Adam (ADAM) 10-Q 2007 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2007

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 or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

1600 RiverEdge Parkway, Suite 100

Atlanta, Georgia 30328-4696

(Address of Principal Executive Offices, Zip Code)

Registrant’s telephone number, including area code:

(770) 980-0888

N/A

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

Indicate by check mark whether the registrant (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  ¨

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

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

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

As of November 7, 2007, there were 9,588,694 shares of the Registrant’s common stock, par value $.01 per share, outstanding.

A.D.A.M., Inc.

Form 10-Q for the Quarter Ended September 30, 2007

		Page No.
	Index
	Part I. Financial Information
ITEM 1.	Consolidated Financial Statements	3
	Consolidated Balance Sheets at September 30, 2007 (unaudited) and December 31, 2006	3
	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2007 and 2006 (unaudited)	4
	Consolidated Statement of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2007 (unaudited)	5
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006 (unaudited)	6
	Notes to Consolidated Financial Statements (unaudited)	7
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	22
ITEM 4.	Controls and Procedures	23
	Part II. Other Information
ITEM 1.	Legal Proceedings	23
ITEM 1A.	Risk Factors	23
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	23
ITEM 3.	Defaults Upon Senior Securities	23
ITEM 4.	Submission of Matters to a Vote of Security Holders	23
ITEM 5.	Other Information	23
ITEM 6.	Exhibits	23

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PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

A.D.A.M., Inc.

Consolidated Balance Sheets

(In thousands, except share data)

	September 30, 2007			December 31, 2006
	(Unaudited)
Assets
Current assets
Cash and cash equivalents	$	10,433		$	6,382
Investments, short term		—			858
Accounts receivable, net of allowances of $396 and $280, respectively		2,574			3,082
Restricted cash		45			2,192
Inventories, net		93			74
Prepaids and other assets		1,004			1,673
Total current assets		14,149			14,261
Property and equipment, net		889			876
Intangible assets, net		10,241			10,276
Goodwill		28,022			27,883
Other assets		152			158
Deferred financing costs, net		933			1,184
Deferred tax assets		5,500			5,500
Total assets	$	59,886		$	60,138
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable and accrued expenses	$	3,125		$	4,075
Deferred revenue		5,475			4,447
Note payable		—			1,500
Current portion of long-term debt		2,000			1,000
Current portion of capital lease obligations		120			155
Total current liabilities		10,720			11,177
Capital lease obligations, net of current portion		113			178
Other liabilities		987			1,314
Long-term debt, net of current portion		21,000			24,000
Total liabilities		32,820			36,669
Commitments and contingencies
Shareholders’ equity
Common stock, $.01 par value; 20,000,000 shares authorized; 9,857,253 shares issued and 9,587,494 shares outstanding at September 30, 2007 and 9,386,878 shares issued and 9,117,119 shares outstanding at December 31, 2006		99			94
Treasury stock, at cost, 269,759 shares		(1,088	)		(1,088	)
Additional paid-in capital		55,688			54,109
Unrealized gain (loss) on investments		(104	)		(2	)
Accumulated deficit		(27,529	)		(29,644	)
Total shareholders’ equity		27,066			23,469
Total liabilities and shareholders’ equity	$	59,886		$	60,138

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

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A.D.A.M., Inc.

Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
Revenues, net:
Licensing	$	5,822		$	3,915		$	17,380		$	8,152
Product		390			368			1,312			1,110
Professional services and other		464			190			1,553			408
Total revenues, net		6,676			4,473			20,245			9,670
Cost of revenues:
Cost of revenues		1,095			587			4,143			1,208
Cost of revenues – amortization		371			257			1,006			634
Total cost of revenues		1,466			844			5,149			1,842
Gross profit		5,210			3,629			15,096			7,828
Operating expenses:
Product and content development		1,107			874			3,427			1,584
Sales and marketing		1,338			801			3,816			1,690
General and administrative		1,420			1,274			3,921			2,472
Total operating expenses		3,865			2,949			11,164			5,746
Operating income		1,345			680			3,932			2,082
Interest expense		626			372			1,938			376
Interest income		(69	)		(178	)		(125	)		(459	)
Loss on sale of assets		—			—			4			—
Income before income taxes		788			486			2,115			2,165
Income tax expense		—			—			—			—
Net income	$	788		$	486		$	2,115		$	2,165
Basic net income per common share	$	0.08		$	0.06		$	0.22		$	0.26
Basic weighted average number of common shares outstanding		9,575			8,711			9,404			8,487
Diluted net income per common share	$	0.07		$	0.05		$	0.20		$	0.21
Diluted weighted average number of common shares outstanding		10,587			10,096			10,326			10,079

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

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A.D.A.M., Inc.

Consolidated Statement of Changes in Shareholders’ Equity

(In thousands, except share data)

(Unaudited)

	Common Stock			Treasury Stock
	Shares	Amount		Shares		Amount			Additional Paid-in Capital		Accumulated Other Comprehensive Income/(Loss)			Accumulated Deficit			Total
Balance at December 31, 2006	9,386,878	$	94	(269,759	)	$	(1,088	)	$	54,109	$	(2	)	$	(29,644	)	$	23,469
Comprehensive income:
Net income	—		—	—			—			—		—			2,115			2,115
Unrealized gain (loss) on investments	—		—	—			—			—		(102	)		—			(102	)
Total comprehensive income																		2,013
Stock-based compensation expense	—		—	—			—			495		—			—			495
Exercise of common stock options	470,375		5	—			—			1,084		—			—			1,089
Balance at September 30, 2007	9,857,253	$	99	(269,759	)	$	(1,088	)	$	55,688	$	(104	)	$	(27,529	)	$	27,066

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

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A.D.A.M., Inc.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Nine Months Ended September 30,
	2007			2006
Cash flows from operating activities
Net income	$	2,115		$	2,165
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,336			765
Deferred financing cost amortization		258			—
Loss on sale of assets		4			—
Stock-based compensation expense		495			120
Other, net		—			(19	)
Changes in assets and liabilities:
Accounts receivable		507			(110	)
Inventories		(18	)		(8	)
Prepaids and other assets		667			(61	)
Accounts payable and accrued liabilities		(950	)		(223	)
Deferred revenue		1,028			(327	)
Other liabilities		(327	)		153
Net cash provided by operating activities		5,115			2,455
Cash flows from investing activities
Acquisition of subsidiary, net of cash acquired of $1,548		—			(29,353	)
Purchases of property and equipment		(354	)		(113	)
Proceeds from sale of property and equipment		7			—
Additional costs of previous acquisition		(139	)		—
Net change in restricted cash		2,148			24
Software product and content development costs		(971	)		(589	)
Maturities and reclassifications of investments		747			2,055
Proceeds of investments		179			3,063
Purchase of investments		(170	)		—
Net cash provided by (used in) investing activities		1,447			(24,913	)
Cash flows from financing activities
Proceeds from issuance of term note		—			20,000
Proceeds from issuance of convertible note		—			5,000
Payment of financing costs		—			(1,339	)
Payment on note payable		(1,500	)		—
Payment on long-term debt		(2,000	)		—
Proceeds from exercise of common stock options		1,089			502
Repayments on capital leases		(100	)		(236	)
Net cash provided by (used in) financing activities		(2,511	)		23,927
Increase in cash and cash equivalents		4,051			1,469
Cash and cash equivalents, beginning of period		6,382			2.816
Cash and cash equivalents, end of period	$	10,433		$	4,285
Interest paid	$	2,265		$	1,350

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

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A.D.A.M., Inc.

