##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-KSB
 (Mark One)
 þ
    
    Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the fiscal year ended December 31, 2007
 o
    
    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the transition period from  to
 Commission File Number 001-15363
 ADSTAR, INC.
 (Name of small business issuer in its charter)
 Delaware
    
    22-3666899(State or other jurisdiction of incorporation or
    
    (I.R.S. Employer Identification No.)organization)
 4553 Glencoe Avenue, Suite 300, Marina del Rey, California 90292
   Title of Each Class
    
    Name of Each Exchange on Which RegisteredCommon Stock, par value $.0001 per share
    
    The NASDAQ Stock Market LLC andWarrants to purchase Common Stock
    
    Boston Stock Exchange
  o
 þ o
 o
 o þ
  ,
  DOCUMENTS INCORPORATED BY REFERENCE
  Transitional Small Business Disclosure Format
(Check One): Yes o No þ




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##### 



ADSTAR, INC. AND SUBSIDIARY
Form 10-KSB Annual Report
 TABLE OF CONTENTS
 PagePART IItem 1.
    
    Business
    
    
    3Item 2.
    
    Description of Property
    
    
    11Item 3.
    
    Legal Proceedings
    
    
    11Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    11PART IIItem 5.
    
    Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities
    
    
    12Item 6.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operation
    
    
    12Item 7.
    
    Financial Statements
    
    
    21Item 8.
    
    Change in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    21Item 8A(T).
    
    Controls And Procedures
    
    
    21Item 8B.
    
    Other Information
    
    
    22PART IIIItem 9.
    
    Directors, Executive Officers, Promoters, Control Persons and Corporate Governance; Compliance With Section 16(a) of the Exchange Act
    
    
    23Item 10.
    
    Executive Compensation
    
    
    25Item 11.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    28Item 12.
    
    Certain Relationships and Related Transactions, and Director Independence
    
    
    31Item 13.
    
    Exhibits
    
    
    31Item 14.
    
    Principal Accountant Fees and Services
    
    
    32EXHIBIT 23.2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 FORWARD-LOOKING STATEMENTS
   2




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PART I
 
 Item 1. BUSINESS
 General
  Corporate History
  AdStar Services
   EdgCapture
  3




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Background
     Marketing
  4




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AdStar Business Strategy
   Competition
     5




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Intellectual Property
     Employees
  Research and Development
  CERTAIN RISK FACTORS THAT MAY AFFECT GROWTH AND PROFITABILITY
  Our Ability To Sustain Our Operations And Ultimately Attain Profitability Could Be Adversely
Affected If We Are Not Able To Generate New Significant ASP Revenues.
  6




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
    
    attract a sufficient number of publishers for our publisher-specific ASP ad-taking
services to permit profitable operations;
    
    develop profitable pricing models for our fees;
    
    respond effectively to competitive pressures; and
    
    attract, retain and motivate qualified personnel.
  We Have A History Of Losses And Until We Are Able To Significantly Increase ASP Revenues We Expect
Continued Losses.
  We May Be Unable To Obtain The Additional Capital Required To Grow Our Business Which Would Have An
Adverse Effect On The Successful Implementation Of Our Planned Business Expansion.
  We Are Vulnerable To Breakdowns In Service, Which Could Cause Our Customers And Prospective
Customers To Lose Faith In Our Ability To Service Their Needs.
  7




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Our Ability To Compete Effectively And Operate Profitably Cannot Be Assured Because Our ASP
Business Competes With Established Methods For Ad-Taking.
  Our Limited Experience May Affect Our Ability To Deal Effectively With Technological Change Which
Could Materially and Adversely Affect Our Business.
  
    
    rapidly changing technology;
    
    evolving industry standards;
    
    frequent new product and service announcements;
    
    introductions and enhancements; and
    
    changing customer demands.
  
    
    our ability to adapt the rapidly changing technologies to the needs of our
advertising and publishing clients; and
    
    our ability to continually improve the performance, features and reliability of our
on-line services.
  We May Not Be Able To Retain Key Existing Employees Or Attract The Additional Employees Essential
To The Success Of Our Business.
  8




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Our Business Could Be Adversely Affected If The Services Of Either Our Chief Executive Officer Or
Chief Technology Officer Become Unavailable To Us.
  We Are Vulnerable To Potential Lawsuits Regarding Ad Content Or System Failure.
  We May Not Be Able To Protect Our Proprietary Rights.
   If Others Develop Alternate Technologies, Or Use Our Technology Without Our Authorization, Our
Business, Results Of Operation And Financial Position Could Be Materially And Adversely Affected.
  9




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Natural Disasters Which Disrupt Our Services Could Have An Adverse Effect On Our Business, Results
Of Operations And Financial Condition.
  Our Corporate Documents May Limit Rights of Stockholders.
  If Our Shares Of Common Stock Are Removed Or Delisted From The Nasdaq Capital Market, The Ability
Of Stockholders To Sell Our Common Stock And Warrants In The Secondary Market Could Be Restricted.
  If We Are Unable To Satisfy Nasdaqs Maintenance Requirements, Our Common Stock May Be Delisted
From Nasdaq Which Could Impair The Liquidity And The Value Of Our Common Stock.
  10




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Item 2. Description of Property
   
 Item 3. Legal Proceedings
  
 Item 4. Submission of Matters to a Vote of Security Holders
   VotesNominee
    
    For
    
    Against
    
    WithheldLeslie Bernhard
    
    
    15,321,425
    
    
    
    
    
    
    
    1,079,114Eli Rousso
    
    
    15,368,890
    
    
    
    
    
    
    
    1,031,649Jeffrey Baudo
    
    
    15,369,480
    
    
    
    
    
    
    
    1,031,059John Rudy
    
    
    15,596,958
    
    
    
    
    
    
    
    803,581Michael Jackson
    
    
    15,596,100
    
    
    
    
    
    
    
    804,439Peter M. Zollman
    
    
    15,544,485
    
    
    
    
    
    
    
    856,054Michael P. Dubreuil
    
    
    15,596,958
    
    
    
    
    
    
    
    803,581
  11




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PART II
 
 Item 5. Market for Common Equity and Related Stockholder Matters
 Market Information
  Sales PricesQuarters within Last Two Fiscal Years
    
    High
    
    LowYear Ended December 31, 2006First quarter
    
    $
    2.60
    
    
    $
    1.75Second quarter
    
    $
    2.18
    
    
    $
    0.85Third quarter
    
    $
    1.19
    
    
    $
    0.69Fourth quarter
    
    $
    2.50
    
    
    $
    0.76Year Ended December 31, 2007First quarter
    
    $
    2.90
    
    
    $
    1.67Second quarter
    
    $
    2.42
    
    
    $
    1.13Third quarter
    
    $
    1.58
    
    
    $
    0.53Fourth quarter
    
    $
    0.76
    
    
    $
    0.22
 $
 Holders
  Dividends
   
 Item 6.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operation
 The following discussion of our financial condition and results of operations should be read in
conjunction with the consolidated financial statements and related notes to the consolidated
financial statements included elsewhere in this annual report. Certain statements in this
discussion and elsewhere in this report constitute forward-looking statements within the meaning of
Section 21E of the Securities and Exchange Act of 1934. See Forward-Looking Statements following
the Table of Contents of this 10-KSB. Because this
 12




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discussion involves risk and uncertainties, our actual results may differ materially from those
anticipated in these forward-looking statements.
 Overview
   Recent developments
     13




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Results of Operations
  Year Ended December 31,2007
    
    
    2006Net revenues
    
    
    100
    %
    
    
    100
    %Cost of revenues
    
    
    43
    %
    
    
    41
    %Gross Profit
    
    
    57
    %
    
    
    59
    %General and administrative expense
    
    
    47
    %
    
    
    37
    %Selling and marketing expense
    
    
    45
    %
    
    
    29
    %Product maintenance and development costs
    
    
    34
    %
    
    
    18
    %Amortization of customer list Restructuring
    
    
    2
    %
    
    
    2
    %Loss from operations
    
    
    -71
    %
    
    
    -27
    %Interest income (expense)
    
    
    1
    %
    
    
    0
    %Loss before taxes
    
    
    -70
    %
    
    
    -27
    %Provision for taxes
    
    
    0
    %
    
    
    0
    %Net loss
    
    
    -70
    %
    
    
    -27
    %Deemed dividend
    
    
    0
    %
    
    
    0
    %Net loss applicable to common shareholders
    
    
    -70
    %
    
    
    -27
    %
 Years Ended December 31, 2007 and 2006
 Revenues
    Cost of revenues
   14




