-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KgllHHTbIcd6UzcODnJcY0/tobeby2YzY1PC5xM5c2XQQ5ScFK8UIW854o81Uxu0 3m0k8wcRLUsO4lot+iD0pQ== 0001157523-04-002712.txt : 20040326 0001157523-04-002712.hdr.sgml : 20040326 20040326154131 ACCESSION NUMBER: 0001157523-04-002712 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20040324 FILED AS OF DATE: 20040326 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: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-26962 FILM NUMBER: 04692934 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 10KSB 1 a4601334.txt A.D.A.M. 10-KSB SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------- FORM 10-KSB (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 OR [ ] 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 of incorporation) (IRS Employer Identification No.) 1600 RiverEdge Parkway, Suite 100 Atlanta, Georgia 30328 (Address of Principal Executive Offices, Zip Code) Issuer's telephone number, including area code: (770) 980-0888 Securities registered under Section 12(b) of the Act: None Securities registered under Section 12(g) of the Act: Title of each class ------------------- Common Stock, par value $.01 Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. The revenues for the year ended December 31, 2003, the most recent fiscal year, were $7,889,452. The aggregate market value of the common equity held by non-affiliates of the Registrant (assuming for these purposes, but without conceding, that all executive officers and directors are "affiliates" of the Registrant) as of February 11, 2004 (based on the closing sale price of the Registrant's common stock, as reported on the Nasdaq SmallCap Market on such date) was $16,047,916. As of March 1, 2004, 7,890,694 shares of common stock were outstanding. Transitional Small Business Disclosure Format Yes __ No _X_ ================================================================================ DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's proxy statement for its 2004 Annual Meeting of Shareholders are incorporated herein by reference in response to Part III of this Form 10-KSB. 2 PART I. 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" under the Private Securities Litigation Reform Act of 1995. When used in this report, the words "believes," "expects," "estimates," "intends," "will" 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 our products and platform technologies, our continuing growth and our ability to contain our operating expenses. 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 1. BUSINESS Overview We specialize in the creation and delivery of interactive health content that can be used by a broad range of healthcare consumers - from those with low health literacy to those who play an active and ongoing role in their personal health management. Our products can be used for learning about general health concerns, specific diseases and treatments, surgical procedures, drug information, specialty health subjects such as women's health and children's health, nutrition, alternative medicine and more. Our health content products meet rigorous editorial standards. We employ two physicians and use an extensive network of physicians and specialists who are continually reviewing and updating our information. We add to our content library when needed such as when important health issues arise (for example, the recent SARS outbreak) or when our customers request specific products to support their product and service offerings. Our health information is accredited by URAC, an industry leading accreditation organization, and we are a founding member of Hi-Ethics, a coalition of the most widely referenced health websites and information providers committed to developing industry standards for the quality of consumer health information. We believe that our health information products and technology are unique in the industry. One of our most valuable strengths, and competitive advantages, is a large, proprietary content library and content management system. This library includes: - -- More than 4,000 health reference articles on disease, conditions, symptoms, surgeries, nutrition and medical tests; - -- Over 40,000 catalogued medical illustrations that we have developed; - -- Thousands of web-enabled animations depicting disease states and other medical conditions, many of which are broadcast quality; - -- Interactive tools that enhance and complement the functionality of our health content products; - -- Unique technology for viewing the anatomy of the human body; and - -- Proprietary content management and delivery technology that allow us to publish our digital assets to a customer's specification efficiently and cost effectively. We sell our health content products primarily through annual licensing agreements to many different types of healthcare and health-related organizations including hospitals, managed care organizations, pharmaceutical companies, disease management vendors, health-oriented Internet websites, healthcare technology companies and large employers. Our products can be incorporated into a customer's website, imbedded in healthcare applications such as an electronic medical record or disease management applications, contained in a printed format, or combined with other products that may be offered to a healthcare consumer. ================================================================================ 3 Healthcare organizations can use our products and technology primarily in two ways: -- To increase the utilization of their products and services; and -- To improve health outcomes and manage the appropriateness of care. In both of these applications, we believe that health content plays a vital role in helping these organizations grow revenues and reduce costs, while adding value for the healthcare consumer. We also work with some of the leading companies in the healthcare industry to integrate our health information into applications such as electronic medical records and disease management applications where specific health information relating to a patient's condition or diagnosis can be made available to them through a personalized website or "patient portal." We believe agreements we have made with ThePort Network, Inc. will allow us to deliver a "patient portal" directly to patients' desktops, with secure, one-to-one communications with their healthcare provider or health plan. Our products also speak to the proliferation of low health literacy - the inability to read, understand or act on health information. Low health literacy is estimated to cost the U.S. healthcare industry approximately $58 billion a year according to organizations that track these types of public health concerns. It spans ethnic boundaries and social classes and is estimated to impact nearly one in three people in the U.S. Our products allow healthcare organizations to reach consumers at multiple reading levels and are enhanced with pictures and animations. The use of visuals has been proven to assist in the understanding and retention of complex information, and we have been at the forefront of providing visually engaging, interactive health information for over a decade. Our extensive collection of medical illustrations, graphics and animations are carefully put into our products so that healthcare consumers can better understand and retain the information they are reading. Our products can also be delivered in a variety of formats - from print handouts to electronic delivery. Several of our products, including the Health Illustrated Encyclopedia, are also available in Spanish, which can address both low health literacy issues, as well as those consumers with limited English proficiency. Over the past two years we have seen a significant shift in our ability to secure new business in healthcare. We believe that the quality of our products, the depth and breadth of the digital assets we own, and the solutions we provide to address issues such as low health literacy, well position us for future growth. Markets We market our products to the healthcare industry, to Internet websites and to educational institutions. Healthcare Industry Our products target a broad range of businesses in the healthcare industry including healthcare providers, managed care organizations, healthcare technology companies and pharmaceutical organizations. Healthcare Providers. The healthcare provider market includes hospitals and hospital systems and large physician practice groups that are providing healthcare services to consumers. We believe our primary revenue opportunities are with the approximately 2,000 hospital facilities that exceed 200 beds. There are two underlying reasons why we believe this market is important: -- Healthcare providers are seeking to enhance their websites with content, tools and services that can increase utilization of their services and support their service line efforts; and -- Healthcare providers are evolving their websites to offer more point-of-care services including the use of personalized health information as part of patient education, physician loyalty programs and risk management. 4 Managed Care Organizations. This market includes a broad range of managed care organizations, consumer directed health plans and large employers who are actively looking for operational improvements through the effective use of health information. We believe that our products are well suited to assist these types of organizations in two important aspects: -- The recognition and identification of disease for early health intervention; and -- Demand management of health plan members and employees to seek health intervention when appropriate or as necessary. Pharmaceutical Organizations. The relaxation of pharmaceutical marketing regulations by the Food and Drug Administration in 1997 has led to the proliferation of Direct to Consumer ("DTC") advertising by the pharmaceutical companies. According to an ACNielson Homescan Rx/OTC Consumer Panel sales analysis of twelve major prescription drug brands DTC-advertised from July though December 2002, 17% of new prescriptions filled came as a direct result of patients requesting the brand. The effects of DTC advertising, along with the billions of dollars pharmaceutical companies are spending on DTC, have created new market opportunities for us as we leverage our ability to customize our health information products to support these marketing efforts. Currently, several leading pharmaceutical organizations license our content products, and we believe there is significant potential to expand these relationships. Healthcare Technology Companies. This market includes healthcare application developers such as electronic medical record vendors, medical device companies, and disease management application developers that can use our content at point-of-care or within the context of the healthcare consumer's specific medical condition or disease state. Internet This market includes large Internet and media-related websites that host a variety of consumer-oriented content and services. These websites generally use our health content either exclusively or as part of a larger health channel offering to serve as a driver for advertising revenue. While we still derive a portion of our revenues and continue to explore ways in which to expand our presence in this market, the number of license agreements we have completed has diminished as the larger websites continue to grow and the number of smaller, more specialized health sites have either shut down or have been acquired. We continue to view this market as an important component in our revenue strategy and will pursue opportunities as they become available. We are actively leveraging existing relationships to provide more content products and professional services. Education The education market includes higher education, K-12 and the allied health markets. Historically, we have serviced this market with our CD-ROM products. We continue to experience a revenue stream from the sale of these CD-ROM products although we have seen a decline in our education revenues as our CD ROM products begin to age. We are currently developing a major upgrade to our flagship educational product, A.D.A.M. Interactive Anatomy, which we expect to release in the summer of 2004. We also believe that the educational market is an important and complementary extension to our broader product strategy in healthcare. Products and Services We offer a comprehensive portfolio of informative, web-enabled products that are designed to explain complex medical issues in a way that can be easily understood by the non-medical healthcare consumer. We have also developed a line of CD-ROM products that are sold primarily to the K-12 and higher education markets, including our flagship software product for higher education, A.D.A.M. Interactive Anatomy. 5 The following chart summarizes our primary products and the typical customers of those products:
- ---------------------------------------------------------------------------------------------------------- PRODUCT CUSTOMER DESCRIPTION - ---------------------------------------------------------------------------------------------------------- Health Illustrated Encyclopedia Hospitals, health plans, consumer- A general health oriented websites, and large employers. reference product containing approximately 3,600 unique articles relating to diseases and health conditions, medical tests, symptoms, injuries, treatment options, surgical procedures and nutrition. The content is organized by topic or condition and is enhanced with graphical illustrations. Also, available in Spanish. - ---------------------------------------------------------------------------------------------------------- In-Depth Disease and Condition Hospitals, health plans, disease Available as a library or Reports management companies, physicians, individually by topic. and medical libraries. Generally sold with the Health Illustrated Encyclopedia. The In- Depth Reports provide the reader a much deeper understanding of the subject. Typically targeted to the 8th grade reading level. - ---------------------------------------------------------------------------------------------------------- Consumer ACCESS Hospitals, health plans, Internet ACCESS provides websites catering to alternative medically reviewed medicine, physicians, spas and health information on the fitness organizations. integration of alternative therapies with traditional medicine. Includes approximately 170 health conditions, 120 herbs and supplements, 20 monographs on complementary treatments, and 1,600 drug monographs. - ---------------------------------------------------------------------------------------------------------- Care Guides Hospitals, health plans, disease Comprehensive patient management organizations, and care guides on the most Internet websites. common chronic conditions: Asthma, Allergies, Diabetes Type 1, High Blood Pressure and High Cholesterol. Designed for ease of use, each guide contains "key points", supplemental reading, and information to help patients make educated healthcare decisions. - ----------------------------------------------------------------------------------------------------------
6
- ---------------------------------------------------------------------------------------------------------- Pregnancy Health Center Hospitals supporting maternity service Provides topical health line, health plans, employers and information and specialty websites. interactive tools addressing pregnancy, from pre-conception to post-partum. - ---------------------------------------------------------------------------------------------------------- Surgeries and Procedures Hospitals, health plans, physician A web-based product practices, and Internet websites. that explains various surgeries and medical procedures using step- by-step, easy to understand language supplemented by medical illustrations, diagrams and imagery. - ---------------------------------------------------------------------------------------------------------- A.D.A.M. Interactive Anatomy Undergraduate and allied health A CD-ROM product that institutions, and undergraduate simulates human anatomy and physiology students. anatomical dissection of both male and female bodies. More than 22,000 anatomical structures can be identified. - ---------------------------------------------------------------------------------------------------------- A.D.A.M. At Home Series School K-12 teachers and students. A series of CD-ROM Editions products including A.D.A.M. The Inside Story, Nine Month Miracle and Life's Greatest Mysteries coupled with curriculum guides for teachers. - ----------------------------------------------------------------------------------------------------------
We offer our customers various custom and professional services including medical illustration, multimedia and animation development and engineering. Our ability to provide customers with these types of professional services is an important component to our position as a full-service solution provider. We believe that in order to provide full-service solutions to our customers, we must provide flexibility in the way our products are configured and delivered. Customer Support and Client Services We believe that a high level of customer support is necessary to attract and retain customers and we therefore provide several levels of customer support for both our CD-ROM and license customers. We provide toll-free telephone technical support for our CD-ROM customers and, through our client services team we maintain direct and ongoing relationships with our license customers for technical support, integration issues, content updates, and maintenance. Platform, Product and Content Development Our proprietary content platform handles the management and workflow associated with our electronic assets. The publishing components of our system allow us to deliver products to our customers more efficiently and with more accuracy. Our system also allows us to customize our product content offerings with minimal development costs. We have also implemented the use of the National Library of Medicine's Unified Medical Language System ("UMLS"). The use of the UMLS assists in the development of systems that help healthcare organizations integrate data across a wide variety of information systems such as electronic medical records and other decision support applications. The UMLS allows us to output any of our health content to any number of standard medical taxonomies such as ICD-9, CPT, MeSH and SnoMed. We believe that providing our customers with data in this fashion will allow them to easily integrate our content into their own systems creating an "actionable" environment between information and related services. 7 With the capabilities of our content management system, and through the development of additional content, products and technologies, we expect to expand our licensing network with new customers and derive additional revenues from our current license customers. We provide our products directly to our customers through File Transfer Protocol (FTP), CD-ROM and web services. We also host content for customers through an Application Services Provider model. Our platform technology and servers are located in a secure data center with built-in redundancies at our corporate offices in Atlanta, Georgia. Editorial Excellence We believe that our health information products are developed and maintained to the highest degree of completeness, relevancy and medical accuracy. Our editorial process is divided into five areas: -- Development. Medical writers, health practitioners and medical illustrators develop our content. Previously published content is reviewed and internally evaluated for completeness and relevancy. Also, textual content is evaluated for enhancement with new and appropriate visuals. -- Review. We have developed an extensive network of reviewers that evaluate the accuracy of the text and visual content. Our network consists of physicians who are specialists in their field that provide input on the medical accuracy, relevancy and completeness of the information. -- Editorial. Our editorial staff reviews all content, both textual and visual, for grammar, style and consistency. A content quality assurance check is also performed. -- Production. The content is indexed, stored in a data management environment, coded and tagged for presentation. Another level of technical and content quality assurance checks are also performed during this step. -- Publication. This is the stage where we publish the content or product to our customers. Our health information is regularly updated and, in most cases, this update cycle is repeated quarterly. We are also a founding member of Hi-Ethics (Health Internet Ethics), a non-profit organization dedicated to providing consumers the highest standards for privacy, security, credibility and reliability of health information via the Internet. In 2002, our chief medical officer, Dr. Alan Greene, was named President of Hi-Ethics and serves as Chair of the Hi-Ethics Quality Work Group, which is developing version 2.0 of the Hi-Ethics principles, which will be the new foundation of URAC standards. Sales and Marketing We market our products and services through a direct sales force, our reseller network and consulting groups that provide professional services such as web strategy to our target markets. We also participate in industry trade shows and conferences. We have also established certain strategic relationships in order to expand the sales and distribution of our products. For example, we have partnered with DrTango, Inc., an organization that has translated several of our content products into Spanish and resells them as part of a Hispanic-focused healthcare strategy. We have several other important relationships that provide us with increased visibility in our markets. Those relationships include resellers that sell to the hospital market and healthcare technology companies that have integrated certain content components from us. We believe that developing more third-party distribution will be an important driver for future revenues. Manufacturing The production of our software products includes CD-ROM pressing, assembly of purchased product components, printing of product packaging and user manuals and shipping of finished goods, all of which is performed by third-party vendors in accordance with our specifications and forecasts. We believe that there are alternate sources for each of these services that could be implemented without material delay, if necessary. 