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2007

1. BUSINESS AND BASIS OF PRESENTATION

Business

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

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and the general instructions to Form 10-Q. Accordingly, certain information and footnotes required by GAAP for complete financial statements may be condensed or omitted. These interim financial statements should be read in conjunction with our audited financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from those estimates.

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

Operating results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007 or any future period.

2. STOCK-BASED COMPENSATION

On January 14, 1999, certain option grants were canceled at the election of their holders and then replaced that day on a one-for-one basis with new options with an exercise price equal to the closing market price that day, $5.25. These options were accounted for in accordance with FASB Interpretation No. 44 (“FIN 44”), “Accounting for Certain Transactions involving Stock Compensation (an interpretation of APB 25)”, which provides guidance on the accounting for certain stock option transactions and subsequent amendments to stock option transactions. FIN 44 requires compensation cost for these variably priced options to be recorded to the extent that the current market price exceeds the options’ grant price. The expense is to be adjusted for increases or decreases in the intrinsic value of the modified awards in subsequent periods and until the awards have been exercised, forfeited, or expired. We had 170,149 variably priced options outstanding at May 22, 2007 and 173,149 at December 31, 2006, all of which had fully vested by January 2002 and were accounted for under FIN 44 (see paragraph below for modifications).

On May 22, 2007, the term of these variably priced options was modified. This modification is accounted for in accordance with the SFAS 123(R) modification provisions. The modified options resulted in an incremental cost of $16,103 on the modification date since the options were fully vested. As a result of the modification, all compensation cost associated with the options will have been recorded as of the modification date and variable accounting will no longer apply. Including this incremental modification cost, we recorded stock-based compensation expense (benefit) of $0 and $133,000 for the three months ended September 30, 2007 and 2006, respectively and $47,000 and $(44,000) for the nine months ended September 30, 2007 and 2006, respectively.

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 123 (revised 2004) (“Statement 123(R)”), “Share-Based Payment,” which is a revision of FASB Statement No. 123 (“Statement 123”), “Accounting for Stock-Based Compensation.” Statement 123(R) supersedes APB Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and amends FASB Statement No. 95, “Statement of Cash Flows.” The approach to accounting for share-based payments in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values and no longer allows pro forma disclosure as an alternative to financial statement recognition.

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

On May 22, 2007, certain 2006 granted options were modified for the service and performance vesting conditions. This modification is accounted for in accordance with the SFAS 123(R) modification provisions. The vesting criteria changed from service and performance based in 2007, 2008 and 2009 to performance based in 2007 and service based in 2008 and 2009. At the modification date we did not believe that it was probable that certain performance targets would be met, but did believe that the new performance targets would be met. A new fair value associated with the options was calculated at the date of modification and this cumulative compensation cost will be recognized over the vesting period of the options.

In accordance with SFAS 123(R), we recorded stock-based compensation expense of $255,000 and $448,000 for the three and nine months ended September 30, 2007, respectively, not including the variably priced options described above. We recorded a stock-based compensation expense of $122,000 and $164,000 for the three and nine months ended September 30, 2006, respectively. Had we continued to account for these options under APB 25 we would have recorded no such expense. After recording the expense through September 30, 2007, there remained approximately $1,139,000 of unrecognized compensation cost related to unvested employee stock options to be recognized over the next 2.7 years.

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

• Expected Dividend Yield – because we do not currently pay dividends, our expected dividend yield is zero,

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

• Risk-free Interest Rate – reflects the average rate on a United States treasury bond with maturity equal to the expected term of the option, and

• Expected Life of Stock Awards – the expected term of the options has been derived from historical employee exercise behavior.

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

Nine Months Ended September 30,	2007			2006
Expected Dividend Yield		—			—
Expected Volatility in Stock Price		50.42	%		73.58	%
Risk-Free Interest Rate		4.84	%		4.73	%
Expected Life of Stock Awards – Years		3.40			3.50
Weighted Average Fair Value at Grant Date	$	2.67		$	3.02

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

The following table summarizes stock option activity for the nine months ended September 30, 2007:

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Life	Aggregate Intrinsic Value
Outstanding at December 31, 2006	3,248,392		$	4.45	—		—
Granted	331,725		$	6.29
Exercised	(470,375	)	$	3.81	—		—
Canceled or expired	(238,817	)	$	5.44	—		—
Outstanding at September 30, 2007	2,870,925		$	4.93	5.20	$	6,796
Exercisable at September 30, 2007	2,136,575		$	4.62	3.83	$	6,287

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Intrinsic value was calculated by multiplying the number of options times the amount by which our market price at September 30, 2007 exceeded the strike price for each option. The market price at September 30, 2007 was $7.79.

3. ACQUISITION OF ONLINEBENEFITS, INC. AND SUBSIDIARIES

On August 14, 2006, A.D.A.M. acquired all of the outstanding capital stock of OnlineBenefits, Inc. and its subsidiaries (collectively, “OnlineBenefits”) from the shareholders thereof for an aggregate purchase price of $33,676,000, which was comprised of $29,500,000 in cash, 529,100 shares of our common stock having a value of $3,000,000, and $1,176,000 in transaction costs pursuant to an agreement and plan of merger.

The acquisition of OnlineBenefits expanded our distribution and customer base. The results of operations of OnlineBenefits commencing on August 14, 2006 are included in the accompanying consolidated financial statements.

The allocation of the purchase price consideration paid at closing to the assets acquired and liabilities assumed was based upon estimates of the fair market value of the acquired assets and assumed liabilities in accordance with Financial Accounting Standards Board Statement No. 141, “Business Combinations” (“FAS 141”). The fair values assigned to the intangibles acquired were formulated based on an independent third-party evaluation.

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

Issuance of common stock	$	3,000
Cash paid		29,500
Total consideration paid to sellers		32,500
Additional cash paid for transaction costs		1,176
Total purchase price		33,676
Less: noncash item of issuance of common stock		(3,000	)
Less: cash acquired in the acquisition		(1,548	)
Net cash paid for acquisition	$	29,128

In addition, we established escrow deposit accounts related to the acquisition of OnlineBenefits, which have been recorded on the accompanying consolidated balance sheet in restricted cash at December 31, 2006. The restricted cash related to the acquisition was paid in full in January 2007.

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

Assets acquired:
Current assets	$	5,289
Property and equipment		549
Intangible asset – customer list		8,800
Intangible asset – technology		500
Long-term assets		157
Total assets acquired		15,295
Liabilities assumed:
Current liabilities		(5,858	)
Non-current liabilities		(1,601	)
Total liabilities assumed		(7,459	)
Net assets acquired		7,836
Costs in excess of net assets acquired (recorded goodwill)		25,840
Total fair value of net assets acquired and goodwill	$	33,676

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4. DEBT

Note Payable

During August 2006, we assumed $1,500,000 of debt associated with the acquisition of OnlineBenefits. This debt was secured by a first priority lien on the software product OnlineBenefits developed under a Joint Development Agreement and a second priority lien on all other assets of OnlineBenefits so long as any Senior Obligations, as defined under the Agreement, were outstanding after which this debt would be secured by all the assets of OnlineBenefits. Accrued interest, at the 8% rate per annum, amounted to approximately $590,000 at December 31, 2006. At December 31, 2006, we had $2,148,000 in Restricted Cash for the payment of principal and interest related to this note, as the note was in dispute with the creditor at the acquisition date.