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General and administrative expense
  Product maintenance and development costs
   Selling and marketing expense
   15




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Amortization of Customer List
  Interest expense and income
  Provision for taxes
     Liquidity and Capital Resources
   16




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Related Party Transactions
  17




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New accounting pronouncements
     Critical Accounting Policies and Estimates
  18




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Revenue Recognition
      19




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Software Development Costs
 .
 Warranties and Product liability
   Allowance for doubtful accounts
  Income taxes
  20




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Intangible Assets
  Contractual Obligations, Commitments and Contingencies
   Less than
    
    
    1 to 3Contractual Obligations
    
    Total
    
    
    1 year
    
    
    Years
    
    
    3 to 5 YearsEmployment agreements
    
    $
    1,799,000
    
    
    $
    586,000
    
    
    $
    809,000
    
    
    $
    404,000Operating lease commitments
    
    
    592,000
    
    
    
    258,000
    
    
    
    278,000
    
    
    
    56,000Capital lease commitment
    
    
    32,000
    
    
    
    10,000
    
    
    
    19,000
    
    
    
    3,000Less: Interest on capital lease
    
    
    (6,000
    )
    
    
    (3,000
    )
    
    
    (3,000
    )
    
    
    $
    2,417,000
    
    
    $
    851,000
    
    
    $
    1,103,000
    
    
    $
    463,000Less: Sublease income
    
    
    (99,000
    )
    
    
    (48,000
    )
    
    
    (51,000
    )
    
    
    $
    2,318,000
    
    
    $
    803,000
    
    
    $
    1,052,000
    
    
    $
    463,000
 
 Item 7. Financial Statements
  
 Item 8. Change in and Disagreements with Accountants on Accounting and Financial Disclosure
  
 Item 8A(T). Controls and Procedures
 Disclosure Controls and Procedures
  21




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Managements Report on Internal Control over Financial Reporting
   Internal ControlIntegrated Framework Internal ControlIntegrated Framework
  Changes in Internal Control over Financial Reporting
  
 Item 8B. Other Information
  22




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PART III
 
 Item 9.
    
    Directors, Executive Officers, Promoters, Control Persons and Corporate Governance;
Compliance with Section 16(a) of the Exchange Act
  DirectorName
    
    Age
    
    Position
    
    SinceLeslie Bernhard
    
    63
    
    President, Chief Executive Officer and Director
    
    1991Eli Rousso
    
    71
    
    Executive Vice President, Chief Technology Officer,
Secretary, Treasurer, and Director
    
    1991Jeffrey Baudo
    
    61
    
    Senior Vice President, Chief Operating Officer, and Director
    
    2001James Linesch
    
    53
    
    Chief Financial OfficerPeter M. Zollman (2)
    
    54
    
    Director
    
    2005Michael Jackson (1)
    
    43
    
    Director
    
    2005John Rudy (1) (2)
    
    65
    
    Director
    
    2005Michael P. Dubreuil (1)(2)
    
    49
    
    Director
    
    2005
 
 (1)
    
    Member of the audit committee of the Board of Directors.(2)
    
    Member of the compensation committee of the Board of Directors. Leslie Bernhard
 Eli Rousso
 Jeffrey Baudo
 Peter M. Zollman
 Michael Jackson
 23




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John Rudy ,
 Michael P. Dubreuil
   Audit Committee Financial Expert
  Section 16(a) Beneficial Ownership Reporting Compliance
   24




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Code of Ethics
  
 Item 10. Executive Compensation
 Summary Compensation Table
  Name and
    
    
    
    
    
    
    
    
    
    OptionPrincipal Position
    
    Year
    
    Salary
    
    Awards
    
    TotalLeslie Bernhard,
    
    
    2007
    
    
    $
    202,160
    
    
    $
    19,831
    (1)
    
    $
    221,991President
& Chief Executive Officer
    
    
    2006
    
    
    $
    202,160
    
    
    
    
    
    
    $
    202,160Eli Rousso
    
    
    2007
    
    
    $
    202,160
    
    
    $
    19,831
    (1)
    
    $
    221,991Executive Vice President & Chief
Technology Officer
    
    
    2006
    
    
    $
    202,160
    
    
    
    
    
    
    $
    202,160Jeffrey Baudo
    
    
    2007
    
    
    $
    182,115
    
    
    $
    19,831
    (1)
    
    $
    201,946Chief
Operating Officer
    
    
    2006
    
    
    $
    182,115
    
    
    
    
    
    
    $
    182,115James Linesch
    
    
    2007
    
    
    $
    153,000
    
    
    $
    48,870
    (1)
    
    $
    202,870Chief
Financial Officer
    
    
    2006
    
    
    $
    133,627
    
    
    $
    29,665
    (2)
    
    $
    163,292
 
 (1)
    
    Calculated utilizing the provisions of Statement of Financial Accounting Standards
(SFAS) No. 123R, Share-based Payments. For details as to the assumptions used to
determine the fair value of the option award, see Note 11 of the consolidated financial
statements included with this Annual Report on Form 10-KSB for the fiscal year ended
December 31, 2007. The number of shares underlying this option award totaled 50,000
shares. See the table below entitled Outstanding Equity Awards at December 31, 2007.(2)
    
    Calculated utilizing the provisions of Statement of Financial Accounting Standards
(SFAS) No. 123R, Share-based Payments.    25




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Outstanding Equity Awards at December 31, 2007
  Number of
    
    Number ofSecurities
    
    SecuritiesUnderlying
    
    UnderlyingUnexercised
    
    Unexercised
    
    Option
    
    OptionOptions
    
    Options
    
    Exercise
    
    ExpirationName
    
    Exercisable (1)
    
    Unexerciseable
    
    Price
    
    DateLeslie Bernhard
    
    
    29,151
    
    
    
    
    
    
    
    0.73
    
    
    
    01/27/1033,075
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1083,333
    
    
    
    
    
    
    
    3.50
    
    
    
    12/20/1083,333
    
    
    
    
    
    
    
    3.00
    
    
    
    12/20/1050,259
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1015,000
    
    
    
    
    
    
    
    2.75
    
    
    
    01/29/12Eli Rousso
    
    
    29,151
    
    
    
    
    
    
    
    0.73
    
    
    
    01/27/1041,925
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1033,075
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1075,000
    
    
    
    
    
    
    
    3.00
    
    
    
    12/20/1075,000
    
    
    
    
    
    
    
    3.50
    
    
    
    12/20/1015,000
    
    
    
    
    
    
    
    2.75
    
    
    
    01/29/12Jeff Baudo
    
    
    26,260
    
    
    
    
    
    
    
    0.73
    
    
    
    01/27/1032,705
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1033,962
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1066,667
    
    
    
    
    
    
    
    3.00
    
    
    
    12/20/1066,667
    
    
    
    
    
    
    
    3.50
    
    
    
    12/20/1015,000
    
    
    
    
    
    
    
    2.75
    
    
    
    01/29/12James Linesch
    
    
    16,667
    
    
    
    33,333
    (2)
    
    
    2.25
    
    
    
    02/19/1115,000
    
    
    
    
    
    
    
    2.54
    
    
    
    01/29/12
    
    
    
    35,000
    (3)
    
    
    1.52
    
    
    
    05/14/12
 26




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(1)
    
    Fully vested(2)
    
    Vest ratably over three years beginning on February 20, 2007 at 16,667 shares per year.(3)
    
    Vest ratably over two years beginning on May 14, 2008 at 17,500 shares per year. Employment Contracts and termination of employment and change-in-control arrangements
    Director Compensation
  OptionName
    
    Awards (1)
    
    TotalMichael Dubreuil
    
    $
    8,631
    
    
    $
    8,631Michael Jackson
    
    $
    8,631
    
    
    $
    8,631John Rudy
    
    $
    8,631
    
    
    $
    8,631Peter M. Zollman
    
    $
    8,631
    
    
    $
    8,631
 27




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(1)
    