8 Proprietary Rights and Licenses We regard our software publications and content assets as proprietary. We rely primarily on a combination of copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements and other methods to protect our proprietary rights. We have obtained U.S. federal registrations of the trademarks and the logos for the "A.D.A.M." marks, as well as numerous other trademarks, which identify our products. We have also obtained registrations of the "A.D.A.M." trademark in Australia, Austria, Benelux, Canada, Chile, China, Denmark, Finland, France, Germany, Ireland, Italy, New Zealand, Norway, Portugal, South Africa, Sweden, Switzerland and Taiwan and we have a pending application to register the mark in Malaysia. We have also acquired and are using a number of registered and unregistered trademarks to identify our products. We use the "A.D.A.M." mark in Japan under license with Kataken Seiko K.K. We are also the owner of a number of domain name registrations. We have applied for and/or obtained numerous U.S. Copyright Registrations for our software, publication and content products, including Health Illustrated Encyclopedia, A.D.A.M. Interactive Anatomy, and Pregnancy Health Center. We do not currently hold any patents or have any patent applications pending. There can be no assurance that these protections will be adequate to protect the intellectual property rights or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies. We further believe that due to the rapid pace of innovation within the multimedia and software industries, factors such as the technological and creative skills of our personnel and the quality of the content of our products are as important in establishing and maintaining a leadership position within the industry as the various legal protections for our technology. We believe that our products, trademarks and other proprietary rights do not infringe upon the proprietary rights of third parties and to date no third party has filed an infringement claim against us. However, as the number of products in our industry increases and the functionality of these products overlap, content providers may become increasingly subject to infringement claims. There can be no assurance that third parties will not assert infringement claims against us in the future with respect to current or future products, trademarks or other works of A.D.A.M. or that any assertion will not require us to enter into royalty arrangements or result in costly litigation. Competition The market in which we operate is highly competitive and continually evolving. There are a number of health content service providers offering products in various pre-packaged and customized ways, including: -- Online content providers and aggregators, targeting the healthcare industry or health conscious consumer, such as WebMD Corporation. -- Public sector and non-profit organizations that provide healthcare information without advertising or commercial sponsorships such as the American Medical Association, the Mayo Clinic and Healthwise, Inc. -- Publishers and distributors of traditional offline media, including those targeting healthcare professionals, many of which have established or may establish websites such as Health Ink & Vitality. -- Healthcare consulting and web development companies such as Greystone.net. Some of our competitors have greater technical, product development, marketing, financial and other resources than we do. These organizations may have longer operating histories, greater brand recognition and larger customer bases. We believe other competitive factors in our markets include ease of implementation and use, pricing, features and quality of customer support. We believe our principal competitive advantages in our markets are: -- Ownership of all our A.D.A.M.-labeled electronic assets; -- The size and scope of our content assets; -- Rigorous editorial review processes; -- URAC accreditation; -- Proprietary content management, delivery and integration technologies; and -- Unique visual content assets that require specialized knowledge and training to create. 9 Employees As of December 31, 2003, we had 35 employees. Of these employees, 19 were engaged primarily in editorial management and product development, 10 in sales and marketing and 6 in finance and administration. Our employees are not covered by a collective bargaining agreement and we have experienced no work stoppages. We consider our employee relations to be good. We believe that our future growth and success will depend upon our ability to retain and continue to attract highly skilled and motivated personnel in all areas of our operations. Factors Affecting Future Performance You should carefully consider each of the following factors along with all of the other information in this Report. The risks and uncertainties described below are not the only ones we will face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business. If any of the following risks and uncertainties develops into actual events, our business, financial condition or results of operations could be materially adversely affected. If that happens, the trading prices of our common stock could decline significantly. -- Although we reported net income for 2003, we have incurred substantial losses in the past. We experienced losses of $1,530,000 in 2002, income of $1,597,000 in 2001 and losses of $7,854,000 in 2000. We cannot offer any assurance that we will be able to sustain profitability in the future. -- 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 license 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 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. 10 -- 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 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 un-issued 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 un-issued 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. -- Our principal shareholders have substantial influence and their interests may differ from those of our other shareholders. As of December 31, 2003, our executive officers, directors and persons who beneficially own more than 5% of our outstanding common stock controlled approximately 14.8% of the combined outstanding voting power of our common stock. As a result, these holders exert substantial influence with respect to all matters submitted to a vote of holders of common stock, including election of our directors. If our remaining shareholders have interests that differ from these holders, their needs may not be met. -- Our Stock Purchase Agreement with Fusion Capital Fund II, LLC may result in significant dilution of our other shareholders. On May 22, 2002, we entered into a Common Stock Purchase Agreement with Fusion Capital Fund II, LLC. Pursuant to this agreement, Fusion Capital has agreed to purchase up to an aggregate of $12,000,000 of our common stock. We have the right to sell up to $15,000 of common stock per trading day under this agreement with Fusion Capital unless our stock price equals or exceeds $7.00, in which case the daily amount may be increased at our option. Fusion Capital is not obligated to purchase any shares of our common stock on any trading days that the market price of our common stock is less than $1.00. Sales of our common stock under this agreement would dilute the ownership of shareholders other than Fusion Capital Fund II, LLC. As of December 31, 2003, we have sold 486,566 shares for $733,000 under this agreement. 11 Acquisitions In December 2001, we acquired Integrative Medicine Communications, Inc. ("IMC"), a leading developer and licensor of health content in the complementary and alternative medicine ("CAM") field. The products, which include a comprehensive, web-enabled database of condition, herbal and supplemental monographs, are designed for use by both professional clinicians and consumers. In February 2002, we acquired Nidus Information Services, Inc. ("Nidus"), a privately held provider of in-depth patient education reports on common health conditions and diseases called WELL-CONNECTED(TM). This library of over 100 reports was originally developed by an experienced team of medical writers and editors and is reviewed for accuracy by a board of physicians with faculty positions at Harvard Medical School and Massachusetts General Hospital. Each report is distinguished from other information sources by its detail of information, quality and currency, its evidence-based approach, and rigorous editorial review. The reports are available through print or web subscriptions and through licensing agreements. They are sold primarily to healthcare providers and Internet portals, health content resellers and medical libraries. We have included the results of these acquisitions in our consolidated financial statements from the date of acquisition. Corporate Information We were incorporated in 1990 as A.D.A.M. Software, Inc. We changed our name to adam.com, Inc. in 1999 and to A.D.A.M., Inc. in 2001. We are headquartered in Atlanta, Georgia. ITEM 2. PROPERTIES Our headquarters are located in approximately 12,000 square feet of leased office space in Atlanta, Georgia. This lease extends through April 2008. We sublease approximately 500 square feet of this space to a company whose Chairman is our Chief Executive Officer and at this time we are not collecting any lease payments in connection with this sublease. We sublease an additional 500 square feet of this space to a company whose Chief Executive Officer is a director of A.D.A.M. and their monthly lease payment is $785. If additional facilities are required, we believe that suitable facilities will be available at market rates. ITEM 3. LEGAL PROCEEDINGS On April 25, 1996, a shareholders' class action lawsuit was filed in Fulton County Superior Court in Atlanta, Georgia against us and certain of our then officers and directors. The complaint alleged violations of Sections 11, 12(2) and 15 of the Securities Act of 1933 and violations of the Georgia Securities Act arising out of alleged disclosure deficiencies in connection with our initial public offering of common stock, which was completed on November 10, 1995. The complaint seeks compensatory damages in an unspecified amount. The court denied in substantial part the defendant's motion to dismiss the complaint and certified the case as a class action for all of the claims except for the claim under the Georgia Securities Act. On March 24, 2004, the Fulton County Superior Court in Atlanta, Georgia approved the stipulation and agreement of settlement. The settlement was within our directors' and officers' liability insurance; and accordingly, our insurance provider has paid this settlement. There is no further obligation by us for this matter except for certain legal costs that were denied by our insurance carrier. As of December 31, 2003, we had accrued $4,430 of such costs. We are subject to other legal proceedings and claims that have arisen in the ordinary course of our business; however, we believe that the ultimate resolution of these matters and the shareholders' lawsuit will not have a material adverse effect on our consolidated financial statements taken as a whole. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the last quarter of 2003. 12 PART II. ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES Market Price Information Our common stock is listed on the Nasdaq SmallCap Market, where it has traded since it was transferred from the Nasdaq National Market on January 31, 2003. The following table sets forth the high and low sales price of our common stock for each quarter during the last two years, as reported by the Nasdaq Stock Market:
High Low ----- ----- Twelve Months Ended December 31, 2002 Quarter ended March 31, 2002........................................................ $4.80 $2.81 Quarter ended June 30, 2002......................................................... $3.96 $1.10 Quarter ended September 30, 2002.................................................... $1.25 $0.50 Quarter ended December 31, 2002..................................................... $1.33 $0.25 Twelve Months Ended December 31, 2003 Quarter ended March 31, 2003........................................................ $1.30 $0.35 Quarter ended June 30, 2003......................................................... $1.74 $0.80 Quarter ended September 30, 2003.................................................... $2.19 $1.12 Quarter ended December 31, 2003..................................................... $2.69 $1.42
At March 1, 2004 there were 160 record holders of our common stock. We have never paid or declared any cash dividends on our common stock and we do not intend to pay dividends on our common stock in the near future. We presently expect to retain any future earnings to fund continuing development and growth of our business. Our payment of dividends in the future is subject to the discretion of our board of directors and will depend on our earnings, financial condition, capital requirements and other relevant factors. 13 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the consolidated financial statements and notes thereto presented elsewhere in this Annual Report on Form 10-KSB. Overview We specialize in the creation and delivery of interactive health content that can be used by a broad range of healthcare consumers - from those with low health literacy to those who play an active and ongoing role in their personal health management. Our products can be used for learning about general health concerns, specific diseases and treatments, surgical procedures, drug information, specialty health subjects such as women's health and children's health, nutrition, alternative medicine and more. Our health content products meet rigorous editorial standards. We employ two physicians and use an extensive network of physicians and specialists who are continually reviewing and updating our information. We add to our content library when needed such as when important health issues arise (for example, the recent SARS outbreak) or when our customers request specific products to support their product and service offerings. Our health information is accredited by URAC, an industry leading accreditation organization, and we are a founding member of Hi-Ethics, a coalition of the most widely referenced health websites and information providers committed to developing industry standards for the quality of consumer health information. We sell our health content products primarily through annual licensing agreements to many different types of healthcare and health-related organizations including hospitals, managed care organizations, pharmaceutical companies, disease management vendors, health-oriented Internet websites, healthcare technology companies and large employers. Our products can be incorporated into a customer's website, imbedded in healthcare applications such as an electronic medical record or disease management applications, contained in a printed format, or combined with other products that may be offered to a healthcare consumer. 14 Over the past two years we have seen a significant shift in our ability to secure new business in healthcare. We believe that the quality of our products, the depth and breadth of the digital assets we own, and the solutions we provide to address issues such as low health literacy, well position us for future growth. Critical Accounting Policies and Estimates Discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the amounts reported in the consolidated financial statements and the accompanying notes. On an on-going basis, we evaluate our estimates, including those related to product returns, product and content development expenses, bad debts, inventories, intangible assets, income taxes, contingencies and litigation. We base our estimates on experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. - -- Revenue Recognition We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," as amended by SAB 101A and 101B and as revised by SAB 104, "Revenue Recognition" and Statement of Position No. 97-2, "Software Revenue Recognition." Accordingly, we recognize revenue when: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management's judgments regarding the fixed nature of the fee charged for services rendered and products delivered and the collectibility of those fees. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. We generate revenues mainly in two ways - Internet-based licensing and product sales. Internet revenues consist primarily of license fees that usually consist of an annual, up-front fee that is initially recorded as deferred revenue. This revenue is recognized ratably over the term of the license agreement beginning after delivery has occurred, upon customer acceptance or live date and, when we have determined that the fees from the agreement are fixed and determinable and there are no significant return or acceptance provisions. For Internet revenue arrangements in which we sell through a reseller, we do not recognize any revenue until an agreement has been finalized between the customer and our authorized reseller and the content has been delivered to the customer by our reseller. Revenue is not recognized under any circumstances, unless collectibility is deemed probable. Revenues from product sales represent the sales of CD-ROM and other offline products and revenues earned under certain royalty agreements. Revenues from product sales are generally recognized at the time title passes to customers, distributors or resellers. Revenues from royalty agreements are recognized as earned based upon performance or product shipment. 15 - -- Sales Returns Allowances and Allowance for Doubtful Accounts Significant management judgments and estimates must be made in connection with establishing the sales returns and other allowances in any accounting period. Management must make estimates of potential future product returns related to current period product revenue. Allowances for estimated product returns are provided at the time of sale. We evaluate the adequacy of allowances for returns primarily based upon our evaluation of historical and expected sales experience and by channel of distribution. The judgments and estimates of management may have a material effect on the amount and timing of our revenue for any given period. Similarly, management must make estimates of the uncollectability of accounts receivable. Management specifically analyzes accounts receivable and historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. - -- Capitalized Software Product and Content Development Costs We capitalize software product and content development costs in accordance with Financial and Accounting Standards Board ("FASB") Statement No. 86 ("FAS 86"), "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed." This statement specifies that costs incurred internally in creating a computer software product shall be charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of all planning, designing, and testing activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements. We cease capitalization of internally developed software when the product is made available for general release to customers and thereafter, any maintenance and customer support is charged to expense when related revenue is recognized or when those costs are incurred. We amortize such capitalized costs as cost of sales on a product-by-product basis using the straight-line method over a period of two years. We continually evaluate the recoverability of capitalized costs and if the successes of new product releases are less that 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 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 expense 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. - -- Inventory We record reserves for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. - -- Legal Contingencies We are subject to certain legal proceedings in the normal course of business. Currently we do not believe that these matters will have a material impact on our financial results or financial position. This conclusion is based primarily on our insurance coverage for these matters. It is possible, however, that future results of operations for any particular quarter or annual period could be materially affected by changes in assumptions or other circumstances involving these legal matters. 16 - -- Goodwill and Intangible Assets We have recorded goodwill in connection with our acquisition of Integrative Medicine Communications, Inc. ("IMC") in 2001 and Nidus Information Services, Inc. ("Nidus") in 2002. In July 2001, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141 requires the purchase method of accounting for all business combinations and that certain acquired intangible assets in a business combination be recognized as assets separate from goodwill. We have applied SFAS 141 in our allocation of the purchase price to the IMC acquisition and to the Nidus acquisition. SFAS 142 requires that goodwill and other intangibles that have an indefinite life are no longer to be amortized but are to be tested for impairment at least annually. In assessing impairment we must make judgments and assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective net assets. Other factors that could cause impairment could result from a significant decline in our stock price for a sustained period and our market capitalization relative to net book value. If these estimates or their related assumptions change in the future, we may be required to record an impairment charge for the recorded goodwill. We conducted the impairment test for fiscal 2003 and concluded no impairment had occurred. Since we did not have any goodwill recorded prior to the IMC and Nidus acquisitions, the provision of SFAS 142 requiring companies to stop amortizing goodwill will have no impact on our ongoing operating results or the comparability of such results with prior periods. - -- Income Taxes As part of the process of preparing our consolidated financial statements we are required to estimate our taxes in each of the jurisdictions in which we operate. This process involves management estimating the actual tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and U.S. GAAP purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increases this allowance in a period, an expense is recorded within the tax provision in the consolidated statement of operations. - -- Variable Stock Options In March 2000, the FASB issued Financial Interpretations No. 44 ("FIN 44"), "Accounting for Certain Transactions involving Stock Compensation (an interpretation of APB Opinion No. 25)." This opinion provides guidance on the accounting for certain stock option transactions and subsequent amendments to stock option transactions. FIN 44 was effective July 1, 2000, but certain conclusions cover specific events that occur after either December 15, 1998 or January 12, 2000. We have from time to time since 1991 granted stock options to our employees to purchase shares of our common stock. Certain of these options were canceled at the option of their holders on January 14, 1999, 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. The adoption of FIN 44 did not have a material impact on our financial position or results of operations. This interpretation requires variable accounting treatment for options that have been modified from their original terms. Accordingly, compensation cost shall 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. As of December 31, 2003, we have 231,400 outstanding options with an exercise price of $5.25 that are considered variable under this interpretation. Because the stock price since the effective date of July 1, 2000 has been below $5.25, we have not recorded any compensation cost related to the re-priced options issued on January 14, 1999. Should our stock price climb above $5.25 our operating results will be affected until the stock options are either exercised or forfeited and could adversely affect any reporting period in which the variable accounting is required. Any charges that result from these variable options would be non-cash operating expenses and will be reported on a separate line item. 17 Recent Accounting Pronouncements In January 2003, the FASB issued SFAS Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities." FIN 46 expands upon existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities, and activities of a variable interest entity. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after December 15, 2003. We do not expect the adoption of FIN 46 to have a significant effect on our financial position, results of operations or cash flows. In December 2003, the Securities and Exchange Commission released Staff Accounting Bulletin No. 104, "Revenue Recognition" ("SAB 104"). SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101, "Revenue Recognition in Financial Statements" related to multiple element revenue arrangements, superceded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." We have assessed the impact of SAB 104 and concluded that the adoption of SAB 104 by us did not have a material impact on our financial statements. 18 The following selected financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto.