In January 2007, the dispute with the creditor was settled and the note and accrued interest were paid in full from Restricted Cash.

Long-term debt

Associated with the acquisition of OnlineBenefits, we entered into a credit agreement (“Credit Agreement”) with Capital Source Finance LLC (“Lender”). The Credit Agreement, with related balances at September 30, 2007, is summarized below (numbers in column are in thousands):

$2,000,000 revolver with Lender – principal repayable in full in August 2011; interest at LIBOR plus 4% or the prime rate (7.75% at September 30, 2007) plus 2.75%, payable quarterly in arrears; revolver unused facility fee of 0.5% per annum of the average daily balance of the unused portion, payable monthly in arrears	$	—
$20,000,000 term loan with Lender – principal repayable in quarterly installments of varying amounts ($1.0 million from June 2008 through September 2008, $1.25 million from December 2008 through September 2010, and $1.5 million from December 2010 through June 2011), interest same as revolver; prepayment premium of either 2% (prior to first anniversary) or 1% (between first and second anniversary) of prepaid amount		18,000
$5,000,000 convertible note with Lender – principal repayable in full in August 2011; interest at LIBOR plus 2.5% or the prime rate plus 1.25%, payable quarterly in arrears; prepayment premium same as term loan; all or any portion of the principal balance is convertible at the option of the Lender into common stock of the Company at a conversion price per share as defined in the agreement		5,000
	$	23,000

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

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

The deferred financing fees related to this debt were a gross amount of $1,340,000 with an accumulated amortization of approximately $407,000 and $140,000 as of September 30, 2007 and December 31, 2006, respectively.

We entered into the First Amendment to the Credit Agreement, dated March 20, 2007, which modified certain terms of the agreement, including certain covenant ratios. The repayment terms were also modified to provide for a single payment of $2,000,000 on March 19, 2007 in lieu of two payments of $1,000,000, each due on December 31, 2007 and March 31, 2008. No other changes were made to the remaining payment terms.

5. INVESTMENTS

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

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At September 30, 2007, we did not hold short-term investments.

At December 31, 2006, our short-term investments included the following (in thousands):

Description	Balance		Purchased	Maturity	Yield at December 31, 2006
Mutual Funds
– AIM Floating Fund	$	858	January 18, 2006	January 18, 2007	5.70	%
Total Short-term Investments	$	858

6. INTANGIBLE ASSETS

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

Capitalized software product and content development costs to be sold, leased or otherwise marketed consist principally of salaries and certain other expenses directly related to the development and modifications of software products and content 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 two years.

In accordance with the American Institute of Certified Public Accountants’ 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, generally three years.

Intangible assets are summarized as follows (in thousands):

	Estimated amortizable lives (years)	September 30, 2007			December 31, 2006
Intangible Assets:
Capitalized software products and content to be sold, leased or otherwise marketed	2 – 3	$	5,720		$	4,749
Software developed for internal use	3		339			339
Purchased intellectual content	3		1,431			1,431
Purchased customer contracts	2		333			333
Purchased customer relationships	15		8,800			8,800
Intangible assets, gross			16,623			15,652
Accumulated amortization:
Capitalized software products and content to be sold, leased or otherwise marketed			(3,668	)		(3,181	)
Software developed for internal use			(286	)		(207	)
Purchased intellectual content			(1,431	)		(1,431	)
Purchased customer contracts			(333	)		(333	)
Purchased customer relationships			(664	)		(224	)
Accumulated amortization			(6,382	)		(5,376	)
Intangible assets, net		$	10,241		$	10,276

Amortization expense for the three and nine months ended September 30, 2007 was $371,000 and $1,006,000, respectively.

Amortization expense for the three and nine months ended September 30, 2006 was $257,000 and $634,000, respectively.

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7. NET INCOME PER COMMON SHARE

We compute basic net income per share by dividing net income by the weighted average number of common shares outstanding for each period. Diluted net income per share is based upon the addition of the effect of common stock equivalents (stock options, and convertible debt) to the denominator of the basic net income per share calculation using the treasury stock method if their effect is dilutive. The computation of net income per share for the three and nine months ended September 30, 2007 and 2006 is as follows (in thousands, except per share data):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Net income	$	788	$	486	$	2,115	$	2,165
Weighted average common shares outstanding – basic		9,575		8,711		9,404		8,487
Common share equivalents (stock options)		1,012		1,385		922		1,592
Weighted average common shares outstanding – diluted		10,587		10,096		10,326		10,079
Net income per share:
Basic	$	0.08	$	0.06	$	0.22	$	0.26
Diluted	$	0.07	$	0.05	$	0.20	$	0.21
Anti-dilutive stock options and convertible debt		1,041		829		1,041		564

8. RELATED PARTY TRANSACTIONS

Investment and Sublease with BeBetter Networks, Inc.

At September 30, 2007 and December 31, 2006, we had a 2% investment in BeBetter Networks, Inc. (“BeBetter”). As of September 30, 2007 and December 31, 2006, our Chairman of the Board of Directors held an approximate 2% voting interest in BeBetter. We account for the investment under the cost method as we have less than a 20% ownership and do not exercise significant influence over BeBetter.

At September 30, 2007 and December 31, 2006, the carrying value of our investment in BeBetter was $0. We have no plans to make additional investments in BeBetter in the future.

Investment and Sublease with ThePort Network, Inc.

As of September 30, 2007 and December 31, 2006, we held an approximate 29% voting interest in ThePort Network, Inc. (“ThePort”). Our Chairman of the Board of Directors, who also currently serves as the Chairman of the Board of Directors and CEO of ThePort, held an approximate 9% voting interest in ThePort at September 30, 2007 and December 31, 2006 and held notes and convertible notes from and made loans to ThePort in the amount of approximately $3,075,000 and $1,699,000 at September 30, 2007 and December 31, 2006, respectively. Two of our other directors also own equity interests in ThePort. The investment is being accounted for under the equity method (see Note 1 to the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2006).

At September 30, 2007 and December 31, 2006, the carrying value of our investment in ThePort was $0. We have not adjusted our investment below zero for our share of ThePort’s losses since then and through September 30, 2007, as we have not provided or committed to provide any additional financial support to ThePort.

9. COMMITMENTS AND CONTINGENCIES

Leases

We lease office space and equipment under non-cancelable lease agreements expiring on various dates through 2011. 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.

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At September 30, 2007, future minimum rentals for noncancelable leases with terms in excess of one year and total payments under license agreements for the remainder of 2007 and beyond were as follows (in thousands):

	License Agreements		Real Estate Leases		Other Operating Leases		Capital Leases
2007	$	41	$	420	$	37	$	47
2008		98		1,594		72		116
2009		—		1,465		46		46
2010		—		1,530		27		21
2011		—		784		5		16
Total future minimum lease payments and payments under license agreements	$	139	$	5,793	$	187		246
Less – amounts representing interest								(12	)
Present value of future minimum lease payments								233
Less – current portion								(120	)
							$	113

Rent expense for the three and nine months ended September 30, 2007 was $246,000 and $732,000, respectively. Rent expense for the three and nine months ended September 30, 2006 was $143,000 and $263,000, respectively.