    Amounts calculated utilizing the provisions of Statement of Financial Accounting
Standards (SFAS) No. 123R, Share-based Payments. See Note 11 of the consolidated
financial statements included with this Annual Report on Form 10-KSB for the year ended
December 31, 2007 regarding assumptions underlying valuation of equity awards. At December
31, 2007 the aggregate number of option awards outstanding for each director was options
for 75,000 shares. Limitation of Directors Liability and Indemnification
   
 Item 11.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
  Shares ofCommon StockBeneficially
    
    Percentage ofName of Beneficial Owner (1)
    
    Owned (2)
    
    OwnershipLeslie Bernhard (3)
    
    
    632,151
    
    
    
    3.1
    %Eli Rousso (4)
    
    
    646,988
    
    
    
    3.1
    %Jeffrey Baudo (5)
    
    
    241,261
    
    
    
    1.2
    %James Linesch (6)
    
    
    48,334
    
    
    
    *Michael Jackson (7)
    
    
    75,000
    
    
    
    *John Rudy (7)
    
    
    75,000
    
    
    
    *Michael Dubreuil (7)
    
    
    75,000
    
    
    
    *Peter M. Zollman (7)
    
    
    87,799
    
    
    
    *Lewis Asset Management
    
    
    1,224,167
    
    
    
    6.0
    %Tribune Company
    
    
    3,443,457
    
    
    
    16.9
    %All Directors and Officers (8 persons) as a group
    
    
    1,881,533
    
    
    
    9.0
    %
 
 *
    
    less than 1%1)
    
    The addresses of the persons named in this table are as follows: Leslie Bernhard, Eli Rousso,
Jeffrey Baudo and James Linesch, c/o AdStar, Inc., 4553 Glencoe Avenue, Suite 300, Marina del
Rey, CA 90292; Michael Jackson, c/o Agency.com Corporate Headquarters, 488 Madison Avenue,
22nd Floor, New York, NY 10022; John Rudy, c/o Beacon Consulting Associates, P.O.
Box 894,169 Main Street, Matawan, NJ 07747; Michael Dubreuil, c/o Brainhunter Global
Solutions, 2 Sheppard Ave. E., Suite 700, Toronto, Ontario, M2N 5Y7; Peter M. Zollman, c/o
Classified Intelligence, 402 Spring Valley Road, Altamonte Springs, FL 32714; Lewis Asset
Management 45 Rockefeller Plaza Suite 2570, New York, NY 10111-2597; and Tribune Company, 435
N. Michigan Ave. Chicago IL. 28




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2)
    
    A person is deemed to be a beneficial owner of securities that can be acquired by such person
within 60 days from the filing of this report upon the exercise of options and warrants or
conversion of convertible securities. Each beneficial owners percentage ownership is
determined by assuming that options, warrants and convertible securities that are held by such
person (but not held by any other person) and that are exercisable or convertible within 60
days from March 24, 2008 have been exercised or converted. Except as otherwise indicated, and
subject to applicable community property and similar laws, each of the persons named has sole
voting and investment power with respect to the shares shown as beneficially owned. On March
24, 2008 20,391,851 shares of Common Stock were outstanding.3)
    
    Includes options to purchase 294,151 shares of AdStar Common Stock at prices between $0.73
and $3.50, exercisable within 60 days.4)
    
    Includes options to purchase 269,151 shares of AdStar Common Stock at prices between $0.73
and $3.50, exercisable within 60 days.5)
    
    Includes options to purchase 241,261 shares of AdStar Common Stock, at prices between $0.73
and $3.50, exercisable within 60 days.6)
    
    Includes options to purchase 48,334 shares of AdStar Common Stock, at prices between $2.25
and $2.54, exercisable within 60 days.7)
    
    Includes options to purchase 75,000 shares of AdStar Common Stock at prices between $0.62
and $1.29, exercisable within 60 days. Securities Authorized for Issuance Under Equity Compensation Plans
 2004 Stock Option Plan
  1999 Stock Option Plan
  29




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Equity Compensation Plan TableNumber of securitiesremaining availablefor future issuanceunder equityNumber of securities to be
    
    
    Weighted-average
    
    
    compensation plansissued upon exercise of
    
    
    exercise price of
    
    
    (excluding securitiesoutstanding options,
    
    
    outstanding options,
    
    
    reflected in columnwarrants and rights
    
    
    warrants and rights
    
    
    (a))(a)
    
    
    (b)
    
    
    (c)Equity Compensation
Plans Approved By
Security Holders
(the 2004 plan and
the 1999 Plan)
    
    
    1,772,247
    
    
    $
    2.10
    
    
    
    576,101Equity Compensation
Plans Not Approved
By Security Holders
    
    
    870,336
    
    
    $
    2.35
    
    
    
    Total
    
    
    2,642,583
    
    
    $
    2.18
    
    
    
    576,101
  
 
 
 
 
 30




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Item 12. Certain Relationships and Related Transactions, and Director Independence
  Director Independence
   
 Item 13. Exhibits
 Exhibits:
 ExhibitNo.
    
    Description3.1
    
    Certificate of Incorporation of AdStar (1)3.1a
    
    Amendment to Certificate of Incorporation, as filed with the Secretary of State of Delaware
on July 11, 2001 (2)3.1b
    
    Amendment to Certificate of Incorporation, as filed with the Secretary of State of Delaware
on November 11, 2004 (3)3.2
    
    By-Laws of AdStar (1)4.1
    
    Specimen Stock Certificate (1)4.6
    
    Form of 5-year warrant issued in connection with the Private Placement of AdStar Common Stock
in September 2003 (4)10.1**
    
    1999 Stock Option Plan (1)10.2**
    
    2004 Stock Option Plan (5)10.3**
    
    Employment Agreement between AdStar and Leslie Bernhard, dated December 21, 2005 (7)10.4**
    
    Employment Agreement Amendment between AdStar and Leslie Bernhard, dated December 21, 2005 (7)10.5**
    
    Employment Agreement between AdStar and Eli Rousso, dated December 21, 2005 (7)10.6**
    
    Employment Agreement Amendment between AdStar and Eli Rousso, dated December 21, 2005 (7)14.1
    
    Code of Ethics (6)21.1
    
    Subsidiaries(6)
 31




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ExhibitNo.
    
    Description23.2
    
    Consent of Holtz Rubenstein Reminick LLP *31.1
    
    Chief Executive Officer Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002*31.2
    
    Chief Financial Officer Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002*32.1
    
    Chief Executive Officer Certification pursuant to section 906 of the Sarbanes-Oxley Act of 2002*32.2
    
    Chief Financial Officer Certification pursuant to section 906 of the Sarbanes-Oxley Act of 2002*
 Notes to exhibits
 *
    
    Filed herewith**
    
    Indicates a management contract or compensatory plan or arrangement(1)
    
    Filed on October 1999 as an exhibit with the same number to Registration Statement on Form
SB-2 (No. 333-84209), and incorporated herein by reference.(2)
    
    Filed as an exhibit to Quarterly Report on Form 10QSB for the period ended September 30, 2001
and incorporated herein by reference.(3)
    
    Filed as an exhibit to the Annual Report on Form 10KSB for the period ended December 31, 2004
and incorporated herein by reference.(4)
    
    Filed on October 16, 2003 as an exhibit with the same number to Registration Statement on
Form S-3 (No. 333-109757) and incorporated herein by reference.(5)
    
    Filed on October 13, 2004 as Appendix A to the Schedule 14A Proxy Statement and incorporated
herein by reference.(6)
    
    Filed as an exhibit to the Annual Report on Form 10KSB for the period ended December 31, 2003
and incorporated herein by reference.(7)
    
    Filed as an exhibit to the Annual Report on Form 10KSB for the period ended December 31, 2005
and incorporated herein by reference. 
 Item 14. Principal Accountant Fees and Services
 :
 2007
    
    
    2006Audit fees
    
    $
    158,000
    
    
    $
    141,000Audit related fees
    
    
    7,000
    
    
    
    5,000Total audit and audit related fees
    
    $
    165,000
    
    
    $
    146,000Tax fees
    
    
    25,000
    
    
    
    24,000All other fees
    
    
    
    
    
    
    Total fees
    
    $
    190,000
    
    
    $
    170,000
 Audit-Related Fees
  Tax Fees
  32




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##### Table of Contents



All Other Fees
   Audit Committee Pre-Approval Policies and Procedures
  33




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SIGNATURES
  AdStar, Inc.By:
    /s/ Leslie BernhardLeslie Bernhard,President and Chief Executive Officer   Signature
    
