	332
Less - amounts representing interest							(37		)

Present value of future minimum lease payments							295

Less - current portion							(157		)

							$	138

We do not have any investments in joint ventures or special purpose entities, and do not guarantee the debt of any third parties. Our subsidiaries are 100% owned by us and are included in our consolidated financial statements.

Our headquarters are located in approximately 12,000 square feet of leased office space in Atlanta, Georgia. The space is leased for a term ending in September 2008. We have additional leased office space of 35,806 square feet in Uniondale, New York. The space is leased for a term ending in June 2011. Approximately 20,200 square feet is sublet to unrelated third parties for $37,000 per month. The difference between our lease rate and the income from the sublease contracts has been recorded as a liability on our accompanying consolidated balance sheet.

Guarantees

We indemnify our customers from third party claims of intellectual property infringement relating to the use of our products. Historically, costs related to this guarantee have not been significant and we are unable to estimate the

potential impact of this guarantee on our future results of operations.

12. CONCENTRATIONS

No one customer accounted for more than 10% of our revenues during the three and nine months ended September 30, 2006 or 2005.

13. INCOME TAXES

For the three and nine months ended September 30, 2006 we recorded an income tax provision of $185,000 and $823,000, or 38% (our estimated effective tax rate) of our pretax income. Additionally, we performed our quarterly evaluation of the deferred tax asset and the related valuation allowance as of September 30, 2006. Based on our analysis for the three months ended September 30, 2006, we reduced the valuation allowance by $185,000. The total reduction of the valuation allowance for the nine months ended September 30, 2006 was $823,000. These two transactions fully offset one another and therefore our income tax provision was zero for the three and nine months ended September 30, 2006. As a result of realizing this aggregate $823,000 of our deferred tax asset during the nine months ended September 30, 2006, we reduced the related valuation allowance to $9,177,000 at September 30, 2006 from $10,000,000 at December 31, 2005.

No provision for income taxes had been reflected for the three or nine months ended September 30, 2005, as we had sufficient net operating loss carry forwards to offset taxable income. As of September 30, 2005, we maintained a valuation allowance against our total net deferred tax asset balance.

At September 30, 2006 we had net operating loss (NOL) and R&D credit carryforwards available for tax purposes of approximately $34,000,000 and $1,000,000, respectively, which will expire on December 31 in years 2006 through 2022 and 2023, respectively. Online Benefits had net operating loss carryforwards available for tax purposes of approximately $32,500,000, which will expire on December 31 in years 2006 through 2023.

14. LEGAL PROCEEDINGS

The Company is involved with several legal actions arising in the normal course of business. Although the final outcome of these matters cannot be determined, it is the Company’s opinion the final resolution of these matters will not have a material adverse effect on its financial position.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

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. Act ual 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 recog nize 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 three ways – licensing, professional services and product sales. Licensing revenue is recognized ratably over the term of the license agreement beginning after delivery has occurred 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 revenue arrangements in which we sell through a reseller, we do not recognize 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 unless collectibility is reasonably assured. 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 t he 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 develo pment 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 successe s 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.

· 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 t he extent we believe that recovery is not likely, we must establish a valuation allowance.

RESULTS OF OPERATIONS

Comparison of the Three Months Ended September 30, 2006 with the Three Months Ended September 30, 2005

Certain items have been reclassified to conform to the current period presentation.

Revenues

	Three Months ended September 30,									2006 % of		2005 % of
	2006		2005		$ Change			% Change		Total Rev		Total Rev

Licensing	$	3,915	$	1,961	$	1,955		99.7	%	87.5	%	72.1	%
Product	368		581		(213		)	(36.7	)%	8.2	%	21.4	%
Professional services and other	190		178		11			6.2	%	4.3	%	6.5	%
Total Net Revenues	$	4,473	$	2,720	$	1,753		64.4	%	100.0	%	100.0	%

Total revenues increased $1,753,000 or 64.4%, to $4,473,000 for the three months ended September 30, 2006 compared to $2,720,000 for the three months ended September 30, 2005.