Our headquarters is located in approximately 12,000 square feet of leased office space in Atlanta, Georgia. The space is leased for a term ending in September 2008. We have additional leased office space of 35,806 square feet in Uniondale, New York. The space is leased for a term ending in June 2011. Approximately 20,200 square feet is sublet to unrelated third parties for a term ending in June 2011 for an amount of $37,000 per month. The difference between our lease rate and the income from the sublease contracts, present valued, amounted to $1,114,000 and $1,332,000 at September 30, 2007 and December 31, 2006, respectively, and has been recorded as a liability on our accompanying consolidated balance sheets as part of our acquisition adjustments related to OnlineBenefits. This liability will be amortized over the term of the lease.

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.

10. CONCENTRATIONS

No one customer accounted for more than 10% of our revenues during the three and nine months ended September 30, 2007 and September 30, 2006.

11. INCOME TAXES

For the three and nine months ended September 30, 2007, we recorded an income tax provision of $299,400 and $ 803,700, or 38% (our estimated effective tax rate) of our pretax income. Additionally, we performed our quarterly evaluation of the deferred tax asset and the related valuation allowance as of September 30, 2007. Based on our analysis for the three months ended September 30, 2007, we reduced the valuation allowance by $299,400. These two transactions fully offset one another and therefore our income tax provision was $0 for the three and nine months ended September 30, 2007. The September 30, 2007 deferred tax asset balance of $5,500,000 also remained unchanged from December 31, 2006. As a result of realizing this additional $299,400 of our deferred tax asset, we reduced the related valuation allowance to $17,158,000 at September 30, 2007 from $17,953,000 at December 31, 2006.

For the three and nine months ended September 30, 2006, we recorded an income tax provision of $185,000 and $823,000, or 38% (our estimated effective tax rate) of our pretax income. Additionally, we performed our quarterly evaluation of the deferred tax asset and the related valuation allowance as of September 30, 2006. Based on our analysis for the three months ended September 30, 2006, we reduced the valuation allowance by $185,000. These two transactions fully offset one another and therefore our income tax provision was $0 for the three months ended September 30, 2006. The September 30, 2006 deferred tax asset balance of $5,500,000 also remained unchanged from December 31, 2005. As a result of realizing this additional $185,000 of our deferred tax asset, we reduced the related valuation allowance to $9,153,000 at September 30, 2006 from $9,976,000 at December 31, 2005.

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At September 30, 2007, we had net operating loss “(NOL)” and research and development “(R&D)” credit carryforwards available for tax purposes of approximately $63 million and $1 million, respectively, both of which will expire on December 31 in years 2007 through 2022 and 2007 through 2023, respectively. Approximately $30 million of the net operating loss carryforwards are attributable to OnlineBenefits.

We adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”) on January 1, 2007. FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. We recognized tax benefits from all tax positions we have taken, and there has been no material adjustment to any carryforwards NOL or R&D credits) as a result of the implementation of FIN 48. Therefore, there are no material unrecognized tax benefits and related FIN 48 tax liabilities at September 30, 2007. In addition, future changes in the unrecognized tax benefits will likely have no impact on our effective tax rate due to the existence of the valuation allowance.

As of September 30, 2007, we have no accrual requirement for interest or penalties related to uncertain tax positions since the tax benefits have not been included in prior income tax return filings. Accrued interest relating to uncertain tax positions would be recorded as a component of interest expense and penalties related to uncertain tax positions would be recorded as a component of general and administrative expenses.

The tax years 2003 to 2006 remain open to examination by the major taxing jurisdictions to which we are subject. Additionally, upon inclusion of the NOL and R&D credit carry forward tax benefits from tax years 2006 to 2023 in future tax returns, the related tax benefit for the period in which the benefit arose may be subject to examination.

12. LEGAL PROCEEDINGS

From time to time we are involved in legal actions arising in the normal course of business. Although the final outcome of existing matters cannot be determined, it is our opinion the final resolution of these matters, if any, would not have a material adverse effect on our financial position.

13. SUBSEQUENT EVENTS

On October 24, 2007, the Company and the Chief Operations Officer of its OnlineBenefits subsidiary, John Gedney, agreed that the Company would terminate Mr. Gedney’s employment agreement with the Company without cause effective as of January 1, 2008. Under the terms of the agreement, the Company will pay Mr. Gedney $375,000 over the next eighteen months plus $53,750 of his earned but unpaid bonus for 2007, and reimburse Mr. Gedney for certain health insurance and life insurance costs for a period of 18 months following the date of termination in January 2008.

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

GENERAL

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

Our highly illustrated and interactive health content can be used for learning about general health concerns, specific diseases, medical conditions and treatments, surgical procedures, drug information, wellness topics, alternative medicine and more. We also develop decision support products, such as our Health Risk Assessment library and DecisionAssist tools that guide consumers in making good healthcare decisions by better understanding their health condition and needs. Our content products and decision support tools are sold primarily through annual licensing agreements to a variety of healthcare and health-related organizations, including hospitals, health plans, pharmaceutical companies, care management vendors, health-oriented Internet websites, and healthcare technology companies. While our content products are mostly licensed for online use, they can also be delivered in a printed or CD-ROM format.

Our benefits management solutions include Benergy™, an award-winning, employer and employee self-service portal to administer, learn about, enroll in, and manage benefits. Benergy reduces costs by automating many HR and benefits tasks

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and serves as a communication vehicle between employer and employee. With A.D.A.M.’s high-quality health content and tools, this solution also serves as a health management platform ideal for consumer driven health plans. Benergy is distributed primarily to the small to mid-size employer market through annual licensing agreements with benefits brokers and benefits consultants.

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

Critical Accounting Policies and Estimates

Discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the amounts reported in the consolidated financial statements and the accompanying notes. On an on-going basis, we evaluate our estimates, including those related to product returns, product and content development expenses, bad debts, intangible assets, income taxes and contingencies. We base our estimates on experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

• Revenue Recognition

We 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) collectability is reasonably assured.

We generate revenues mainly in three ways – licensing, professional services and product sales. Licensing revenue is recognized ratably over the term of the license agreement beginning after delivery has occurred and when we have determined that the fees from the agreement are fixed and determinable and there are no significant returns or acceptance provisions. When a contract includes multiple elements, such as services, the entire fee is allocated to each respective element based on vendor specific objective evidence of fair value, and recognized when the revenue criteria for each element is met. Service revenues are generally recognized upon completion and acceptance by the customer. For revenue arrangements in which we sell through a reseller, we do not recognize revenue until an agreement has been finalized between the customer and our authorized reseller and the content has been delivered to the customer by the reseller. Revenue is not recognized unless collectability is reasonably assured. Revenues from product sales are generally recognized at the time title passes to customers, distributors or resellers. Revenues from royalty agreements are recognized as earned based upon performance or product shipment.

• Capitalized Software Product and Content Development Costs

We capitalize software product and content development costs in accordance with Financial Accounting Standards Board Statement No. 86 (“FAS 86”), “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” This statement specifies that costs incurred internally in creating a computer software product shall be charged to expense when incurred as research and development until technological feasibility has been established for the product. Technological feasibility is established upon completion of all planning, designing, and testing activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements. We cease capitalization of internally developed software when the product is made available for general release to customers and thereafter, any maintenance and customer support is charged to expense when related revenue is recognized or when those costs are incurred. We amortize such capitalized costs as cost of revenues on a product-by-product basis using the greater of the ratio of current product revenue to the total of current and anticipated product revenue or on a straight line basis over the estimated life of the software, which we have determined to generally be two years. We continually evaluate the recoverability of capitalized costs and if the successes of new product releases are less than we anticipate then a write-down of capitalized costs may be made which could adversely affect our results in the reporting period in which the write-down occurs.

