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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
(FEE REQUIRED)
FOR THE FISCAL YEAR ENDED MARCH 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
(NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM TO
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Commission file number 0-26962
A.D.A.M. SOFTWARE, INC.
(Exact name of Registrant as specified in its charter)
GEORGIA 58-1878070
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
1600 RiverEdge Parkway
Suite 800
Atlanta, Georgia 30328
(Registrants address including zip code)
(770) 980-0888
(Registrant's telephone number, including area code)
Securities registered pursuant to Section(b) of the Act:
NONE
Securities registered pursuant to Section(g) of the Act:
COMMON STOCK $.01 PAR VALUE
(TITLE OF CLASS)
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
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The aggregate market value of the voting stock held by non-affiliates of
the Registrant was $9,686,443 at June 25, 1996 based on the closing market price
of the Common Stock on such date as reported by the Nasdaq Stock Market's
National Market. As of such date, there were 5,254,647 shares of Registrant's
Common Stock, $.01 per share par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Annual Meeting of
Shareholders to be held on September 18, 1996 are incorporated by reference into
Part III.
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TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business..................................................................... 1
Item 2. Properties................................................................... 11
Item 3. Legal Proceedings............................................................ 11
Item 4. Submission of Matters to a Vote of Security-Holders.......................... 11
Item X. Executive Officers of the Registrant......................................... 11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........ 13
Item 6. Selected Financial Data...................................................... 13
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................. 14
Item 8. Financial Statements and Supplementary Data.................................. 18
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial
Disclosure................................................................. 18
PART III
Item 10. Directors and Executive Officers of the Registrant........................... 19
Item 11. Executive Compensation....................................................... 19
Item 12. Security Ownership of Certain Beneficial Owners and Management............... 19
Item 13. Certain Relationships and Related Transactions............................... 19
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............. 20
SIGNATURES.............................................................................. 23
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PART I
ITEM 1. BUSINESS
GENERAL
A.D.A.M. Software, Inc. (the "Company" or "A.D.A.M.") creates, publishes
and markets educational multimedia software products that provide anatomical,
medical, scientific and health-related information for the academic/health
professional ("academic") and consumer markets. A.D.A.M. products incorporate
internally developed, original medical illustrations with text, audio,
photography, animation and video in easy-to-use, interactive software
applications.
The Company creates educational multimedia software products with varying
levels of content, functionality and price for both the academic and consumer
markets. The A.D.A.M. Scholar Series includes products for the medical school,
undergraduate and K-12 institutional and student markets, and the A.D.A.M. At
Home Series includes products for children and adult consumers. A.D.A.M.
Comprehensive, the Company's flagship A.D.A.M. Scholar Series product, was
completed in March 1993 and A.D.A.M. The Inside Story, the Company's first
product in the A.D.A.M. At Home Series, was released in September 1994. The
Company's products are provided on CD-ROM disks that can be used on Apple
Macintosh or Windows-based multimedia PCs.
The Company was incorporated as a Georgia corporation and commenced
operations in March 1990. The Company was organized by the management of
Medical-Legal Illustrations, Inc. ("MLI"), a predecessor company, which was
founded in 1984 and merged into the Company effective June 30, 1992. MLI which
produced customized medical illustrations, operated as a division of the Company
until March 31, 1994, when the Company made the strategic decision to
discontinue its customized medical illustration business. In connection with the
discontinuance of these operations, the Company entered into certain license and
royalty arrangements with J.S.K., Inc., a company controlled by John W.
McClaugherty, a director of the Company.
STRATEGY
The Company's strategy is to establish itself as a leading educational
software publisher specializing in anatomical, medical, scientific and
health-related information for the academic and consumer markets. To address the
academic market, the Company intends to continue to develop and enhance software
products that advance the study, comprehension and dissemination of anatomical,
medical, scientific and health-related information and to aggressively expand
market share. To address the consumer market, the Company's strategy is to focus
on enhancing and upgrading the Company's proven successful title, A.D.A.M. The
Inside Story, as well as leveraging the Company's other consumer titles in
creative ways. There can be no assurance that the Company will successfully
implement its business strategy.
The key elements of the Company's business strategy are to continue to:
- Establish the "A.D.A.M." Brand Name as a Recognized Leader in Educational
Software. Management of the Company believes that establishing brand name
recognition for the "A.D.A.M." name across the Company's various markets
is an essential element of the Company's long-term sales and marketing
strategy and will permit the company to leverage the strength of its brand
in marketing and promoting the sale of its existing and future products.
Ideally, students would become familiar with the "A.D.A.M." brand name and
its reputation for high-quality educational multimedia products at a young
age and purchase more advanced "A.D.A.M." products as their level of
education advances and their need for more detailed anatomical, medical,
scientific and health-related information increase. Conversely, the
Company believes that its most advanced academic products add credibility
to its K-12 and consumer software products.
- Develop and Enhance a Broad Array of High Quality, Market-Driven
Educational Multimedia Software Products. The Company offers a range of
educational multimedia software products targeted for customers ranging
from students, educators and medically-related professionals with the
A.D.A.M. Scholar Series to children and adult consumers with the A.D.A.M.
At Home Series. In
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developing its multimedia software products, the Company dedicates
marketing, research and development resources to create high-quality
products that match an identified market opportunity. The A.D.A.M. product
development team, consisting of medical illustrators, anatomists,
commercial illustrators, script writers, multimedia experts and software
engineers, uses its collective skills in interface design, interactive
functionality, character development, and engaging storytelling to create
high-quality educational products.
- Leverage the A.D.A.M. Image Database and Creative and Technical
Capabilities. Management of the Company believes that the A.D.A.M. Image
Database and the Company's programming and creative capabilities represent
core assets which should facilitate the development of health-related
multimedia software products for users ranging from the health-minded
consumer to students, educators and medically-related professionals. The
Company intends to leverage its extensive library of digitized anatomical
and medical information and its interactive programming and creative
design capabilities to develop and enhance high quality products. There
can be no assurance that the Company will continue to create new products
or that such new products will be accepted by the market.
- Strengthen Distribution Capabilities. The Company addresses the academic
market principally through strategic alliances and other relationships
with existing distributors. More recently, in the undergraduate market,
the Company has expanded its direct telesales operations and increased
lead generation activities. The Company addresses the consumer market
through distribution relationships with existing distributors and
retailers. A.D.A.M. intends to strengthen the distribution of its existing
consumer products by leveraging its products using bundling, original
equipment manufacturers, and private label activities and by seeking
additional retail distribution outlets and alternative distribution
channels. There can be no assurance that distributors and retailers will
purchase the Company's products or provide the Company's products with
adequate levels of shelf space and promotional support.
PRODUCTS
General
The Company develops a range of educational multimedia software products
with varying levels of price, content and functionality targeted for customers
ranging from the health-minded consumer to students, educators and
medical-related professionals. The Company has created two product categories:
The A.D.A.M. Scholar Series, designed for the academic market, and the A.D.A.M.
At Home Series, designed for the consumer market. All of the Company's products
operate on Apple Macintosh and Windows-based multimedia PCs. Japanese versions
of the Company's products operate on the DOS/V Windows and NEC Windows platforms
and, in the case of A.D.A.M. Comprehensive, the Apple Macintosh platform.
All of the Company's products incorporate images from the A.D.A.M. Image
Database. The original database was assembled by a team of master degreed
medical illustrators, anatomists, commercial illustrators, multimedia experts
and software engineers over a three and one-half year period and continues to
expand as the Company produces new images. The proprietary A.D.A.M. Image
Database currently includes more than 4,000 original medical illustrations that
have been scanned into a computer database on a layer by layer basis. The images
have been assembled and linked together to present an interactive view of the
human anatomy. This database permits the Company to create products like
A.D.A.M. Comprehensive, which allows the user to observe and identify anatomical
structures at different magnification levels, simulate surgery using an onscreen
"scalpel" tool, "peel-back" successive layers of anatomy (i.e., to go from the
skin to the bone, layer by layer, at a given point on the body), highlight
individual anatomical systems or structures, and view anatomical systems or
structures, and view anatomical structures from multiple perspectives.
The Company's educational multimedia software products have received
significant media and professional recognition including two 1996 Software
Publishers Association Codie awards for Best Curriculum Based Education Program
and Best Education Program for Middle School (for A.D.A.M. The Inside Story-
School Edition), two 1995 Software Publishers Association Codie Awards for Best
Overall Education Program (for A.D.A.M. Standard and A.D.A.M. Benjamin/Cummings
Interactive Physiology) and Best
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Home Learning Program (for A.D.A.M. The Inside Story), the 1993 NewMedia
INVISION Multimedia Best of Show Award (for A.D.A.M. Comprehensive) and the 1992
Frank J. Netter Award for medical illustration excellence (for A.D.A.M.
Comprehensive). The Codie Awards are sponsored annually by the Software
Publishers Association (the "SPA"), an industry trade group consisting of most
software publishers. In 1996 and 1995 respectively, over 900 and 680 products
were entered into the Codie competition. One award is given in each of a number
of categories and winners are selected via ballot by SPA member companies. The
INVISION awards are sponsored annually by New Media Magazine. Products are
reviewed and judged by a panel of industry experts, journalists and publishers
selected by INVISION staff. The Best of Show award is given to the best overall
product among all entries based on factors including quality of content,
execution and innovativeness. The Frank J. Netter Award is sponsored by the
Versalius Trust and the winner is selected by a vote of the Versalius Trust for
Visual Education in the Health Sciences. The award is given to the entry that
(1) best represents anatomical accuracy and scientific detail as taught in
medical illustration programs worldwide and (2) exemplifies an innovative
product that has had a substantial impact on medical education. In addition to
the aforementioned industry awards, the Company's academic and consumer products
have been the subject of numerous reviews and commentaries, the majority of
which have been favorable. Occasionally, however, a review or commentary has
been critical of particular elements of the product being discussed, including
criticism related to subject matter, speed, cost and image pixelation when
greatly enlarged.
A.D.A.M. SCHOLAR SERIES PRODUCTS
A.D.A.M. COMPREHENSIVE is designed for the medical school, graduate
institution and medically-related professional marketplace. As the Company's
flagship product, it is the most sophisticated and comprehensive core anatomy
software product based on the amount and detail-level of anatomical content and
software functionality. The key features of A.D.A.M. Comprehensive include (1)
Approximately 1,000 layers of anatomy and 22,000 identifiable anatomical
structures; (2) Extensive medical terminology and comprehensive labeling
designed for graduate level study; (3) Anterior, posterior, medial and lateral
dissectible views of anatomy; (4) Three levels of magnification; (5)
Histologies, cross-sections, radiologies, MRIs, text overviews, and select audio
pronunciations; (6) Interactive systems study that permits exploration of each
system of the human body; and (7) An expanded interface with an unabridged
bookshelf that accepts optional CD-ROM animation books, projects and additional
content. The Company also offers a lower-priced version of A.D.A.M.
Comprehensive for graduate health science students, which has most of the same
features as A.D.A.M. Comprehensive but cannot be used with A.D.A.M. Studio.
A.D.A.M. STANDARD is designed primarily for undergraduate institutions with
health science programs. It is the intermediate-level application in the
A.D.A.M. Scholar Series and provides a thorough overview of human anatomy. The
key features of A.D.A.M. Standard are: (1) Approximately 200 layers of anatomy
and 18,000 identifiable anatomical structures; (2) Scientific and medical
terminology consistent with undergraduate level of study; (3) Anterior,
posterior and limited lateral dissectible views of anatomy and a static medial
view; (4) Three levels of magnification; (5) Histologies, cross-sections, MRI's,
text, overviews and select audio pronunciations; (6) Interactive systems study
that permits exploration of each system of the human body; and (7) An expanded
interface with a bookshelf that accepts additional content. The Company also
offers a lower-priced version of A.D.A.M. Standard for undergraduate health
science students, which has most of the same features as A.D.A.M. Standard but
cannot be used with A.D.A.M. Studio.
A.D.A.M. ESSENTIALS is designed primarily for high school biology/anatomy
teachers, libraries and introductory/non-major college courses. A.D.A.M.
Essentials incorporates a simplified interface design, which enables the user to
explore dissectible anatomy and animations of physiological content in a simple,
easy-to-use manner. The key features of A.D.A.M. Essentials include: (1)
Approximately 100 layers of anatomy and 4,000 identifiable anatomical
structures; (2) Lay and scientific terminology, labeling and an audio
pronunciation guide appropriate for introductory level study; (3) Interactive
systems study with 38 animations and text overviews that permit exploration of
each system of the human body and its related functions; (4) Anterior and
posterior dissectible views of anatomy; (5) Two levels of magnification; and (6)
Interactive puzzles designed to enhance learning comprehension.
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A.D.A.M. ESSENTIALS -- SCHOOL EDITION is a curriculum-oriented solution for
the study of human anatomy and physiology at the high school level. It combines
A.D.A.M. Essentials with a comprehensive Teachers' Guide that includes student
worksheets, ideas for classroom activities, laboratory exercises, a bibliography
of additional learning resources and teacher reference materials.
A.D.A.M. BENJAMIN/CUMMINGS INTERACTIVE PHYSIOLOGY is a series of
co-developed products with Benjamin/Cummings Publishing Company, Inc.
("Benjamin/Cummings") designed for the undergraduate health sciences curriculum.