    
    
    TitlePrincipal Executive Officer/s/ Leslie Bernhard
    
    
    
    President and Chief Executive Officer and DirectorLeslie BernhardPrincipal Financial Officer/s/ James Linesch
    
    
    
    Chief Financial OfficerJames LineschDirectors/s/ Eli Rousso
    
    
    
    DirectorEli Rousso/s/ Jeffrey Baudo
    
    
    
    DirectorJeffrey Baudo/s/ John C. Rudy
    
    
    
    DirectorJohn C. Rudy/s/ Michael J. Jackson
    
    
    
    DirectorMichael J. Jackson/s/ Michael Dubreuil
    
    
    
    DirectorMichael Dubreuil/s/ Peter M. Zollman
    
    
    
    DirectorPeter M. Zollman
 34




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Index To Financial Statements
 PageReport of Independent Registered Public Accounting Firm
    
    
    F-2Financial Statements:Consolidated Balance Sheet as of December 31, 2007
    
    
    F-3Consolidated Statements of Operations for the two years ended December 31, 2007
    
    
    F-4Consolidated Statements of Stockholders Equity for the two
years ended December 31, 2007
    
    
    F-5Consolidated Statements of Cash Flows for the two years ended December 31, 2007
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7
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Report of Independent Registered Public Accounting Firm
 
      
 F-2




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AdStar, Inc. and Subsidiary
 
 Consolidated Balance Sheet
As of December 31, 2007
 AssetsCurrent assets:Cash and cash equivalents
    
    $
    717,000Accounts receivable, net of allowance for doubtful accounts of $71,000
    
    
    571,000Notes receivable from officers  current portion
    
    
    9,000Prepaid and other current assets
    
    
    126,000Total current assets
    
    
    1,423,000Notes receivable from officers, net of current portion
    
    
    197,000Property and equipment, net
    
    
    109,000Capitalized and purchased software, net
    
    
    261,000Intangible assets, net
    
    
    1,133,000Goodwill
    
    
    2,132,000Other assets
    
    
    40,000Total assets
    
    $
    5,295,000Liabilities and Stockholders EquityCurrent liabilities:Due to publications
    
    $
    1,223,000Accounts payable and accrued expenses
    
    
    630,000Deferred revenue and customer deposits  current portion
    
    
    113,000Capital lease obligations  current portion
    
    
    6,000Total current liabilities
    
    
    1,972,000Deferred revenues, net of current portion
    
    
    24,000Capital lease obligations, net of current portion
    
    
    20,000Total liabilities
    
    
    2,016,000Commitments and contingenciesStockholders equity:Preferred Stock, par value $0.0001; authorized 5,000,000 shares; 0
issued and outstanding
    
    
    Common Stock, par value $0.0001; authorized 40,000,000 shares;
20,209,648 issued and 20,141,852 outstanding
    
    
    2,000Additional paid-in capital
    
    
    27,051,000Treasury stock; 67,796 shares, at cost
    
    
    (68,000
    )Accumulated deficit
    
    
    (23,706,000
    )Total stockholders equity
    
    
    3,279,000Total liabilities and stockholders equity
    
    $
    5,295,000
  F-3




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AdStar, Inc. and Subsidiary
 
 Consolidated Statements of Operations
For the Years
Ended December 31, 2007 and 2006
 2007
    
    
    2006ASP, net
    
    $
    1,910,000
    
    
    $
    1,908,000Licensing and software
    
    
    2,282,000
    
    
    
    2,477,000Customization and other
    
    
    568,000
    
    
    
    729,000Net revenues
    
    
    4,760,000
    
    
    
    5,114,000Cost of revenues, including depreciation and
amortization of $339,000 and $432,000
    
    
    2,067,000
    
    
    
    2,112,000Gross profit
    
    
    2,693,000
    
    
    
    3,002,000General and administrative expense
    
    
    2,226,000
    
    
    
    1,900,000Product maintenance and development costs
    
    
    1,627,000
    
    
    
    934,000Selling and marketing expense
    
    
    2,127,000
    
    
    
    1,468,000Amortization of customer list
    
    
    88,000
    
    
    
    88,000Loss from operations
    
    
    (3,375,000
    )
    
    
    (1,388,000
    )Interest income
    
    
    78,000
    
    
    
    13,000Interest expense
    
    
    (5,000
    )
    
    
    (5,000
    )Loss before income taxes
    
    
    (3,302,000
    )
    
    
    (1,380,000
    )Provision for income taxes
    
    
    (8,000
    )
    
    
    (13,000
    )Net loss
    
    $
    (3,310,000
    )
    
    $
    (1,393,000
    )Loss per share  basic and diluted
    
    $
    (0.16
    )
    
    $
    (0.07
    )Weighted average number of shares  basic and diluted
    
    
    20,122,014
    
    
    
    19,339,000
  F-4




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AdStar, Inc. and Subsidiary
 
 Consolidated Statements of Stockholders Equity
For the Two Years
Ended December 31, 2007
 Additional
    
    
    
    
    
    
    TotalCommon Stock
    
    
    Treasury Stock
    
    
    Paid-In
    
    
    Accumulated
    
    
    StockholdersShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Deficit
    
    
    EquityBalance, December 31, 2005
    
    
    18,250,287
    
    
    $
    2,000
    
    
    
    67,796
    
    
    $
    (68,000
    )
    
    $
    23,683,000
    
    
    $
    (19,003,000
    )
    
    $
    4,614,000Common Stock sale,
net of offering costs
    
    
    1,000,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,440,000
    
    
    
    
    
    
    
    1,440,000Non-cash financing cost
of warrants issued in
connection with Common
Stock sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,000
    )
    
    
    
    
    
    
    (20,000
    )Warrants issued in
connection with Common
Stock sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,000
    
    
    
    
    
    
    
    20,000Warrants exercised
    
    
    91,486
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    85,000
    
    
    
    
    
    
    
    85,000Options exercised
    
    
    297,278
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    265,000
    
    
    
    
    
    
    
    265,000Stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    360,000
    
    
    
    
    
    
    
    360,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,393,000
    )
    
    
    (1,393,000
    )Balance, December 31, 2006
    
    
    19,639,051
    
    
    
    2,000
    
    
    
    67,796
    
    
    
    (68,000
    )
    
    
    25,833,000
    
    
    
    (20,396,000
    )
    
    
    5,371,000Warrants issued in
connection with Nokia
contract
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    216,000
    
    
    
    
    
    
    
    216,000Warrants exercised
    
    
    20,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,000
    
    
    
    
    
    
    
    15,000Options exercised
    
    
    550,597
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    344,000
    
    
    
    
    
    
    
    344,000Stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    643,000
    
    
    
    
    
    
    
    643,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,310,000
    )
    
    
    (3,310,000
    )Balance, December 31, 2007
    
    
    20,209,648
    
    
    $
    2,000
    
    
    
    67,796
    
    
    $
    (68,000
    )
    
    $
    27,051,000
    
    
    $
    (23,706,000
    )
    
    $
    3,279,000
  F-5




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AdStar, Inc. and Subsidiary
 
 Consolidated Statements of Cash Flows
For the Two Years
Ended December 31,
 2007
    
    
    2006Cash flows from operating activities:Net loss
    
    $
    (3,310,000
    )
    
    $
    (1,393,000
    )Adjustments to reconcile net loss to net cash used in operating
activities:Depreciation and amortization
    
    
    508,000
    
    
    
    593,000Loss on disposal of equipment
    
    
    6,000
    
    
    
    Stock based charges
    
    
    859,000
    
    
    
    360,000Write-down of capitalized software
    
    
    357,000
    
    
    
    Bad debt provision (recovery)
    
    
    (17,000
    )
    
    
    8,000Changes in assets and liabilities:Accounts receivable
    
    
    (82,000
    )
    
    
    91,000Prepaids and other assets
    
    
    73,000
    
    
    
    (67,000
    )Due to publications
    
    
    42,000
    
    
    
    (133,000
    )Accounts payable and accrued expenses
    
    
    (40,000
    )
    
    
    (7,000
    )Deferred revenue and customer deposits
    
    
    (168,000
    )
    
    
    31,000Net cash used in operating activities
    
    
    (1,772,000
    )
    
    
    (517,000
    )Cash flows from investing activities:Additions to capitalized and purchased software
    