We also capitalize internal software development costs in accordance with the American Institute of Certified Public Accountants’ Statement of Position 98-1 (“SOP 98-1”), “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” This statement specifies that computer software development costs for computer software intended for internal use occurs in three stages: (1) the preliminary project stage, where costs are expensed as incurred, (2) the application

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development stage, where costs are capitalized, and (3) the post-implementation or operation stage, where again costs are expensed as incurred. We cease capitalization of developed software for internal use when the software is ready for its intended use and placed in service. We amortize such capitalized costs as cost of revenues on a product-by-product basis using the straight-line method over a period of three years. We continually evaluate the usability of the products that make up our capitalized costs and if certain circumstances arise such as the introduction of new technology in the marketplace that management intends to use in place of the capitalized project, then a write-down of capitalized costs may be made which could adversely affect our results in the reporting period in which the write-down occurs.

• Goodwill and Intangible Assets

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” we evaluate goodwill and intangible assets for impairment on an annual basis. Additionally, goodwill is tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of an entity below its carrying value. These events or circumstances would include a significant change in the business climate, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business or other factors. The carrying value of goodwill is evaluated in relation to the operating performance and estimated future discounted cash flows of the entity.

• Income Taxes

As part of the process of preparing our consolidated financial statements we are required to estimate our taxes in each of the jurisdictions in which we operate. This process involves management estimating the actual tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and U.S. GAAP purposes. These differences result in deferred tax assets and liabilities, which are included within our accompanying consolidated balance sheet. We must then assess the likelihood that deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance.

• Stock-based Compensation

On January 1, 2006, we adopted SFAS No. 123(R) using the modified prospective application transition approach method. We recorded stock-based compensation expense of $ 255,000 and $495,000 for the three and nine months ended September 30, 2007, respectively. We recorded a stock-based compensation expense of $255,000 and $120,000 for the three and nine months ended September 30, 2006, respectively. Had we continued to account for these options under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” we would have recorded no such expense. We expect to incur approximately $1,139,000 of expense over the next 2.7 years for all unvested options outstanding at September 30, 2007.

RESULTS OF OPERATIONS

Comparison of the Three Months Ended September 30, 2007 with the Three Months Ended September 30, 2006

Certain prior period items have been reclassified to conform to the current period presentation. The Product revenue classification was labeled Education for the three months ended September 30, 2006.

Revenues

	Three Months Ended September 30,
	2007		2006		$ Change		% Change		2007 % of Total Rev		2006 % of Total Rev
A.D.A.M., Inc. Consolidated
Licensing	$	5,822	$	3,915	$	1,907	48.7	%	87.2	%	87.5	%
Product		390		368		22	6.0	%	5.8	%	8.2	%
Professional services and other		464		190		274	144.2	%	7.0	%	4.3	%
Total Net Revenues	$	6,676	$	4,473	$	2,203	49.3	%	100.0	%	100.0	%

We acquired OnlineBenefits on August 14, 2006, and, accordingly, the results of OnlineBenefits are included in the consolidated operating results subsequent to the acquisition. To facilitate the review of the results for the comparable period, the table below shows the results of our operating units excluding the amounts reported by OnlineBenefits.

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	Three Months Ended September 30,
	2007		2006		$ Change			% Change		2007 % of Total Rev		2006 % of Total Rev
A.D.A.M., Inc. excluding OnlineBenefits
Licensing	$	2,524	$	2,250	$	274		12.2	%	85.5	%	83.2	%
Product		390		368		22		6.0	%	13.2	%	13.6	%
Professional services and other		39		88		(49	)	(55.7	)%	1.3	%	3.2	%
Total Net Revenues	$	2,953	$	2,706	$	247		9.1	%	100.0	%	100.0	%

Total net revenues increased 49.3%, or $2,203,000, to $6,676,000 for the three months ended September 30, 2007 compared to $4,473,000 for the three months ended September 30, 2006. Revenues from OnlineBenefits for the three months ended September 30, 2007 accounted for $3,723,000 of the net increase. Excluding the results of OnlineBenefits, total revenue increased $247,000 or 9.1% for the three months ended September 30, 2007 compared to the three months ended September 30, 2006.

Licensing revenues increased 48.7%, or $1,907,000, to $5,822,000 for the three months ended September 30, 2007 compared to $3,915,000 for the three months ended September 30, 2006. Licensing revenues are derived from licensing our products primarily to healthcare organizations, technology companies, benefit brokers, employers, and internet customers. OnlineBenefits licensing revenue from benefit brokers and employers accounted for $1,633,000 of the total $1,907,000 increase in licensing revenue for the three months ended September 30, 2007.

Excluding the results of OnlineBenefits, licensing revenue increased 12.2%, or $274,000, to $2,524,000 for the three months ended September 30, 2007 compared to $2,250,000 for the three months ended September 30, 2006. Licensing revenue increased by $138,000 and $126,000 in internet and healthcare, respectively as a the result of new customer contracts. As a percent of total revenues, revenues from licensing were 85.5% of revenue for the three months ended September 30, 2007 compared to 83.2% for the three months ended September 30, 2006.

Revenues from product sales increased 6.0%, or $22,000, to $390,000 for the three months ended September 30, 2007 compared to $368,000 for the three months ended September 30, 2006. Product revenues consist primarily of our A.D.A.M. product sales to the educational market. The increase in 2007 was attributable to increased volume from our distribution partners, both domestic and international, in our education markets. As a percent of total revenues, A.D.A.M revenues from product sales were 13.2% for the three months ended September 30, 2007 compared to 13.6% for the three months ended September 30, 2006.

Professional services and other revenues increased 144.2%, or $274,000, to $464,000 for the three months ended September 30, 2007 compared to $190,000 for the three months ended September 30, 2006. Professional services and other revenue are derived from products such as administrative service provider services, direct to consumer products, custom implementation services, and sales of nonrecurring products such as books, subscriptions, and images. OnlineBenefits and its related administrative service provider business accounted for $425,000 of the total revenue for professional services and other. Excluding Online Benefits, professional services and other revenue decreased 55.7%, or $49,000, to $39,000 for the three months ended September 30, 2007 compared to $88,000 for the three months ended September 30, 2006. As a percentage of total revenues, excluding OnlineBenefits, the professional services and other revenues accounted for approximately 1.3% for the three months ended September 30, 2007 compared to 3.2% for the three months ended September 30, 2006.

Operating Costs and Expenses

Certain prior period items have been reclassified to conform to the current period presentation. This reclassification primarily relates to the allocation of depreciation and amortization to the related categories.