Each module is designed to complement A.D.A.M. Standard, integrating anatomical
structures with physiological functions. A.D.A.M. Benjamin/Cummings Interactive
Physiology uses animation, audio, narration and video to explain difficult and
complicated physiology concepts and processes. Its organization and self-test
features provide the methodology for curriculum integration. Current products
available are a Cardiovascular Module, a Muscular Module and a Respiratory
Module. Benjamin/Cummings and the Company have an agreement to co-develop four
additional modules for the series.
A.D.A.M. STUDIO is designed to operate in conjunction with A.D.A.M.
Comprehensive or A.D.A.M. Standard to meet the customization and integration
needs of the academic and professional marketplace. It permits users to
customize the content of the A.D.A.M. products by integrating additional
digitized media into the A.D.A.M. products and creating a personal archive of
interactive images and multimedia projects. A.D.A.M. Studio enables users to:
(1) modify, cut, paste, copy and adapt the image database in a variety of
manners; (2) integrate external media from a variety of sources such as slides,
x-rays, text, graphics, animations, audio and video into the A.D.A.M. programs;
and (3) generate interactive documents, exhibits and original multimedia works.
A.D.A.M. Studio is an add-on product and will not operate independently of
A.D.A.M. Comprehensive or A.D.A.M. Standard.
CD-ROM ANIMATION BOOKS include A.D.A.M. Trauma, A.D.A.M. Obstetrics and
Gynecology and A.D.A.M. Orthpaedic and are intended primarily for the graduate
education and professional markets. A.D.A.M. Trauma, which operates only in
conjunction with A.D.A.M. Comprehensive, contains a set of interactive
animations, patient education documents and accompanying tools for simulating
typical head, back and burn injuries. A.D.A.M. Obstetrics and Gynecology, which
operates in conjunction with A.D.A.M. Comprehensive or as a stand-alone program,
offers a selection of birth and gynecological procedures for anatomy/medical
instruction, physicians' reference and patient communication. A.D.A.M.
Orthopaedic, which operates in conjunction with A.D.A.M. Comprehensive or as a
stand-alone program, contains a series of animations of various surgical
procedures for anatomy of the lower limbs.
SCHOOL EDITION OF A.D.A.M. AT HOME SERIES Products include A.D.A.M. The
Inside Story, Nine Month Miracle and Life's Greatest Mysteries -- School
Editions. They combine the stand-alone A.D.A.M. At Home Products with
comprehensive Teachers' Guides to meet the needs of a classroom setting.
A.D.A.M. The Inside Story -- School Edition enables study of human anatomy and
physiology in a middle school biology or life sciences course, while Nine Month
Miracle -- School Edition is designed to supplement the study of human
reproduction at the high school level. The Teachers' Guides for each product
include student worksheets, ideas for classroom activities, laboratory
exercises, a bibliography of additional learning resources and teacher reference
materials.
The A.D.A.M. Scholar Series Products contributed approximately 57.2%, 73.0%
and 96.7% of net revenues in fiscal 1996, fiscal 1995 and fiscal 1994,
respectively. The Company anticipates that it will continue to devote resources
to developing products for the academic market.
A.D.A.M. AT HOME SERIES PRODUCTS
A.D.A.M. THE INSIDE STORY is a consumer "edutainment" product designed for
use by all members of the family. A.D.A.M. The Inside Story is the Company's
first product in the A.D.A.M. At Home Series and it provides A.D.A.M. anatomy in
an easy-to-use software application. A.D.A.M. The Inside Story features a
"Family Scrapbook" in which modern-day Adam and Eve characters lead a
light-hearted and animated tour through each system of the body. These
characters are given personalities and provide an entertaining story-line
approach to the exploration of human anatomy. Fifty-two animations, six
interactive puzzles and a medical glossary provide an engaging and educational
multimedia experience. During fiscal 1997, the
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Company will release an updated version of A.D.A.M. The Inside Story which will
include among other features new 3-D graphics and one-button Internet
connectivity.
NINE MONTH MIRACLE is a consumer "edutainment" product designed for use by
all members of the family interested in pregnancy. Nine Month Miracle contains
accurate and informative animations and video in which modern-day Adam and Eve
characters join medical experts for a month-by-month tour depicting the
development of a fetus from conception through delivery. This product also
integrates dramatic intra-uterine photography by Lennart Nilsson, an informative
glossary from the American College of Obstetricians and Gynecologists and
emotional video footage from the Nine Months documentary to create a unique
multimedia experience. Nine Month Miracle also features "Emily's New Sister," a
chapter where cartoon animations allow younger children to discover the miracle
of a new baby through the eyes of a 7-year old character named Emily.
LIFE'S GREATEST MYSTERIES is a consumer "edutainment" product designed for
use by all members of the family that provides an interactive exploration of the
myths, mysteries and curiosities of the human body. Using detailed animations
and a simple "Q&A" format, a live entertaining character named Bob Winkle
reveals answers to dozens of questions ranging from "What is cancer?" and "What
causes Alzheimer's Disease?" to curiosities such as "What causes headaches?" and
"Why does hair turn grey?" Life's Greatest Mysteries also includes activities to
help reinforce key concepts, a supplemental text reference section and a
glossary of key terms.
The A.D.A.M. At Home Series Products contributed approximately 39.3%, 21.0%
and 0% of net revenues in fiscal 1996, fiscal 1995 and fiscal 1994,
respectively. Because of the risks involved in introducing new consumer products
in today's unstable retail environment, in the fourth quarter of fiscal 1996 the
Company decided to temporarily halt the development and publishing of any new
consumer titles that would be solely funded by the Company.
PRODUCT DEVELOPMENT
The Company believes in a thorough and systematic approach to product
development which includes stages of market analysis, specification development,
product creation and testing.
All product ideas that have received preliminary approval from senior
management of the Company for possible development are subject to extensive
market analysis prior to product definition. This analysis focuses on market
size, product potential, sales projections and pricing strategies. As a result
of the analysis, each product concept is evaluated for return on investment,
sales potential and overall strategic value. The completed analysis from this
stage is then presented to senior management of the Company for final product
development decisions.
Once accepted for development, product candidates enter into the
specification stage, during which the product concept develops into a detailed
design. During this stage, writers, content experts and other production
partners are identified and brought under contract. Additionally, third party
content such as images, audio tracks and existing video are also located and
licensed. When appropriate, the Company may develop simple prototypes during the
specification stage to test interface, navigation and content with internal and
external focus groups.
Upon completion of the specification stage, products enter the product
development stage. It is during this stage that the Company's designers,
illustrators, programmers, and other creative talent become actively involved in
developing the product. At several points during the development stage the
product is sent to various evaluators, including potential customers, to conduct
functionality tests and to gain user feedback, the results of which are
integrated back into the design specifications. In addition to the functionality
and testing, management believes it is important for the Company to continually
market test products at several other levels. Since the Company is producing
information products, it is necessary to constantly assess the accuracy of the
content, which includes text, illustrations, animations, video and audio.
Products also undergo usability testing to determine the friendliness of the
interface, appropriateness of tools and other aspects of a user's interaction
with the product.
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The Company has entered into a co-development agreement with
Benjamin/Cummings which provides for the co-development, on an exclusive basis,
of products for certain specified education markets (secondary school science,
undergraduate science and health science education, and schools of nursing). The
Company may terminate the agreement on September 1, 1997 if the Company does not
receive specified revenues from Benjamin/Cummings by that date. If the minimum
revenue target is satisfied, then Benjamin/Cummings will have the right to
extend the term for an additional four years. The agreement does not impose any
capital commitments on the part of either party. The agreement provides that
particular products will be developed pursuant to separate product development
agreements. The Company and Benjamin/Cummings have entered into two such product
development agreements; the first such agreement provided for development of the
first three modules of the A.D.A.M. Benjamin/Cummings Interactive Physiology
Series (Cardiovascular, Muscular and Respiratory Modules), all of which have
been completed, and the second agreement provides for the development of an
additional four modules through June 1997. Both product development agreements
provide for the Company to receive a royalty. Under the second agreement, the
Company is required to spend certain specified minimums on the development of
such modules. The agreements may be terminated by either party for material
breach. Historically, the effect of these agreements has not been significant to
the financial position of the Company nor is it anticipated to be in the future.
For the fiscal years ended March 31, 1996, 1995 and 1994 total expenditures
for product development, including capitalized expenses, were $2,940,000,
$2,850,000 and $1,800,000, respectively.
SALES, MARKETING AND DISTRIBUTION
The Company employs a wide range of marketing and distribution strategies
in the academic and consumer markets to promote brand name recognition and
broaden product distribution. To capitalize on the innovative nature of its
products, the company has developed a public relations program that has resulted
in coverage for the Company in a wide variety of publications and broadcasts.
The Company also makes use of new information technology for communication and
public relations purposes, such as a fax-on-demand information system and the
A.D.A.M. Worldwide Web Page available on the Internet.
The Company has distribution relationships with Industrial Co.
("Matsushita"), Benjamin/Cummings Publishing Company, Inc. ("Benjamin/Cummings")
and Ingram Micro, Inc. ("Ingram Micro"). The sales of the Company's products
through Ingram Micro, Inc. represented approximately 18% of the Company's total
net revenues in fiscal 1996. No other distributors or retailers accounted for
more than 10% of the Company's revenues during fiscal 1996.
In the academic market, the Company markets its products through both
direct and indirect channels. Historically, the Company promoted the products in
the A.D.A.M. Scholar Series directly to the academic marketplace through its
sales and marketing personnel based in Atlanta, Georgia. Direct sales and
marketing activities include advertising in publications, media relations,
direct mailings, distribution of brochures, participation in educational
seminars, campus visits by field sales personnel, and telemarketing and
telesales efforts. In fiscal 1995, the Company increased the range and scope of
its distribution efforts through the development of strategic alliances with
numerous established distribution networks including Addison-Wesley Publishing
Company ("Addison-Wesley"), Benjamin/Cummings and Churchill Livingstone USA.
Marketing support for the Company's indirect sales efforts includes the
development of print and electronic catalogs, creation and supply of special
demonstrative software, training kits, and media relations.
In the consumer market, the Company believes that marketing to both its
distribution channels and to the end user is fundamental to its success. The
Company utilizes advertising in computer and general consumer publications,
in-store promotions, merchandising, direct mailings to targeted audiences in the
retail and distribution community, training kits, demo disks, participation in
key consumer retail conferences and on-line marketing to promote sales of its
consumer products. The Company sells its software products through multiple
channels, including software distributors such as Ingram Micro and ABCO,
software retailers such as Egghead and Software Etc., computer superstores such
as CompUSA and Computer City, consumer electronics stores such as Circuit City
and Best Buy, mass merchants such as Target, and mail order companies such as
Mac Warehouse and Tiger. Additionally, the Company offers consumers the
opportunity to purchase products by calling a toll-free telephone number, the
fulfillment of which is handled by Advanced Access, a fulfillment company under
contract to the Company. There can be no assurance that distributors and
retailers will purchase the Company's products. To distribute in the retail
market, the Company primarily utilizes external sales organizations, such as
manufacturing representative firms, to promote its products into the channel.
The Company may add internal sales staff or develop strategic alliances in the
future to strengthen and expand its selling capabilities for the consumer
market. There can be no assurance that such sales staff or strategic alliances
will materially increase the Company's sales to the consumer market.
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The distribution channels through which consumer software products are sold
have been characterized by rapid change, including consolidations and financial
difficulties of certain distributors and retailers. Retailers of the Company's
consumer products typically have a limited amount of shelf space with intense
competition among educational software products. There can be no assurance that
such distributors and retailers will continue to purchase the Company's products
or provide the Company's products with adequate shelf space. The Company records
an allowance against sales based on historical experience and anticipated
returns. To the extent that the Company's sales returns exceed the Company's
allowances, the Company's results of operations could be materially adversely
impacted.
A large portion of the Company's business is highly seasonal, with
operating results varying substantially from quarter to quarter. Historically,
this trend has been the result of cyclical variations in funding experienced by
certain of the Company's academic customers and the seasonal buying patterns in
the consumer market. The Company's historical revenues and results of operations
are not necessarily indicative of future revenues and results of operations
because the market for educational multimedia software products is rapidly
evolving and the Company's revenues in any period are significantly affected by
the announcements and product offerings of the Company and its competitors, as
well as consumer and academic demands and the economy in general. The Company's
expense levels are based, in part, on its expectations as to future revenues. If
revenue levels are below expectations, the Company may be unable or unwilling to
reduce expenses proportionately and operating results are likely to be adversely
affected. Products are generally shipped as orders are received and accordingly
the Company has historically operated with little backlog. As a result, revenues
in any quarter are substantially dependent on the quantity of product orders
received in that quarter.
In the international market, the Company depends primarily on strategic
partners to promote, distribute and sell its software products. The Company has
established distribution relationships with several key players in the academic
markets, such as Matsushita in Japan, Pearson Professional in Asia and Churchill
Livingstone UK in Europe, and with several key players in the consumer markets,
such as BOMICO in Germany. Certain of the Company's international distribution
arrangements are structured as standard distribution or reseller arrangements
where the partner purchases product at a wholesale price from the Company's
inventories while others involve republishing the software products where the
partner is responsible for product localization, sales, marketing and consumer
support and the Company receives a royalty on the sales. International revenues
comprised 15.2%, 28.6% and 28.1% of the Company's total net revenues in fiscal
1996, fiscal 1995 and fiscal 1994, respectively.
STRATEGIC ALLIANCES
An essential element of the company's business strategy is to develop
alliances with domestic and international educational and medical publishers and
others in an effort to establish effective distribution channels for its
products and, in certain cases, to facilitate new product development. A summary
of the Company's significant alliances is set forth below.