    
    (373,000
    )
    
    
    (19,000
    )Purchase of property and equipment
    
    
    (45,000
    )
    
    
    (25,000
    )Additions to intangible assets
    
    
    
    
    
    
    (5,000
    )Repayment of officer receivable
    
    
    10,000
    
    
    
    8,000Net cash used in investing activities
    
    
    (408,000
    )
    
    
    (41,000
    )Cash flows from financing activities:Sale of common stock, net of costs
    
    
    
    
    
    
    1,440,000Proceeds from exercise of options and warrants
    
    
    359,000
    
    
    
    350,000Principal repayments on loans from shareholders
    
    
    
    
    
    
    (21,000
    )Principal repayments on capital leases
    
    
    (7,000
    )
    
    
    (4,000
    )Net cash provided by financing activities
    
    
    352,000
    
    
    
    1,765,000Net (decrease) increase in cash and cash equivalents
    
    
    (1,828,000
    )
    
    
    1,207,000Cash and cash equivalents at beginning of year
    
    
    2,545,000
    
    
    
    1,338,000Cash and cash equivalents at end of year
    
    $
    717,000
    
    
    $
    2,545,000
  F-6




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AdStar, Inc. and Subsidiary
 
 Notes to Consolidated Financial Statements
 1.
    
    Organization and BusinessAdStar, Inc. (the Company or AdStar) (formerly AdStar.com, Inc. and AdStar-Services,
Inc.) was incorporated in the State of New York on June 29, 1991 as an S-Corporation under
the Internal Revenue Code. In 1999, the Company reincorporated as a C-Corporation in
Delaware.The Companys original core business was the licensing of proprietary software systems and
supplying the related support and maintenance. This professional software system allows
large commercial advertising agencies and corporations to directly enter classified
advertisements into the publishing systems at the Companys customers, through modems on a
dial-up basis and through the Internet. The Companys customers are principally located in
the United States.In 2001, the Company introduced its AdStar e-business application services. Using the
Companys proprietary software solution platform, the Company enables both print and on-line
publications to electronically receive completed classified advertising copy using the
Internet as the communication channel. The services are provided on an application service
provider (ASP) basis, enabling publishers to expand their relationships with advertising
customers using a single integrated platform, while increasing sales volumes at reduced
costs.On October 21, 2003, AdStar acquired all of the business and assets of Edgil Associates,
Inc. (Edgil). Edgil was incorporated in the State of Massachusetts on February 22, 1984 as
a C-Corporation. Edgil, based in Billerica, Massachusetts, is a provider of complete
automated payment processing systems and content processing solutions for the publishing
industry. Edgils core business has been licensing proprietary software systems and
supplying the related support and maintenance.Edgil develops software applications primarily for the newspaper publishing industry. Its
management and personnel combine extensive knowledge of newspaper publishing systems with
technical expertise in database management systems, electronic commerce, and Web application
development. Edgil offers system integration services, installation support, training, and
customer service. Edgils product strategy focuses on providing publishers with the
financial benefits afforded by reduced labor costs and lower credit card processing discount
rates. Edgils experience with integration services has given the EdgCapture product line
the technical differentiation to meet the specific credit card processing requirements of
the publishing industry.2.
    
    Basis of Presentation and Summary of Significant Accounting PoliciesBasis of PresentationThe accompanying financial statements have been prepared assuming the Company will have
liquidity to maintain its required minimum level of operations. At December 31, 2007, we had
an accumulated deficit of $23,706,000. We have incurred significant recurring net losses.
For the years ended December 2007 and 2006 we had net losses of $3,310,000 and $1,393,000.
Our 2007 net losses were principally attributable to our business development costs and
software development costs. At December 31, 2007, the Company had negative working capital
of $549,000.Revenues for the year ended December 31, 2007 have decreased to $4,760,000 from $5,114,000
in the prior year. While the Company continues to add new customers and revenues, such
increases in revenues may be mitigated by losses of certain revenues from customers who
elect to utilize other applications for
 F-7




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##### Table of Contents



processing their web-based advertising placements. Company management has become aware that
one of its largest customer publications may convert to an in-house system for its web-based
ad intake sometime in 2008, representing approximately 12% of revenues in 2007,
approximately 12% of accounts receivable at December 31, 2007, and approximately $320,000 of
due to publications at December 31, 2007. A definitive timetable for this conversion has not
been established and the Company has not received notification of a change.The Company may continue to incur losses until it is able to increase revenues significantly
from fees derived from its advertising intake and payment processing services. Operational
cash expenditures are anticipated to decrease as a result of cost cutting strategies,
including a reduction in staff during the fourth quarter of 2007 and first quarter of 2008.
The ASP business continues to be adopted by new customers in the marketplace. However, the
ability to increase revenues from ASP service offerings during the next 12 months may be
hampered by the current unstable climate in the advertising market relating to newspaper
publishers and state of the economy in general. These factors, coupled with possible
competition from other vendors, the extended selling cycle in the industry, and customer
delays in customization and implementations, could delay its ability to increase revenue to
a level sufficient to cover expenses.The continuation of AdStars business is dependent upon achieving a break even or profitable
level of operations or on obtaining further financing. To the extent that funds generated
from operations are insufficient, the Company will have to raise additional working capital
from private placements, public offerings and/or bank financing. No assurance can be given
that additional financing will be available, or if available, will be on terms acceptable to
the Company. If adequate working capital is not available the Company may be required to
further reduce certain discretionary spending, which could have a material adverse effect on
the Companys ability to achieve its intended business objectives.These conditions raise doubt about the Companys ability to continue as a going concern.
The financial statements do not include any adjustments relating to the recoverability and
classification of liabilities that might be necessary should the Company be unable to
continue as a going concern.Principles of ConsolidationThe accompanying consolidated financial statements include the accounts of AdStar, Inc. and
its wholly owned subsidiary Edgil Associates, Inc. All intercompany transactions and
balances have been eliminated in consolidation.Use of EstimatesThe 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 revenues and expenses during
the reporting period. Actual results could differ from those estimates.Cash and Cash EquivalentsThe Company considers all highly liquid investments purchased with an initial maturity of
three months or less to be cash equivalents. Cash and cash equivalents are carried at cost,
which approximates fair value. At December 31, 2007, the company had cash balances held at a
financial institution which exceed FDIC insurance limits by $617,000.
 F-8




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##### Table of Contents



Supplemental schedule of noncash investing and financing activities for the two years ended
December 31, 2007:
 2007
    
    
    2006Supplemental cash flow disclosure:Taxes paid
    
    $
    18,000
    
    
    $
    15,000Interest paid
    
    $
    5,000
    
    
    $
    5,000
 Concentration of Credit Risk and Major CustomersFinancial instruments that potentially subject the Company to significant concentrations of
credit risk are principally comprised of cash; trade accounts receivable and shareholder
loans.The Company generally contracts with individual publication customers for its services,
however, a number of publication customers fall under common enterprise ownership. For the
year ended December 31, 2007, three groups of customers, under common ownership, accounted
for 19%, 12% and 12% of the Companys revenues. For the year ended December 31, 2006, three
groups of customers, under common ownership, accounted for 17%, 13% and 11% of the Companys
revenues. At December 31, 2007, three groups of customers, under common ownership,
accounted for 25%, 13% and 13% of the Companys accounts receivable, respectively. At
December 31, 2006, two groups of customers, under common ownership, accounted for 23% and
10% of the Companys accounts receivable, respectively.The majority of the Companys customers have historically consisted of newspapers and
publishers of classified advertisements. The Companys customers on its website are the
general public.Accounts Receivable and Allowance for Doubtful AccountsWe regularly evaluate the collectibility of our trade receivables based on a combination of
factors. When a customers account becomes past due, we initiate dialogue with the customer
to determine the cause. If it is determined that the customer will be unable to meet its
financial obligation to us, due to a bankruptcy filing, deterioration in the customers
operating results or financial position or other material events impacting their business,
we record a specific reserve for bad debt to reduce the related receivable to the amount we
expect to recover given all information presently available. We also record reserves for bad
debts for all other customers based on certain other factors including length of time the
receivables are past due and historical collection experience with individual customers. If
circumstances related to specific customers change, our estimates of the recoverability of
receivables could materially change.Property and EquipmentProperty and equipment are stated at cost less accumulated depreciation and amortization.
When such items are retired or otherwise disposed of, the cost and related accumulated
depreciation and amortization are relieved from the accounts and the resulting gain or loss
is reflected in operations. Depreciation and amortization are provided using the
straight-line method over the estimated useful lives of the assets. The depreciation and
amortization periods by asset category are as follows:
 Furniture and fixtures
    