Revenues from the licensing market increased $1,955,000, or 99.7%, to $3,915,000 for the three months ended September 30, 2006 compared to $1,961,000 for the three months ended September 30, 2005. The increase in revenues was primarily due to the acquisition of Online Benefits and its $1,767,000 of revenues and revenues from their new customers and new contracts. The new contracts are primarily due to the Company’s ongoing sales and marketing efforts to sign new customers and the technological initiatives undertaken to enable our content products to be used in broader applications within the markets we serve. As a percent of total revenues, revenues from the licensing market increased to 87.5% for the three months ended September 30, 2006 compared to 72.1% for the three months ended September 30, 2005.

Revenues from product sales decreased $213,000, or 36.7%, to $368,000 for the three months ended September 30, 2006 compared to $581,000 for the three months ended September 30, 2005. The product revenues consist primarily of CD ROM and DVD-based product sales to the educational market. This decrease was the result of a large order in 2005, as well as 2005 benefiting from the first year uplift from the release of our AIA product upgrade. As a percent of total revenues, revenues from product were 8.2% for the three months ended September 30, 2006 compared to 21.4% for the three months ended September 30, 2005.

Revenues from professional services and other sources accounted for less than 7% of revenue for both 2006 and 2005. These revenues are typically one time items such as custom implementation services, subscriptions to our in-depth reports, and sales of nonrecurring items such as images. Aggregate revenues were $190,000 for the three months ended September 30, 2006 which was an $11,000 or 6.2% increase from the same period a year ago.

Operating Costs and Expenses

Certain items have been reclassified to conform to the current period presentation.

	Three Months
	Ended September 30,								2006 % of		2005 % of
	2006		2005		$ Change		% Change		Total Rev		Total Rev

Cost of Revenues	$	587	$	279	$	308	110.4	%	13.1	%	10.2	%
Cost of Revenues – Amortization	257		173		84		48.6	%	5.7	%	6.4	%
General and Administrative	1,274		608		666		109.5	%	28.5	%	22.4	%
Product and Content Development	874		441		433		98.2	%	19.5	%	16.2	%
Sales and Marketing	801		508		293		57.7	%	17.9	%	18.7	%
Total Operating Costs and Expenses	$	3,793	$	2,009	$	1,784	88.8	%	84.7	%	73.9	%

Cost of revenues increased $308,000, or 110.4%, to $587,000 for the three months ended September 30, 2006 compared to $279,000 for the three months ended September 30, 2005. Cost of revenues consists primarily of costs associated with (1) licensing, such as royalties and distribution license fees, (2) product sales, such as shipped product components, packaging and shipping costs, and (3) implementation costs related to professional services. The increase in cost of revenues was primarily attributable to a $282,000 increase from the acquisition of Online Benefits. As a percent of total revenues, cost of revenues was 13.1% for the three months ended September 30, 2006 and 10.2% for the three months ended September 30, 2005.

Cost of revenues – amortization increased $84,000, or 48.6%, to $257,000 for the three months ended September 30, 2005. Cost of revenues – amortization consists primarily of costs associated with amortization of capitalized customer lists, software product, and content development costs. As a percent of total revenues, cost of revenues – amortization was 5.7% for the three months ended September 30, 2006 and 6.4% for the three months ended September 30, 2005.

General and administrative expenses increased $666,000, or 109.5%, to $1,274,000 for the three months ended September 30, 2006 from $608,000 for the three months ended September 30, 2005. This increase was primarily attributable to a (1) $301,000 increase from the acquisition of Online Benefits and (2) stock-based compensation expense increase due to our increased stock price and its effect on our variably priced stock option expense, offset by a $141,000 increase in salaries, employee recruiting and benefits, and a $43,000 decrease in our estimated bad debt expense. As a percent of total revenues, general and administrative expenses were 28.5% for the three months ended September 30, 2006 compared to 22.4% for the three months ended September 30, 2005.