Addison-Wesley Publishing Company, a subsidiary of Pearson PLC
- Through its subsidiary, Benjamin/Cummings, Addison-Wesley is a major
publisher for the undergraduate market for science, health science,
nursing and allied health. Addison-Wesley is an investor and has product
development and distribution relationships with the Company.
- The Company and Benjamin/Cummings have agreed to co-develop a series of
multimedia products, known as A.D.A.M. Benjamin/Cummings Interactive
Physiology, for the undergraduate health science market. The first three
modules, Cardiovascular Module, Muscular Module and Respiratory Module
already have been completed. See "-- Products."
- The Company and Benjamin/Cummings have signed a distribution agreement
under which Benjamin/ Cummings distributes the A.D.A.M. Scholar Series of
products to the undergraduate market in the United States and Canada with
primary emphasis on A.D.A.M. Standard. The distribution agreement provides
for an initial term of two years ending August 4, 1996. However, during
the fourth quarter of fiscal 1996 the Company and Benjamin/Cummings agreed
that Benjamin/Cummings would cease
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direct sales and marketing activities of A.D.A.M. Standard and focus its
selling efforts on Student Edition products in school bookstores.
Benjamin/Cummings is not subject to any capital requirements or minimum
purchase commitments under the agreement. Benjamin/Cummings is required to
pay the Company for copies of products distributed by Benjamin/Cummings in
accordance with the Company's product list, as in effect from time to
time.
Matsushita Electric Industrial Co., Ltd.
- Matsushita is one of the world's largest consumer electronics companies
and the parent entity to Panasonic, Technics, Quasar and National. The
Company and Matsushita have an exclusive distribution relationship for
A.D.A.M. products in Japan.
- Matsushita funded the conversion of the A.D.A.M. Comprehensive and
A.D.A.M. Essentials products into Kanji, the principal Japanese language.
- Matsushita has assembled a group of third-party distributors to sell
A.D.A.M. Comprehensive in Japan, including: Canotec, the largest dealer of
Apple Macintosh in Japan; Maruzen, a major medical and educational
publisher; Uchida Yoko Co., Ltd., a major distributor of Fujitsu computers
in the Japanese market; and AMCO, a large medical equipment sales company.
In addition, Matsushita is utilizing Nippon Electric Company to distribute
A.D.A.M. Essentials in Japan and has associated with Softbank to sell
A.D.A.M. The Inside Story in Japan once the Kanji language conversion is
completed on this product.
- The exclusive distribution agreement with Matsushita provided for an
initial term of three years ending April 16, 1996. Matsushita is not
subject to any continuing capital commitments or minimum purchase
requirements under the agreement, nor is the Company subject to any
capital or similar commitments or requirements. The Company and Matsushita
are currently negotiating an extension to the exclusive distribution
agreement. Matsushita is required to pay the Company for copies of
products distributed by Matsushita in accordance with the agreement
product price list or royalty, as in effect or as modified from time to
time.
Churchill Livingstone, a division of Pearson PLC
- Churchill Livingstone is Europe's oldest and largest medical publisher
and is the publisher of Gray's Anatomy, the top selling medical title in
the world. Pearson PLC also is the ultimate parent entity to
Addison-Wesley with whom the Company has a strategic alliance. The Company
has two distribution relationships with Churchill Livingstone.
- Churchill Livingstone UK and the Company have entered into an agreement
pursuant to which Churchill Livingstone UK distributes A.D.A.M.
Comprehensive and A.D.A.M. Standard to the higher education market in
Europe on a limited exclusive basis. The distribution agreement provided
for an initial term of one year ending December 30, 1995. The Company and
Churchill Livingstone UK have negotiated a one year extension with certain
modifications to the agreement. Churchill Livingstone UK is not subject to
any capital requirements or minimum purchase commitments. Churchill
Livingstone is required to pay the Company for copies of products
distributed by Churchill Livingstone in accordance with the Company's
product price list, as in effect from time to time.
- The Company and Churchill Livingstone USA have signed a limited exclusive
distribution agreement under which Churchill Livingstone USA distributes
A.D.A.M. products to the medical school, graduate institution and health
professional markets in North America. The agreement requires Churchill
Livingstone to achieve minimum sales levels to maintain this exclusive
relationship. The agreement provides for an initial term of one year
ending May 8, 1996. Churchill Livingstone has met the minimum purchase
commitment objective for the initial term, and the agreement has been
extended for one year. The term of the agreement may continue to be
extended for consecutive additional one year terms, subject to the
achievement of mutually agreed upon annual sales performance objectives.
If the annual sales performance objectives are not met in the second year
of
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the agreement, then the Company may terminate the agreement. Churchill
Livingstone is required to pay the Company for copies of products
distributed by Churchill Livingstone in accordance with the Company's
product price list, as in effect from time to time.
ANATOMICAL REVIEW CONSULTANTS
The Company engages the services of individuals with expertise in the
fields of anatomy, biology and medicine to assist the Company in its endeavor to
ensure that the A.D.A.M. Image Database conforms to the highest standards of
anatomical accuracy and instructional utility. These individuals make periodic
recommendations to the Company with respect to content accuracy and testing
reliance of the Company's products and product development candidates.
As of March 31, 1996 the anatomical review consultants were as follows:
NAME AFFILIATION
- - --------------------------------------------- ---------------------------------------------
Anne M.R. Agur, B.Sc. (TO), M.Sc............. Associate Professor, Anatomy and Cell Biology
University of Toronto, Faculty of Medicine
Arthur English, Ph.D......................... Professor of Anatomy
Emory University School of Medicine
Keith L. Moore, Ph.D......................... Professor, Anatomy and Cell Biology
University of Toronto, Faculty of Medicine
Todd Olson, Ph.D............................. Professor of Anatomy
Albert Einstein College of Medicine
Wojciech (Albert) Pawlina, M.D............... Assistant Professor, Anatomy and Cell Biology
University of Florida College of Medicine
Vick Williams, M.D., Ph.D.................... Professor, Cellular and Structural Biology
University of Texas Health Science Center
at San Antonio
MANUFACTURING
The production of the Company's software includes CD-ROM pressing, assembly
of purchased product components, printing of product packaging and user manuals
and shipping of finished goods, which is performed by third-party vendors in
accordance with the Company's specifications and forecasts. The Company believes
that there are alternate sources of these services that could be implemented
without material delay.
PROPRIETARY RIGHTS AND LICENSES
The Company regards its software and the A.D.A.M. Image Database as
proprietary and relies primarily on a combination of copyright, trademark, trade
secret and confidential information laws, employee and third-party nondisclosure
agreements and other methods to protect its proprietary rights. There can be no
assurance that these protections will be adequate to protect the Company's
intellectual property rights or that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technologies. The Company has obtained federal registrations of
its trademarks "A.D.A.M.," "SCHOLAR SERIES", and the "WALKING MAN" logo in the
United States and has applied for registration of the trademark "NINE MONTH
MIRACLE." The Company has also obtained registrations of the "A.D.A.M."
trademark in 22 foreign countries and has applications for registration of the
mark pending in an additional 7 countries. The Company does not currently hold
any patents or have any patent applications pending. The Company believes that,
due to the rapid pace of innovation within the multimedia and software
industries, factors such as the technological and creative skills of its
personnel and the quality of the content of its products are more important in
establishing and maintaining a leadership position within the industry than are
the various legal protections of its technology.
The Company licenses certain software programs from third-party developers
and incorporates them into its products. Such software products are widely
licensed by the respective developers thereof for incorporation
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by other developers (like A.D.A.M.) in their products and provide specific
functionality required in order to operate the product. For example, the Company
licenses Macromind Director, a program distributed by Macromedia, which permits
a product to display animated sequences. This product is incorporated in several
A.D.A.M. products. Generally, the licenses grant to the Company nonexclusive,
worldwide licenses with respect to the subject program and terminate only upon a
material breach by the Company. Certain of the licenses require payment of
annual license fees (but such annual license fees do not exceed $25,000 per
annum in the aggregate). If a third-party agreement for licensed software
expires or terminates and the Company is unable to renew or extend the
agreement, the Company could be required to engage in independent development of
replacement software or to obtain a suitable replacement. The Company believes
that licenses for alternative software programs are generally available on
commercial terms from a number of licensors. The Company owns and does not
license the anatomical illustrations included in the A.D.A.M. Image Database,
but licenses certain additional multimedia content included in its products,
including video, photographs, music and text, from various third parties that is
incorporated in its products. Such licenses generally provide the Company with
fully-paid perpetual, worldwide licenses to include the licensed content in a
designated product.
The Company believes that its products, trademarks and other proprietary
rights do not infringe on the proprietary rights of third-parties. However, as
the number of software products in the multimedia industry increases and the
functionality of these products further overlaps, software developers may become
increasing subject to infringement claims. There can be no assurance that
third-parties will not assert infringement claims against the Company in the
future with respect to current or future products, trademarks or other Company
works or that any assertion may not require the Company to enter into royalty
arrangements or result in costly litigation.
COMPETITION
The educational multimedia software industry is intensely competitive and
demand for particular software products may be adversely affected by the
increasing number of available competitive products. The Company competes in the
academic marketplace primarily with other companies offering educational
software products on anatomy, health and medical topics and, to a lesser extent,
with larger publishers of traditional print textbooks on anatomy and medicine.
Existing competitors may continue to broaden their product lines and potential
competitors, including large hardware or software manufacturers and educational
publishers may enter or increase their focus on the academic market, resulting
in greater competition for the Company. In the K-12 academic marketplace, the
Company faces direct competition from other companies offering educational
software products. In the consumer market, the Company faces direct competition
from other companies offering educational software products as well as
competition for shelf space from companies offering entertainment and consumer
software products. Moreover, competition for the Company's products is
influenced by the timing of competitive product releases and the similarity of
such products to those of the Company, which may result in significant price
competition, reduced profit margins, loss of shelf space or a reduction in
sell-through of the company's products at retail stores. There can be no
assurance that any of the Company's software products will compete effectively
against other interactive multimedia software products in general or anatomical,
health, medical and educational information products in particular. The
Company's competitors include many companies, most of which have substantially
greater financial, development, marketing and personnel resources than those of
the Company. Moreover, the price of the Company's products and the computer
hardware required to operate them may be higher than alternative competitive
informational sources such as anatomy textbooks.
EMPLOYEES
As of March 31, 1996, the Company employed 75 full-time persons. Of these,
32 were engaged primarily in product development, 16 in sales, 6 in marketing
and 21 in finance and administration. The Company currently employs 12 degreed
medical illustrators and 4 commercial illustrators. None of the Company's
employees are covered by a collective bargaining agreement and the Company has
experienced no work stoppages. The Company considers its employee relations to
be good. Management believes that the
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Company's future growth and success will depend upon its ability to retain and
continue to attract highly skilled and motivated personnel in all areas of its
operations.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Portions of this Annual Report include forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Although the Company believes that the
expectations reflected in such forward-looking statements are based upon
reasonable assumptions, it can give no assurance that its expectations will be
achieved. Important factors that could cause actual results to differ materially
from the Company's current expectations are disclosed in conjunction with the
forward-looking statements included herein.
ITEM 2. PROPERTIES
The Company's headquarters and principal operations are located in
approximately 33,000 square feet of leased office space in Atlanta, Georgia. The
space is leased for a term ending in 2002. Management of the Company believes
that the Company's current facilities will be adequate through at least 1998. If
additional facilities are required, the Company believes that suitable
facilities will be available.
ITEM 3. LEGAL PROCEEDINGS
On April 25, 1996, a class action lawsuit was filed in Fulton County
Superior Court in Atlanta, Georgia by an owner of 1,000 shares of A.D.A.M.
common stock against the Company and certain of its officers and directors
(Robert S. Cramer, Jr., Curtis A. Cain, Gregory M. Swayne, Holcombe T. Green,
Jr. and John W. McClaugherty). The complaint alleges violations of sections 11,
12(2) and 15 of the Securities Act of 1933, violations of the Georgia Securities
Act and negligent misrepresentation arising out of alleged disclosure
deficiencies in connection with the Company's initial public offering which was
completed on November 10, 1995. The complaint seeks compensatory damages and
reimbursements for plaintiff's fees and expenses. The Company and its officers
and directors intend to defend vigorously against the allegations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1996.
ITEM X. EXECUTIVE OFFICERS OF THE REGISTRANT
The persons who are executive officers of A.D.A.M. Software, Inc. and their
positions are as follows:
NAME AGE POSITIONS WITH THE COMPANY
- - ------------------------------------------- --- -------------------------------------------
Robert S. Cramer........................... 35 Chairman of the Board, Co-Founder and
Director
Curtis A. Cain............................. 37 Chief Executive Officer
Gregory M. Swayne.......................... 38 President Founder, Vice President
Production and Director
Robert A. DiProva.......................... 48 Chief Financial Officer, Vice President of
Administration, Secretary and Treasurer
Joseph R. Fuller........................... 33 Vice President of Marketing
David A. Tranberg.......................... 43 Vice President of Sales
ROBERT S. CRAMER, JR. Mr. Cramer, a co-founder of the Company, has served
as Chairman of the Board and a Director since the Company's inception in March
1990. From 1987 to 1992, he served as Chairman of the Board of Directors of
Medical Legal Illustrations, Inc. ("MLI"), a predecessor to the Company. In
1989, Mr. Cramer served as an Executive Editor and Co-Publisher of Atlanta
Computer Spectrum, a regional technology publication he helped to create. Also,
since 1994, Mr. Cramer has served as Chairman of the
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Board of the Atlanta Task Force for the Homeless, a community-wide, non-profit
organization working with and on the behalf of homeless people.