	Three Months Ended September 30,
	2007		2006		$ Change		% Change		2007 % of Revenue		2006 % of Revenue
A.D.A.M., Inc. Consolidated
Cost of revenues	$	1,095	$	587	$	508	86.5	%	16.4	%	13.1	%
Cost of revenues – amortization		371		257		114	44.4	%	5.6	%	5.7	%
Product and content development		1,107		874		233	26.7	%	16.6	%	19.5	%
Sales and marketing		1,338		801		537	67.0	%	20.0	%	17.9	%
General and administrative		1,420		1,274		146	11.5	%	21.3	%	28.5	%
Total Operating Costs and Expenses	$	5,331	$	3,793	$	1,538	40.5	%	79.8	%	84.8	%

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We acquired OnlineBenefits on August 14, 2006, and accordingly, the results of OnlineBenefits are included in the consolidated operating results subsequent to the acquisition. To facilitate the review of the results for the comparable period, the table below shows the results of just our operating units and excludes the amounts reported by OnlineBenefits.

	Three Months Ended September 30,
	2007		2006		$ Change			% Change		2007 % of Revenue		2006 % of Revenue
A.D.A.M., Inc. excluding OnlineBenefits
Cost of revenues	$	39	$	305	$	(266	)	(87.2	)%	1.3	%	11.3	%
Cost of revenues – amortization		149		158		(9	)	(5.7	)%	5.0	%	5.8	%
Product and content development		593		384		209		54.4	%	20.1	%	14.2	%
Sales and marketing		779		447		332		74.3	%	26.4	%	16.5	%
General and administrative		1,140		961		179		18.6	%	38.6	%	35.5	%
Total Operating Costs and Expenses	$	2,700	$	2,255	$	445		19.7	%	91.5	%	83.3	%

Cost of revenues increased $508,000, or 86.5%, to $1,095,000 for the three months ended September 30, 2007 compared to $587,000 for the three months ended September 30, 2006. Cost of revenues consists primarily of royalties and distribution license fees, production costs for product sales, and personnel support for our benefit and broker management products. OnlineBenefits’ cost of revenues accounted for $669,000 of the total cost of revenues for the three months ended September 30, 2007. Excluding the results of OnlineBenefits, cost of revenues decreased 87.2% or $266,000 for the three months ended September 30, 2007. The decrease in cost of revenues is primarily attributable to the expiration of licensing agreements related to licensed healthcare content. As a percent of total revenues, cost of revenues, excluding OnlineBenefits, was 1.3% for the three months ended September 30, 2007 compared to 11.3% for the three months ended September 30, 2006.

Cost of revenues – amortization increased $114,000, or 44.4%, to $371,000 for the three months ended September 30, 2007 compared to $257,000 for the three months ended September 30, 2006. Cost of revenues – amortization consists primarily of costs associated with amortization of capitalized customer lists, software product, and content development costs. OnlineBenefits’ cost of revenues – amortization related to amortization of acquired customer lists and software product was $222,000 for the three months ended September 30, 2007. Excluding the results of OnlineBenefits, cost of revenues – amortization decreased $9,000, or 5.7% for the three months ended September 30, 2007. This decrease is related to capital projects prior to 2007 that became fully amortized. As a percent of total revenues, cost of revenues – amortization, excluding OnlineBenefits, was 5.0% for the three months ended September 30, 2007 compared to 5.8% for the three months ended September 30, 2006.

Product and content development expenses increased $233,000, or 26.7%, to $1,107,000 for the three months ended September 30, 2007 from $874,000 for the three months ended September 30, 2006. This increase was primarily attributable to the acquisition of OnlineBenefits. The increase attributable to OnlineBenefits product and development costs was $24,000. The remaining $209,000 increase is primarily attributable to $78,000 of develop costs expensed versus capitalized for work to design and maintain new and existing products and $116,000 of allocated support related costs for product and content development. As a percent of total revenues, product and content development expenses, excluding OnlineBenefits, were 20.1% for the three months ended September 30, 2007 compared to 14.2% for the three months ended September 30, 2006.

Sales and marketing expenses increased $537,000, or 67.2%, to $1,338,000 for the three months ended September 30, 2007 from $801,000 for the three months ended September 30, 2006. OnlineBenefits accounted for $205,000 of the total sales and marketing expense increase. The remaining $332,000 increase is primarily attributable to $139,000 of additional salary from increased sales staff and $88,000 of allocated support related costs for the sales and marketing departments. As a percent of total revenues, sales and marketing expenses, excluding OnlineBenefits, were 26.4% for the three months ended September 30, 2007 compared to 16.5% for the three months ended September 30, 2006.

General and administrative expenses increased $146,000, or 11.5%, to $1,420,000 for the three months ended September 30, 2007 from $1,274,000 for the three months ended September 30, 2006. OnlineBenefits’ general and administrative expenses accounted for a decrease of $33,000. The additional $179,000 was primarily related to a $144,000 increase in salary and compensation expense and $200,000 in consulting costs primarily related to SOX compliance. These increases were partially offset by a decrease of $204,000 of allocated support related cost. As a percent of total revenues, general and administrative expenses, excluding OnlineBenefits, were 38.6% for the three months ended September 30, 2007 compared to 35.5% for the three months ended September 30, 2006.

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As a result of the factors described above, operating profit increased $665,000 to $1,345,000 for the three months ended September 30, 2007 compared to an operating profit of $680,000 for the three months ended September 30, 2006.

Other Expenses and Income

Interest expense was $626,000 and $372,000 for the three months ended September 30, 2007 and 2006, respectively. This increase in interest expense was primarily due to higher borrowing levels on loans secured to finance the acquisition of OnlineBenefits.

Interest income was $69,000 and $178,000 for the three months ended September 30, 2007 and 2006, respectively. This decrease was primarily due to higher levels of cash investments for the three months ended September 30, 2006 compared to three months ended September 30, 2007. This decrease in cash was attributable to the cash used in the purchase of OnlineBenefits.

Net Income

As a result of the factors described above, net income increased $302,000 to $788,000 for the three months ended September 30, 2007 compared to net income of $486,000 for the three months ended September 30, 2006.

Comparison of the Nine Months Ended September 30, 2007 with the Nine Months Ended September 30, 2006

Certain prior period items have been reclassified to conform to the current period presentation. The Product revenue classification was labeled Education for the nine months ended September 30, 2006.

Revenues

	Nine Months Ended September 30,				$ Change		% Change		2007 % of Total Rev		2006 % of Total Rev
	2007		2006
A.D.A.M., Inc. Consolidated
Licensing	$	17,380	$	8,152	$	9,228	113.2	%	85.8	%	84.3	%
Product		1,312		1,110		202	18.2	%	6.5	%	11.5	%
Professional services and other		1,553		408		1,145	280.6	%	7.7	%	4.2	%
Total Net Revenues	$	20,245	$	9,670	$	10,575	109.4	%	100.0	%	100.0	%

We acquired OnlineBenefits on August 14, 2006, and accordingly, the results of OnlineBenefits are included in the consolidated operating results subsequent to the acquisition. In order to facilitate the review of the results for the comparable period, the table below shows the results of our operating units excluding the amounts reported by OnlineBenefits.

	Nine Months Ended September 30,				$ Change		% Change		2007 % of Total Rev		2006 % of Total Rev
	2007		2006
A.D.A.M., Inc. excluding OnlineBenefits
Licensing	$	7,343	$	6,486	$	857	13.2	%	81.7	%	82.1	%
Product		1,312		1,110		202	18.2	%	14.6	%	14.0	%
Professional services and other		335		306		29	9.5	%	3.7	%	3.9	%
Total Net Revenues	$	8,990	$	7,902	$	1,088	13.8	%	100.0	%	100.0	%

Total net revenues increased 109.4%, or $10,575,000 to $20,245,000 for the nine months ended September 30, 2007 compared to $9,670,000 for the nine months ended September 30, 2006. Revenues from OnlineBenefits for the nine months ended September 30, 2007 accounted for $9,487,000 of the net increase. Excluding the results of OnlineBenefits, total revenue increased $1,088,000 or 13.8% organically for the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006.