Twelve Months Ended Nine December 31, Months Ended December 31, 2003 2002 2001 2000 1999 (In thousands, except per share data) STATEMENT OF OPERATIONS DATA: Net revenues........................................................... $7,889 $8,924 $8,946 $8,621 $3,144 Costs and expenses: Costs of revenues...................................................... 1,668 1,478 1,588 742 551 General and administrative............................................. 1,774 2,451 2,156 3,323 2,997 Product and content development........................................ 1,375 2,476 2,243 4,091 5,015 Sales and marketing.................................................... 1,743 2,782 1,961 2,958 2,680 Depreciation and amortization.......................................... 767 909 820 2,410 764 Restructuring.......................................................... -- -- -- 733 1,049 Total costs and expenses............................................... 7,327 10,096 8,768 14,257 13,056 Operating income (loss)................................................ 562 (1,172) 178 (5,636) (9,912) Interest income (expense), net......................................... 46 66 99 (987) 158 Realized loss and impairment of investment securities.................. -- (176) (146) (1,105) -- Realized gain on sale of assets, net................................... -- -- 1,808 -- -- Income (loss) before income taxes, minority interest and equity in net losses of affiliate..................................... $608 $(1,282)$1,939 $(7,728)$(9,754) Income taxes........................................................... -- -- -- -- -- Income (loss) before minority interest and equity in net losses of affiliate................................................... $608 $(1,282)$1,939 $(7,728)$(9,754) Minority interest in consolidated subsidiary........................... -- -- -- -- 175 Equity in net losses of affiliate...................................... -- (248) (342) (126) -- Net income (loss)...................................................... $608 $(1,530)$1,597 $(7,854)$(9,579) Basic net income (loss) per share...................................... $0.08 $(0.22) $0.25 $(1.42) $(2.04) Weighted average number of common shares and share equivalents outstanding, basic........................................ 7,306 7,107 6,453 5,536 4,707 Diluted net income (loss) per share.................................... $0.07 $(0.22) $0.24 $(1.42) $(2.04) Weighted average number of common shares and share equivalents outstanding, diluted...................................... 8,169 7,107 6,555 5,536 4,707 December 31, 2003 2002 2001 2000 1999 (In thousands) BALANCE SHEET DATA: Cash and short-term investments........................................ $4,554 $2,220 $2,878 $1,666 $1,477 Accounts receivable-net................................................ 1,407 1,288 1,949 1,046 828 Total current assets................................................... 6,355 3,838 5,436 3,259 3,544 Goodwill............................................................... 2,043 2,043 1,474 -- -- Total assets........................................................... 10,496 8,691 9,861 6,817 7,736 Deferred revenue....................................................... 2,295 1,916 1,621 2,479 731 Short-term debt........................................................ 11 19 34 188 733 Total liabilities...................................................... 2,976 2,679 2,688 4,162 4,359 Total shareholders' equity............................................. 7,520 6,012 7,173 2,655 3,377 Working capital (deficiency)........................................... 3,415 1,206 2,756 (903) (815)
19 Quarterly Financial Information The following tables set forth summary earnings data for each quarter of the last two years: 2003 Three Months Ended March 31 June 30 September 30 December 31 (In thousands, except per share data) Operating revenues $2,344 $1,934 $1,873 $1,738 Operating income 288 113 76 85 Net income 299 126 86 97 Earning per share basic $0.04 $0.02 $0.01 $0.01 Earning per share diluted $0.04 $0.02 $0.01 $0.01 2002 Three Months Ended March 31 June 30 September 30 December 31 (In thousands, except per share data) Operating revenues $2,108 $2,153 $2,283 $2,380 Operating income (199) (570) (318) (85) Net income (230) (563) (419) (318) Earning per share basic and diluted $(0.03) $(0.08) $(0.06) $(0.05) Results of Operations The following table sets forth for the periods indicated the percentages of our net revenues represented by each line item:
Twelve Months Twelve Months Twelve Months ended ended ended December 31, 2003 December 31, 2002 December 31, 2001 --------------------------------------------------------------- Net revenues............................. 100% 100% 100% Cost and expenses: Cost of revenues........................ 21.1 16.6 17.8 General and administrative.............. 22.5 27.5 24.1 Product and content development......... 17.4 27.7 25.1 Sales and marketing..................... 22.1 31.2 21.9 Depreciation and amortization........... 9.7 10.2 9.1 --------------------------------------------------------------- Total costs and expenses................ 92.8 113.2 98.0 --------------------------------------------------------------- Operating income (loss).................. 7.2% (13.2%) 2.0%
Twelve months ended December 31, 2003 compared to twelve months ended December 31, 2002 Total net revenues decreased $1,035,000, or 11.6%, to $7,889,000 for 2003 compared to $8,924,000 for 2002. Revenues from the healthcare industry increased $1,317,000, or 45.2%, to $4,231,000 for 2003 compared to $2,914,000 for 2002. Our products for the healthcare industry target a broad range of businesses including hospitals and hospital systems, managed care organizations, healthcare technology companies, and pharmaceutical companies. We believe we are well positioned to grow our business in healthcare as the demand for health information grows and as content becomes an increasingly important business driver within the healthcare industry. We have also undertaken technological initiatives to enable our content products to be used in broader applications within the healthcare industry such as electronic medical records and other point-of-care applications. These initiatives as well as our continuing efforts to expand our presence in the healthcare industry contributed to the increase in healthcare industry revenues during 2003. As a percent of total revenues, revenues from the healthcare industry increased to 53.6% for 2003 compared to 32.7% for 2002. 20 Revenues from the Internet market decreased $1,770,000, or 44.7%, to $2,186,000 for 2003 compared to $3,956,000 for 2002. The Internet market includes Internet portals and large media-related websites that host a variety of consumer-oriented content and services. The decrease in our Internet revenues was primarily due to the expiration of a license agreement we had with WebMD Corp. during the first quarter of 2003, which accounted for approximately 7% of our revenues during 2003 and 26% of our revenues during 2002. As a percent of total revenues, revenues from the Internet market decreased to 27.7% during 2003 compared to 44.3% for 2002. Revenues from the education market decreased $585,000, or 29.1%, to $1,425,000 for 2003 compared to $2,010,000 for 2002. Education market revenues consist primarily of CD ROM-based product sales. The decrease in our education market revenues was primarily associated with a $338,000 decrease in sales of our online subscription products due to expense reductions within our customers' budgets, net of a $9,000 increase in revenue from license agreements. Also, attributable to this decrease was a $261,000 decrease in sales of our CD ROM-based product, attributable primarily to an aging product line. We are currently in development for a major upgrade to our flagship product for education, A.D.A.M. Interactive Anatomy, which we expect to release in the summer of 2004. This decrease in education revenue also includes the recognition of $136,000 of revenue from the IMC Consult newsletter during 2003. During the fourth quarter of 2002, we transferred to a company that publishes another newsletter all of our rights under subscription agreements relating to the IMC newsletter commencing with the January 2003 issue. As of December 31, 2003, we do not have any deferred revenue related to the IMC Consult newsletter, and we no longer have any obligations in relationship to the IMC Consult newsletter. As a percent of total net revenues, net revenues from the education market decreased to 18.1% for 2003 compared to 22.5% for 2002. Cost of revenues increased $190,000, or 12.9%, to $1,668,000 for 2003 compared to $1,478,000 for 2002. Cost of revenues includes shipped product components, packaging and shipping costs, newsletter printing costs, distribution license fees, royalties, and amortization of capitalized software product and content development costs. This increase was the result of a $407,000 increase in distribution license fees from the sales of our Spanish language products and the sales of our third party licensing agreement products. This increase was offset by a $87,000 decrease in our IMC cost of revenues due to the transfer of subscription rights of the IMC newsletter to another publisher, a $66,000 decrease in our cost of goods sold related to our CD ROM products, a $60,000 decrease in software product and content development amortization due to capitalized products and content being fully amortized, and a $4,000 decrease in fees for updates and printing expenses relating to our Well-Connected content. As a percent of total revenues, cost of revenues increased to 21.1% for 2003 compared to 16.6% for 2002. General and administrative expenses decreased $677,000, or 27.6%, to $1,774,000 for 2003 from $2,451,000 for 2002. This decrease was primarily attributable to a $250,000 decrease of royalty expense and settlement charges related to an affiliate (see "Liquidity and Capital Resources"), a $186,000 decrease in our rent expense due to the new lease for our Atlanta office, a $166,000 decrease in legal fees pertaining to the shareholder class action lawsuit, corporate and miscellaneous matters, securities, and trademarks. Also, contributing to this decrease was a $102,000 decrease in administration expenses due to the closing of our IMC office located in Boston during 2003, a $69,000 decrease in bad debt expense due to an increase in collectibility of our account receivables, a $33,000 decrease in taxes and licenses expense pertaining to property tax and business license reductions, a $24,000 decrease in salaries and overall general and administration expenses due to headcount reductions during 2002 due to management's continuing cost reduction measures, and a $15,000 decrease in our accounting fees. This decrease was offset by a $71,000 increase in fees associated with Nasdaq and investor relation expenses, a $53,000 increase in consulting fees associated with the Restricted Common Stock Purchase Agreement, a $30,000 increase in our general insurance expenses due to higher premium rates, and a $14,000 increase in our legal fees pertaining to our content licensing agreements. As a percent of total revenues, general and administrative costs decreased to 22.5% for 2003 compared to 27.5% for 2002. Product and content development costs decreased $1,101,000, or 44.5%, to $1,375,000 for 2003 from $2,476,000 for 2002. This decrease was primarily attributable to a $594,000 decrease in salary and consulting expenses and a $145,000 decrease in overhead expenses and overall general expenses due to reductions in headcount during 2002 and management's continuing cost reduction measures. Also, contributing to this decrease was a $172,000 decrease in consulting, editorial review, and salary expenses due to the transfer of subscription rights of the IMC Consult newsletter to another publisher, as described above, and an $81,000 decrease in content acquisition. This decrease was offset by a $109,000 decrease in capitalized expenses of internally developed products. As a percent of total revenues, product development costs decreased to 17.4% for 2003 compared to 27.7% for 2002. 21 Sales and marketing expenses decreased $1,039,000, or 37.3%, to $1,743,000 for 2003 from $2,782,000 for 2002. This decrease was primarily attributable to a $314,000 decrease in salaries and consulting expenses and a $116,000 decrease in overhead and overall general expenses due to reductions in headcount during 2002 and management's continuing cost reduction measures and a $291,000 decrease in sales expenses due to the closing of our IMC office located in Boston during 2003. Also, attributable to this decrease was a $158,000 decrease in direct mail campaign expenses due to the transfer of subscription rights of the IMC Consult newsletter to another publisher, as described above, a $94,000 decrease in advertising expenses, an $84,000 decrease in trade show expenses, and a $36,000 decrease in travel expenses. This decrease was offset by a $54,000 increase in commissions and bonuses due to a revision of sales incentives. As a percent of total revenues, sales and marketing expenses decreased to 22.1% for 2003 compared to 31.2% for 2002. Depreciation and amortization expenses decreased $142,000, or 15.6%, to $767,000 for 2003 from $909,000 for 2002. This decrease was primarily attributable to a $207,000 decrease in the depreciation of fixed assets. This decrease was offset by a $65,000 increase due to the amortization of purchased intellectual content and purchased customer contracts. As a percent of total revenues, depreciation and amortization expenses decreased to 9.7% for 2003 compared to 10.2% for 2002. Interest income, net, decreased $20,000, or 30.3%, to $46,000 for 2003, as compared to interest income of $66,000 for 2002. This decrease was primarily attributable to a decrease in interest income of $19,000 due to a decrease in interest earned of $17,000 from a note receivable during 2003 compared to 2002 and a $2,000 decrease in interest income due to the declining prime interest rate. This decrease was offset by a $1,000 decrease in interest expense due to the expiration of several of our capital leases. For 2003, no provision was made for income taxes, as we had sufficient net operating loss carry forwards to offset taxable income. We currently meet the requirements for the small corporation exemption for Alternative Minimum Tax purposes. As of December 31, 2003, we continue to maintain a valuation allowance against our total net deferred tax asset balance. We did not record any impairment charges during 2003. During 2002, we recorded an impairment charge totaling $176,000 for our equity investment in ThePort Network, Inc. ("ThePort") and our cost investment in BeBetter Networks, Inc. This impairment charge was recorded due to continuing losses and our decision to terminate our subscription fee agreement with ThePort. The results of operations of ThePort have been accounted for as equity investment and accordingly, we recorded our share of ThePort's results of operations in our consolidated financial statements for 2002. We recorded our share of ThePort's losses of approximately $248,000 for the twelve months ended December 31, 2002. As of December 31, 2003 and December 31, 2002, the carrying value of this investment was $0. Since the carrying value of this investment is $0 and we have no future obligations to fund ThePort, we did not report any of ThePort's results of operations in our consolidated financial statements for 2003. As a result of the above, we had net income of $608,000, or $0.08 per share, for 2003 compared to a net loss of $1,530,000, or $0.22 per share, for 2002. Twelve months ended December 31, 2002 compared to twelve months ended December 31, 2001 Total net revenues decreased $22,000, or 0.2%, to $8,924,000 for 2002 compared to $8,946,000 for 2001. Revenues from the healthcare industry increased $1,797,000, or 160.9%, to $2,914,000 for 2002 compared to $1,117,000 for 2001. Our products for the healthcare industry target a broad range of businesses including hospitals and hospital systems, managed care organizations, healthcare technology companies and pharmaceutical companies. Our decision to expand our presence in the healthcare industry and the inclusion of $287,000 of revenues from sales of IMC and Nidus licensed products contributed to the increase in healthcare industry revenues during 2002. As a percent of total revenues, revenues from the healthcare industry increased to 32.7% for 2002 compared to 12.5% for 2001. Revenues from the Internet market decreased $1,851,000, or 31.9%, to $3,956,000 for 2002 compared to $5,807,000 for 2001. The Internet market includes large Internet websites that host a variety of consumer-oriented content and services. The decrease in our Internet revenues was primarily associated with the loss of customers as a result of bankruptcy or loss of funds including Dr. Koop Lifecare Corp. This decrease was partially offset by the inclusion of $666,000 of revenues from sales of IMC and Nidus licensed products during 2002. As a percent of total revenues, revenues from the Internet market decreased to 44.3% during 2002 compared to 64.9% for 2001. We anticipate that revenues from the Internet market will continue to decrease. One large customer, from whom we generated $2,346,000 of revenues during 2002, did not renew its license agreement when the agreement expired in March 2003. 