CURTIS A. CAIN. Mr. Cain has served as the Company's Chief Executive
Officer since April 1994. Prior thereto, he served as the Company's Chief
Operating Officer from March 1992 to March 1994, President of MLI from February
1992 until the merger of MLI and the Company in May 1992 and Consultant to MLI
from November 1991 to January 1992. Previously, he was employed by Clayton,
Williams and Sherwood, a real estate investment firm, serving as Regional
Manager and Director of Finance and Business Development from August 1987 to
September 1991. Prior thereto, he served in the United States Marine Corps from
1981 to 1985, attaining the rank of Captain.
GREGORY M. SWAYNE. Mr. Swayne, a co-founder of the Company, has served as
President, Vice President of Production and a Director of the Company since its
inception in March 1990. As the original founder of MLI, he served as President
of MLI from 1985 until February 1992, and as a director of MLI from 1985 until
the merger of MLI and the Company in May 1992. Mr. Swayne is a master degreed
medical illustrator who completed a three year graduate program in medical
illustration that required him to participate in all the first year medical
school courses (including gross anatomy, histology, embryology and neuroanatomy)
as well as a full year of direct surgical observation and illustration.
ROBERT A. DIPROVA. Mr. DiProva joined the Company in September 1995 as
Chief Financial Officer, Vice President of Administration, Secretary and
Treasurer. Prior thereto, he served from 1989 until August 1995 as Chief
Financial Officer, Vice President and Treasurer for Dateq Information Network,
Inc., a publicly held technology firm, and was responsible for all financial,
MIS, human resources and administrative functions. Previously thereto, he served
as Corporate Controller for Rhodes, Inc., a specialty furniture retailer, from
1984 to 1988. Mr. DiProva is a Certified Public Accountant and a member of the
Georgia Society of Certified Public Accountants.
JOSEPH R. FULLER. Mr. Fuller has served as the Company's Vice President of
Marketing since January 1996. Prior thereto, he served as the Company's Director
of Marketing from April 1995 to December 1995, and as Manager -- Consumer
Division from April 1994 to March 1995. Previously, he was employed by Hayes
Microcomputer Products, Inc., a developer and marketer of personal
communications hardware and software, in management roles within Product
Development, Product Management, and Business Development from July 1984 to
March 1994.
DAVID A. TRANBERG. Mr. Tranberg joined the Company in January 1996 as Vice
President of Sales. Prior thereto, he served from January 1995 until November
1995 as Vice President of Sales and Marketing at The Blue Ribbon Soundworks,
Ltd., a multimedia software developer. Prior thereto, he served from January
1994 to September 1994 as Vice President of Sales at SofNet, Inc., a
communications software developer; from June 1993 to December 1994 as Eastern
Regional Sales Manager at Media Vision, a multimedia hardware and software
developer; from March 1992 to May 1993 as Vice President, Western Area Sales at
Melita International, a telecommunications integrator; and from January 1989 to
November 1991, as Regional Vice President for Ashton-Tate, developer of dBase.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is quoted on the NASDAQ National Market system
under the symbol "ADAM". The following table sets forth the high and low bid
quotations of the Company's Common Stock as reported by NASDAQ since the
Company's initial public offering, which was consummated on November 10, 1995.
HIGH LOW
---- ---
1996
Fiscal Third Quarter (commencing November 10, 1995)................. $14 1/8 $4 3/8
Fourth Quarter...................................................... 7 4 1/2
At June 18, 1996 there were approximately 180 record holders of the
Company's Common Stock.
The Company has never paid or declared any cash dividends on its Common
Stock and does not intend to pay dividends on its Common Stock in the
foreseeable future. To date, the Company has incurred losses and presently
expects to retain its future anticipated earnings to finance development of and
expansion of its business. The payment by the Company of dividends, if any, on
its Common Stock in the future is subject to the discretion of the Board of
Directors and will depend on the Company's earnings, financial condition,
capital requirements and other relevant factors.
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED MARCH 31,
-----------------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
STATEMENT OF OPERATIONS:
Net revenues..................................... $ 6,447 $ 5,742 $ 2,813 $ 976 $ 107
Cost and expenses:
Cost of revenues............................... 1,491 791 293 114 10
Sales and marketing............................ 4,090 3,666 1,965 1,141 324
Product development............................ 2,847 2,401 1,759 1,023 500
General and administrative..................... 2,008 1,774 1,554 1,200 594
------- ------- ------- ------- -------
Total costs and expenses............... 10,436 8,632 5,571 3,478 1,428
------- ------- ------- ------- -------
Operating income (loss)........................ (3,989) (2,890) (2,758) (2,502) (1,321)
Interest expense................................. (317) (383) (90) (117) (124)
Interest income.................................. 415 43 64 3 --
------- ------- ------- ------- -------
Income (loss) from continuing operations.... (3,891) (3,230) (2,784) (2,616) (1,445)
Loss from discontinued operations.............. -- (400) (185) (223)
------- ------- ------- ------- -------
Loss before extraordinary item.............. (3,891) (3,230) (3,184) (2,801) (1,668)
Extraordinary loss from early extinguishment of
debt, net of income tax benefit of $29...... (46) -- -- -- --
------- ------- ------- ------- -------
Net loss............................... $(3,937) $(3,230) $(3,184) $(2,801) $(1,668)
======= ======= ======= ======= =======
Net loss per share from continuing
operations.................................. $ (1.13) $ (1.22) $ (1.11) $ (1.35) $ (1.02)
Net loss per share............................. (1.14) (1.22) (1.27) (1.44) (1.18)
Weighted average number of common shares and
share equivalents outstanding............... 3,673 2,694 2,510 1,939 1,419
======= ======= ======= ======= =======
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YEAR ENDED MARCH 31,
-----------------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents........................ 5,352 940 716 348 299
Working capital (deficiency)..................... 15,354 (1,736) (593) (550) (707)
Total assets..................................... 18,871 4,247 3,632 1,340 628
Short-term debt.................................. 250 2,530 284 480 654
Long-term debt................................... -- 298 336 546 529
Convertible Preferred Stock...................... -- 2,022 -- -- --
Total shareholders' equity (deficit)... 16,896 (1,943) (1,284) (653) (1,046)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
A.D.A.M. creates, publishes and markets educational multimedia software
products that provide anatomical, medical, scientific and health-related
information for the academic and consumer markets. The Company sells its
products into the academic and consumer markets through alliances with
distributors and by direct sales and marketing activities. Revenue from product
sales is generally recognized at the time of shipment to customers, distributors
and resellers or, in the case of consignment arrangements, at the time of
shipment from the consignee to their customers. The company records allowances
for product returns based on historical experience and anticipated returns.
Payments received in advance of shipments are recorded as deferred revenue and
customer deposits in the balance sheet and are recognized as revenue when the
related software is shipped and all related obligations are fulfilled.
The Company's first products addressed the graduate education and
professional markets, which are characterized by higher unit prices, lower cost
of goods sold as a percentage of selling price and lower unit volumes.
Accordingly, such products have a significantly higher gross margin than the
Company's consumer products. In early 1994, the Company made the strategic
decision to leverage its A.D.A.M. Image Database and multimedia capabilities
into developing products for the larger consumer and general education markets.
As a result, the Company's product mix is shifting from predominately higher
priced products for graduate education and professional markets to a broad array
of products with lower price points for the general education and consumer
markets. The Company's consumer products generally have a lower unit price,
higher cost of goods sold as a percent of price and lower gross margin. The
average net revenues received by the Company were approximately $50 per unit for
the 129,000 units of software sold in fiscal 1996 as compared to approximately
$101 per unit for the 56,700 units of software sold in fiscal 1995 and
approximately $1,174 per unit for the 2,400 units of software sold in fiscal
1994. The significant reduction in price points due to changes in product mix
results in lower gross margins and higher costs of revenue as a percentage of
net revenue. The Company expects these trends to continue. In addition in April
1996, the Company announced that in order to expand market share and pursue a
more volume driven business in the academic market, the Company had reduced the
prices of several of its academic products by approximately 40%. The Company
believes these price reductions will result in lower gross margins and higher
costs of revenues as a percentage of net revenue.
The Company has experienced substantial losses since its inception
resulting in an accumulated deficit of approximately $17.1 million as of March
31, 1996. For the fiscal years ended March 31, 1996, 1995 and 1994 the Company
incurred net losses of approximately $3.9 million, $3.2 million and $3.2 million
respectively, and anticipates that it will also incur a net loss during the
fiscal year ending March 31, 1997. Management believes that the Company must
successfully implement its business strategy and significantly increase its
revenues from the academic and consumer markets in order to achieve
profitability. At March 31, 1996, the Company had net operating loss
carryforwards available for tax purposes of approximately $14.8 million, which
will expire in years 2004 through 2011. Future sale of shares by certain
significant shareholders could create a substantial ownership change (as defined
by the Internal Revenue Service) which would limit the amount of the Company's
future taxable income that may be offset by preownership net operating loss
carryforwards.
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RESULTS OF OPERATIONS
The following table sets forth for the periods indicated selected financial
data and the percentages of the Company's net revenues represented by each line
item and the percentage change in each line item.
PERCENTAGE CHANGE
YEAR ENDED MARCH 31, -------------------
------------------------- 1996 TO 1995 TO
1996 1995 1994 1995 1994
----- ----- ----- ------- -------
Net revenues...................................... 100.0% 100.0% 100.0% 12.3% 104.1%
Costs and expenses:
Cost of revenues................................ 23.1 13.8 10.4 88.5 170.0
Sales and marketing............................. 63.4 63.8 69.9 11.6 86.6
Product development............................. 44.2 41.8 62.5 18.6 36.5
General and administration...................... 31.1 30.9 55.2 13.2 14.2
----- ----- -----
Total costs and expenses................ 161.8 150.3 198.0
----- ----- -----
Operating income (loss)........................... (61.8) (50.3) (98.0)
The following table sets forth for the periods indicated the revenues
derived by the Company from the academic and consumer markets and from other
sources. It also sets forth the revenues derived from each of these markets and
sources as a percentage of total net revenues. Other revenues include royalty
income, license fees and support services.
YEAR ENDED MARCH 31,
----------------------------
1996 1995 1994
------ ------ ------
Academic................................................. $3,688 $4,194 $2,719
Consumer................................................. 2,533 1,207 --
Other revenues........................................... 226 341 94
------ ------ ------
Net revenues................................... $6,447 $5,742 $2,813
====== ====== ======
Fiscal 1996 Compared to Fiscal 1995
Total net revenues increased 12.3% to $6,447,000 in fiscal 1996 compared to
$5,742,000 in fiscal 1995 as a result of increased sales of the Company's
products to the consumer market, partially offset by a decline in revenues from
the academic market. Total unit shipments of the Company's products increased to
approximately 129,000 units in fiscal 1996 from approximately 56,700 units in
fiscal 1995 due to a continued shift in the Company's product mix toward higher
volume, lower priced consumer products.
Net revenues from the academic market decreased 12.1% to $3,688,000 in
fiscal 1996 from $4,194,000 in fiscal 1995 due primarily to a significant
reduction of revenues from strategic partners during the fourth quarter of
fiscal 1996. The decrease was further impacted by the Company's aggressive
policy on price protection resulting in an increase in an allowance of
approximately $315,000 in the fourth quarter for anticipated price reductions on
several academic products. As a percent of total net revenues, net revenues from
the academic market decreased to 57.2% in fiscal 1996 compared to 73.0% in
fiscal 1995.
Net revenues from the consumer market increased 109.9% to $2,533,000 in
fiscal 1996 from $1,207,000 in fiscal 1995 due primarily to a full year of
continued sales of A.D.A.M. The Inside Story and the Company's introduction of
its second consumer title Nine Month Miracle in April 1995. The Company's third
consumer title, Life's Greatest Mysteries, which was launched in October 1995,
experienced lower than expected sales during the Company's fourth quarter of
fiscal 1996. As a percent of total net revenues, net revenues from the consumer
market increased to 39.3% in fiscal 1996 compared to 21.0% in fiscal 1995.
The Company believes that its future revenue growth will depend on, among
other things, its ability to introduce new and upgraded products to the
marketplace, the extent of competition, unit pricing trends, the demand for its
software in the academic and consumer markets, and the performance of the
Company's
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strategic partners in areas of marketing, sales and distribution of the
Company's products. In this regard, the Company considers its future revenues to
be unpredictable.
Cost of revenues increased 88.5% to $1,491,000 in fiscal 1996 compared to
$791,000 in fiscal 1995. Cost of revenues, which includes the cost of support,
packaging, documentation, royalties, and amortization of capitalized product
development costs, increased primarily from increases in net revenues,
specifically in the consumer market and an increase in amortization of
capitalized product. As a percent of total net revenues, cost of revenues
increased to 23.1% in fiscal 1996 compared to 13.8% in fiscal 1995 due to the
above factors, as well as a shift in the Company's product mix towards higher
volume, lower priced consumer products.
Sale and marketing expenses increased 11.6% to $4,090,000 in fiscal 1996
from $3,666,000 in fiscal 1995, primarily as a result of increased marketing
expenses relating to the introduction of Nine Month Miracle and Life's Greatest
Mysteries in the consumer market. As a percentage of total net revenues, sales
and marketing expenses decreased slightly to 63.4% in fiscal 1996 from 63.8% in
fiscal 1995.