Product and content development expenses increased $433,000, or 98.2%, to $874,000 for the three months ended September 30, 2006 from $441,000 for the three months ended September 30, 2005. This increase was primarily attributable to the acquisition of Online Benefits. As a percent of total revenues, product and content development expenses were 19.5% for the three months ended September 30, 2006 compared to 16.2% for the three months ended September 30, 2005.

Sales and marketing expenses increased $293,000, or 57.7%, to $801,000 for the three months ended September 30, 2006 from $508,000 for the three months ended September 30, 2005. This increase was primarily attributable to the acquisition of Online Benefits. As a percent of total revenues, sales and marketing expenses were 17.9% for the three months ended September 30, 2006 compared to 18.7% for the three months ended September 30, 2005.

As a result of the factors described above, operating profit decreased $31,000 to $680,000 for the three months ended September 30, 2006 compared to an operating profit of $711,000 for the three months ended September 30, 2005.

Other Expenses and Income

Interest expense was $372,000 and $8,000 for the three months ended September 30, 2006 and 2005, respectively. This increase in interest expense was primarily due to higher borrowing levels on loans secured to finance the acquisition of Online Benefits.

Interest income was $178,000 and $109,000 for the three months ended September 30, 2006 and 2005, respectively. This increase was primarily due to increased levels of cash investments.

For the three months ended September 30, 2006, we recorded an income tax provision of $185,000, or 38% (our estimated effective tax rate) of our pretax income of $486,000. Additionally, we performed a periodic re-evaluation of our deferred tax asset and the related valuation allowance as of September 30, 2006 and based on our analysis we reduced the valuation allowance by an additional $185,000. These two transactions fully offset one another and therefore had no effect on our net income for the three months ended September 30, 2006.

The Company recorded an income tax benefit of $5,600,000 for the three months ended September 30, 2005 due to the reversal of a portion of our deferred tax asset valuation allowance.

As a result of the above, we had a net income of $486,000 for the three months ended September 30, 2006 compared to a net income of $6,412,000 for the three months ended September 30, 2005.

Comparison of the Nine Months Ended September 30, 2006 with the Nine Months Ended September 30, 2005

Revenues

Certain items have been reclassified to conform to the current period presentation.

	Nine Months ended September 30,									2006 % of		2005 % of
	2006		2005		$ Change			% Change		Total Rev		Total Rev

Licensing	$	8,152	$	5,597	$	2,555		45.6	%	84.3	%	74.2	%
Product	1,110		1,460		(350		)	(24.0	)%	11.5	%	19.3	%
Professional services and other	408		490		(82		)	(16.6	)%	4.2	%	6.5	%
Total Net Revenues	$	9,670	$	7,547	$	2,123		28.1	%	100.0	%	100.0	%

Total revenues increased $2,123,000, or 28.1%, to $9,670,000 for the nine months ended September 30, 2006 compared to $7,547,000 for the nine months ended September 30, 2005.

Revenues from licensing increased $2,555,000, or 45.6%, to $8,152,000 for the nine months ended September 30, 2006 compared to $5,597,000 for the nine months ended September 30, 2005. The increase in licensing revenues was primarily attributable to a (1) $1,665,000 increase from the acquisition of Online Benefits and (2) $890,000 increase in new customer contracts and increased reseller revenues. Revenues growth was seen in several licensing customer markets including the pharmaceuticals, technology, and payor markets. As a percent of total revenues, revenues from licensing increased to 84.3% for the nine months ended September 30, 2006 compared to 74.2% for the nine months ended September 30, 2005.

Revenues from product sales, which consists primarily of CD ROM and DVD-based product sold to our educational markets, decreased $350,000, or 24.0%, to $1,110,000 for the nine months ended September 30, 2006 compared to $1,460,000 for the nine months ended September 30, 2005. This decrease in 2006 was mainly attributable to the return of sales of the Company’s Interactive Anatomy 4.0 2005 product to historical sales levels as sales increased during 2005 due to the release of a major upgrade of this product which led to an uplift in revenues. As a percent of total revenues, revenues from product decreased to 11.5% for the nine months ended September 30, 2006 compared to 19.3% for the nine months ended September 30, 2005.