22 Revenues from the education market increased $31,000, or 1.6%, to $2,010,000 for 2002 compared to $1,979,000 for 2001. The education market revenues consist primarily of CD ROM-based product sales. The increase is primarily attributable to the inclusion of revenues in the education market of $351,000 from sales of IMC and Nidus licensed products during 2002. This increase was partially offset by a decrease in revenues from the education market due to the sale of our 50% ownership interest in the intellectual property rights associated with the A.D.A.M./Benjamin Cummings Interactive Physiology series of educational products to Pearson PLC during 2001. As a percent of total net revenues, net revenues from the education market increased to 22.5% for 2002 compared to 22.1% for 2001. Cost of revenues decreased $110,000, or 6.9%, to $1,478,000 for 2002 compared to $1,588,000 for 2001. Cost of revenues includes shipped product components, packaging and shipping costs, newsletter printing costs, distribution license fees, royalties, and amortization of capitalized software product and content development costs. These decreases were primarily the result of the amortization and write off during 2001 of older technology acquired in 2000 and the decreased royalties payable to third parties due to the sale of our 50% ownership interest in the intellectual property rights associated with the A.D.A.M./Benjamin Cummings Interactive Physiology series of educational products to Pearson PLC during 2001. These decreases were offset by an increase in our royalty fees from the sales of our Spanish language products and costs associated with the operations of IMC and Nidus during 2002. As a percent of total revenues, cost of revenues decreased to 16.6% for 2002 compared to 17.8% for 2001. General and administrative expenses increased $295,000, or 13.7%, to $2,451,000 for 2002 from $2,156,000 for 2001. This increase is primarily attributable to $250,000 of royalty expense and settlement charges related to an affiliate (see "Liquidity and Capital Resources"), $203,000 increase in legal and accounting expenses pertaining to an outstanding lawsuit and the acquisitions of IMC and Nidus, an increase in bad debt expense of $115,000, and increased general administration costs of $95,000 due to the acquisitions of IMC and Nidus. These increases were partially offset by a $136,000 decrease in salary expenses in the 2002 period due to a decrease in headcount in the Atlanta office and a decrease in non-cash stock compensation charges of $143,000. Additionally, 2001 included an $86,000 loss associated with the closing of our San Francisco office. As a percent of total revenues, general and administrative costs increased to 27.5% for 2002 compared to 24.1% for 2001. Product and content development costs increased $233,000, or 10.4%, to $2,476,000 for 2002 from $2,243,000 for 2001. This increase is primarily attributable to an increase of $435,000 due to additions of the product and development costs of IMC and Nidus. This increase was partially offset by capitalization of internally developed products of $656,000 in 2002, decreased editorial expenses, and decreased production expenses related to the discontinuance of operations of the DrGreene.com website in the third quarter of 2001. As a percent of total revenues, product development costs increased to 27.7% for 2002 compared to 25.1% for 2001. Sales and marketing expenses increased $821,000, or 41.9%, to $2,782,000 for 2002 from $1,961,000 for 2001. This increase is primarily attributable to the acquisition of IMC and Nidus, which increased sales and marketing expenses $600,000 during 2002. Also, this increase is partially attributable to an increase of $223,000 resulting from increased staffing and marketing efforts in the healthcare industry during 2002. As a percent of total revenues, sales and marketing expenses increased to 31.2% for 2002 compared to 21.9% for 2001. Depreciation and amortization expenses increased $89,000, or 10.9%, to $909,000 for 2002 from $820,000 for 2001. This increase is primarily attributable to a $536,000 increase due to the amortization of purchased intellectual content and purchased customer contracts in connection with the acquisitions of IMC and Nidus. This increase is offset by a $447,000 decrease in the depreciation of fixed assets and a decrease in amortization expenses in 2002 due to the 2001 write-off of the Informational Medical Systems, Inc. ("IMS") assets, a collection of patient consent forms for surgical procedures purchased in 1999. As a percent of total revenues, depreciation and amortization expenses increased to 10.2% for 2002 compared to 9.1% for 2001. Interest income, net, decreased $33,000, or 33.3%, to $66,000 for 2002, as compared to interest income of $99,000 for 2001. This decrease was primarily attributable to a decrease in interest income of $19,500 due to the maturing of Certificates of Deposits and a decrease in interest earned of $8,500 from a notes payable during 2002 compared to 2001. During 2001, we sold our 50% ownership interest in the intellectual property rights associated with the A.D.A.M./Benjamin Cummings Interactive Physiology Series to Pearson Education, Inc. for $1,950,000 in cash resulting in a net gain of $1,808,000 after expenses. There were no gains on the sale of assets during 2002. 23 No provision for income taxes was reflected for 2002 as we had net losses during the period. During 2002, we did meet the requirements for the small corporation exemption for Alternative Minimum Tax purposes. For 2001, no provision was estimated for income taxes, as we had sufficient net operating loss carry forwards to offset taxable income. As of December 31, 2002, we continued to maintain a valuation allowance against our total net deferred tax asset balance. We recorded an impairment charge totaling $176,000 during 2002 for our equity investment in ThePort Network, Inc. ("ThePort") and our cost investment in BeBetter Networks, Inc. This impairment charge was recorded due to continuing losses and our decision to terminate our subscription fee agreement with ThePort. Please see "Liquidity and Capital Resources" below. During 2001, we recorded an investment loss of $146,000 due to the difference in the book value of investment securities held at the end of 2000 and the amount realized from their sale in 2001. The results of operations of ThePort have been accounted as an equity investment and accordingly, we recorded our share of ThePort's results of operations in our consolidated financial statements for 2002 and 2001. We recorded our share of ThePort's losses of approximately $248,000 for the twelve months ended December 31, 2002 and our share of ThePort's losses of approximately $342,000 for the twelve months ended December 31, 2001. At December 31, 2002, the carrying value of this investment was approximately $0. As a result of the above, we had net loss of $1,530,000 for 2002 compared to a net income of $1,597,000 for 2001. Liquidity and Capital Resources As of December 31, 2003, we had cash and cash equivalents of $4,554,000 and working capital of $3,415,000. For 2003, we had net income as a result of decreased operating expenses. Operating expense levels, excluding potential non-recurring, non-cash charges, have been decreasing as reflected in the results of operations for the twelve months ended December 31, 2003. We expect costs to remain relatively constant in relation to the current levels of revenues for the foreseeable future due to our cost control measures that were implemented in the later half of 2002. We anticipate continued current levels of investment for product and content development, improvement of existing and development of new technologies, infrastructure development and product marketing and sales efforts. However, we will also continue to evaluate opportunities that create efficiencies, consolidate operating costs and reduce overhead such that overall operating expense levels remain controlled. Cash provided by operating activities increased to $2,130,000 during 2003 as compared to cash provided by operating activities of $1,022,000 during 2002. As a result of net income and a decrease in accounts payable and accrued liabilities and a decrease in inventory, we recognized benefits of our cost control measures implemented in the later half of 2002 as it relates to cash flows. The benefits were offset by an increase in deferred revenues and accounts receivable primarily due to an increase in the number of healthcare industry license agreements during 2003 and a net decrease in non-cash expenses such as depreciation and amortization. Cash used in investing activities was $624,000 during 2003 as compared to cash used in investing activities of $923,000 during 2002. Cash used by investing activities in 2003 was due primarily to the costs associated with software product and content development. Cash used by investing activities in 2002 was due primarily to the equity investment in ThePort, the acquisition of IMC and Nidus, and costs associated with software product and content development. During 2003, our purchases of property and equipment increased $35,000 as compared to 2002. Cash provided by financing activities increased to $828,000 during 2003 as compared to cash used in financing activities of $757,000 during 2002. The primary financing activities impacting cash flows in 2003 related to additional common stock sales under the Common Stock Purchase Agreement entered into in 2002 with Fusion Capital Fund (described below) and common stock sales under the Restricted Common Stock Purchase Agreement entered into in 2003 with James T. Atenhan and Victor P. Thompson (also described below), which resulted in $833,000 of cash. In 2002, the primary financing activity affecting cash flows related to the repurchase of common stock from one shareholder in a private transaction that resulted in a use of $717,000 of cash. On February 15, 2003, we entered into a Restricted Common Stock Purchase Agreement with James T. Atenhan and Victor P. Thompson (each a "Purchaser") in connection with a consulting agreement with a financial services firm controlled by the Purchasers. Each Purchaser purchased 37,500 shares of our common stock at a purchase price of $.40 per share. The purchase price of our common stock was discounted from the $.78 market price on the date we entered into the agreement. In connection with the sale, we recorded deferred compensation expense for services of $28,500. This deferred compensation was expensed over the six-month service period. 24 On August 1, 2003, we entered into a second Restricted Common Stock Purchase Agreement with the Purchasers in connection with a twelve-month extension of the consulting contract. Each Purchaser purchased 38,889 shares of our common stock at a purchase price of $.90 per share. The purchase price was discounted from the $1.86 market price on the date we entered into the agreement. In connection with the sale, we recorded deferred compensation expense for services of $74,667. This deferred compensation expense is being expensed over the twelve-month service period which began September 1, 2003. As of December 31, 2003, the remaining deferred compensation expense for services was approximately $50,000. On May 22, 2002, we entered into a Common Stock Purchase Agreement with Fusion Capital Fund II, LLC. Pursuant to this agreement, Fusion Capital agreed to purchase up to an aggregate of $12,000,000 of our common stock. We have the right to sell up to $15,000 of our common stock per trading day under this agreement unless our stock price equals or exceeds $7.00, in which case the daily amount may be increased at our option. Fusion Capital is not obligated to purchase any shares of our common stock on any trading days that the market price of our common stock is less than $1.00. Since we registered 3,500,000 shares for sale to Fusion Capital pursuant to the agreement, the selling price of our common stock to Fusion Capital will have to average at least $3.43 per share for us to receive the maximum proceeds of $12,000,000 without registering additional shares of common stock, which we have the right but not the obligation to do. Assuming a purchase price of $1.00 per share and the purchase by Fusion Capital of the full 3,500,000 shares under the agreement, proceeds to us would be $3,500,000. If we sell more than the 1,352,100 shares to Fusion Capital (19.99% of our outstanding shares as of May 22, 2002, the date of the agreement, exclusive of the 160,000 shares issued to Fusion Capital as a commitment fee), we would first be required to seek shareholder approval of the agreement under Nasdaq rules. We may, but are under no obligation to, request our shareholders to approve the agreement. We may terminate the agreement at any time, and Fusion Capital may terminate the agreement at any time after approximately 40 months following the date the purchase obligation under the agreement became effective. During 2003, we sold 486,566 shares for $733,000, under this agreement. On December 31, 1999, we issued two notes, in exchange for $500,000 each, from one of our officer-directors and a commercial bank. These notes accrued interest at 10% per annum with principal and interest due initially on December 31, 2000. The terms of these notes allowed for an extension of nine months, to September 30, 2001 at the option of the holders. We issued warrants to purchase 85,000 shares of common stock to the lenders in conjunction with the issuance of the notes and the related extensions pursuant to the original terms of the notes. The warrants are exercisable at any time at the option of the holders through December 31, 2005 and entitled the holders to purchase an equal number of common shares at a weighted-average price of $7.63 per share. We paid the note and interest earned in full to the commercial bank in 2000 and paid the note and interest in full to our Chief Executive Officer in 2001. During 2002 and 2001, we acquired additional preferred stock interests in ThePort, for $250,000 and $275,000 in cash, respectively. During 2002, we also accepted 196,616 shares of common stock of ThePort valued at approximately $49,000 pursuant to the sublease agreement ThePort signed with us (see paragraph below). As of December 31, 2003, we have an approximate 34% voting interest in ThePort. Our voting interest increased from December 31, 2002 due to our Series B preferred stock investment being converted into common stock at a one-to-five conversion rate. As of December 31, 2003 and December 31, 2002, the carrying value of this investment was $0. We have no future obligations to fund ThePort. In connection with this preferred stock investment in 2001, we entered into a five-year agreement that provided us exclusive distribution rights to ThePort's products within the healthcare industry. As of December 31, 2001, we had pre-paid $125,000 of the contract fee to be applied against future subscription fees. We had committed to generate $1,500,000 in subscription fees during the initial term of the agreement. The initial term of the agreement commenced on August 20, 2001 and was to continue for five years from that date. On February 14, 2003, ThePort agreed to accept an additional payment of $125,000 from us, which released us from the minimum guarantee in its entirety. ThePort is entitled to retain the $125,000 pre-payment previously made and we are granted non-exclusive rights to ThePort's products within the healthcare industry. On April 10, 2002, for a term beginning on November 1, 2001, we signed an 8-month sublease agreement with ThePort. We received 14,044 shares of ThePort's common stock monthly over the term of the agreement, which rate was determined based upon the fair market value of the leased space and ThePort common stock as of April 10, 2002. After the expiration of the sublease on June 30, 2002, we continued to sublease this space to ThePort on a month-to-month basis for the same monthly consideration until December 31, 2002. Since then, we have not received any type of consideration as lease payments. On May 30, 2001, we received a full-recourse promissory note from our Chief Executive Officer for approximately $341,000 (the "Exercise Note") for the exercise of 150,000 options at $1.94 per share and a $50,000 promissory note (the "Tax Note") in connection with a loan to our Chief Executive Officer to pay taxes related to the stock exercise. The notes accrue interest of 6.25% per annum and are due in full on or before May 29, 2006. Part of the Exercise Note, $291,000, is secured by 150,000 shares of our common stock and is recorded in shareholders' equity. As of December 31, 2003, all of the approximately $55,000 of interest accrued on both notes had been paid and $11,000 of principal had been paid with respect to the Tax Note, leaving a remaining balance of $39,000 (see paragraph below). 25 On October 1, 2002, we entered into an amended and restated employment agreement with our Chief Executive Officer, which was corrected on March 17, 2004. The employment agreement as amended provides for a base salary and bonuses of approximately $289,000 in the event that our Chief Executive Officer remains in our employment as of the bonus payment dates through May 2006. During the year ended December 31, 2003, our Chief Executive Officer earned and received bonus payments totaling $78,866, which were applied towards accrued interest and the outstanding note receivable balance. We have also entered into certain agreements to license content for our services from various unrelated third parties. We also have contractual obligations at December 31, 2003, relating to real estate, capital and operating lease arrangements. Total payments due and estimated under license payments and real estate, operating and capital leases and total bonus amounts due under an employment agreement are listed below:
License Annual Real Estate Year Agreements Bonus Leases Operating Leases Capital Leases Total - -------------------------- ---------- ---------- ----------- ---------------- -------------- --------- 2004.................. $210,000 0 225,000 33,000 15,000 483,000 2005.................. $100,000 $105,000 229,000 3,000 15,000 452,000 2006.................. 0 $105,000 234,000 0 15,000 354,000 2007.................. 0 0 239,000 0 11,000 250,000 2008.................. 0 0 182,000 0 0 182,000