Product development costs increased 18.6% to $2,847,000 in fiscal 1996 from
$2,401,000 in fiscal 1995 due primarily to an increase in consulting costs
related to product development activity and a $356,000 reduction in the amount
of development costs capitalized for fiscal 1996 compared to fiscal 1995. The
reduction in capitalized development costs was due to changes in design
specifications of new products later in the development process which resulted
in an extension of the time required before technological feasibility was
achieved and thereby shortened the period during which development costs were
capitalized. As a percentage of total net revenues, product development expenses
increase to 44.2% in fiscal 1996 from 41.8% in fiscal 1995. Total expenditures
for product development, including capitalized expenses, increased to $2,940,000
in fiscal 1996 compared to $2,850,000 in fiscal 1995. The Company capitalized
product development expenses of $93,000 and $449,000 in fiscal 1996 and fiscal
1995, respectively which represented 3.2% and 15.8% of total expenditures for
product development in these respective periods. Amortization of capitalized
product development cost totaled $356,000 and $119,000 in fiscal 1996 and 1995,
respectively, and is charged to and included in cost of revenues described
above.
General and administrative expenses increased 13.2% to $2,008,000 in fiscal
1996 from $1,774,000 in fiscal 1995 primarily as a result of increased
consulting and professional fees associated with being a public company. As a
percentage of total net revenues, general and administrative expenses increased
to 31.1% in fiscal 1996 from 30.9% in fiscal 1995.
Fiscal 1995 Compared to Fiscal 1994
Total net revenues increased 104.1% to $5,742,000 in fiscal 1995 from
$2,813,000 in fiscal 1994 as a result of increased sales of the Company's
products in the academic market and the initiation of sales of the Company's
products to the consumer market beginning September 1994. Total unit shipments
of the Company's products increased to approximately 56,700 units in fiscal 1995
from approximately 2,400 units in fiscal 1994 due to a shift in the Company's
product mix toward higher volume, lower priced consumer products.
Net revenues from the academic market increased 54.2% to $4,194,000 in
fiscal 1995 from $2,719,000 in fiscal 1994 as a result of the introduction of
new products and an increase in the number of resellers of the Company's
products. Net revenues from products introduced in fiscal 1995, including
A.D.A.M. Essentials, A.D.A.M. Standard and A.D.A.M. Benjamin/Cummings
Interactive Physiology: Cardiovascular Module, generated $1,153,000 of net
revenues in fiscal 1995. As a percentage of total revenues, net revenues from
the academic market decreased to 73.0% in fiscal 1995 from 96.7% in fiscal 1994.
Net revenues from the consumer market of $1,207,000 in fiscal 1995 resulted
from sales of A.D.A.M. The Inside Story, which was introduced in September 1994.
Net revenues from the consumer market comprised 21.0% of total net revenues in
fiscal 1995.
Cost of revenues increased 170.0% to $791,000 in fiscal 1995 from $293,000
in fiscal 1994, primarily as a result of increased net revenues and a $116,000
increase in amortization of capitalized software development costs. As a
percentage of total net revenues, cost of revenues increased to 13.8% in fiscal
1995 from 10.4% in
16
19
fiscal 1994, primarily due to a shift in the Company's product mix toward higher
volume, lower-priced consumer products.
Sales and marketing expenses increased 86.6% to $3,666,000 in fiscal 1995
from $1,965,000 in fiscal 1994, primarily as a result of product launch and
marketing expenses of approximately $1,361,000 relating to the Company's
introduction of products for the consumer market. As a percentage of total net
revenues, sales and marketing expenses decreased to 63.8% in fiscal 1995 from
69.9% in fiscal 1994.
Product development expenses increased 36.5% to $2,401,000 in fiscal 1995
from $1,759,000 in fiscal 1994, primarily as a result of an increase in
personnel and consulting costs for the development of new products. As a
percentage of total net revenues, product development expenses decreased to
41.8% in fiscal 1995 from 62.5% in fiscal 1994. Total expenditures for product
development, including capitalized expenses, increased to $2,850,000 in fiscal
1995 from $1,800,000 in fiscal 1994. The Company capitalized product development
expenses of $449,000 and $41,000 in fiscal 1995 and fiscal 1994, respectively,
which represented 15.8% and 2.3% of total expenditures for product development
in these respective periods. Amortization of capitalized product development
cost totaled $119,000 and $3,000 in fiscal 1995 and fiscal 1994, respectively,
and is charged to and included in cost of revenues described above.
General and administrative expenses increased 14.2% to $1,774,000 in fiscal
1995 from $1,554,000 in fiscal 1994, primarily due to an increase in
infrastructure expenses to support the growth of the Company's operations. As a
percentage of total net revenues, general and administrative expenses decreased
to 30.9% in fiscal 1995 from 55.2% in fiscal 1994.
LIQUIDITY AND CAPITAL RESOURCES
Since the Company's organization in 1990, the Company has financed its
operations primarily through private placements of Common Stock and preferred
stock and borrowings, having received net proceeds totaling approximately
$10,423,000 from private sales of Common Stock and $6,104,000 from private sales
of Convertible Preferred Stock. On November 10, 1995 the Company received net
proceeds of approximately $16,500,000 from its initial public offering of Common
Stock. At March 31, 1996 the Company had cash and cash equivalents of
$5,352,000, short-term investments of $10,981,000, and working capital of
$15,354,000. Cash used in operating activities was $2,601,000 in fiscal 1996,
$3,504,000 in fiscal 1995 and $2,223,000 in fiscal 1994, principally as a result
of net losses for these periods. Cash used in investing activities was
$11,028,000 in fiscal 1996, $462,000 in fiscal 1995 and $2,098,000 in fiscal
1994. The increase in fiscal 1996 primarily reflects the purchase of short-term
investments. Cash provided by financing activities was $18,041,000 in fiscal
1996, $4,190,000 in fiscal 1995 and $4,689,000 in fiscal 1994. The increase in
fiscal 1996 primarily reflects the proceeds from the issuance of common stock
resulting from the initial public offering.
At March 31, 1996 the Company had used approximately $2,000,000 of the net
proceeds from its initial public offering to repay outstanding indebtedness,
consisting of all principal and accrued interest outstanding under the
subordinated bridge notes issued to certain investors in fiscal 1995, and the
Company's term loan with a bank.
The Company uses its working capital to finance ongoing operations and to
fund expansion and development of its product lines. In addition, the Company
evaluates from time to time other acquisitions of products or companies that
compliment the Company's business. At this time, the Company is not committed to
incur any significant capital expenditure in fiscal 1997.
The Company expects that cash flow from operations and existing cash and
short-term investments will be adequate to meet the Company's cash requirements
for the short and long term (i.e. twelve months or less and one to two years
respectively).
17
20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information included under Item 14(a)(1) and (2).
ITEM. 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable
18
21
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information under the heading "Election of Directors" entitled
"Nominees for Election Term Expiring in 1996", "Directors Continuing in Office
Until 1997" and "Directors Continuing in Office Until 1998" of the Proxy
Statement for the Annual Meeting of Shareholders to be held September 18, 1996
(the "Proxy Statement") is incorporated hereby by reference for information on
the directors of the Registrant. See Item X in Part I hereof for information
regarding executive officers of the Registrant. The information under the
heading "Other Matters" entitled "Compliance with Section 16(a) of the
Securities Exchange Act of 1934" of the Proxy Statement is incorporated herein
by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information under the heading "Election of Directors" entitled
"Compensation of Directors" of the Proxy Statement and the sections under the
heading "Executive Compensation" entitled "Summary Compensation Table," "Option
Grants in Last Fiscal Year," "Fiscal Year-End Option Value Table" and
"Compensation Committee Interlocks and Insider Participant" of the Proxy
Statement are incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the heading "Common Stock Ownership by Management and
Principal Shareholders" of the Proxy Statement is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the heading "Certain Transactions" of the Proxy
Statement is incorporated herein by reference.
19
22
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are included as part of this report:
PAGE
----
(1) Financial Statements:
Report of Independent Accountants...................................... F-1
Balance Sheet at March 31, 1996 and 1995............................... F-2
Statement of Operations for the three years ended March 31, 1996....... F-3
Statement of Changes in Shareholders' Equity (Deficit) for the three
years ended March 31, 1996.............................................. F-4
Statement of Cash Flows for the three years ended March 31, 1996....... F-5
Notes to Financial Statements.......................................... F-6
(2) Financial Statement Schedule:
For the three years ended March 31, 1996
II -- Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
EXHIBIT DESCRIPTION
- - ------- ---------------------------------------------------------------------------------
3.1* -- Amended and Restated Articles of Incorporation of the Company.
3.2* -- Amended and Restated Bylaws of the Company.
4.1* -- Amended and Restated Articles of Incorporation of the Company (incorporated by
reference to Exhibit 3.1).
4.2* -- Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit
3.2).
4.3* -- Specimen Common Stock Certificate Stock Option Plan.
4.4* -- Forms of Option Certificates relating to Company's 1992 Stock Option Plan.
4.5* -- Form of Warrants to Purchase shares of Common Stock, dated April through
November, 1994.
4.6* -- Warrant issued to The Robinson-Humphrey Company, Inc. on May 23, 1995.
10.1* -- Convertible Preferred Stock Purchase Agreement by and among the Company, Chemical
Bank, as trustee for the Firestone Tire and Rubber Master Trust (the "Firestone
Trust") and James D. Oelschlager, dated as of December 22, 1994.
10.2* -- Convertible Preferred Stock Purchase Agreement by and among the Company, the
Firestone Trust and James D. Oelschlager, as trustee for the Oak Associates
Profit Sharing Plan and Trust, dated as of May 23, 1995.
10.3* -- Convertible Preferred Stock Purchase Agreement by and between the Company and
Addison-Wesley Publishing Company, Inc., dated as of August 22, 1995.
10.4* -- Form of Convertible Preferred Stock Purchase Agreement by and between the Company
and certain investors, dated as of August 30, 1995.
10.5* -- Termination Agreement by and between John W. McClaugherty and the Company,
effective as of March 31, 1994.
10.6* -- ADAM/McClaugherty Termination-Redemption Agreement between the Company and John
W. McClaugherty, dated August 30, 1995.
10.7* -- Irrevocable Standby Letter of Credit issued by NationsBank of Georgia, N.A., for
the benefit of the Northwestern Mutual Life Insurance Company.
10.8* -- Amended and Restated 1992 Stock Option Plan.
10.9* -- 401(k) Adoption Agreement and Trust.
10.10* -- Employment Agreement between the Company and Robert S. Cramer, Jr., dated
December 21, 1994.
10.11* -- Employment Agreement between the Company and Curtis A. Cain, dated December 19,
1994.
20
23
EXHIBIT DESCRIPTION
- - ------- ---------------------------------------------------------------------------------
10.12* -- Employment Agreement between the Company and Gregory M. Swayne, dated December
19, 1994.
10.13* -- Employee Confidentiality, Non-disclosure and Non-competition Agreement between
the Company and Robert A. DiProva, dated September 1, 1995.
10.14* -- Severance Agreement between the Company and Robert A. DiProva, dated September 1,
1995.
10.15 -- Employee Confidentiality, Non-disclosure and Non-competition Agreement between
the Company and David Tranberg dated January 25, 1996.
10.16 -- Severance Agreement between the Company and David Tranberg, dated January 25,
1996.
10.17 -- Employee Confidentiality, Non-disclosure and Non-competition Agreement between
the Company and Joseph R. Fuller, dated April 18, 1994.
10.18 -- Severance Agreement between the Company and Joseph R. Fuller, dated January 15,
1996.
10.19* -- Sublease between I.B.M. Corporation and the Company, dated as of March 1, 1994.
10.20* -- Sublease Agreement between PCI Group and the Company, dated as of October 13,
1994.
10.21* -- Lease between Northwestern Mutual Life Insurance Company and the Company, dated
as of March 1, 1994.
10.22*+ -- Software Distribution Agreement by and among Matsushita Electric Industrial Co.,
C.I.T.D. and the Company, dated April 16, 1993.
10.23*+ -- Co-Development Agreement by and among Addison-Wesley Publishing Company, Inc.
("Addison-Wesley"), The Benjamin/Cummings Publishing Company, Inc. ("Benjamin/
Cummings") and the Company, dated June 25, 1993.
10.24*+ -- Product Development Agreement (Physiology Product) between Benjamin/Cummings and
the Company, dated August 4, 1994, as amended by Letter Agreement dated May 19,
1995.
10.25*+ -- Product Development Agreement (Physiology Product -- Modules 4-8) between
Benjamin/ Cummings and the Company, dated as of September 14, 1995.
10.26*+ -- Software Reseller Agreement by and between Churchill Livingstone, Medical
Division of Longman Group UK Ltd., and the Company, dated as of December 30, 1993
(the agreement was assigned by Churchill Livingstone to Pearson Professional
Limited, its successor, effective as of January 1, 1995).
10.27* -- Publishing Agreement by and between Williams & Wilkins and the Company, dated
February 22, 1994.
10.28* -- License Agreement by and between J.S.K., Inc. and the Company, dated April 1,
1994, as amended on August 30, 1995.
10.29* -- Software Reseller Agreement between J.S.K., Inc. and the Company, dated April 29,
1994, as amended on August 30, 1995.
10.30*+ -- Software Distribution Agreement between Brderbund Software, Inc. and the Company,
dated as of June 1, 1994, as amended by Amendment No. 1, dated as of November 1,
1994.
10.31*+ -- Software Reseller Agreement among the Company, Addison-Wesley, through its
Addison-Wesley/Benjamin Cummings Group Sales Force Division, Benjamin/Cummings,
and Addison-Wesley Publishers, Ltd., dated as of August 4, 1994.