Licensing revenues increased 113.2%, or $9,228,000, to $17,380,000 for the nine months ended September 30, 2007 compared to $8,152,000 for the nine months ended September 30, 2006. Licensing revenues are derived from licensing our products primarily to healthcare organizations, technology companies, benefit brokers, employers, and internet customers. OnlineBenefits licensing revenue from benefit brokers and employers accounted for $8,371,000 of the total $9,228,000 increase in licensing revenue for the nine months ended September 30, 2007.

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Excluding the results of OnlineBenefits, licensing revenue increased 13.2%, or $857,000, to $7,343,000 for the nine months ended September 30, 2007 compared to $6,486,000 for the nine months ended September 30, 2006. This organic growth was from increased revenue of $457,000 and $264,000 in internet and managed healthcare, respectively, as a result of new customer contracts. As a percent of total revenues, revenues from licensing were 81.7% of revenue for the nine months ended September 30, 2007 compared to 82.1% for the nine months ended September 30, 2006.

Revenues from product sales increased 18.2%, or $202,000, to $1,312,000 for the nine months ended September 30, 2007 compared to $1,110,000 for the nine months ended September 30, 2006. Product revenues consist primarily of our A.D.A.M. product sales to the educational market. The increase in 2007 was attributable to increased volume from our distribution partners, both domestic and international, in our education markets. As a percent of total revenues, A.D.A.M. revenues from product sales were 14.6% for the nine months ended September 30, 2007 compared to 14.0% for the nine months ended September 30, 2006.

Professional services and other revenues increased 280.6%, or $1,145,000, to $1,553,000 for the nine months ended September 30, 2007 compared to $408,000 for the nine months ended September 30, 2006. Professional services and other revenue are derived from products such as administrative service provider services, direct to consumer products, custom implementation services, and sales of nonrecurring products such as books, subscriptions, and images. OnlineBenefits and its related administrative service provider business accounted for $1,218,000 of the total revenue for professional services and other. Excluding OnlineBenefits, the professional services and other revenues accounted for approximately 3.7% for the nine months ended September 30, 2007 compared to 3.9% for the nine months ended September 30, 2006.

Operating Costs and Expenses

Certain prior period items have been reclassified to conform to the current period presentation. This reclassification primarily relates to the allocation of depreciation and amortization to the related categories.

	Nine Months Ended September 30,				$ Change		% Change		2007 % of Revenue		2006 % of Revenue
	2007		2006
A.D.A.M., Inc. Consolidated
Cost of revenues	$	4,143	$	1,208	$	2,935	243.0	%	20.5	%	12.5	%
Cost of revenues – amortization		1,006		634		372	58.7	%	5.0	%	6.6	%
Product and content development		3,427		1,584		1,843	116.4	%	16.9	%	16.4	%
Sales and marketing		3,816		1,690		2,126	125.8	%	18.8	%	17.5	%
General and administrative		3,921		2,472		1,449	58.6	%	19.4	%	25.6	%
Total Operating Costs and Expenses	$	16,313	$	7,588	$	8,725	115.0	%	80.6	%	78.5	%

We acquired OnlineBenefits on August 14, 2006, and accordingly, the results of OnlineBenefits are included in the consolidated operating results subsequent to the acquisition. In order to facilitate the review of the results for the comparable period, the table below shows the results of our operating units excluding the amounts reported by OnlineBenefits.

	Nine Months Ended September 30,				$ Change			% Change		2007 % of Revenue		2006 % of Revenue
	2007		2006
A.D.A.M., Inc. excluding OnlineBenefits
Cost of revenues	$	792	$	926	$	(134	)	(14.5	)%	8.8	%	11.7	%
Cost of revenues – amortization		408		535		(127	)	(23.7	)%	4.5	%	6.8	%
Product and content development		1,727		1,094		633		57.9	%	19.2	%	13.8	%
Sales and marketing		2,073		1,336		737		55.2	%	23.1	%	16.9	%
General and administrative		2,942		2,160		782		36.2	%	32.7	%	27.3	%
Total Operating Costs and Expenses	$	7,942	$	6,051	$	1,891		31.3	%	88.3	%	76.6	%

Cost of revenues increased $2,935,000, or 243.0%, to $4,143,000 for the nine months ended September 30, 2007 compared to $1,208,000 for the nine months ended September 30, 2006. Cost of revenues consists primarily of royalties and distribution license fees, production costs for product sales, and personnel support for our benefit and broker management products. OnlineBenefits’ cost of revenues accounted for $3,351,000 of the total cost of revenues for the nine months ended September 30, 2007. Excluding the results of OnlineBenefits, cost of revenues decreased 14.5% or $134,000 for the nine months ended September 30, 2007. The decrease in cost of revenues is primarily attributable to the expiration of licensing agreements related to licensed healthcare content. As a percent of total revenues, cost of revenues, excluding OnlineBenefits, was 8.8% for the nine months ended September 30, 2007 compared to 11.7% for the nine months ended September 30, 2006.

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Cost of revenues – amortization increased $372,000, or 58.7%, to $1,006,000 for the nine months ended September 30, 2007 compared to $634,000 for the nine months ended September 30, 2006. Cost of revenues – amortization consists primarily of costs associated with amortization of capitalized customer lists, software product, and content development costs. OnlineBenefits’ cost of revenues – amortization related to amortization of acquired customer lists and software product was $598,000 for the nine months ended September 30, 2007. Excluding the results of OnlineBenefits, cost of revenues – amortization decreased $127,000, or 23.7% for the nine months ended September 30, 2007. This decrease is related to capital projects prior to 2007 that became fully amortized. As a percent of total revenues, cost of revenues – amortization, excluding OnlineBenefits, was 4.5% for the nine months ended September 30, 2007 compared to 6.8% for the nine months ended September 30, 2006.

Product and content development expenses increased $1,843,000, or 116.4%, to $3,427,000 for the nine months ended September 30, 2007 from $1,584,000 for the nine months ended September 30, 2006. This increase was primarily attributable to the acquisition of OnlineBenefits. OnlineBenefits incurred product and development costs of $1,700,000. The remaining $633,000 increase is primarily attributable to $174,000 of additional salary and related costs that will be used to enhance and develop new products and $343,000 of allocated support related costs for product and content development. As a percent of total revenues, product and content development expenses, excluding OnlineBenefits, were 19.2% for the nine months ended September 30, 2007 compared to 13.8% for the nine months ended September 30, 2006.

Sales and marketing expenses increased $2,126,000, or 125.8%, to $3,816,000 for the nine months ended September 30, 2007 from $1,690,000 for the nine months ended September 30, 2006. OnlineBenefits accounted for $1,743,000 of the total sales and marketing expense. The remaining $737,000 increase is primarily related to $130,000 of additional salary, $142,000 related to employee acquisition costs, $157,000 from additional marketing programs, and $225,000 of allocated support related costs for the sales and marketing departments. As a percent of total revenues, sales and marketing expenses, excluding OnlineBenefits, were 23.1% for the nine months ended September 30, 2007 compared to 16.9% for the nine months ended September 30, 2006.