We believe that cash on hand, together with anticipated cash flow from operations and the proceeds already realized from the Common Stock Purchase Agreement described above will be sufficient to meet our working capital needs through December 31, 2004. 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 may 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 or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and results of operations. Off Balance Sheet Arrangements We do not have any off balance sheet arrangements as of December 31, 2003. Recent Developments On January 3, 2003, the Compensation/Stock Option Committee of our Board granted a total of 1,245,000 stock options to our employees and non-employee directors under our 2002 Incentive Stock Option Plan. The options have an exercise price of $.41. Of this total, 656,664, net of forfeitures, became exercisable on January 2, 2004 and by March 1, 2004, 179,966 of these options had been exercised. Of the remaining options granted on January 3, 2003, net of forfeitures, 253,332 options will become exercisable on January 2, 2005 and the balance of the options will become exercisable on January 2, 2006. 26 ITEM 7. FINANCIAL STATEMENTS The following financial statements are included as Exhibit 99.1 of this Report and are incorporated by reference in response to this item. (1) Financial Statements: Report of Independent Auditors Consolidated Balance Sheets at December 31, 2003 and 2002 Consolidated Statements of Operations for the years ended December 31, 2003, 2002, and 2001 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2003, 2002, and 2001 Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002, and 2001 Notes to Consolidated Financial Statements (2) Consolidated Financial Statement Schedule: For the twelve months ended December 31, 2003, 2002, and 2001 Schedule II-Valuation and Qualifying Accounts All other schedules have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES Not applicable. ITEM 8A. CONTROLS AND PROCEDURES An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer, or CEO, and Chief Operating Officer (our acting Chief Financial Officer), or COO, of the effectiveness of our disclosure controls and procedures as of December 31, 2003. Based on that evaluation, our management, including the CEO and COO, concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported as specified in the SEC's rules and forms. 27 PART III. ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is incorporated herein by reference to our proxy statement for our 2004 Annual Meeting of Shareholders. ITEM 10. EXECUTIVE COMPENSATION The information required by this Item is incorporated herein by reference to our proxy statement for our 2004 Annual Meeting of Shareholders. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by this Item is incorporated herein by reference to our proxy statement for our 2004 Annual Meeting of Shareholders. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated herein by reference to our proxy statement for our 2004 Annual Meeting of Shareholders. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. The list of exhibits filed with this report appears immediately following the signature page of this report and is incorporated herein by reference. (b) Reports on Form 8-K. During the quarter ended December 31, 2003, we filed a Form 8-K on October 29, 2003 regarding our press release to announce third quarter results for 2003. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Audit Fees During 2003, we were billed $39,000 by our principal accountants for the review of our quarterly financials that were included in our Form 10-QSBs. During 2002, we were billed $34,500 by our principal accountants for the review of our quarterly financials that were included in our Form 10-Qs. During 2003, we were billed $35,000 and we accrued $52,000 for the audit of our annual financial statements that are included in this Form 10-KSB. We were billed $72,000 during 2002 for the audit of our annual financial statements that were included in our Form 10-K for 2002. Audit-Related Fees We did not have any billings from our principal accountants for audit-related fees during 2002 or 2003. Tax Fees During 2003, we accrued $28,000 for professional tax services to be rendered by our principal accountants for tax compliance, tax advice, and tax planning in relation to 2003 tax services. We were billed $16,909 during 2002 for professional tax services rendered by our principal accountants for 2002 tax services. This amount included $1,320 for services rendered in connection with the preparation of Federal and state extensions, $8,500 for services rendered in connection with the preparation of Federal and Georgia income tax returns for the 2002 tax year, $5,250 for services rendered in connection with the preparation of state and local income tax returns for the states of Connecticut, California, Colorado, Illinois, Massachusetts, New York State and the city of New York, and $1,839 for the allocation of certain overhead expenses including computer software, telephone, and reproduction costs. 28 All Other Fees During 2003, we did not accrue and we were not billed any other fees by our principal accountants. For 2002, we were billed $17,500 by our principal accountants for services in connection with our filing of a Form S-3 and a Form S-1. 29 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. Date: March 26, 2004 A.D.A.M., INC. (Registrant) By: /s/ Robert S. Cramer, Jr. ---------------------------------------------------- Robert S. Cramer, Jr. Chairman of the Board and Chief Executive Officer (principal executive officer) By: /s/ Kevin S. Noland ---------------------------------------------------- Kevin S. Noland President, Chief Operating Officer and Corporate Secretary (acting principal financial and accounting officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated, on March 26, 2004. Signature Title - -------------------------------------------------------------------------------- /s/ Robert S. Cramer, Jr. Chairman of the Board and Chief Executive Officer - ------------------------------ Robert S. Cramer, Jr. /s/ Daniel S. Howe Director - ------------------------------ Daniel S. Howe /s/ John W. McClaugherty Director - ------------------------------ John W. McClaugherty /s/ Francis J. Tedesco, M.D. Director - ------------------------------ Francis J. Tedesco, M.D. /s/ Mark Kishel, M.D. Director - ------------------------------ Mark Kishel, M.D. 30 EXHIBIT INDEX The following exhibits are filed as part of, or are incorporated by reference into, this report on Form 10-KSB: Exhibit No. Description 3.1 Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999) 3.2 Amendment to the Articles of Incorporation (incorporated by reference to Exhibit 3.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999) 3.3 Amended and Restated By-Laws (incorporated by reference to the Company's Registration Statement on Form S-1, File No. 33-96864, dated September 12, 1995, as amended) 10.1 Amended and Restated 1992 Stock Option Plan (incorporated by reference to the Company's Registration Statement on Form S-1, File No. 33-96864, dated September 12, 1995, as amended) 10.2 401(k) Adoption Agreement and Trust (incorporated by reference to the Company's Registration Statement on Form S-1, File No. 33-96864, dated September 12, 1995, as amended) 10.3 Amended and Restated Employment Agreement between the Company and Robert S. Cramer, dated October 1, 2002 (the "Cramer Employment Agreement") (incorporated by reference to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2002) 10.4 Letter agreement regarding calculation of bonus payments under the Cramer Employment Agreement (filed herewith) 10.5 Employment Agreement between the Company and Kevin S. Noland, dated December 21, 2001 (incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001) 10.7 Bridge Note and Warrant Purchase Agreement between Union Street Partners, L.P and Robert S. Cramer, Jr. and the Company dated December 31, 1999 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1999) 10.8 Registration Rights Agreement between Union Street Partners, L.P and Robert S. Cramer, Jr. and the Company dated December 31, 1999 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1999) 10.9 Common Stock Purchase Agreement dated May 22, 2003 between the Company and Fusion Capital Fund II, LLC (incorporated by reference to the Company's Registration Statement of Form S-3, File No. 333-45294, dated September 7, 2000, as amended) 10.10 2002 Stock Incentive Plan (incorporated by reference to the Company's definitive proxy statement filed on May 24, 2002 in connection with its 2002 Annual Meeting of Shareholders) 14.1 Code of Ethics (filed herewith) 21.1 Subsidiaries of the Company (filed herewith) 23.1 Consent of PricewaterhouseCoopers LLP (filed herewith) 31.1 Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith) 31.2 Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith) 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) 99.1 Financial Statements (filed herewith) 31 EX-10.4 3 a4601334ex104.txt A.D.A.M., INC. EXHIBIT 10.4 Exhibit 10.4 A.D.A.M. March 17, 2004 A.D.A.M., Inc. 1600 RiverEdge Parkway Suite 100 Atlanta, Georgia 30328 ATTN: Compensation Committee Re: Amended and Restated Employment Agreement (the "Employment Agreement") between A.D.A.M., Inc. (the "Company") and the undersigned dated October 1, 2002 (capitalized terms used in this letter and not defined shall have the meanings assigned in the Employment Agreement) Gentlemen: On October 1, 2002 my Employment Agreement was amended and restated to among other things provide for a bonus and method of payment. Upon subsequent review with the Compensation Committee, it was determined that the total amount of bonus to be earned was incorrect. The correct total bonus amount should have been $289,175.52. Such amount would be earned as of the bonus payment date defined in the Employment Agreement. The correct bonus payment date and amount of bonus schedule is as follows: Bonus Payment Date Amount of Bonus ------------------ --------------- May 29, 2003 $ 78,866.04 May 29, 2005 $105,154.24 May 29, 2006 $105,154.24 ----------- $289,174.52 As of December 31, 2003, I have been paid by the Company as reported on Form W-2, the full amount earned for the 2003 bonus payment date. This letter supercedes the bonus schedule in Section 2.2 of the Employment Agreement. Very Truly Yours, /s/ Robert S. Cramer, Jr. Robert S. Cramer, Jr. 1600 RiverEdge Parkway, Suite 100, Atlanta, Georgia 30328 T 770 980 0888 F 770 955 3088 www.adam.com Nasdaq: ADAM EX-14.1 4 a4601334ex141.txt A.D.A.M., INC. EXHIBIT 14.1 Exhibit 14.1 A.D.A.M., INC. Code of Ethics For Senior Financial Officers This Code of Ethics for Senior Financial Officers (this "Code") applies to the Chief Executive Officer and all senior financial officers, including the Chief Financial Officer, Corporate Controller and senior accounting personnel of the Company identified by the Chief Financial Officer (the "senior financial officers"). The Company's senior financial officers shall (absent a waiver from the audit committee of the Company's board of directors, after full disclosure), to the best of their knowledge and ability, adhere to and advocate the following principles and responsibilities governing their professional and ethical conduct. The failure to adhere to this Code will result in the disciplinary action deemed appropriate by appropriate supervisory personnel or by the Company's board of directors, which may include termination of employment. 1. Senior financial officers shall act with honesty and integrity. Senior financial officers shall avoid all actual or apparent conflicts of interest between personal and professional relationships and shall disclose to the audit committee of the board of directors any material transaction or relationship that reasonably could be expected to give rise to such conflict. 2. Senior financial officers shall endeavor to provide information that is full, fair, accurate, timely, and understandable in all reports and documents that the Company files with, or submits to, the Securities and Exchange Commission (the "SEC") and other public filings or communications made by the Company. 3. Senior financial officers shall endeavor to faithfully comply with all laws, rules and regulations of federal, state, and local governments, and all applicable private or public regulatory agencies. 4. Senior financial officers shall act in good faith, responsibly, with due care, competence, and diligence. Senior financial officers shall not knowingly or recklessly misrepresent material facts or allow their independent judgment to be subordinated. 5. Senior financial officers shall respect the confidentiality of information acquired in the course of their employment except when authorized or otherwise legally obligated to disclose such information. Senior financial officers shall not use for personal advantage confidential information acquired in the course of their employment. 6. Senior financial officers shall proactively promote ethical behavior among peers and subordinates in the work place. 7. Senior financial officers shall act responsibly in their use of and control over the Company's assets and resources. 8. Senior financial officers shall promptly report to the audit committee any violation or suspected violation of this Code. Each senior financial officer is expected to adhere at all time to this Code. Only the audit committee of the board of directors shall have the authority to approve any deviation or waiver from this Code. Any waiver and the reasons for it shall be promptly disclosed in a filing on Form 8-K with the SEC or, subject to satisfaction of any conditions established by the SEC, posted on the Company's website. EX-23.1 5 a4601334ex231.txt A.D.A.M. EXHIBIT 23.1 Exhibit 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-113848, No. 333-07785, No. 333-65452, and No. 333-92403), Form S-3 (No. 333-45294 and No. 333-88540) and Form S-1 (No.333-89958) of A.D.A.M., Inc. and of our report dated March 25, 2004, relating to the financial statements and financial statement schedule, which appear in this Form 10-KSB. /s/PricewaterhouseCoopers LLP Atlanta, Georgia March 26, 2004 EX-31.1 6 a4601334ex311.txt A.D.A.M., INC. EXHIBIT 31.1 Exhibit 31.1 I, Robert S. Cramer, certify that: 1. I have reviewed this Annual Report on Form 10-KSB of A.D.A.M., Inc.; 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 registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant 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 registrant, 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 registrant'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 registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant'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 registrant's internal control over financial reporting. Date: March 26, 2004 By: /s/ Robert S. Cramer, Jr. ==================================== Chairman and Chief Executive Officer EX-31.2 7 a4601334ex312.txt A.D.A.M., INC. EXHIBIT 31.2 Exhibit 31.2 I, Kevin S. Noland, certify that: 1. I have reviewed this Annual Report on Form 10-KSB of A.D.A.M., Inc.; 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 registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant 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 registrant, 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 registrant'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 registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal controls over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant'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 registrant's internal control over financial reporting. Date: March 26, 2004 By: /s/ Kevin S. Noland ===================================== Chief Operating Officer and President (acting principal financial and accounting officer) EX-32 8 a4601334ex321.txt A.D.A.M., INC. EXHIBIT 32.1 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 the Year End Report of A.D.A.M., Inc. (the "Company") on Form 10-KSB for the year ended December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned, Robert S. Cramer, Jr., President and Chief Executive Officer of the Company, and Kevin S. Noland, Chief Operating Officer and acting chief financial and accounting 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/ Robert S. Cramer, Jr. ------------------------------------------- Robert S. Cramer, Jr. President and Chief Executive Officer March 26, 2004 /s/ Kevin S. Noland ------------------------------------------- Kevin S. Noland Chief Operating Officer and Corporate Secretary (acting chief financial and accounting officer) March 26, 2004 EX-99 9 a4601334ex991.txt A.D.A.M., INC. EXHIBIT 99.1 Exhibit 99.1 Report of Independent Auditors To the Board of Directors and Shareholders of A.D.A.M., Inc.: In our opinion, the consolidated financial statements listed in the index appearing under Item 7(1) present fairly, in all material respects, the financial position of A.D.A.M., Inc. and its subsidiaries (the "Company") at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 7(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Atlanta, Georgia March 25, 2004 A.D.A.M., Inc. Consolidated Balance Sheets (In thousands, except per share data) December 31, 2003 2002 ---------- --------- Assets Current assets Cash and cash equivalents $ 4,554 $ 2,220 Accounts receivable, net of allowances of $111 and $122, respectively 1,407 1,288 Inventories, net 66 84 Non-interest bearing note receivable, net of unamortized discount of $0 and $1, respectively - 34 Interest bearing note receivable 50 - Prepaids and other assets 278 212 --------- --------- Total current assets 6,355 3,838 Property and equipment, net 185 226 Intangible assets, net 1,636 2,249 Goodwill 2,043 2,043 Restricted time deposits 238 257 Note receivable from related party 39 78 --------- --------- Total assets $ 10,496 $ 8,691 ========= ========= Liabilities and Shareholders' Equity Current liabilities Accounts payable and accrued expenses $ 634 $ 697 Deferred revenue 2,295 1,916 Current portion of capital lease obligations 11 19 --------- --------- Total current liabilities 2,940 2,632 --------- --------- Capital lease obligations, net of current portion 36 47 --------- --------- Total liabilities 2,976 2,679 --------- --------- Commitments and contingencies Shareholders' equity Preferred stock, no par value; 10,000,000 shares authorized; no shares issued and outstanding - - Common stock, $.01 par value; 20,000,000 shares authorized; 7,710,728 and 7,041,384 shares issued and outstanding, respectively 77 70 Common stock warrants 353 353 Additional paid-in capital 48,306 47,363 Note receivable from shareholder (291) (291) Deferred compensation for services (50) - Accumulated deficit (40,875) (41,483) --------- --------- Total shareholders' equity 7,520 6,012 --------- --------- Total liabilities and shareholders' equity $ 10,496 $ 8,691 ========= ========= 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) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2002 2001 ------------- ------------ ------------ Total revenues $ 7,889 $ 8,924 $ 8,946 ------------- ------------ ------------ Costs and expenses Cost of revenues (exclusive of depreciation shown below) 1,668 1,478 1,588 General and administrative 1,774 2,451 2,156 Product and content development 1,375 2,476 2,243 Sales and marketing 1,743 2,782 1,961 Depreciation and amortization 767 909 820 ------------- ------------ ------------ Total operating costs and expenses 7,327 10,096 8,768 ------------- ------------ ------------ Operating income (loss) 562 (1,172) 178 Interest income (expense), net 46 66 99 Realized loss and impairment of investment securities - (176) (146) Realized gain on sale of assets - - 1,808 ------------- ------------ ------------ Income (loss) before equity in net losses of affiliate 608 (1,282) 1,939 Equity in losses of affiliate - (248) (342) ------------- ------------ ------------ Net income (loss) $ 608 $ (1,530) $ 1,597 ============= ============ ============ Basic net income (loss) per common share $ 0.08 $ (.22) $ 0.25 ------------- ------------ ------------ Basic weighted average number of common shares outstanding 7,306 7,107 6,453 ------------- ------------ ------------ Diluted net income (loss) per common share $ 0.07 $ (.22) $ 0.24 ------------- ------------ ------------ Diluted weighted average number of common shares outstanding 8,169 7,107 6,555 ------------- ------------ ------------ The accompanying notes are an integral part of these consolidated financial statements. A.D.A.M., Inc. Consolidated Statements of Changes in Shareholders' Equity (In thousands, except per share data)