10.32*+ -- Software Reseller Agreement between the Company and Addison-Wesley, through its
Addison-Wesley School Division, dated as of February 9, 1995.
10.33* -- Compact Disc Distribution Agreement between Apple Computer, Inc. and the Company,
dated August 18, 1994, as amended by Amendment 1, dated as of January 23, 1995
and Amendment 2, dated as of July 11, 1995.
10.34*+ -- Software Reseller Agreement between Longman Asia Limited and the Company, dated
as of October 21, 1994, as amended by Amendment No. 1, dated as of November 6,
1994.
10.35*+ -- Software Reseller Agreement between Churchill Livingstone, Inc. and the Company,
dated as of May 8, 1995.
10.36* -- Localization Agreement between Sunflowers Interactive Entertainment, a
wholly-owned subsidiary of BOMICO, and the Company, dated June 28, 1995.
21
24
EXHIBIT DESCRIPTION
- - ------- ---------------------------------------------------------------------------------
10.37* -- Software Reseller Agreement between BOMICO UNTERHALTUNGSSOFT-UND-HARDWARE
VERTRIEBS GMBH and the Company, dated June 28, 1995.
10.38* -- Distribution Agreement with Ingram Micro, dated August 10, 1995.
10.39* -- Vendor Agreement between ABCO Distributors, Inc. and the Company, dated August
10, 1994.
10.40 -- Publishing/Developer Agreement by and between J.S.K., Inc. and the Company dated
as of November 30, 1995.
10.41 -- Software Reseller Agreement between Pearson Professionals (Australia) and the
Company dated as of December 13, 1995.
10.42 -- Addendum dated January 19, 1996 to Distribution Agreement with Ingram Micro,
dated August 10, 1995.
10.43 -- Localization Agreement between ZEMI Corp. and the Company dated June 7, 1996.
10.44++ -- Amendment dated June 11, 1996 to Product Development Agreement (Physiology
Product -- Modules 4-8) between Benjamin/Cummings and the Company, dated as of
September 14, 1995.
11.1 -- Computation of Per Share Earnings.
27.1 -- Financial Data Schedule (for SEC use only).
- - ---------------
* Incorporated by reference to the Company's Registration on Statement on
Form S-1, File No. 33-96864
+ The Company has been granted confidential treatment of portions of this
Exhibit.
Accordingly, portions thereof have been omitted and filed separately.
++ The Company has applied for confidential treatment of portions of this
Exhibit. Accordingly, portions thereof have been omitted and filed
separately.
(b) Reports on Form 8-K
No reports on Form 8-K have been filed with the Securities and Exchange
Commission during the fourth quarter of fiscal 1996.
22
25
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. SOFTWARE, INC.
(Registrant)
By: ROBERT S. CRAMER, JR.
------------------------------------
Robert S. Cramer, Jr.
Chairman of the Board, Co-Founder
and Director
Date: June 30, 1996
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 and on the dates indicated.
SIGNATURE TITLE DATE
- - --------------------------------------------- --------------------------------- --------------
ROBERT S. CRAMER, JR. Chairman of the Board, Co-Founder June 30, 1996
- - --------------------------------------------- and Director
Robert S. Cramer, Jr.
CURTIS A. CAIN Chief Executive Officer June 30, 1996
- - --------------------------------------------- (Principal Executive Officer)
Curtis A. Cain
GREGORY M. SWAYNE President, Co-Founder, Vice- June 30, 1996
- - --------------------------------------------- President of Production and
Gregory M. Swayne Director
ROBERT A. DIPROVA Chief Financial Officer and Vice- June 30, 1996
- - --------------------------------------------- President of Administration
Robert A. DiProva (Principal Financial Officer)
MICHAEL S. FISHER Controller (Controller) June 30, 1996
- - ---------------------------------------------
Michael S. Fisher
JOHN W. MCCLAUGHERTY Director June 30, 1996
- - ---------------------------------------------
John W. McClaugherty
- - --------------------------------------------- Director June 30, 1996
Sally D. Elliott
DR. ANTHONY J. GATTI Director June 30, 1996
- - ---------------------------------------------
Dr. Anthony J. Gatti
HOLCOMBE T. GREEN, JR. Director June 30, 1996
- - ---------------------------------------------
Holcombe T. Green, Jr.
- - --------------------------------------------- Director June 30, 1996
J. Larry Jones
DR. C. EVERETT KOOP Director June 30, 1996
- - ---------------------------------------------
Dr. C. Everett Koop
23
26
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
A.D.A.M. Software, Inc.
In our opinion, the financial statements listed in the index appearing
under Item 14(a)(1) and (2) on page 20 present fairly, in all material respects,
the financial position of A.D.A.M. Software, Inc. at March 31, 1996 and 1995,
and the results of its operations and its cash flows for each of the three years
in the period ended March 31, 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards 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 the opinion expressed above.
PRICE WATERHOUSE LLP
Atlanta, Georgia
May 10, 1996
F-1
27
A.D.A.M. SOFTWARE, INC.
BALANCE SHEET
MARCH 31,
-----------------------
1996 1995
-------- --------
(IN THOUSANDS, EXCEPT
SHARE DATA)
ASSETS
Current assets
Cash and cash equivalents.......................................... $ 5,352 $ 940
Short-term investments............................................. 10,981 --
Accounts receivable, net of allowances of $766 and $110............ 448 1,024
Inventories........................................................ 433 170
Prepaids and other................................................. 115 --
-------- --------
Total current assets....................................... 17,329 2,134
Property and equipment, net.......................................... 889 1,014
Software development costs, net...................................... 105 368
Restricted certificate of deposit.................................... 548 731
-------- --------
$ 18,871 $ 4,247
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities
Accounts payable................................................... $ 526 $ 397
Accrued liabilities................................................ 614 446
Accrued interest................................................... 158 171
Accrued compensation and employee benefits......................... 182 130
Deferred rent...................................................... 245 196
Third party advances............................................... 250 250
Subordinated notes payable to related parties...................... -- 1,319
Current portion of notes payable................................... -- 961
-------- --------
Total current liabilities.................................. 1,975 3,870
Notes payable........................................................ -- 298
-------- --------
Total liabilities.......................................... 1,975 4,168
-------- --------
Mandatorily redeemable convertible preferred stock Series A, $0.01
par value; $12 redemption value; 937,500 shares authorized; 0 and
262,500 shares issued and outstanding.............................. -- 2,022
Shareholders' equity (deficit)
Preferred stock, no par value; 9,062,500 shares authorized; no
shares issued and outstanding................................... -- --
Common stock, $0.01 par value; 20,000,000 shares authorized;
5,234,647 and 2,696,887 shares issued and outstanding........... 52 27
Common stock warrants.............................................. 135 --
Additional paid-in capital......................................... 33,783 10,168
Accumulated deficit................................................ (17,074) (12,138)
-------- --------
16,896 (1,943)
Commitments (Note 12)................................................
-------- --------
$ 18,871 $ 4,247
======== ========
The accompanying notes are an integral part of these financial statements.
F-2
28
A.D.A.M. SOFTWARE, INC.
STATEMENT OF OPERATIONS
YEAR ENDED MARCH 31,
-------------------------------
1996 1995 1994
------- ------- -------
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
Net revenues.................................................. $ 6,447 $ 5,742 $ 2,813
------- ------- -------
Cost and expenses
Cost of revenues............................................ 1,491 791 293
Sales and marketing......................................... 4,090 3,666 1,965
Product development......................................... 2,847 2,401 1,759
General and administrative.................................. 2,008 1,774 1,554
------- ------- -------
10,436 8,632 5,571
------- ------- -------
Operating loss........................................... (3,989) (2,890) (2,758)
Interest expense.............................................. (317) (383) (90)
Interest income............................................... 415 43 64
------- ------- -------
Loss from continuing operations before income taxes........... (3,891) (3,230) (2,784)
Income taxes.................................................. -- -- --
------- ------- -------
Loss from continuing operations.......................... (3,891) (3,230) (2,784)
------- ------- -------
Discontinued operations
Loss from operations of MLI (less applicable income taxes of
$0)...................................................... -- -- (291)
Loss on disposal of MLI (less applicable income taxes of
$0)...................................................... -- -- (109)
------- ------- -------
Loss from discontinued operations before extraordinary
item..................................................... -- -- (400)
Extraordinary loss on extinguishment of debt (net of income
tax benefit of $29)...................................... (46) -- --
------- ------- -------
Net loss................................................. $(3,937) $(3,230) $(3,184)
======= ======= =======
Net loss per common share and common share equivalent
Loss before discontinued operations......................... $ (1.13) $ (1.22) $ (1.11)
Loss from discontinued operations........................... -- -- (.16)
Loss from extraordinary item................................ (.01) -- --
------- ------- -------
Net loss per common share..................................... $ (1.14) $ (1.22) $ (1.27)
======= ======= =======
Weighted average number of common shares and common share
equivalents outstanding..................................... 3,673 2,694 2,510
======= ======= =======
Unaudited pro forma and supplemental earnings per share
Pro forma net loss per common share......................... $ (.99) $ (1.17)
======= =======
Pro forma weighted average number of common shares
outstanding.............................................. 3,962 2,766
======= =======
Supplemental pro forma net loss per common share............ $ (.92)
=======
Supplemental pro forma weighted average number of common
shares outstanding....................................... 4,055
=======
The accompanying notes are an integral part of these financial statements.
F-3
29
A.D.A.M. SOFTWARE, INC.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
COMMON STOCK ADDITIONAL COMMON
------------------ PAID-IN STOCK ACCUMULATED
SHARES AMOUNT CAPITAL WARRANTS DEFICIT TOTAL
--------- ------ ---------- -------- ----------- -------
(IN THOUSANDS, EXCEPT SHARE DATA)
BALANCE AT MARCH 31, 1993............ 2,169,739 $ 22 $ 5,049 $ -- $ (5,724) $ (653)
Issuance of common stock............. 450,000 4 4,980 -- -- 4,984
Net loss............................. -- -- -- -- (3,184) (3,184)
Conversion of borrowings from
shareholder and accrued interest to
common
stock.............................. 65,515 1 130 -- -- 131
Exercise of common stock options..... 2,000 -- 6 -- -- 6
--------- ------ ---------- -------- ----------- -------
BALANCE AT MARCH 31, 1994............ 2,687,254 27 10,165 -- (8,908) 1,284
Net loss............................. -- -- -- -- (3,230) (3,230)
Accretion of discount on mandatorily
redeemable preferred stock......... -- -- (47) -- -- (47)
Notes receivable received for stock
options exercised.................. -- -- (43) -- -- (43)
Exercise of common stock options..... 9,633 -- 93 -- -- 93
--------- ------ ---------- -------- ----------- -------
BALANCE AT MARCH 31, 1995............ 2,696,887 27 10,168 -- (12,138) (1,943)
Issuance of common stock............. 1,558,600 15 16,489 -- -- 16,504
Net loss............................. -- -- -- -- (3,937) (3,937)
Retirement of common shares.......... (125,000) (1) (999) (1,000)
Conversion of preferred stock........ 762,500 8 6,186 -- -- 6,194
Accretion of discount on mandatorily
redeemable preferred stock......... -- -- (244) -- -- (244)
Exercise of common stock options..... 341,660 3 1,184 -- -- 1,187
Issuance of common stock warrants.... -- -- -- 135 -- 135
--------- ------ ---------- -------- ----------- -------
BALANCE AT MARCH 31, 1996............ 5,234,647 $ 52 $ 33,783 $135 $ (17,074) $16,896
======== ====== ======= ======= ========= =======
The accompanying notes are an integral part of these financial statements.
F-4
30
A.D.A.M. SOFTWARE, INC.
STATEMENT OF CASH FLOWS
YEAR ENDED MARCH 31,
----------------------------
1996 1995 1994
-------- ------- -------
(IN THOUSANDS)
Cash flows from operating activities
Net loss....................................................... $ (3,937) $(3,230) $(3,184)
Adjustments to reconcile net loss to net cash used in operating
activities Depreciation and amortization.................... 796 562 274
Accretion................................................... (118) -- --
Loss on disposal of property and equipment.................. -- -- 16
Loss on disposal of MLI..................................... -- -- 109
Loss on extinguishment of debt.............................. 75 -- --
Changes in assets and liabilities
Decrease (increase) in accounts receivable................ 576 (477) (24)
(Increase) in inventories................................. (263) (14) (156)
(Increase) decrease in prepaids and other assets.......... (115) -- 26
Increase (decrease) in accounts payable................... 129 (141) 338
Increase (decrease) in accrued liabilities................ 168 (499) 325
(Decrease) increase in accrued interest................... (13) 132 --
Increase (decrease) in accrued compensation and employee
benefits............................................... 52 26 (6)
Increase in deferred rent................................. 49 137 59
-------- ------- -------
Net cash used in operating activities.................. (2,601) (3,504) (2,223)
-------- ------- -------
Cash flows from investing activities
Purchases of short-term investments............................ (20,803) -- --
Proceeds from sale of short-term investments................... 10,000 -- --
Purchases of property and equipment............................ (315) (180) (1,159)
Redemption (purchase) of restricted certificate of deposit..... 183 167 (898)
Software development costs..................................... (93) (449) (41)
-------- ------- -------
Net cash used in investing activities.................. (11,028) (462) (2,098)
-------- ------- -------
Cash flows from financing activities
Proceeds from issuance of common stock, net of issuance costs,
and exercise of options..................................... 17,691 7 4,990
Repurchase of common stock..................................... (1,000) -- --
Proceeds from issuance of mandatorily redeemable preferred
stock, net of issuance costs................................ 3,928 1,975 --
Proceeds from issuance of subordinated debt.................... -- 2,244 --
Borrowings under line of credit................................ -- 291 100
Repayments under line of credit................................ -- (291) (300)
Repayments of notes payable.................................... (2,578) (36) (30)
Other.......................................................... -- (71)
-------- ------- -------
Net cash provided by financing activities................... 18,041 4,190 4,689
-------- ------- -------
Increase in cash and cash equivalents............................ 4,412 224 368
Cash and cash equivalents, beginning of period................... 940 716 348
-------- ------- -------
Cash and cash equivalents, end of period......................... $ 5,352 $ 940 $ 716
======== ======= =======
The accompanying notes are an integral part of these financial statements.