Revenues from professional services and other sources accounted for less than 7% of revenue for both 2006 and 2005. These revenues are typically one time items such as custom implementation services, subscriptions to our in-depth reports, and sales of nonrecurring items such as images. Aggregate revenues from this market were $408,000 for the nine months ended September 30, 2006 which was an $82,000, or 16.6%, decrease from the same period a year ago.

Operating Costs and Expenses

Certain items have been reclassified to conform to the current period presentation.

	Nine Months
	Ended September 30,								2006 % of		2005 % of
	2006		2005		$ Change		% Change		Total Rev		Total Rev

Costs of Revenues	$	1,208	$	891	$	317	35.6	%	12.5	%	11.8	%
Costs of Revenues - Amortization	634		533		101		18.9	%	6.5	%	7.1	%
General and Administrative	2,472		1,893		579		30.6	%	25.6	%	25.1	%
Product and Content Development	1,584		1,103		481		43.6	%	16.4	%	14.6	%
Sales and Marketing	1,690		1,363		327		24.0	%	17.5	%	18.1	%
Total Operating Costs and Expenses	$	7,588	$	5,783	$	1,805	31.2	%	78.5	%	76.7	%

Cost of revenues was $1,208,000 for the nine months ended September 30, 2006 compared to $891,000 for the nine months ended September 30, 2005. Cost of revenues consists primarily of costs associated with (1) licensing, such as royalties and distribution license fees and (2) product sales, such as shipped product components, packaging and shipping costs. The $317,000, or 35.6%, increase was primarily attributable to a $282,000 increase from the acquisition of Online Benefits. As a percent of total revenues, cost of revenues increased to 12.5% for the nine months ended September 30, 2006 compared to 11.8% for the nine months ended September 30, 2005.

Cost of revenues – amortization was $634,000 for the nine months ended September 30, 2006 compared to $533,000 for the nine months ended September 30, 2005. Cost of revenues – amortization consists primarily of costs associated with amortization of capitalized customer list, software product and content development costs. The $101,000, or 18.9%, increase was primarily due to an increase in amortization from customer lists and software acquired from Online Benefits. As a percent of total revenues, cost of revenues increased to 6.5% for the nine months ended September 30, 2006 compared to 7.1% for the nine months ended September 30, 2005.

General and administrative expenses increased $579,000, or 30.6%, to $2,472,000 for the nine months ended September 30, 2006 from $1,893,000 for the nine months ended September 30, 2005. This increase was primarily attributable to a $301,000 increase from the acquisition of Online Benefits, a $155,000 increase in salaries and benefits, a $127,000 increase in professional fees, and increases in rent, travel other general administrative expenses. As a percent of total revenues, general and administrative costs increased to 25.6% for the nine months ended September 30, 2006 compared to 25.1% for the nine months ended September 30, 2005.

Product and content development expenses increased $481,000, or 43.6%, to $1,584,000 for the nine months ended September 30, 2006 from $1,103,000 for the nine months ended September 30, 2005. This increase was due primarily to a $489,000 increase attributable to the acquisition of Online Benefits. As a percent of total revenues, product development expenses increased to 16.4% for the nine months ended September 30, 2006 compared to 14.6% for the nine months ended September 30, 2005.

Sales and marketing expenses increased $327,000, or 24.0%, to $1,690,000 for the nine months ended September 30, 2006 from $1,363,000 for the nine months ended September 30, 2005. This increase was primarily attributable to a $354,000 increase attributable to the acquisition of Online Benefits. As a percent of total revenues, sales and marketing expenses was 17.5% for the nine months ended September 30, 2006 compared to 18.1% for the nine months ended September 30, 2005.

As a result of the factors described above, operating profit increased $318,000 to $2,082,000 for the nine months ended September 30, 2006 compared to an operating profit of $1,764,000 for the nine months ended September 30, 2005.

Other Expenses and Income

Interest expense was $376,000 and $27,000 for the nine months ended September 30, 2006 and 2005, respectively. This increase in interest expense was primarily due to higher borrowing levels on loans secured to finance the acquisition of Online Benefits.