    7 yearsComputer equipment
    
    3 yearsComputer Software
    
    3 to 5 yearsLeasehold improvements
    
    Shorter of useful life or remaining lease term
 F-9




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Maintenance and minor replacements are charged to expense as incurred while renewals and
improvements are capitalized. Leasehold improvements are amortized over their estimated
useful lives or the remaining lives of the related leases, whichever is shorter.Software Development CostsIn March 2000, the Financial Accounting Standards Boards Emerging Issue Task Force (EITF)
issued EITF No. 00-2 Accounting for Web Site Development Costs, which provides guidance
with respect to capitalization of certain costs incurred in connection with Web development
activities and references Statement of Financial Accounting Standards (SFAS) No. 86
Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise Marketed. In
accordance with these pronouncements, costs to establish the technological feasibility of
software applications developed by the Company are charged to expense as incurred. Certain
costs incurred subsequent to achieving technological feasibility are capitalized.
Accordingly, the Company capitalizes a portion of the internal labor costs and external
consulting costs associated with essential website development and enhancement activities.
Costs associated with conceptual design and feasibility assessments as well as maintenance
and routine changes are expensed as incurred. Capitalized costs are amortized based on
current or future revenue for each product with an annual minimum equal to the straight-line
basis over the estimated economic lives of the applications, not to exceed 5 years. In
accordance with this policy, the Company has capitalized expenditures incurred to enhance
the AdStar ASP application suite of products. At December 31, 2007, the Company has
capitalized software development costs of $3,385,000, with associated accumulated
amortization of $3,124,000. During the fiscal quarter ended September 30, 2007, the Company
capitalized certain development costs, in the aggregate amount of 275,000. During the
quarter ended December 31, 2007, the Company determined that the initial commercial use of
the software was delayed. Due to uncertainty in the deployment of this software, the
Company has determined that the amount should be recorded to expense during the year ended
December 31, 2007.Intangible AssetsIntangible assets are comprised of purchased customer list, trademarks, license agreements
and proprietary technology and are carried at cost less accumulated amortization.
Amortization is calculated on a straight-line basis over the estimated useful lives of the
intangible assets of 5 and 17 years.Long-Lived AssetsThe carrying value of long-lived assets, as defined under SFAS 144, is periodically reviewed
by management and impairment losses, if any, are recognized when the expected undiscounted
future operating cash flows derived from such assets are less than their carrying value.GoodwillIn accordance with SFAS No. 142, the Company recorded goodwill of $2,132,000 from the
purchase of Edgil Associates, Inc. In accordance with SFAS 142 the Company does not
amortize goodwill. However the Company evaluates goodwill at least on an annual basis for
impairment or when there are indications of impairment. In future periods if goodwill is
determined to be impaired, the Company will recognize a non-cash charge equal to the excess
of the carrying value over the fair value. There can be no assurance that future
evaluations of goodwill will not result in impairment and a charge to earnings.The Company completed its annual impairment analysis including obtaining an independent
outside appraisal and such analysis indicated that the amount of goodwill is not impaired.
 F-10




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##### Table of Contents



Fair Value of Financial InstrumentsCash and cash equivalents, accounts receivable, shareholder notes receivable, accounts
payable, deferred revenue, notes payable, capital leases and accrued expenses approximates
their fair value because of the short-term maturity or the current lending rates of these
instruments.Revenue RecognitionThe Company derives revenue from several products and services as follows:ASP revenue  The Company receives revenue from providing an application service provider
(ASP) product that allows customers to use the Companys software applications on a
shared system over the Internet. This technology is a publisher-specific ad-taking
website service that offers visitors to a newspapers Web page the opportunity to buy
classified ads, for both the print and/or on-line editions of the newspaper, in real-time,
on a 24/7 basis. The Company receives monthly fees for hosting the transactions and
providing customer support, and recognizes the fees ratably over the contract period. Under
the guidance provided by the Securities Exchange Commission Staff Accounting Bulletin
(SAB) No. 101, Revenue Recognition and the Emerging Issues Task Force (EITF) Abstract
No. 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent (EITF 99-19), we
are, in substance, acting as an agent for the publishers and therefore recognize as revenue
only the net fees realized on the transactions. We recognize revenue on a per-transaction
basis when the ad is placed through their system and collection from the customer is
probable.Licensing and Software; Customization and other revenues  The Company generates revenue
from technology service contracts that generally contain multiple elements such as software
customization services, monthly fees and PCS. Revenue from these arrangements is recognized
in accordance with SOP 97-2, Software Revenue Recognition, and SOP 98-9, Software Revenue
Recognition with Respect to Certain Transactions. Accordingly, revenue is allocated to each
element within the contract based on the relative fair values of those elements using vendor
specific objective evidence. Revenue from monthly fees and PCS under software maintenance
arrangements is based upon renewal rates and is recognized ratably over the term of the
arrangement. Revenue from software customization services is recognized as the services are
performed, using a percentage of completion methodology based on labor hours.Deferred revenue consists primarily of deferred revenues from long-term License and Software
contracts, PCS maintenance arrangements prepaid annually and customization and other
revenues billed and paid in advance. Revenues from upfront license fees, monthly fees and
PCS under software maintenance arrangements is based upon renewal rates and is recognized
ratably over the term of the arrangement, licenses and maintenance generally range from
month-to-month up to 10 years on AdStar and 1 year up to 25 on Edgil, respectively. At
December 31, 2007, deferred revenues are $132,000, revenues from PCS contracts paid in
advance and $5,000 prepaid customer deposits. Revenue from software customization services
is recognized upon the completion of services.Areas requiring managements judgment includes revenue recognition and cost estimation on
the fixed fee software customization element of the contracts. Revenue is recognized on
these contracts using a percentage-of-completion methodology, based upon labor input
measures and an estimate of time to completion. Monthly, technical management reviews the
estimate of labor hours required to complete the customization and the effect of any change
in estimate is reflected in the period in which the change is first known. Such changes in
estimates have not been material to our results of operation. The corresponding cost of
revenue charge is derived based upon the same labor input measurements and our existing cost
structure. If the Company does not accurately estimate the resources required under the
contract or the scope of the work to be performed, or if the Company does not manage its
projects properly within the prescribed timeframe, future margins may be significantly and
adversely affected. If increases in projected costs-to-complete are sufficient to create a
loss contract, the entire estimated loss is charged to operations in
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the period the loss first becomes known. The complexity of the estimation process and
uncertainties inherent in software customization activities may affect the percentages
derived under the percentage-of-completion accounting method, which in turn may affect the
amounts reported in the financial statements.Income TaxesThe Company utilizes the liability method of accounting for income taxes. Under this
method, deferred tax liabilities and assets are determined based on the difference between
the financial statement and tax bases of assets and liabilities using enacted tax rates in
effect for the period in which the differences are expected to reverse. Valuation allowances
are established, when necessary, to reduce the deferred tax assets to the amounts expected
to be realized.Advertising CostsThe Company expenses the costs of advertising in the periods in which those costs are
incurred. Advertising expense was approximately $4,000 for both the years ended December 31,
2006 and 2007.Earnings (Loss) Per ShareBasic earnings (loss) per share is computed by dividing the net income (loss) applicable to
Common Stockholders by the weighted average number of shares of Common Stock outstanding
during the period. Diluted earnings (loss) per share is computed by dividing the net income
(loss) applicable to Common Stockholders by the weighted average number of common shares
outstanding plus the number of additional common shares that would have been outstanding if
all dilutive potential common shares had been issued, using the treasury stock method.
Potential common shares are excluded from the computation when their effect is antidilutive.For the years ended December 31, 2007 and 2006, diluted earnings (loss) per share does not
include 2,642,583 and 2,470,978, respectively of options and warrants to purchase Common
Stock, as their inclusion is antidilutive.Warranties and Product liabilityThe Company warrants that its products conform to their respective functional
specifications. The Companys customized software products, ASP application products and
Software License Agreements are warranted to perform as designed. Such warranties are
extended throughout the term of extended service agreements that clients enter into with the
Company. Direct costs associated with the initial period of service have been insignificant
and are generally covered by upfront fees. At December 31, 2007 and 2006 all costs
associated with contract service were recorded directly into cost of revenues.We currently carry product liability insurance. We believe the amount of insurance is
adequate to cover our risks. To further mitigate our risks, our standard service agreement
expressly limits its liabilities and warranties of its products and services in accordance
with accepted provisions of the Uniform Commercial Code as adopted in most states.Accounting for Stock-Based CompensationDuring 2006, the Company adopted the provisions of, and accounting for stock-based
compensation in accordance with, the Financial Accounting Standards Boards (FASB)
Statement of Financial Accounting Standards No. 123  revised 2004 (SFAS 123(R),
Share-Based Payment which replaced` Statement of Financial Accounting Standards No. 123
(SFAS 123), Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25
(APB 25), Accounting for Stock Issued to Employees.
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Under the fair value recognition provisions of this statement, stock-based compensation cost
is measured at the grant date based on the fair value of the award and is recognized as
expense on a straight-line basis over the requisite service period, which often is the
vesting period.See Note 11 for further information regarding stock-based compensation assumptions and
expenses.Fair Value DisclosuresThe fair value of each option grant was determined using the Black-Scholes option-pricing
model. The Company calculated the fair value of each option granted on the date of grant
using the minimum value method or Black-Scholes model as prescribed by SFAS No. 123 using
the following assumptions:
 Year Ended December 31,2007
    