F-5
31
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A.D.A.M. Software, Inc. (A.D.A.M. or the Company) creates, publishes and
markets educational multimedia software products that provide anatomical,
medical, scientific and health-related information for the academic/professional
(academic) and consumer markets. A.D.A.M.(R) products incorporate internally
developed, original medical illustrations with text, audio, photography,
animation and video in easy-to-use, interactive software applications.
BASIS OF PRESENTATION
The accompanying financial statements for the year ended March 31, 1994
include the accounts of A.D.A.M. and Medical-Legal Illustrations, Inc. (MLI).
Effective June 30, 1992, MLI was merged into A.D.A.M., with MLI operating as the
medical illustrations business of A.D.A.M., and the separate corporate existence
of MLI ceased. The merger was accounted for as a combination of entities under
common control and was accounted for by combining the historical accounts of
A.D.A.M. and MLI (in a manner similar to a pooling of interest) since A.D.A.M.
and MLI had common shareholders. The shareholders of MLI received 312,760 shares
of A.D.A.M. common stock for the 1,250 outstanding common shares of MLI.
Subsequently, on March 31, 1994, the Company approved a plan to discontinue the
operations and dispose of the medical illustrations business (Note 14). The
disposal of MLI was reflected in the March 31, 1994 financial statements.
Certain prior year amounts in the financial statements have been
reclassified to conform to current year presentation.
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
The Company sells its products into the academic and consumer markets
through alliances with distributors and by direct sales and marketing
activities. Revenue from product sales is generally recognized at the time of
shipment to customers, distributors or resellers or, in the case of consignment
arrangements, at the time of shipment from the consignee to their customers. The
Company records allowances for product returns based on historical experience
and anticipated returns. Payments received in advance of shipments are recorded
as deferred revenue and customer deposits in the accompanying balance sheet and
are recognized as revenue when the related software is shipped.
RESTRICTED CERTIFICATE OF DEPOSIT
In connection with the Company's noncancellable operating lease for its
office space, the Company is required to purchase certificates of deposit with a
bank securing a letter of credit guaranteeing rental payments under the lease
(see Note 12). The certificate of deposit matures May 29, 1996, bears interest
at 4.3% and is carried at cost which approximates market.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of marketable securities and trade receivables.
The Company restricts investment of marketable
F-6
32
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
securities to short-term investment grade securities and direct or guaranteed
obligations of the United States government.
A significant portion of the Company's revenues and related receivables are
from major distributors. At March 31, 1996, the Company had receivables from two
major distributors of approximately $400,000 and $133,000, respectively. Total
sales to these distributors were approximately 18% and 5% of net revenues during
fiscal 1996.
INVENTORIES
Inventories consist principally of computer software media and related
shipping supplies and are stated at the lower of specific cost or market. Cost
is determined using the first-in, first-out method.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost, less accumulated depreciation
and amortization. Depreciation and amortization are provided using the
straight-line method for financial reporting purposes and accelerated methods
for income tax purposes over the estimated useful lives of three to five years.
SOFTWARE DEVELOPMENT COST
Capitalized software development costs consist principally of salaries and
certain other expenses directly related to development and modifications of
software products capitalized in accordance with the provisions of Statement of
Financial Accounting Standards (SFAS) No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed". Capitalization of
such costs begins when a working model has been produced as evidenced by
completion of design, planning, coding and testing such that the product meets
its design specifications and has thereby established technological feasibility
as defined in SFAS No. 86. Capitalization of such costs ends when the resulting
product is available for general release to the public. Amortization of
capitalized software 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 the Company has determined is not more than eighteen months. It
is reasonably possible that those estimates of anticipated product revenues, the
remaining estimated economic life of the product, or both will be reduced
significantly in the near term due to changing technologies. As a result, the
carrying amount of capitalized software costs may be reduced materially in the
near term.
INCOME TAXES
On April 1, 1993, the Company adopted SFAS 109, "Accounting for Income
Taxes." The adoption of SFAS 109 changed the Company's method of accounting for
income taxes from the deferred method to an asset and liability approach. The
asset and liability approach requires the recognition of deferred tax
liabilities and assets for the expected future tax consequences of temporary
differences between the financial statement carrying amounts and the tax bases
of existing assets and liabilities. The adoption of SFAS 109 did not have a
significant effect on the financial statements.
LOSS PER SHARE
Net loss per share is computed using the weighted average number of common
shares and common share equivalents outstanding during 1996, 1995 and 1994. The
loss per common share gives effect to the accretion of discount on mandatorily
redeemable preferred stock. The Company's stock options and warrants are
excluded from the calculation of loss per share due to their anti-dilutive
effect.
F-7
33
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PRO FORMA NET LOSS PER SHARE (UNAUDITED)
Pro forma net loss per share has been included to give effect to the
conversion of the Company's outstanding convertible preferred stock upon
consummation of the initial public offering (see Notes 8 and 9).
Pro forma net loss per share is computed using the weighted average number
of common shares and common share equivalents outstanding during 1996 and 1995.
The number of pro forma weighted average shares outstanding during 1996 and 1995
is based on the number of weighted average shares outstanding in each period
after giving effect to the estimated number of additional shares (289,000 in
fiscal 1996 and 72,000 in fiscal 1995) that would have been outstanding upon
conversion of the mandatorily redeemable preferred stock. The Company's stock
options and warrants are excluded from the 1996 and 1995 calculation of pro
forma net loss per share due to their anti-dilutive effect.
SUPPLEMENTAL PRO FORMA NET LOSS PER SHARE (UNAUDITED)
Supplemental pro forma net loss per share for 1996 is computed using the
pro forma weighted average number of shares of common stock and common stock
equivalents increased by the estimated number of additional shares to repay
certain indebtedness. This payment was effected after consummation of the
initial public offering. Pro forma net loss is decreased to give effect to the
reduction in interest costs of approximately $187,000 in fiscal 1996.
NEW PRONOUNCEMENTS
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation" (SFAS 123) which establishes a fair value based method model to
value options and determine compensation costs at the date of grant. However,
SFAS 123 provides companies with the election to continue to measure
compensation cost using the methods prescribed by Accounting Principles Board
Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25). Companies
making such election must make pro forma comparative disclosures of net income
and earnings per share beginning in fiscal years beginning after December 31,
1995 as if SFAS 123 had been applied. The Company intends to elect the
disclosure alternative of SFAS 123; therefore, no adjustment as a result of
adopting this statement is anticipated.
2. MARKETABLE SECURITIES
On March 31, 1996, the Company held investments in marketable securities
which it classified as held-to-maturity. Held-to-maturity securities represent
those securities that the Company has both the positive intent and ability to
hold to maturity and are carried at amortized cost. Securities with a maturity
date within one year are classified as short-term investments as a part of
Current Assets and are stated at fair value plus accrued interest. These
held-to-maturity securities at March 31, 1996 included the following (in
thousands):
GROSS
AMORTIZED FAIR UNREALIZED
COST VALUE GAIN/(LOSS)
--------- ------- -----------
Paine Weber Commercial Paper, face value of $2,000,000
interest at 5.38% due April 1, 1996.................. $ 2,000 $ 1,999 $ (1)
CIGNA Commercial Paper, face value of $2,000,000
interest at 5.38%, due April 1, 1996................. 2,000 1,999 (1)
GMAC Commercial Paper, face value of $2,000,000
interest at 5.33%, due June 6, 1996.................. 1,981 1,979 (2)
U.S. Treasury Note, face value of $1,000,000 interest
at 7.25%, due November 30, 1996...................... 1,036 1,012 (24)
F-8
34
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
GROSS
AMORTIZED FAIR UNREALIZED
COST VALUE GAIN/(LOSS)
--------- ------- -----------
U.S. Treasury Strips, face value of $1,000,000 interest
at 5.34%, due May 15, 1996........................... 994 994 --
AMEX -- Commercial Paper, face value of $1,000,000
interest at 5.56%, due June 3, 1996.................. 990 990 --
CIGNA Financial -- Commercial Paper, face value of
$1,000,000 interest at 5.34%, due August 30, 1996.... 977 977 --
Federal Home Loan Bank Note, face value of $1,000,000
interest at 5.4%, due March 28, 1997................. 1,003 999 (4)
--------- ------- -----------
$10,981 $10,949 $ (32)
======= ======= =========
Net unrealized losses on held-to-maturity securities have not been
recognized in the accompanying financial statements. There were no realized
gains or losses for the years ended March 31, 1996, 1995 and 1994.
3. INVENTORIES
The components of inventory are summarized as follows (in thousands):
MARCH 31,
-----------
1996 1995
---- ----
Raw materials........................................................... $274 $111
Finished goods.......................................................... 159 59
---- ----
$433 $170
==== ====
4. PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows (in thousands):
MARCH 31,
----------------
1996 1995
------- ------
Computers........................................................... $ 1,073 $ 840
Equipment........................................................... 257 221
Furniture and fixtures.............................................. 545 515
Leasehold improvements.............................................. 167 161
------- ------
2,042 1,737
Less -- accumulated depreciation and amortization................... (1,153) (723)
------- ------
$ 889 $1,014
======= ======
Depreciation and amortization of property and equipment totalled
approximately $440,000, $443,000 and $271,000 for 1996, 1995 and 1994,
respectively.
F-9
35
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. PRODUCT DEVELOPMENT EXPENDITURES
Product development expenditures are summarized as follows (in thousands):
YEAR ENDED MARCH 31,
----------------------------
1996 1995 1994
------ ------ ------
Total development expenditures........................... $2,940 $2,850 $1,800
Less: Additions to capitalized software development,
prior to amortization.................................. (93) (449) (41)
------ ------ ------
Product development expense.............................. $2,847 $2,401 $1,759
====== ====== ======
The activity in the capitalized software development account is summarized
as follows (in thousands):
YEAR ENDED MARCH 31,
----------------------------
1996 1995 1994
------ ------ ------
Balance at beginning of year, net........................ $ 368 $ 38 $ --
Additions................................................ 93 449 41
Amortization expense..................................... (356) (119) (3)
------ ------ ------
Balance at end of year, net.............................. $ 105 $ 368 $ 38
====== ====== ======
Capitalized software development costs of approximately $0, $140,000 and
$12,000 at March 31, 1996, 1995 and 1994, respectively, were not subject to
amortization as products were not available for general release.
6. DEBT
Debt consists of the following (in thousands):
MARCH 31,
----------------
1996 1995
---- -------
Note payable to bank, bearing interest at 8.5% per annum, payable in
monthly principal and interest installments of $5,345 Through
February 1998 with a final payment due March 15, 1998,
collateralized by substantially all Company assets and secured by
guarantees from certain officers and shareholders................. $-- $ 334
Subordinated notes payable, including notes payable to a shareholder
and other related parties of approximately $1,319, bearing
interest at 15% per annum, payable in quarterly interest
installments, and principal payments due April 28, 1995 through
November 29, 1995................................................. -- 2,244
---- -------
-- 2,578
Less current maturities........................................... -- (2,280)
---- -------
Long-term debt.................................................... $-- $ 298
==== =======
During fiscal years 1996 and 1995, the Company maintained a line of credit
with a bank. At March 31, 1996, borrowings of $450,000 were available under the
line of credit agreement through May 1996 bearing interest at prime (8.25% at
March 31, 1996) plus 1% with an annual renewal fee of 1% of the unused line of
credit. The line of credit is collateralized by substantially all of the
Company's assets. At March 31, 1996 and 1995, the Company had no borrowings
outstanding under the agreement.
At March 31, 1996 and 1995, the Company had unsecured advances of $250,000
plus accrued interest payable to a third party. The advances are payable on
demand.
F-10
36
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. INCOME TAXES
On April 1, 1993, the Company adopted SFAS 109 and recorded a deferred
benefit of approximately $2,066,000 for net operating loss carryforwards and
$28,000 of cumulative temporary deductible differences. Simultaneously, the
Company recorded a valuation allowance of approximately $2,094,000.
At March 31, 1996, the Company had net operating loss carryforwards
available for tax purposes of approximately $14,775,000, which will expire in
years 2004 through 2011. Future sale of shares by certain significant
shareholders could create a substantial ownership change (as defined by the
Internal Revenue Service) which would limit the amount of the Company's future
taxable income that may be offset by preownership change net operating loss
carryforwards.