General and administrative expenses increased $1,449,000, or 58.6%, to $3,921,000 for the nine months ended September 30, 2007 from $2,473,000 for the nine months ended September 30, 2006. OnlineBenefits’ general and administrative expenses accounted for $979,000 of this increase. The remaining $782,000 increase was primarily related to a $375,000 increase in our stock-based compensation expense, $584,000 increase in salary and compensation expense, $109,000 in travel, and $281,000 in consulting expense primarily related to compliance with the Sarbanes-Oxley Act of 2002 (“SOX”). These costs were partially offset by a decrease of $568,000 of allocated support related costs. As a percent of total revenues, general and administrative expenses, excluding OnlineBenefits, were 32.7% for the nine months ended September 30, 2007 compared to 27.3% for the nine months ended September 30, 2006.

As a result of the factors described above, operating profit increased $1,850,000 to $3,932,000 for the nine months ended September 30, 2007 compared to an operating profit of $2,082,000 for the nine months ended September 30, 2006.

Other Expenses and Income

Interest expense was $1,938,000 and $376,000 for the nine months ended September 30, 2007 and 2006, respectively. This increase in interest expense was primarily due to higher borrowing levels on loans secured to finance the acquisition of OnlineBenefits.

Interest income was $125,000 and $459,000 for the nine months ended September 30, 2007 and 2006, respectively. This decrease was primarily due to higher levels of cash investments for the first nine months of 2006 compared to the first nine months of 2007. This decrease in cash was attributable to the cash used in the purchase of OnlineBenefits.

Net Income

As a result of the factors described above, net income decreased $50,000 to $2,115,000 for the nine months ended September 30, 2007 compared to net income of $2,165,000 for the nine months ended September 30, 2006.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2007, we had cash and cash equivalents of $10,433,000 and working capital of $3,429,000.

Cash provided by operating activities was $5,115,000 during the nine months ended September 30, 2007, as compared to cash provided of $2,455,000 during the nine months ended September 30, 2006. This $2,660,000 increase was due primarily to an increase in net income (net of non-cash related add-backs such as depreciation and amortization and stock-based compensation expense) of $896,000, additional cash provided by deferred revenue of $1,355,000, a decrease in accounts receivable of $617,000, and a decrease in prepaids and other assets of $728,000. These decreases were partially offset by an increase in accounts payable and accrued liabilities related to payments of severance and accrued interest of $727,000.

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Cash provided by investing activities was $1,447,000 during the nine months ended September 30, 2007, as compared to cash used of $24,913,000 during the nine months ended September 30, 2006. This increase of $26,360,000 in cash inflow was primarily due to the August 2006 acquisition of OnlineBenefits of $29,353,000 and the January 2007 change in Restricted Cash related to the payment of the OnlineBenefits note payable of $2,148,000. This increase was partially offset by an increase in purchase of property and equipment of $241,000, an increase in software product and content development costs of $382,000, and decrease in proceeds from maturity and proceeds of short term investments of $4,192,000.

Cash used in financing activities was $2,511,000 during the nine months ended September 30, 2007, as compared to cash provided of $23,927,000 during the nine months ended September 30, 2006. The $26,438,000 decrease in cash inflow was primarily due to the proceeds from the note related to the acquisition of OnlineBenefits of $25,000,000, the OnlineBenefits note payable of $1,500,000, and the early payment of long term debt of $2,000,000. These payments were partially offset by $587,000 ofproceeds from the exercise of common stock options and the financing fee recorded in 2006 related to the OnlineBenefits acquisition of $1,339,000.

We also use working capital to finance ongoing operations, fund the development and introduction of new business strategies and internally developed software, acquire complementary businesses and acquire capital equipment.

Additional information regarding contracts, commitments, and debt that affect our liquidity and capital resources is provided in Note 4 (Debt) and Note 9 (Commitments and Contingencies) to the unaudited financial statements included in this report.

We believe our cash resources from cash, short-term investments, a $2 million revolver with our lender, together with anticipated cash flows from operations, will be sufficient to meet our working capital needs for the next twelve months. However, we may be required to raise additional funds to accelerate development of new and existing services and products, to respond to competitive pressures or to possibly acquire complementary products, businesses or technologies. There can be no assurance that any required additional financing will be available on terms favorable to us, or at all. If additional funds are raised by the issuance of equity securities, our shareholders would experience dilution of their ownership interest and these securities may have rights senior to those of the holders of the common stock. If additional funds are raised by the issuance of debt securities, we may be subject to certain limitations on our operations, including limitations on the payment of dividends. If adequate funds are not available or not available on acceptable terms, we may be unable to take advantage of acquisition opportunities, develop or enhance services and products or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and results of operations. We do not have any material off-balance sheet arrangements.

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to risk and related changes in interest rates relates primarily to our variable rate debt (Note 4 – Debt) and our investment portfolio (Note 5 – Investments). As of September 30, 2007, we had $10,433,000 of cash and cash equivalents and $45,000 in restricted time deposits. Due to the conservative and short-term nature of our investment portfolio, we believe that even a sudden 10% change in interest rates would not have a material effect on the value of the portfolio. The average yield on our cash and cash equivalents at September 30, 2007, was approximately 4.36%. The impact on our future interest income depends largely on the gross amount of our investment portfolio. We do not expect our operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates.

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As of September 30, 2007, we had a total of $23 million in variable rate debt at differing interest rates tied to LIBOR. If the interest rates on our existing variable rate debt were to increase by 10% over the next 12 months we would incur $2,300,000 of additional interest expense over a 12-month period and would potentially be in default of the long-term debt covenants.

ITEM 4. CONTROLS AND PROCEDURES

Management has developed and implemented policies and procedures for reviewing, on a quarterly basis, our disclosure controls and procedures and our internal control over financial reporting. Management, including our CEO and CFO, evaluated the effectiveness of the design and operation of disclosure controls and procedures as of the end of the period covered by this report and, based on their evaluation, our CEO and CFO have concluded that these controls and procedures are operating effectively. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information we are required to disclose in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports we file under the Exchange Act is accumulated and communicated to management, including the principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.

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

In anticipation of the requirement to complete and disclose Management’s assessment regarding internal controls over financial reporting in the annual report for the year ended December 31, 2007, the Audit Committee has approved a project including deliverables, timetable, and establishment of a process to review compliance with sections 302 and 404 of Sarbanes-Oxley Act of 2002 (“SOX”) and expedite necessary remediation, if any. The Company’s objective is not merely to comply with these requirements, but to use them as a catalyst to examine financial, management and operational processes and programs throughout the organization. Management believes that executing a SOX compliance initiative that seeks to improve processes and programs throughout the Company will achieve a net benefit in terms of improved risk management, operational efficiency and effectiveness, and enhanced shareholder confidence.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None

ITEM 1A. RISK FACTORS

There has been no material change in the information provided in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS.

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

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

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31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

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

	A.D.A.M., Inc. (Registrant)
Date: November 13, 2007	By:	/s/ KEVIN S. NOLAND
		Kevin S. Noland
		President and Chief Executive Officer (principal executive officer)
Date: November 13, 2007	By:	/s/ MARK B. ADAMS
		Mark B. Adams
		Chief Financial Officer and Corporate Secretary (principal financial officer)

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