Interest income was $459,000 and $230,000 for the nine months ended September 30, 2006 and 2005, respectively. This increase was primarily due to higher levels of investments during 2006 prior to the acquisition of Online Benefits.

For the nine months ended September 30, 2006, we recorded an income tax provision of $823,000, or 38% (our estimated effective tax rate) of our pretax income of $2,165,000. Additionally, we performed a periodic re-evaluation of our deferred tax asset and the related valuation allowance as of September 30, 2006 and, based on our analysis, we reduced the valuation allowance by an additional $823,000. These two transactions fully offset one

another and, therefore, had no effect on our net income for the nine months ended September 30, 2006.

The Company recorded an income tax benefit of $5,600,000 for the nine months ended September 30, 2005 due to the reversal of a portion of our deferred tax asset valuation allowance.

As a result of the above, we had a net income of $2,165,000 for the nine months ended September 30, 2006 compared to a net income of $7,567,000 for the nine months ended September 30, 2005.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2006 we had cash and cash equivalents of $4,285,000, short term investments totaling $2,743,000 and working capital of $4,030,000.

Cash provided by operating activities was $2,455,000 during the nine months ended September 30, 2006, as compared to $3,163,000 during the nine months ended September 30, 2005. This $708,000 decrease was due primarily to the $5,402,000 decrease in net income for the 2006 nine month period over the 2005 nine month period, the $110,000 increase in accounts receivable for the first nine months of 2006 compared to the $549,000 decrease in the first nine months of 2005, the $327,000 decrease of deferred revenue for the first nine months of 2006 compared to the $4,000 inncrease in the first nine months of 2005, partially offset by the zero change in the deferred tax asset in the first nine months of 2006 compared to the $5,600,000 change experienced in the first nine months of 2005.

Cash used by investing activities was $24,913,000 during the nine months ended September 30, 2006, as compared to cash used of $4,850,000 during the nine months ended September 30, 2005. This increase in cash outflow was primarily due to the acquisition of Online Benefits during the third quarter 2006.

Cash provided by financing activities was $23,927,000 during the nine months ended September 30, 2006, as compared to cash provided by financing activities of $171,000 during the nine months ended September 30, 2005. The increase in cash inflow was primarily due to the debt proceeds obtained during the third quarter 2006 related to the acquisition of Online Benefits.

We also 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.

Additional information regarding contracts, commitments, and debt that affect our liquidity and capital resources is provided in Note 11(Commitments and Contingencies) and Note 4 (Debt) to the unaudited financial statements included in this report.

We believe that cash and short-term investments, together with anticipated cash flows from operations, will be sufficient to meet our working capital needs for the next twelve months. However, we may be required to raise additional funds in order to accelerate development of new and existing services and products, to respond to competitive pressures or to possibly acquire complementary products, businesses or technologies. There can be no assurance that any required additional financing will be available on terms favorable to us, or at all. If additional funds are raised by the issuance of equity securities, our shareholders would experience dilution of their ownership interest and these securities may have rights senior to those of the holders of the common stock. If additional funds are raised by the issuance of debt securities, we may be subject to certain limitations on our operations, including limitations on the payment of dividends. If adequate funds are not available or not available on acceptable terms, we may be unable to take advantage of acquisition opportunities, develop or enhance services and products or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and results of operations.

We do not have any material off-balance sheet arrangements.

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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to risk and related changes in interest rates relates primarily to our investment portfolio (Note 3 - Investments) and our variable rate debt (Note 14 - Debt). As of September 30, 2006, we had $4,285,000 of cash and cash equivalents, $2,743,000 in short term investments and $44,000 in restricted time deposits. Due to the conservative and short-term nature of our investment portfolio, we believe that even a sudden 10% change in interest rates would not have a material effect on the value of the portfolio. The average yield on our short-term investments at September 30, 2006, all of which mature between October 2006 and January 2007, was approximately 5.53%. The impact on our future interest income depends largely on the gross amount of our investment portfolio. We do not expect our operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates.