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 pre-tax
loss from continuing operations as a result of the following items (in
thousands):
YEAR ENDED MARCH 31,
---------------------------
1996 1995 1994
------- ------- -------
Federal tax benefit on income from continuing operations
at statutory federal income tax rate................... $(1,319) $(1,098) $ (947)
(Increase) decrease due to:
Change in valuation allowance.......................... 1,430 1,264 1,295
Loss attributable to MLI............................... -- -- (152)
State taxes............................................ (117) (128) (110)
Research and development credits....................... (12) (51) (48)
Other.................................................. 18 13 (38)
------- ------- -------
$ -- $ -- $ --
======= ======= =======
The components of the Company's deferred tax assets and liabilities are as
follows (in thousands):
MARCH 31,
-----------------
1996 1995
------- -------
Deferred tax assets Fixed assets................................. $ 23 $ 1
Accrued expenses............................................... 94 89
Allowance for doubtful accounts................................ 286 42
Net operating loss carryforwards............................... 5,609 4,563
Research and development credits............................... 111 99
------- -------
6,123 4,794
------- -------
Deferred tax liabilities Software development cost............... (40) (141)
------- -------
(40) (141)
------- -------
Net deferred tax asset before valuation allowance................ 6,083 4,653
Valuation allowance.............................................. (6,083) (4,653)
------- -------
$ -- $ --
======= =======
Net tax assets increased approximately $1,430,000 for the year ended March
31, 1996, primarily due to an increase in net operating loss carryforwards. Due
to the existence of continuing losses, the Company recorded a corresponding
increase in the valuation allowance of $1,430,000. Management's estimate of the
valuation allowance could be effected in the near term based on taxable income
generated in future years.
F-11
37
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. MANDATORILY REDEEMABLE PREFERRED STOCK
During fiscal 1996 and 1995, the Company issued 500,000 shares and 262,500
shares, respectively, of Series A preferred stock (Convertible Preferred stock)
at $8.00 per share. The Convertible Preferred stock was convertible into a like
number of shares of the Company's common stock. The call features of the
Convertible Preferred stock allowed for redemption by the Company of the stock
beginning on the fifth anniversary of the initial issuance of the Convertible
Preferred stock, and on each anniversary thereafter. Holders of the Convertible
Preferred stock could redeem the stock beginning on the fifth anniversary of the
initial issuance of the Convertible Preferred stock. The redemption price
included a guaranteed annual return of 10% per share and the conversion feature
expired on the tenth anniversary of the initial issuance of the Convertible
Preferred stock. Accretion of the discount on the mandatorily redeemable
preferred stock was recorded as a charge to additional paid-in capital and a
credit to the mandatorily redeemable preferred stock account.
Upon consummation of the initial public offering discussed in Note 9, the
762,500 shares were automatically converted into an equal number of common
shares.
9. SHAREHOLDERS' EQUITY
In November 1995, the Company completed an initial public offering of
2,000,000 shares of its common stock comprised of 1,558,600 newly-issued Company
shares and 441,400 shares sold by Selling Shareholders. Employees and certain
shareholders exercised 191,200 options and sold the shares obtained as part of
the Offering. The Company used a portion of the proceeds to repay indebtedness
and for general corporate purposes.
10. COMMON STOCK, OPTIONS AND WARRANTS
A.D.A.M. has two stock option plans under which the Company may grant
incentive or non-qualified stock options to full-time employees and key persons.
Options are granted at an exercise price which is not less than fair market
value as estimated by the Board of Directors and vest ratably over a three-year
period. Options granted under the 1991 Option Plan expire five years from the
date of grant. Options granted under the 1992 Option Plan expire ten years from
the date of grant.
In addition to the options granted under A.D.A.M.'s incentive and
non-qualified stock option plans, A.D.A.M. also granted options to purchase
shares of its common stock to certain employees, directors and consultants in
connection with their association with the Company. These options are
immediately exercisable and expire five years from the date of grant with the
exception of 5,000 options granted during fiscal 1995 which expire ten years
from the date of grant.
Additionally, in June 1993, the Company issued options to purchase 245,000
shares of its common stock to an investor at $11.11 per share. These options
expired in June 1995 without exercise. In August 1995, the Company issued
options to purchase 64,658 shares of its common stock to an investor at $11.11
per share. These options are exercisable for one year from the date of issuance.
F-12
38
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Transactions related to stock options for the three years ended March 31,
1996 are as follows:
OPTION PRICE
SHARES PER SHARE
--------- ------------
Outstanding at March 31, 1993................................. 1,147,760 $ 2.00-7.00
Granted..................................................... 302,467 11.11
Exercised................................................... (2,000) 3.00
Canceled or expired......................................... (1,800) 11.11
--------- ------------
Outstanding at March 31, 1994................................. 1,446,427 2.00-11.11
Granted..................................................... 151,900 8.00-11.11
Exercised................................................... (9,633) 3.00-7.00
Canceled or expired......................................... (93,067) 5.00-11.11
--------- ------------
Outstanding at March 31, 1995................................. 1,495,627 2.00-11.11
Granted..................................................... 449,758 4.75-12.00
Exercised................................................... (341,660) 2.00-7.00
Canceled or expired......................................... (473,990) 3.00-11.11
--------- ------------
Outstanding at March 31, 1996................................. 1,129,735 $ 2.00-12.00
======== ==========
The options outstanding at March 31, 1996 for 1,129,735 shares are
exercisable at prices ranging from $2.00 to $12.00 per share for total exercise
value of approximately $7,772,000. The Company has reserved 1,400,000 shares of
common stock for issuance under the 1992 Option Plan.
The subordinated notes payable issued during fiscal 1995 included 112,188
warrants exercisable into a like number of common shares for $8.00 per share.
During the first six months of fiscal 1996, the maturity of $1,650,000 aggregate
principal amount of subordinated notes was extended for an additional year in
exchange for the issuance of 82,500 warrants. An additional 19,375 warrants were
issued to the placement agent for the Convertible Preferred Stock. The warrants
are exercisable beginning on the first anniversary of the date of notes issuance
and expire five years thereafter.
11. RELATED PARTY TRANSACTIONS
During 1996, the Company sold approximately $308,000 of product to
Benjamin/Cummings, a subsidiary of an investor of the Company. Additionally, the
Company had royalty revenues of approximately $93,000 related to
Benjamin/Cummings. The Company purchased approximately $30,000 of product from
Benjamin/Cummings during the year and paid royalty expense of approximately
$47,000.
During fiscal 1996, an officer and shareholder of the Company borrowed
$25,000 as evidenced by a promissory note which bore interest at 12% per annum.
The promissory note was repaid in conjunction with the initial public offering.
During fiscal 1996, the Company sold approximately $64,000 of product to
J.S.K., Inc. (JSK), whose president is a director and shareholder of the
Company. JSK paid the Company approximately $86,000 in licensing and rental fees
during the same period.
During fiscal 1995, the Company issued subordinated debt in the amount of
$718,750 and $600,000 to an officer and shareholder of the Company and to other
entities operated by a director of the Company, respectively. The subordinated
notes payable bearing interest at 15%, payable in quarterly installments, are
due on varying maturity dates from May 2, 1996 through November 29, 1996. The
subordinated notes payable issued during fiscal 1995 included 35,938 and 17,500
warrants exercisable into an equal number of shares of common stock for $8.00
per share. During fiscal 1996, the Company repaid the subordinated debt with
proceeds from the initial public offering discussed in Note 9.
Certain officers and shareholders have guaranteed repayment of the
Company's bank indebtedness (see Note 6).
F-13
39
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
12. COMMITMENTS
The Company leases office space and equipment under noncancellable
lease agreements expiring on various dates through 2002. At March 31, 1996,
future minimum rentals for noncancellable leases with terms in excess of
one year were as follows (in thousands):
MINIMUM
ANNUAL
YEAR ENDING MARCH 31, RENTALS
- - --------------------- -------
1997......................................................................... $ 635
1998......................................................................... 642
1999......................................................................... 733
2000......................................................................... 752
2001......................................................................... 752
Thereafter................................................................... 940
-------
$4,454
=======
Rent expense for the years ended March 31, 1996, 1995 and 1994 was
approximately $663,000, $670,000 and $341,000, respectively.
The Company is required to secure rental payments under the office space
lease agreement with a letter of credit supported by certificates of deposit.
The amount of the certificates of deposit securing the letter of credit
decreases over the term of the lease.
The Company entered into a development agreement in September 1995 whereby
the Company is required to fund a minimum of $250,000 for four products to be
completed by June 1997. There were no costs capitalized under this agreement
during fiscal 1996.
During December 1994, the Company entered into employment agreements with
certain officers of the Company. Each agreement expires on December 31, 1997
(the "Expiration Date") and is automatically renewable for successive one-year
periods unless written notice of non-renewal is given by either party. If the
agreements are terminated without cause, the Company will be obligated to pay
certain amounts as specified by the agreements.
13. SUPPLEMENTAL CASH FLOW INFORMATION
Cash and cash equivalents include cash on hand and on deposit and highly
liquid investments with an original maturity of three months or less. Cash
payments during the year 1996, 1995 and 1994 include interest of approximately
$329,000, $252,000 and $63,000, respectively.
Noncash investing and financing activities having an impact on the balance
sheet are as follows:
YEAR ENDED MARCH 31,
--------------------
1996 1995 1994
------ ---- ----
Conversion of borrowings from shareholder and accrued interest to
common stock................................................... -- -- $131
Notes receivable taken for stock options exercised............... -- $43 --
Additions to common stock through decreases in accrued
liabilities.................................................... -- 43 --
Conversion of preferred stock.................................... $6,194 -- --
Preferred stock accretion........................................ 244 47 --
Issuance of common stock warrants................................ 135 -- --
F-14
40
A.D.A.M. SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
14. DISCONTINUED OPERATIONS
On March 31, 1994, the Company made the strategic decision to focus its
business exclusively on creating educational multimedia software products and to
discontinue its customized medical illustration business. As part of this
strategic decision, the Company terminated all employees associated with the
medical legal illustrations business and entered into an agreement (the
Agreement) on April 7, 1994 with a former officer of the Company which licenses
the MLI trademark, the right to use electronic anatomical images, and the MLI
name in exchange for royalties from future MLI revenues.
The discontinuance of MLI's operations is recorded as a disposal of a
segment as of March 31, 1994 in the accompanying financial statements and,
accordingly, the operating results have been classified as discontinued
operations for 1994. The historical cash flows from MLI's operations consist of
funding its losses through equity transactions and have not been separately
stated in the statement of cash flows for 1994. MLI revenues for the year ended
March 31, 1994 were approximately $1,006,000. In connection with the Agreement,
the Company retained $50,000 of MLI customer deposits, accrued $121,000 of
employee severance expenses and transferred equipment with a net book value of
$38,000 to MLI at March 31, 1994. Any future royalties derived from the
Agreement have not been reflected in the computation of the loss on disposal at
March 31, 1994 due to the uncertainty in the realizability of the potential
receivable and will be reflected in the Company's future results from operations
as the royalties are collected.
No income tax benefits have been allocated to the division's fiscal 1994
losses or the loss on disposal because there are no realizable taxable benefits
available to allocate to the discontinued operation. Such losses are included in
the Company's net operating loss carryforwards disclosed in Note 7.
15. PRODUCT SALES
The Company exports its products through agreements with international and
domestic distributors which grant territorial rights. During 1996, 1995 and
1994, the Company had net revenue from international sales of $983,000,
$1,645,000 and $790,000, respectively. A summary of revenues by geographic area
for 1996, 1995 and 1994 is as follows (in thousands):
YEAR ENDED MARCH 31,
----------------------------
1996 1995 1994
------ ------ ------
United States............................................ $5,464 $4,097 $2,023
Europe................................................... 359 633 174
Pacific Rim and Asia..................................... 370 791 464
Other.................................................... 254 221 152
------ ------ ------
$6,447 $5,742 $2,813
====== ====== ======
16. SUBSEQUENT EVENT
On April 25, 1996 the Company and certain of its officers and directors
were named in a class action lawsuit. The complaint alleges violations of
Section 11, 12(2) and 15 of the Securities Act of 1933, violations of the
Georgia Securities Act and negligent misrepresentation arising out of alleged
disclosure deficiencies in connection with the Company's initial public offering
which was completed on November 10, 1995. The complaint seeks compensatory
damages and reimbursements for plaintiff's fees and expenses. The Company and
its officers and directors intend to defend vigorously against the allegations.
The Company cannot estimate the impact of the outcome of the lawsuit on the
financial condition or results of operations.
F-15
41
SCHEDULE II
A.D.A.M. SOFTWARE
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEAR ENDED MARCH 31, 1996
BALANCE
AT CHARGED TO ACCOUNTS BALANCE AT
BEGINNING COSTS AND WRITTEN END OF
DESCRIPTION OF PERIOD EXPENSES OFF PERIOD
- - ------------------------------------------------------ --------- ---------- -------- ----------
(THOUSANDS OF DOLLARS)
Allowance for Doubtful Accounts....................... $ 110 $ 687 $ 31 $ 766
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FOR THE YEAR ENDED MARCH 31, 1995
BALANCE
AT CHARGED TO ACCOUNTS BALANCE AT
BEGINNING COSTS AND WRITTEN END OF
DESCRIPTION OF PERIOD EXPENSES OFF PERIOD
- - ------------------------------------------------------ --------- ---------- -------- ----------
(THOUSANDS OF DOLLARS)
Allowance for Doubtful Accounts....................... $ 51 $ 53 $ (6) $ 110
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FOR THE YEAR ENDED MARCH 31, 1994
BALANCE
AT CHARGED TO ACCOUNTS BALANCE AT
BEGINNING COSTS AND WRITTEN END OF
DESCRIPTION OF PERIOD EXPENSES OFF PERIOD
- - ------------------------------------------------------ --------- ---------- -------- ----------
(THOUSANDS OF DOLLARS)
Allowance for Doubtful Accounts....................... $ 40 $ 46 $ 35 $ 51
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