    2006Risk-free interest rate
    
    
    4.6
    %
    
    
    4.7
    %Expected lives (years)
    
    
    3.9
    
    
    
    3.5Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected volatility
    
    
    76.2
    %
    
    
    73.7
    %Forfeiture rate
    
    
    10
    %
    
    
    10
    %
 New accounting pronouncementsIn September 2006, the FASB issued SFAS No. 157, Fair Value Measures (SFAS No. 157).
SFAS No. 157 defines fair value, establishes a framework for measuring fair value and
enhances disclosures about fair value measures required under other accounting
pronouncements, but does not change existing guidance as to whether or not an instrument is
carried at fair value. SFAS No. 157 is effective for fiscal years beginning after November
15, 2007, the year beginning January 1, 2008 for the Company. The adoption of SFAS No. 157
is not anticipated to have a material impact on the Companys financial statements.In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits entities to choose to
measure many financial assets and financial liabilities at fair value. Unrealized gains and
losses on items for which the fair value option has been elected will be reported in
earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The
adoption of SFAS No. 159 is not anticipated to have an impact on the Companys financial
statements.In December 2007, the FASB issued SFAS 141(R), Business Combinations. SFAS 141(R) provides
companies with principles and requirements on how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, liabilities assumed, and any
noncontrolling interest in the acquiree as well as the recognition and measurement of
goodwill acquired in a business combination. SFAS 141(R) also requires certain disclosures
to enable users of the financial statements to evaluate the nature and financial effects of
the business combination. Acquisition costs associated with the business combination will
generally be expensed as incurred. SFAS 141(R) is effective for business combinations
occurring in fiscal years beginning after December 15, 2008, which will require the Company
to adopt these provisions for business combinations occurring in fiscal 2010 and thereafter.
Early adoption of SFAS 141(R) is not permitted.In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated
Financial Statements  an amendment of ARB No. 51. This Statement clarifies that a
noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity
that should be reported as equity in the consolidated financial statements. This Statement
changes the way the consolidated income statement is presented by requiring net income to be
reported at amounts that include the amounts attributable to both the parent and the
noncontrolling interest and to disclose those amounts on the face of the income
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statement. SFAS 160 is effective for fiscal years beginning after December 15, 2008. Early
adoption of SFAS 160 is not permitted. The Company is currently evaluating the impact that
SFAS 160 will have on our financial statements and disclosures.
 3.
    
    Property and EquipmentProperty and equipment consisted of the following at December 31, 2007:
 Computer equipment
    
    $
    429,000Production equipment
    
    
    234,000Furniture and fixtures
    
    
    101,000Leasehold improvements
    
    
    10,000774,000Less: Accumulated depreciation and amortization
    
    
    665,000Property and equipment, net
    
    $
    109,000
 Computer equipment and furniture and fixtures include equipment held under capital leases of
$36,000. Depreciation and amortization expense for December 31, 2007 and 2006 was
approximately $57,000 and $61,000 including amortization of computer equipment and furniture
and fixtures held under capital leases of approximately $1,000 in each year. Accumulated
depreciation on property and equipment held under capital leases was $5,000 and $4,000 at
December 31, 2007 and 2006, respectively.4.
    
    Capitalized and Purchased SoftwareCapitalized and purchased software consisted of the following at December 31, 2007:
 Capitalized software
    
    $
    2,811,000Purchased software
    
    
    574,0003,385,000Less: Accumulated depreciation and amortization
    
    
    3,124,000Capitalized and purchased software, net
    
    $
    261,000
 Amortization expense for capitalized and purchased software for the years ended December 31,
2007 and 2006 was approximately $362,000 and $444,000, respectively.5.
    
    Intangible AssetsIntangible assets are comprised of the following at December 31, 2007:
 Customer list
    
    $
    1,500,0000Trademarks
    
    
    202,0001,702,000Less: Accumulated amortization
    
    
    569,000Intangible assets, net
    
    $
    1,133,000
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Amortization expense for the years ended December 31, 2007 and 2006 was approximately
$88,000 in both years. Amortization of intangibles is as follows for the years ending
December 31:
 2008
    
    $
    89,0002009
    
    
    89,0002010
    
    
    89,0002011
    
    
    89,0002012
    
    
    89,000Thereafter
    
    
    688,000Total
    
    $
    1,133,000
 6.
    
    Due to publicationsThe Company processes credit cards on behalf of certain of its customers as part of ASP
services provided. Due to publications is a result of contractual customer arrangements
whereby the Company receives net proceeds daily on behalf of these customers for third party
ads placed via credit card. These transactions are collected, reconciled monthly and
submitted to the publication, net of processing fees, generally within 30 days from the
month end. The balance of Due to Publications at December 31, 2007 was $1,223,000.7.
    
    Income TaxesProvision for income taxes consists of the following:
 2007
    
    
    2006Current taxesFederal
    
    $
    
    
    
    $
    State
    
    
    8,000
    
    
    
    13,000DeferredFederal
    
    
    (1,296,000
    )
    
    
    (516,000
    )State
    
    
    (203,000
    )
    
    
    (94,000
    )Total deferred taxes
    
    
    (1,499,000
    )
    
    
    (610,000
    )Change in valuation allowance
    
    
    1,499,000
    
    
    
    610,000Income tax provision
    
    $
    8,000
    
    
    $
    13,000
 Deferred taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes. Significant components for the Companys deferred taxes at December
31, 2007 consisted of the following:
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##### Table of Contents



2007Deferred tax assets:Net operating loss carry forwards
    
    $
    8,054,000Other
    
    
    375,000Gross deferred tax asset
    
    
    8,429,000Deferred tax liabilityDepreciation and amortization
    
    
    (430,000
    )Gross deferred tax liabilities
    
    
    (430,000
    )Net Deferred tax asset
    
    
    7,999,000Less: Valuation allowance
    
    
    (7,999,000
    )Gross deferred tax asset
    
    $
    
 In assessing the realizability of deferred tax assets, management considers whether it is
more likely than not that some portion or all of the deferred tax assets will be realized.
Based upon the level of historical losses and projections of future taxable income over the
periods in which the deferred tax assets are deductible, a full valuation allowance has been
provided as management believes that it is more likely than not, based upon available
evidence, that the deferred tax assets will not be realized.As of December 31, 2007, the Company has federal net operating loss carry forwards of
approximately $21,187,000, and has state net operating loss carry forwards of approximately
$9,619,000. The federal and state net operating loss carry forwards will begin to expire in
2018 and 2006, respectively. The Companys ability to utilize net operating loss carry
forwards may be limited in the event that a change in ownership, as defined in the Internal
Revenue Code, occurs in the future.The provision for income taxes for the years ended December 31, 2006 and 2007 differs from
the amount that would result from applying the federal statutory rate as follows:
 2007
    
    2006Statutory regular federal income tax rate
    
    
    (34.0
    %)
    
    
    (34.0
    %)State taxes, net of federal benefit
    
    
    (3.5
    %)
    
    
    (4.1
    %)Change in valuation allowance
    
    
    36.5
    %
    
    
    37.1
    %(1.0
    %)
    
    
    (1.0
    %)
 8.
    