Accumulated Note Common Stock Additional Common Other Receivable Deferred ------------------ Paid-in Stock Accumulated Comprehensive Treasury from Compensation Shares Amount Capital Warrants Deficit Income Stock Shareholder for Services Total ----------- ------ -------- -------- ----------- ------------- -------- ----------- ------------ ------- Balance at December 31, 2000 $6,081,413 $61 $43,804 $353 $(41,550) $(13) $- $- $- $2,655 ----------- ------ -------- -------- ----------- ------------- -------- ----------- ------------ ------- Net income - - - - 1,597 - - - - 1,597 Other comprehensive income, net of tax Net realized loss on investment - - - - - 13 - - - 13 ----------- ------ -------- -------- ----------- ------------- -------- ----------- ------------ ------- Total comprehensive income - - - - 1,597 13 - - - 1,610 Exercise of common stock options 80,269 1 151 - - - 141 (291) - 2 Net capital contribution from shareholder - - 90 - - - - - - 90 Stock issuance in connection with acquisition 470,000 4 1,439 - - - - - - 1,443 Sale of common stock under equity purchase agreement 663,920 7 1,366 - - - - - - 1,373 Treasury stock returned - - - - - - (141) - - (141) Stock compensation - - 141 - - - - - - 141 ----------- ------ -------- -------- ----------- ------------- -------- ----------- ------------ ------- Balance at December 31, 2001 7,295,602 $73 $46,991 $353 $(39,953) $- $- $(291) $- $7,173 ----------- ------ -------- -------- ----------- ------------- -------- ----------- ------------ ------- Net loss - - - - (1,530) - - - - (1,530) ----------- ------ -------- -------- ----------- ------------- -------- ----------- ------------ ------- Total comprehensive loss - - - - (1,530) - - - - (1,530) Exercise of common stock options 17,016 - 35 - - - - - - 35 Stock issuance in connection with acquisition and asset purchase 295,000 3 1,207 - - - - - - 1,210 Return of shares held in escrow (42,734) (1) (116) - - - - - - (117) Issuance of commitment shares and related expenses in connection with stock purchase agreement 160,000 2 (44) - - - - - - (42) Repurchase of common stock (683,500) (7) (710) - - - - - - (717) ----------- ------ -------- -------- ----------- ------------- -------- ----------- ------------ ------- Balance at December 31, 2002 7,041,384 $70 $47,363 $353 $(41,483) $- $- $(291) $- $6,012 ----------- ------ -------- -------- ----------- ------------- -------- ----------- ------------ ------- Net income - - - - 608 - - - - 608 ----------- ------ -------- -------- ----------- ------------- -------- ----------- ------------ ------- Total comprehensive income - - - - 608 - - - - 608 Issuance of restricted shares and related deferred compensation in connection with stock purchase agreement for services 152,778 1 202 - - - - - (103) 100 Stock compensation for services - - - - - - - - 53 53 Exercise of common stock options 30,000 1 13 - - - - - - 14 Sale of common stock under equity purchase agreement 486,566 5 728 - - - - - - 733 ----------- ------ -------- -------- ----------- ------------- -------- ----------- ------------ ------- Balance at December 31, 2003 7,710,728 $77 $48,306 $353 $(40,875) $- $- $(291) $(50) $7,520 =========== ====== ======== ======== =========== ============= ======== =========== ============ =======
The accompanying notes are an integral part of these consolidated financial statements. A.D.A.M., Inc. Consolidated Statements of Cash Flows (In thousands)
Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2002 2001 ------------- ------------- ------------- Cash flows from operating activities Net income (loss) $608 $(1,530) $1,597 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities Depreciation and amortization 1,393 1,595 1,999 Gain on sale of intellectual property - - (1,808) Gain (loss) on sale of assets (9) (1) 94 Stock compensation for services 53 - - Stock compensation charges - - 141 Stock received for rent - (85) (42) Realized loss and impairment of investment activities - 176 146 Equity in net loss of affiliate - 248 342 Other, net (21) (17) (8) Changes in assets and liabilities Accounts receivable (168) 701 (640) Inventories 19 62 16 Prepaids and other assets (61) 40 (7) Accounts payable and accrued liabilities (63) (328) (1,339) Deferred revenue 379 161 (1,365) ------------- ------------- ------------- Net cash provided by (used in) operating activities 2,130 1,022 (874) ------------- ------------- ------------- Cash flows from investing activities Investment in equity affiliate - (250) (275) Proceeds from short-term investments - - 283 Purchases of property and equipment (85) (50) (81) Repayments on notes receivable 94 136 153 Net change in restricted time deposits 12 (9) 109 Software product and content development costs (645) (656) (896) Proceeds from sale of intellectual property - - 1,950 Acquisition, net of cash acquired - (94) 7 ------------- ------------- ------------- Net cash (used in) provided by investing activities (624) (923) 1,250 ------------- ------------- ------------- Cash flows from financing activities Proceeds from sales of common stock 833 - 1,373 Debt and equity issuance costs - (42) - Proceeds from exercise of common stock options and warrants 14 35 2 Capital contribution from shareholder, net of expenses - - 90 Repurchase of common stock - (717) - Repayments on capital leases (19) (33) - Payments of notes payable - - (205) ------------- ------------- ------------- Net cash provided by (used in) financing activities 828 (757) 1,260 ------------- ------------- ------------- Increase (decrease) in cash and cash equivalents 2,334 (658) 1,636 Cash and cash equivalents, beginning of period 2,220 2,878 1,242 ------------- ------------- ------------- Cash and cash equivalents, end of period $4,554 $2,220 $2,878 ------------- ------------- ------------- Interest paid $7 $66 $15 ------------- ------------- ------------- Incurred capital lease obligations $- $57 $- Assumed debt of acquired business $- $- $42 Settlement of note receivable $- $- $134
The accompanying notes are an integral part of these consolidated financial statements. A.D.A.M., Inc. Notes to Consolidated Financial Statements 1. Description of Business and Summary of Significant Accounting Policies We specialize in the creation and delivery of interactive health content that can be used by a broad range of healthcare consumers - from those with low health literacy to those who play an active and ongoing role in their personal health management. Our products can be used for learning about general health concerns, specific diseases and treatments, surgical procedures, drug information, specialty health subjects such as women's health and children's health, nutrition, alternative medicine and more. Basis of Presentation Principles of consolidation The consolidated financial statements include the accounts of our company and our wholly owned subsidiaries. We have one investment in which we have less than a 20% ownership. This investment is included in the consolidated financial statements at the cost of our investment, as we do not have significant influence over the investee. All inter company transactions and balances have been eliminated. Equity investment During the year ended December 31, 2001, we acquired an additional preferred stock interest in ThePort Network, Inc. ("ThePort") for $275,000 in cash, resulting in our having an approximately 25% voting interest as of December 31, 2001. The results of operations of ThePort have been accounted for as an equity investment and accordingly, for the year ended December 31, 2001, we recorded our share of ThePort's losses of $342,000. At December 31, 2001, the carrying value of this investment was $40,000. During the year ended December 31, 2002, we acquired an additional preferred stock interest in ThePort for $250,000 in cash, resulting in our having an approximately 24% voting interest as of December 31, 2002. For the year ended December 31, 2002 we recorded our share of ThePort's losses of $248,000. As of December 31, 2003, we had an approximate 34% voting interest in ThePort and this investment was accounted for under the equity method. Our voting interest increased from December 31, 2002 due to our Series B preferred stock investment being converted into common stock at a one-to-five conversion rate. As of December 31, 2003 and December 31, 2002 the carrying value of this investment was $0. We have no future obligations to fund ThePort. Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue recognition We generate revenues mainly in two ways - Internet-based licensing and shipped product sales. Internet revenues consist primarily of license fees that usually consist of an annual, up-front fee that is initially recorded as deferred revenue. This revenue is recognized ratably over the term of the license agreement beginning after delivery has occurred, upon customer acceptance, when we have determined that the fees from the agreement are fixed and determinable, and there are no significant return or acceptance provisions. For Internet revenue arrangements in which we sell through a reseller, we do not recognize any revenue until an agreement has been finalized between the customer and our authorized reseller and the content has been delivered to the customer by the reseller. Revenue is not recognized under any circumstances, unless collectibility is deemed probable. Shipped product revenues represent the sales of software products and revenues earned under certain royalty agreements. Revenues from product sales are generally recognized at the time title passes to customers, distributors or resellers. Revenues from royalty agreements are recognized as earned based upon performance or product shipment. Revenue is recognized in accordance with SEC Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"), as amended by SAB 101A and SAB 101B and as revised by SAB 104, "Revenue Recognition" and Statement of Position No. 97-2, "Software Revenue Recognition." Accordingly, revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred, fees are fixed or determinable, collectibility is probable and there are no significant return or acceptance provisions. Allowances for estimated product returns and bad debts are provided at the time of sale. We evaluate the adequacy of allowances for returns and doubtful accounts based upon our evaluation of historical and expected sales experience and by channel of distribution. As certain conditions change, such as sell-through experience, channels of distribution, and general economic conditions, the estimated reserves required for returns and allowances may also change. Concentration of credit risk Financial instruments that potentially subject us to concentration of credit risk consist primarily of trade receivables. For the years ended December 31, 2003 and December 31, 2002, one customer accounted for approximately 7% and 26% of total revenues, respectively. This customer's license agreement with us expired during March 2003 and we have not received any revenues from the customer since that time. Fair value of financial instruments The carrying amounts of our financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and other liabilities, approximate fair value due to their short maturities. Cash and cash equivalents Cash and cash equivalents include cash on hand and deposits and highly liquid investments with an original maturity of three months or less. Inventories Inventories consist principally of computer software media, books and related shipping materials and are stated at the lower of cost or market. Cost is determined using the first-in, first-out method. The valuation of inventory requires us to estimate net realizable value. We write down our inventory for estimated obsolescence or to the lesser of cost or market value. Property and equipment Property and equipment are recorded at cost and depreciated over their estimated useful lives using the straight-line method. Property and equipment held under capital leases and leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the related asset. Upon retirement or sale, the cost of assets disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to income. Repairs and maintenance costs are expensed as incurred. Intangible assets Intangible assets consist of purchased intellectual content, purchased customer contracts, capitalized software product and content development costs to be sold, leased or otherwise marketed, and software development costs for internal use software. For the year ended December 31, 2003 and 2002, purchased intellectual content and purchased customer contracts represent intangible assets acquired in 2002 from Nidus Information Services, Inc. ("Nidus") (Note 3) and in 2001 from Integrative Medicine Communications, Inc. ("IMC"). In addition, purchased intellectual content includes assets that were purchased from HIP International, Inc. in January 2002. 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 capitalized in accordance with the provisions of SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." 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 twenty-four months. In accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," 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 of three years. Impairment of long-lived assets and goodwill We evaluate impairment of long-lived assets, including property, plant and equipment and intangible assets with finite lives, whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the asset, an impairment loss is recognized. Measurement of an impairment loss for long-lived assets is based on discounted cash flows and the fair value of the asset. We evaluate goodwill 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. Product and content development expenditures Product and content development expenditures include costs incurred in the development, enhancement and maintenance of our content and technology. Costs that are not capitalized are charged to expense as incurred. Restricted time deposits In connection with our non-cancelable operating leases for our office space and telephone system, we are required to purchase time deposits to secure letters of credit with the bank guaranteeing payments under the leases. The time deposits bear interest at an average rate of approximately 1.61% and are carried at cost, which approximates fair value. The classification of these investments is determined based on the expected term of the collateral requirement and not necessarily the maturity date of the underlying securities. Income taxes We account for income taxes utilizing the liability method and deferred income taxes are determined based on the estimated future tax effects of differences between the financial reporting and income tax basis of assets and liabilities given the provisions of the enacted tax laws. A valuation allowance is provided against deferred tax assets for which it is more likely than not that the asset will not be realized. Stock-based employee compensation We account for stock-based employee compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations and we provide the disclosures required by SFAS No. 123, "Accounting for Stock-Based Compensation." Accordingly, compensation cost for stock options issued to employees is measured as the excess, if any, of the quoted market price of our stock at the date of the grant over the amount an employee must pay to acquire the stock. Employee stock option compensation expenses were $0, $0, and $141,000 during 2003, 2002, and 2001. Had we determined employee compensation costs using a fair value based methodology at the grant date for our stock options under SFAS 123, our pro forma consolidated net income (loss) would have been as follows (in thousands, except per share data):
Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2002 2001 ------------- ------------- ------------- Net income (loss) as reported $608 $(1,530) $1,597 Add stock-based employee compensation expense included in reported net income (loss) - - 141 Deduct total stock-based employee compensation expense determined under fair-value base method (888) (1,840) (2,731) ------------- ------------- ------------- Pro forma net loss $(280) $(3,370) $(993) ------------- ------------- ------------- Basic net (loss) income per share As reported $0.08 $(0.22) $0.25 Pro forma $(0.04) $(0.47) $(0.15) Diluted net (loss) income per share As reported $0.07 $(0.22) $0.24 Pro forma $(0.04) $(0.47) $(0.15)
Net income (loss) per common share Net income (loss) per share is computed in accordance with SFAS No. 128, "Earnings Per Share." We compute basic income (loss) per share by dividing net income by the weighted average number of issued common shares for each period. Diluted income (loss) per share is based upon the addition of the effect of common stock equivalents (stock options and warrants) to the denominator of the basic income (loss) per share calculation using the treasury stock method, if their effect is dilutive. The computation of income (loss) per share for the twelve months ended December 31, 2003, 2002 and 2001 is as follows (in thousands, except per share data):
Twelve Months Ended December 31, --------------------------------- 2003 2002 2001 --------- ---------- ---------- Net income (loss) $608 $(1,530) $1,597 Weighted average common shares outstanding 7,306 7,107 6,453 Weighted average common shares equivalents (stock options and warrants) 826 N/A 84 Weighted average shares in escrow 37 N/A 18 --------- ---------- ---------- Weighted average diluted common shares outstanding 8,169 7,107 6,555 Net income (loss) per share: Basic $0.08 $(0.22) $0.25 Diluted $0.07 $(0.22) $0.24 Anti-dilutive stock options and warrants outstanding 2,611 2,742 1,784 Anti-dilutive shares in escrow 0 287 0
For the twelve months ended December 31, 2002, diluted net loss per share does not differ from basic net loss per share since potential common shares from the exercise of stock options and warrants and shares in escrow are all treated as anti-dilutive. We had 2,611,000, 2,742,000 and 1,784,000 options and warrants outstanding which were anti-dilutive for the twelve months ended December 31, 2003, 2002 and 2001 respectively. We had 287,000 shares in escrow, which were anti-dilutive for the twelve months ended December 31, 2002. Comprehensive income (loss) SFAS No. 130, "Reporting Comprehensive Income," requires that all items, which are to be recognized as components of comprehensive income (loss), be reported on a financial statement that is displayed with the same prominence as net income (loss). The component of comprehensive income (loss) other than net income (loss) includes unrealized losses on investment securities. Comprehensive income (loss) is presented as a component of our statements of shareholders' equity. Reclassifications Certain comparative amounts have been reclassified to conform to current year presentation. Recent accounting pronouncements In January 2003, the FASB issued SFAS Interpretation No. 46 ("FIN46"), "consolidation of Variable Interest Entities." FIN 46 expands upon existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities, and activities of a variable interest entity. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after December 15, 2003. We do not expect the adoption of FIN 46 to have a significant effect on our financial position, results of operations or cash flows. In December 2003, the Securities and Exchange Commission released Staff Accounting Bulletin No. 104, "Revenue Recognition" (SAB 104). SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101, "Revenue Recognition in Financial Statements" related to multiple element revenue arrangements, superceded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." We have assessed the impact of SAB 104 and concluded that the adoption of SAB 104 by us did not have a material impact on our financial statements. 2. Liquidity Our financial statements have been prepared assuming we will continue as a going concern. Although we reported net income for December 31, 2003, we recorded net losses in the past, except for 2001 and we could generate losses in 2004 and beyond. In addition to working capital generated from operations, we have raised funds through the sale of debt and equity securities and may require additional financing before maintaining profitability. The additional financing would be required to expand the infrastructure needed to manage our growth, and to further expand existing services into new markets and to expand new product and service offerings into existing markets. Management believes that the cash on hand together with anticipated cash flows from operations and the proceeds already realized from the Common Stock Purchase Agreement will be sufficient to meet our working capital needs for the year ending December 31, 2004. 3. Acquisition of Integrative Medicine Communications, Inc. and Nidus Information Services, Inc. Integrative Medicine Communications, Inc. In December 2001, we acquired 100% of the outstanding common stock of IMC for 470,000 shares of our common stock. IMC was a privately held provider of science-based information on wellness and alternative medicine to healthcare professionals and consumers. Based upon the purchase agreement, we had an obligation to issue 470,000 shares of our common stock in exchange for all of the outstanding common stock of IMC, subject to adjustment. On April 2, 2002, the total number of shares, we were obligated to issue, was reduced by 42,734, and we recognized a corresponding decrease in goodwill of $117,000. Nidus Information Services, Inc. In February 2002, we acquired 100% of the outstanding common stock of Nidus for 260,000 shares of our common stock. Nidus was a privately held provider of in-depth patient education reports on common health conditions and diseases. In accordance with SFAS 141, the total purchase price was allocated to the net tangible assets and intangible assets, including goodwill, acquired based on the estimated fair value at the date of acquisition. The results of Nidus' operations have been included in our consolidated financial statements since February 14, 2002. The following table summarizes the allocation of the fair values of the assets acquired and liabilities assumed at the date of acquisition and any subsequent adjustments to the allocation (in thousands):
IMC Purchase IMC Adjusted Nidus Purchase Nidus Adjusted Purchase Purchase Price Allocation Price Allocation Price Allocation Price Allocation December 31, Allocation December 31, March 31, Allocation December 31, 2001 Adjustment 2003 2002 Adjustment 2003 ----------------- ---------------- ----------------- ---------------- Current assets $315 $315 $41 $41 Property and equipment 26 26 - - Intangible assets 1,053 1,053 560 560 Goodwill 1,473 (106) 1,367 658 18 676 ----------------- ---------------- ----------------- ---------------- Total assets acquired 2,867 2,761 1,259 1,277 Current liabilities (776) (11) (787) - - Deferred revenue (511) (511) (118) (18) (136) Long-term liabilities (8) (8) - - ----------------- ---------------- ----------------- ---------------- Total liabilities assumed (1,295) (1,306) (118) (136) ----------------- ---------------- ----------------- ---------------- Net assets acquired $1,572 $1,455 $1,141 $1,141 ================= ================ ================= ================
The following unaudited pro forma financial information reflects our results of operations for the year ended December 31, 2002 and 2001, as if the acquisitions had occurred on January 1, 2001. These unaudited pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what operating results would have been had the acquisitions actually taken place on January 1, 2001 and may not be indicative of future operating results. The unaudited pro forma results are summarized as follows (in thousands, except per share amounts): Year Ended Year Ended December 31, December 31, 2002 2001 ------------ ------------ Revenues $8,981 $11,577 Net (loss) income $(1,565) $60 Basic net (loss) income per share $(0.22) $0.01 Diluted net (loss) income per share $(0.22) $0.01 4. Property and Equipment Property and equipment are summarized as follows (in thousands):
Estimated Useful Life December 31, (Years) 2003 2002 ------------- -------------- -------------- Computers 3 $1,741 $1,789 Equipment 5 481 481 Furniture and fixtures 5 539 539 Leasehold improvements 7 56 181 -------------- -------------- 2,817 2,990 Less - accumulated depreciation and amortization (2,632) (2,764) -------------- -------------- $185 $226 -------------- --------------
Depreciation and amortization expense for the years end December 31, 2003, 2002, and 2001 was $134,000, $342,000, and $499,000, respectively. 5. Product and Content Development Expenditures Product and content development expenditures are summarized as follows (in thousands):
Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2002 2001 --------------- --------------- -------------- Total product and content development expenditures $2,020 $3,132 $3,139 Less: additions to capitalized software product and content development (645) (656) (896) --------------- --------------- -------------- Product and content development expense $1,375 $2,476 $2,243 --------------- --------------- --------------
6. Intangible Assets The following table shows the allocation of the purchase price to intangibles with a definite life and their amortization period for the IMC and Nidus acquisitions (in thousands):
Purchase Amortization Assets Price Period 2003 2004 2005 - ----------------------------------- ---------- -------------- --------- --------- --------- IMC - ----------------------------------- Purchased intellectual content $807 3 Years $269 $247 $- Purchased customer contracts $246 2 Years $113 $- $- NIDUS - ----------------------------------- Purchased intellectual content $472 3 Years $157 $157 $20 Purchased customer contracts $88 2 Years $44 $6 $- HIP - ----------------------------------- Purchased intellectual content $152 3 Years $51 $51 $50 --------- --------- --------- $634 $461 $70 ========= ========= =========
Intangible assets are summarized as follows (in thousands):
Estimated amortizable December 31, lives (years) 2003 2002 ------------- ------------- ------------- Capitalized software products and content to be sold, leased or otherwise marketed 2 $3,048 $2,499 Software developed for internal use 3 525 430 Purchased intellectual content 3 - 5 1,431 1,431 Purchased customer contracts 2 333 333 ------------- ------------- Intangible assets, gross 5,337 4,693 ------------- ------------- Less accumulated amortization: Capitalized software products and content to be sold, leased or otherwise marketed (2,246) (1,756) Software developed for internal use (222) (88) Purchased intellectual content (906) (429) Purchased customer contracts (327) (171) ------------- ------------- Accumulated amortization (3,701) (2,444) ------------- ------------- Intangible assets, net $1,636 $2,249 ------------- -------------
Amortization expense, which includes the amortization of capitalized software product and content development reported in cost of revenues, for the years ended December 31, 2003, 2002, and 2001 was $1,259,000, $1,253,000, and $833,000, respectively. During the year ended December 31, 2001, we recognized an impairment charge of approximately $255,000 to reduce certain purchased intellectual content to its net realizable value and we recognized an impairment charge of approximately $362,000 to reduce certain internally developed software to its net realizable value. 7. Accounts Payable and Accrued Expenses Accounts payable and accrued expenses consist of the following (in thousands):
December 31, 2003 2002 ------------- -------------- Accounts payable $21 $98 Accrued professional fees 117 134 Accrued compensation and employee benefits 168 124 Other accrued expenses 328 341 ------------- -------------- $634 $697 ------------- --------------
8. Income Taxes The provision for income taxes differs from the amount computed by applying the applicable U.S. statutory federal income tax rate of 34 percent to income (loss) from continuing operations before income taxes as a result of the following (in thousands):
Year Ended Year Ended December 31, December 31, 2003 2002 ------------- ------------- Federal tax provision (benefit) on income (loss) before income taxes at statutory federal income tax rate $207 $(436) Change in valuation allowance (235) 482 State taxes, net of federal benefit 24 (51) Other 4 5 ------------- ------------- $- $- ------------- -------------
The components of our deferred tax assets and liabilities are as follows (in thousands):
December 31, 2003 2002 ------------ ------------ Deferred tax assets Accrued expenses and other liabilities $89 $184 Allowance for doubtful accounts 41 46 Intangible assets 493 516 Fixed assets 230 300 Research and development credits 739 739 Capitalized development 1,263 1,454 Capital loss carryforwards 161 - Net operating loss carryforwards 13,505 13,498 ------------ ------------ 16,521 16,737 ------------ ------------ Deferred tax liabilities Software product and content development costs (581) (686) ------------ ------------ (581) (686) ------------ ------------ Net deferred tax asset before valuation allowance 15,940 16,051 Valuation allowance (15,940) (16,051) ------------ ------------ $- $- ------------ ------------
At December 31, 2003, we had net operating loss (NOL) and general business credit carryforwards available for tax purposes of approximately $35,541,000 and $739,000, respectively, which will expire in years 2007 through 2023 and 2007 through 2022, respectively. We acquired approximately $10 million of NOL carryforwards as a result of the acquisition of IMC in December of 2001. Internal Revenue Code Section 382 limits the utilization of NOL carryforwards when a change in ownership as defined by the Internal Revenue Service occurs. The acquisition of IMC resulted in an ownership change within the meaning of Internal Revenue Section 382. The total annual Section 382 limitation is approximately $60,000. Of the total $10 million pre-changed NOLs acquired from IMC, the pre-change NOLs estimated to be available for use after the application of the IRC 382 limitation is approximately $1.2 million. At December 31, 2003 and 2002, we had recorded a valuation allowance equal to our net deferred tax assets as management believes it is more likely than not that the net deferred tax assets will not be realized. 9. Equity Purchase Agreements On September 5, 2000, we entered into a Common Stock Purchase Agreement with Fusion Capital Fund II, LLC. Pursuant to the agreement, Fusion Capital agreed to purchase up to $12,000,000 of our common stock in two rounds of $6,000,000 each. The purchase price was based upon the future market price of our common stock. We determined the month of purchase based on our cash requirements. As of December 31, 2001, we had sold 963,920 shares of common stock pursuant to the agreement and received cash totaling approximately $2,370,000, including 663,920 shares for $1,373,000 in 2001. In the fourth quarter of 2001,the agreement with Fusion Capital Fund II expired. On May 22, 2002, we entered into a second Common Stock Purchase Agreement with Fusion Capital Fund II, LLC. Pursuant to this agreement, Fusion Capital agreed to purchase up to an aggregate of $12,000,000 of our common stock. We have the right to sell up to $15,000 of our common stock per trading day under this agreement unless our stock price equals or exceeds $7.00, in which case the daily amount may be increased at our option. Fusion Capital is not obligated to purchase any shares of our common stock on any trading days that the market price of our common stock is less than $1.00. Since we registered 3,500,000 shares for sale to Fusion Capital pursuant to the agreement, the selling price of our common stock to Fusion Capital will have to average at least $3.43 per share for us to receive the maximum proceeds of $12,000,000 without registering additional shares of common stock, which we have the right but not the obligation to do. Assuming a purchase price of $1.00 per share and the purchase by Fusion Capital of the full 3,500,000 shares under the agreement, proceeds to us would be $3,500,000. If we decided to sell more than the 1,352,100 shares to Fusion Capital (19.99% of our outstanding shares as of May 22, 2002, the date of the agreement, exclusive of the 160,000 shares issued to Fusion Capital as a commitment fee), we would first be required to seek shareholder approval of the agreement in order to be in compliance with Nasdaq rules. We may, but shall be under no obligation to, request our shareholders to approve the transaction contemplated by the agreement. We may terminate the agreement at any time, and Fusion Capital may terminate the agreement at any time after approximately 40 months following the date the purchase obligation under the agreement became effective. As of December 31, 2003, we had sold 486,566 shares for $733,000 under this agreement. 10. Treasury Stock During the year ended December 31, 2002, we repurchased and retired 683,500 shares of our common stock from one shareholder in a private transaction for $1.05 per share for an aggregate price of $717,675. During the year ended December 31, 2001, we received 70,464 shares of common stock from an employee as repayment for a note receivable entered into in March 2000. All of these shares were reissued during the year ended December 31, 2001 to employees upon the exercise of stock options. 11. Consulting Agreements On February 15, 2003, we entered into a Restricted Common Stock Purchase Agreement with James T. Atenhan and Victor P. Thompson (each a "Purchaser") in connection with a consulting agreement with a financial services firm controlled by the Purchasers. Each Purchaser purchased 37,500 shares of our common stock at a purchase price of $.40 per share. The purchase price of our common stock was discounted from the $.78 market price on the date we entered into the agreement. In connection with the sale, we recorded deferred compensation for services of $28,500. This deferred compensation expense was expensed over the six-month service period. On August 1, 2003, we entered into a second Restricted Common Stock Purchase Agreement with the Purchasers in connection with a twelve-month extension of the consulting contract. Each Purchaser purchased 38,889 shares of our common stock at a purchase price of $.90 per share. The purchase price of our common stock was discounted from the $1.86 market price on the date we entered into the agreement. In connection with the sale, we recorded deferred compensation for services of $74,667. This deferred compensation expense is being expensed over the twelve-month service period, which began September 1, 2003. As of December 31, 2003, the remaining deferred compensation expense for services was approximately $50,000. 12. Common Stock Options and Warrants In 2002, our Board 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 fair market value of our common stock, and the options generally vest ratably over a three-year period. Options granted under the Plan expire ten years from the date of grant. As of December 31, 2002, we had options outstanding to purchase a total of 2,651,854 shares of our common stock under our 2002 Stock Incentive Plan and our 1992 Option Plan. Under the 1992 Option Plan, we had reserved 4,500,000 shares of common stock and no additional options may be granted under the Plan. The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in the years ended December 31, 2003, 2002, and 2001, respectively: dividend yield of 0% for all periods; expected volatility of 125%, 120%, and 114%, respectively; average risk-free interest rates of 2.29%, 3.78%, and 4.20%, respectively; and an expected life of 3.5 for all periods with the exception of options granted during 2003, 2002, and 2001 with one-year vesting periods, which have an expected life of two years. The following table summarizes stock option activity for the years ended December 31, 2003 and 2002 and 2001:
Weighted Weighted Average Average Exercise Price Exercise Fair Shares Per Share Price Value ----------- -------------- ---------- ----------- Outstanding at December 31, 2000 1,859,702 2.00-20.63 7.27 - Granted 1,169,221 0.46-2.97 2.16 1.55 Exercised (150,733) 1.94-2.63 1.94 - Canceled or expired (690,277) 1.94-20.00 6.49 - ----------- Outstanding at December 31, 2001 2,187,913 0.46-20.63 5.77 - Granted 900,475 1.21-4.51 3.13 3.07 Exercised (17,016) 1.94-2.25 2.07 - Canceled or expired (419,518) 1.21-15.00 3.97 - ----------- Outstanding at December 31, 2002 2,651,854 0.46-20.63 4.67 - ----------- Granted 1,278,750 0.41-1.75 0.43 0.43 Exercised (30,000) 0.46 0.46 - Canceled or expired (198,428) 0.41-12.75 1.98 - ----------- Outstanding at December 31, 2003 3,702,176 0.41-20.63 3.34 - ----------- Options exercisable at December 31, 2003 2,148,684 -----------
The following table summarizes additional information about stock options outstanding at December 31, 2003:
Options Outstanding Options Exercisable ---------------------------------------- --------------------------- Weighted Number Average Weighted Number Weighted Outstanding at Remaining Average Exercisable at Average Range of December 31, Contractual Exercise December 31, Exercise Exercise Price 2003 Life Price 2003 Price - ------------------------------------ ------------ ------------ -------------- ------------ $ 0.41 to 0.85 1,166,250 9.01 $0.42 833 $0.57 $ 1.58 to 2.94 761,947 6.97 2.08 672,105 2.10 $ 3.06 to 4.75 910,694 7.45 3.35 612,461 3.49 $ 5.00 to 5.91 380,936 5.50 5.49 380,936 5.49 $ 7.94 to 12.75 297,210 5.12 8.77 297,210 8.77 $13.00 to 20.63 185,139 5.95 13.87 185,139 13.87 -------------- -------------- 3,702,176 7.38 $3.34 2,148,684 $5.03 -------------- --------------
In January 1999, we provided employee holders of options with exercise prices from $3.50 and higher the opportunity to cancel such options in exchange for an equal number of options with a vesting period of one year at the then current market price of $5.25. As a result of this election, 423,400 options were canceled and reissued in January 1999. As of December 31, 2003, we had 231,400 outstanding options with an exercise price of $5.25 that are considered variable. The new option exercise price equals the market price on the date of the repricing and, correspondingly, compensation expense was not recognized. The vesting period of these options is one year. As a result of the issuance of FASB Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation an interpretation of APB Opinion No. 25," these options are being treated as variable awards. Accordingly, compensation cost shall be adjusted for increases in the fair value of the awards past $5.25 until these options are either exercised or forfeited. As of December 31, 2003, no compensation cost has been recognized for these options, as the fair value of our common stock has not exceeded $5.25 per share. As of December 31, 2003, we had warrants outstanding to purchase a total of 85,000 shares of our common stock at a weighted average exercise price of $7.63 per share. These warrants were issued in conjunction with the issuances of notes on December 31, 1999 and are exercisable at any time at the election of the holders through December 31, 2005. 13. Employee Benefit Plan We sponsor a defined contribution plan that provides all our permanent employees an opportunity to accumulate funds for their retirement. In January 1999, we began to match the contributions of participating employees to the extent of 50% of the first 6% contributed by the participant. Company matching contributions to the plan were approximately $69,000 for the year ended December 31, 2001. During calendar 2002, our matching contributions to the plan were approximately $52,000, and we discontinued our matching of contributions to the plan during the third quarter of 2002. 14. Related Party Transactions On April 2, 2001, for a term beginning on January 1, 2001, we signed an 18-month sublease agreement with a company whose president is an A.D.A.M. board member. We received 8,333 shares of the tenant's common stock monthly over the term of the agreement, which ended June 30, 2002. From June 30, 2002 through December 31, 2002, we continued to sublease space to this company on a month-to-month basis for the same monthly consideration. The shares are valued at the fair market value of the leased space and are recorded on our balance sheet as a long-term asset. As of December 31, 2003 and 2002, the shares were valued at $0. We evaluate the asset for impairment at the end of each reporting period to determine if the decline is "other than temporary." For the year ended December 31, 2002, we recorded an impairment charge of $84,000 to write off our investment based upon management's assessment that the decline in the carrying value is "other than temporary." Additionally, we received warrants to purchase 25,000 common shares of the tenant that became fully exercisable on January 1, 2002. From December 2002 through September 2003, we allowed the tenant to occupy this space and did not collect any lease payments. Beginning in October 2003, we began collecting cash lease payments of $785 per month from the tenant. Under the terms of an amendment to the lease agreement, we have the right to require the tenant to vacate the space upon 30 days notice. As of December 31, 2003 our Chief Executive Officer had an approximate 3% voting interest in this company. On May 30, 2001, we received a full-recourse promissory note from our Chief Executive Officer for approximately $341,000 (the "Exercise Note") for the exercise of 150,000 options at $1.94 per share and a $50,000 promissory note (the "Tax Note") in connection with a loan to our Chief Executive Officer to pay taxes related to the stock exercise. The notes accrue interest of 6.25% per annum and are due in full on or before May 29, 2006. Part of the Exercise Note, $291,000, is secured by 150,000 shares of our common stock and is recorded in shareholders' equity. As of December 31, 2003, all of the approximately $55,000 of interest accrued on both notes had been paid and $11,000 of principal had been paid with respect to the Tax Note, leaving a remaining balance of $39,000 (Note 15). On April 10, 2002, for a term beginning on November 1, 2001, we entered into an 8-month sublease agreement with ThePort Network, Inc. ("ThePort"). We received 14,044 shares of ThePort's common stock monthly over the term of the agreement, which ended on June 30, 2002. The shares are valued at the fair market value of the rent of the leased space. After the expiration of the sublease on June 30, 2002, we continued to sublease this space to ThePort on a month-to-month basis for the same monthly consideration until December 31, 2002. Since then, we have not received any type of consideration as lease payments. During the year ended December 31, 2002, we accepted a total of 196,616 shares of common stock valued at approximately $49,000. For the year ended December 31, 2002, we recorded an impairment charge of $92,000 to write-off our investment in ThePort based upon management's assessment that the carrying value was permanently impaired. In connection with our preferred stock investment in ThePort, during the year ended December 31, 2001, we entered into a five-year agreement whereby we had exclusive distribution rights to ThePort's products within the healthcare industry. As of December 31, 2001, we had pre-paid $125,000 of the contract fee to be applied against future subscription fees. We had committed to generate $1,500,000 in subscription fees during the initial term of the original agreement. The initial term of the agreement commenced on August 20, 2001 and continued for five years from that date. On February 14, 2003, ThePort agreed to accept a payment of $125,000 from us to release us from the minimum guarantee in its entirety. ThePort retained the $125,000 pre-payment previously made and we were granted non-exclusive rights to ThePort's products within the healthcare industry. Our Chief Operating Officer served on the Board of Directors of ThePort from December 2001 through August 2002. Our Chief Executive Officer, who currently serves as the Chairman of the Board of Directors of ThePort, has acquired an approximate 10% voting interest in ThePort and holds a convertible note and loans from ThePort in the amount of approximately $919,000 at December 31, 2003. This represents a decrease in his ownership from the 14% percentage voting interest held at December 31, 2002, which is due to Series B preferred stock being converted into common stock at a one-to-five conversion rate. Two of our other directors also own equity interests in ThePort. 15. Commitments and Contingencies 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. At December 31, 2003, future minimum rentals for noncancelable leases with terms in excess of one year and total payments due under license agreements were as follows (in thousands):
Year Ending License Real Estate Operating Capital December 31, Agreements Leases Lease Lease 2004 210 225 33 15 2005 100 229 3 15 2006 - 234 - 15 2007 - 239 - 11 2008 - 182 - - ------------- ------------- ------------ ------------ Total future minimum lease payments and payments under license agreements $310 $1,109 $36 56 ------------- ------------- ------------ Less - amounts representing interest (9) ------------ Present value of future minimum lease payments 47 Less - current portion 11 ------------ $36 ------------
Rent expense for the years ended December 31, 2003, 2002 and 2001 was $269,000, $488,000 and $421,000, respectively. Our headquarters are located in approximately 12,000 square feet of leased office space in Atlanta, Georgia. On October 1, 2002, we entered into an amended and restated employment agreement with our Chief Executive Officer, which was corrected on March 17, 2004. The employment agreement as amended provides for a base salary and bonuses of approximately $289,000 in the event that our Chief Executive Officer remains in the employment of the Company as of the bonus payment dates through May 2006. During the year ended December 31, 2003, our Chief Executive Officer earned and received bonus payments totaling $78,866, which were applied towards accrued interest and the outstanding note receivable balance. On April 25, 1996, a shareholders' class action lawsuit was filed in Fulton County Superior Court in Atlanta, Georgia against us and certain of our then officers and directors. The complaint alleged violations of Sections 11, 12(2) and 15 of the Securities Act of 1933 and violations of the Georgia Securities Act arising out of alleged disclosure deficiencies in connection with our initial public offering of common stock, which was completed on November 10, 1995. The complaint seeks compensatory damages in an unspecified amount. The court denied in substantial part the defendant's motion to dismiss the complaint and certified the case as a class action for all of the claims except for the claim under the Georgia Securities Act. On March 24, 2004, the Fulton County Superior Court in Atlanta, Georgia approved the stipulation and agreement of settlement. The settlement was within our directors' and officers' liability insurance; and accordingly, our insurance provider has paid this settlement. There is no further obligation to us for this matter except for certain legal costs that were denied by our insurance carrier. As of December 31, 2003 we had accrued $4,430 of such costs. We are subject to other legal proceedings and claims that have arisen in the ordinary course of our business; however, we believe that the ultimate resolution of these matters and the shareholders' lawsuit will not have a material adverse effect on our consolidated financial statements taken as a whole. In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" which clarifies disclosure, recognition and measurement requirements related to certain 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. 16. Segment Information We operate in one segment comprised of three markets: healthcare, Internet, and education. We sell our products through agreements, which grant territorial rights to international and domestic distributors. During the years ended December 31, 2003, 2002 and 2001, we had net revenues from international sales of approximately $276,000, $303,000, and $324,000, respectively. A summary of revenues based on geographic location of customers is as follows (in thousands): Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2002 2001 ------------- ------------- ------------- United States $7,613 $8,621 $8,622 Europe 104 129 69 Pacific Rim and Asia 135 51 86 Other 37 123 169 ------------- ------------- ------------- $7,889 $8,924 $8,946 ------------- ------------- ------------- No customers contributed greater than 10% of total revenues for the year ended December 31, 2003. One customer contributed greater than 10% of total revenues for the year ended December 31, 2002. Two customers contributed greater than 10% of total revenues for the year ended December 31, 2001. The breakdown of revenues from each of these customers is as follows: Revenue for the Revenue for the Revenue for the Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2002 2001 ------------------- ------------------- ------------------- Customer 1 $576 7% $2,346 26% $2,302 26% Customer 2 N/A N/A N/A N/A 1,048 12% All Other 7,313 93% 6,578 74% 5,596 62% $7,889 100% $8,924 100% $8,946 100%
SCHEDULE II A.D.A.M., INC. SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS For the Twelve Months Ended December 31, 2003 Charged to Balance at Revenues, Balance at beginning Costs and Accounts Deductions/ end of Description of Period Expenses Written Off Aquisitions Period ---------------------------------------- ------------ ------------ --------------------- ------------- ------------ (Thousands of Dollars) Allowance for doubtful accounts and product returns $122 $14 $(25) $-- $111 ------------ ------------ --------------------- ------------- ------------ Valuation allowance for deferred taxes $16,051 $(235) $-- $124 $15,940 ============ ============ ===================== ============= ============ For the Twelve Months Ended December 31, 2002 Charged to Balance at Revenues, Balance at beginning Costs and Accounts end of Description of Period Expenses Written Off Acquisitions Period ---------------------------------------- ------------ ------------ --------------------- ------------- ------------ (Thousands of Dollars) Allowance for doubtful accounts and product returns $86 $126 $(90) $-- $122 ============ ============ ===================== ============= ============ Valuation allowance for deferred taxes $15,877 $482 $-- $(308) $16,051 ============ ============ ===================== ============= ============ For the Twelve Months Ended December 31, 2001 Charged to Balance at Revenues, Balance at beginning Costs and Accounts end of Description of Period Expenses Written Off Acquisitions Period ---------------------------------------- ------------ ------------ --------------------- ------------- ------------ (Thousands of Dollars) Allowance for doubtful accounts and product returns $106 $65 $(99) $14 $86 ------------ ------------ --------------------- ------------- ------------ Valuation allowance for deferred taxes $15,959 $(749) $-- $667 $15,877 ============ ============ ===================== ============= ============
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