As of September 30, 2006, the Company had a total of $25 million in variable rate debt at differing interest rates tied to libor. If the interest rates on the Company’s existing variable rate debt were to increase by 10% over the next twelve months, the Company would incur $2,500,000 of additional interest expense over a 12-month period and would potentially be in default of the long-term debt covenants.

ITEM 4. CONTROLS AND PROCEDURES

Management has developed and implemented a policy and procedures for reviewing, on a quarterly basis, our disclosure controls and procedures and our internal control over financial reporting. Management, including our CEO and CFO, evaluated the effectiveness of the design and operation of disclosure controls and procedures as of the end of the period covered by this report and, based on their evaluation, our CEO and CFO have concluded that these controls and procedures are operating effectively. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports we file under the Exchange Act is accumulated and communicated to management, including the principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.

During the third quarter 2006, the Company acquired Online Benefits. Both prior to and following the acquisition, the Company assessed the effectiveness of internal controls over financial reporting and found such controls, both before and after the acquisition, to be effective.

Management has evaluated any changes in our internal controls over financial reporting that occurred during the period covered in this report and has concluded, except as noted in the preceding paragraph, there were no significant changes in our internal control over financial reporting during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1A. RISK FACTORS

In addition to other factors addressed elsewhere in this report, the following are certain of the factors that could cause our actual results to differ materially from the expected results described in our forward-looking statements:

· We may be unable to obtain sufficient capital to pursue our growth and market development strategies, which would hurt our financial results. We can offer no assurance that our revenues will be sufficient to cover our expenses or that capital will be available to us on satisfactory terms or at all, to fund any shortfall in these costs and revenues.

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

· Some competitors have advantages over us because of their longer operating histories, greater name recognition, or greater financial, technical and marketing resources. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. They could also devote greater resources to the promotion and sale of their products or services. Furthermore, mergers and acquisitions among other companies could intensify our existing competition or create new competitors.

· We can offer no assurance that the loss of any significant customer will not materially adversely affect our business.

· We face technological challenges in our ability to deliver customized information in the rapidly changing healthcare industry, which may limit our ability to maintain existing customers or attract new customers. We believe that health information will become more customized to an individual’s personal health management needs. As a result, we will need to have adequate technology infrastructure that will allow us to deliver in a cost effective manner portions of our content assets based on each customer’s requirements.

· We may be unable to successfully identify, acquire, manage or integrate complementary businesses. Our long-term growth strategy may include acquiring businesses with complementary products, technologies or professional services. Moving forward, we may not be successful in acquiring other complementary businesses or assimilating their personnel and operations. These difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations. Future acquisitions may also cause us to incur expenses such as in-process research and development expenses, which may negatively affect our earnings. We cannot be certain that we will successfully overcome these risks with respect to any future acquisitions. In addition, we have historically paid a portion of the consideration for some of our acquisitions by issuing common stock. The issuance of additional common stock or other securities convertible into common stock in connection with future acquisitions would dilute the ownership interests of our existing shareholders.

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

and our business will suffer.

· Our stock price is extremely volatile and could decline significantly. Since our initial public offering in 1995, there has been significant volatility in the price of our common stock. This volatility has often been unrelated to our operating performance. There can be no assurance that the market price of our common stock will be maintained or that the volume of trading in our shares will not decrease. Furthermore, following periods of volatility in the market price of a company’s securities, securities class action claims frequently are brought against the subject company. To the extent that the market price of our shares falls dramatically in any period of time, shareholders may bring claims, with or without merit, against us. Such litigation would be expensive to defend and would divert management attention and resources regardless of outcome.

· We must comply with Section 404 of the Sarbanes-Oxley Act which will require us to increase our expenses associated with the development and testing of our internal controls. There can be no assurance that we will not have significant deficiencies or material weaknesses in our internal controls or that we will not encounter higher than anticipated expenses associated with compliance that may adversely affect our share price.

· We have adopted certain anti-takeover provisions that may deter a takeover. Our articles of incorporation and bylaws contain provisions that may deter a takeover, including a takeover on terms that many of our shareholders might consider favorable, such as: the authority of our board of directors to issue common stock and preferred stock and to determine the price, rights (including voting rights), preferences, privileges and restrictions of each series of preferred stock, without any vote or action by our shareholders; the existence of large amounts of authorized but unissued common stock and preferred stock; staggered, three-year terms for our board of directors; and advance notice requirements for board of directors nominations and for shareholder proposals. The rights and preferences of any series of preferred stock could include a preference over the common stock on the distribution of our assets upon a liquidation or sale of our company, preferential dividends, redemption rights, the right to elect one or more directors and other voting rights. The rights of the holders of any series of preferred stock that may be issued in the future may adversely affect the rights of the holders of the common stock. We have no current plans to issue preferred stock. In addition, certain provisions of Georgia law and our stock option plan may also discourage, delay or prevent a change in control of our company or unsolicited acquisition proposals.

· A significant number of unissued shares are available for future sale and could adversely affect the market price of our common stock. If our shareholders, option holders, or warrant holders exercise their rights to sell substantial amounts of our common shares in the public market, the market price of our common stock could fall. Given the unpredictable transaction volumes for our common stock, the sale of a significant amount of these shares at any given time could cause the market price of our common stock to decline or otherwise be highly volatile. Such sales could also make it more difficult for us to sell equity or equity-related securities in the future at a time and price when we deem conditions to be more favorable.

ITEM 6. EXHIBITS.

The following exhibits are filed with this report or incorporated herein by reference:

Exhibit Number		Exhibit Description

2.1		Agreement and Plan of Merger dated August 14, 2006 (incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on August 16, 2006).

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		Credit Agreement dated August 14, 2006 (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on August 16, 2006).

10.2		Conversion and Registration Rights Agreement dated as of August 14, 2006 (incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed on August 16, 2006).

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	A.D.A.M., Inc.
	(Registrant)

Date: November 14, 2006	By:	/s/ KEVIN S. NOLAND
		Kevin S. Noland
		President, Chief Executive Officer and Corporate Secretary


Date: November 14, 2006	By:	/s/ MARK B. ADAMS
		Mark B. Adams Chief Financial Officer

EXHIBIT INDEX

Exhibit Number		Exhibit Description

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

EX-31.1 2 a06-22036_1ex31d1.htm CERTIFICATION OF CEO PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

Exhibit 31.1

CERTIFICATION

I, Kevin S. Noland certify that:

1. I have reviewed this quarterly report on Form 10-Q of A.D.A.M., Inc. (the “Company”) for the quarter ended September 30, 2006;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this report;

4. The Company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Company and we have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986];

c) evaluated the effectiveness of the Company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) disclosed in this report any change in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting; and

5. The Company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Company’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Company’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internal control over financial reporting.

Date:	November 14, 2006	/s/ KEVIN S. NOLAND
		Kevin S. Noland President, Chief Executive Officer and Corporate Secretary

EX-31.2 3 a06-22036_1ex31d2.htm CERTIFICATION OF CFO PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

Exhibit 31.2

CERTIFICATION

I, Mark B. Adams, certify that:

1. I have reviewed this quarterly report on Form 10-Q of A.D.A.M., Inc. (the “Company”) for the quarter ended September 30, 2006;

b) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986];

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internal control over financial reporting.

Date:	November 14, 2006

		/s/ MARK B. ADAMS
		Mark B. Adams
		Chief Financial Officer

EX-32.1 4 a06-22036_1ex32d1.htm CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Exhibit 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with this Quarterly Report of A.D.A.M., Inc. (the “Company”) on Form 10-Q for the quarterly period ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, Kevin S. Noland, President, Chief Executive Officer and Corporate Secretary of the Company, and Mark B. Adams, Chief Financial Officer of the Company, do hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of our knowledge:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ KEVIN S. NOLAND
Kevin S. Noland President, Chief Executive Officer and Corporate Secretary
November 14, 2006

/s/ MARK B. ADAMS
Mark B. Adams
Chief Financial Officer
November 14, 2006