    CapitalizationCommon StockOn February 16, 2006, the Company entered into a Securities Purchase Agreement to sell to a
single accredited institutional investor one million (1,000,000) shares of its Common Stock
at an aggregate purchase price of $1,650,000. The Company filed a registration statement
covering the resale of those shares on April 7, 2006, and caused the registration statement
to be effective on May 18, 2006. The Company paid the placement agent a cash placement fee
of 51/2% of the amount raised, and warrants, exercisable for three years, to
purchase 25,000 shares of its Common Stock at a price of $4.00 per share. Net proceeds from
the sale were $1,440,000. The issuance was acquired for investment by an accredited
investor and was issued without registration under the Securities Act of 1933, as amended,
pursuant to the exemptions provided under sections 4(6) and 4(2) thereof and the exemption
provided by Regulation D.
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Stock Options and Employee Benefit PlansThe Companys stock option program is a long-term retention program that is intended to
attract, retain and provide incentives for talented employees, officers and directors, and
to align stockholder and employee interests. Currently, the Company grants options from
either the 1999 Stock Option Plan or the 2004 Stock Option Plan (the Plans), under which
options could be granted to all employees, including executive officers and non-employee
directors of the Company.The Plans provide for issuance of nonqualified and incentive stock options to officers, key
employees, consultants and non-employee directors of the Company. Each nonqualified stock
option shall have an exercise price not less than 100% of the fair value of the Common Stock
on the date of grant, unless as otherwise determined by the committee that administers the
Plans. Incentive stock options shall have an exercise price equal to or greater than the
fair value of the Common Stock on the date of grant provided that incentive stock option
granted to a 10% holder of the Companys voting stock shall have an exercise price equal to
or greater than 110% of the fair market value of the Common Stock on the date of grant. Each
option generally has a term of five years from the date of grant unless otherwise determined
by the committee that administers the Plans. Option vesting periods are generally three
years, and have five-year contractual terms. Certain option and share awards provide for
accelerated vesting if there is a change in control (as defined in the Plans).The Company currently uses the Black-Scholes option pricing model to determine the fair
value of stock options. The determination of the fair value of stock-based payment awards on
the date of grant using an option-pricing model is affected by the stock price as well as
assumptions regarding a number of complex and subjective variables. These variables include
the expected stock price volatility over the term of the awards, actual and projected
employee stock option exercise behaviors, risk-free interest rate and expected dividends.The Company estimates the expected term of options granted by taking an average of the
mid-point between the vesting date and the expiration date of the option. The volatility of
its common stock is determined by using historical volatility. The risk-free rate for
periods within the contractual life of the option is based on the United States Treasury
yield curve in effect at the time of grant. The Company does not anticipate paying any
cash dividends in the foreseeable future and therefore uses an expected dividend yield of
zero in the option valuation model. Estimated forfeitures are required at the time of grant
and those estimates are revised in subsequent periods if actual forfeitures differ from
those estimates. The estimate of forfeitures is based on historical rates, adjusted for
expected activity in the future. All stock-based payment awards are amortized on a
straight-line basis over the requisite service periods of the awards, which are generally
the vesting periods.As of December 31, 2007, there was $179,000 of unrecognized compensation cost, net of
forfeitures, related to unvested share-based compensation arrangements. This compensation
expense is expected to be recognized on a straight-line basis over the remaining
weighted-average vesting period of approximately three years. At December 31, 2007, there
were 576,000 shares available for future grants under the Plans.The assumptions used to value option grants are as follows:
 Year EndedDecember 31, 2007Risk-free interest rate
    
    
    4.6
    %Expected lives (years)
    
    
    3.9Dividend yield
    
    
    0.0
    %Expected volatility
    
    
    76.2
    %
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During the year ended December 31, 2007, the Company issued 596,000 options to its
employees; and 265,000 options were granted to consultants in connection with services to be
rendered. Total stock-based compensation recognized on the Companys consolidated statement
of operations for the year ended December 31, 2007 is $643,000.During the year ended December 31, 2007, 550,597 stock options were exercised, with net cash
receipts of $344,000. The total intrinsic value of options exercised during the year ended
December 31, 2007 was $882,000.The following table summarizes all stock option activity for the year ended December 31,
2007 and includes all options currently outstanding under the Plans and 530,000
non-qualified options issued outside the Plans.
 WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateExercise
    
    
    Contractual
    
    
    IntrinsicShares
    
    
    Price
    
    
    Term
    
    
    ValueOutstanding at December 31, 2006
    
    
    2,209,844
    
    
    $
    1.80Granted
    
    
    861,000
    
    
    
    1.87Exercised
    
    
    (550,597
    )
    
    
    .64Forfeited
    
    
    (218,000
    )
    
    
    1.78Outstanding at December 31, 2007
    
    
    2,302,247
    
    
    $
    2.11
    
    
    
    3.28
    
    
    $
    Options exercisable at December 31, 2007
    
    
    1,880,250
    
    
    $
    2.15
    
    
    
    3.16
    
    
    $
    
  Options Exercisable atOptions Outstanding at December 31, 2007
    
    December 31, 2007Weighted Average
    
    WeightedNumber of
    
    Remaining
    
    Average
    
    Number of
    
    WeightedRange of
    
    Shares
    
    Contractual Life
    
    Exercise
    
    Shares
    
    AverageExercise Price
    
    Outstanding
    
    (years)
    
    Price
    
    Exercisable
    
    Exercise Price$0.01  $0.99
    
    
    323,590
    
    
    
    3.18
    
    
    $
    0.74
    
    
    
    287,091
    
    
    $
    0.72$1.00  $1.99
    
    
    541,656
    
    
    
    3.33
    
    
    $
    1.42
    
    
    
    372,657
    
    
    $
    1.37$2.00  $2.99
    
    
    987,001
    
    
    
    3.44
    
    
    $
    2.41
    
    
    
    770,502
    
    
    $
    2.42$3.00  $4.50
    
    
    450,000
    
    
    
    2.97
    
    
    $
    3.25
    
    
    
    450,000
    
    
    $
    3.252,302,247
    
    
    
    
    
    
    
    
    
    
    
    1,880,250
 WarrantsIn connection with a contract agreement with Nokia Corporation, fully-vested warrants were
granted on February 13, 2007 to purchase 100,000 shares of the Companys common stock at a
price of $2.45 with a ten year life. The company recognized the cost of these warrants in
the amount of $216,000. The warrants were granted in connection with a contract with Nokia Corporation to develop a pilot program
for processing advertisements placed on cellular phones.
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During the year ended December 31, 2007, 20,000 warrants were exercised, with net cash
receipts of $15,000.The following table summarizes activity for the year ended December 31, 2007.
 WeightedAverage ExerciseShares
    
    PriceOutstanding at December 31, 2006
    
    
    261,134
    
    
    $
    2.60Issued
    
    
    100,000
    
    
    
    2.45Exercised
    
    
    (20,000
    )
    
    
    0.75Forfeited
    
    
    (798
    )
    
    
    0.75Outstanding at December 31, 2007
    
    
    340,336
    
    
    $
    2.67Warrants exercisable at December 31, 2007
    
    
    340,336
    
    
    $
    2.67
 9.
    
    Shareholder receivableIn July 2002, AdStar entered into a loan transaction with Leslie Bernhard, President and
Chief Executive Officer and Eli Rousso, Executive Vice President and Chief Technical Officer
for $110,434 and $100,000, respectively. As part of the transaction, Ms. Bernhard and Mr.
Rousso each issued to AdStar an unsecured, non-negotiable promissory note bearing interest
at 5.56% with monthly principal and interest payments of $763 and $691, respectively. The
notes are payable on a monthly basis, with all remaining outstanding principal and interest
amounts due on July 31, 2022. Concurrently, an outstanding note from Ms. Bernhard in the
amount of $39,566 was restructured under the same terms and conditions as the aforementioned
new note. The loans are forgiven if there is a change in control in AdStar or if the loan
holder is dismissed for other than cause as defined by the loan and employment agreements.
At December 31, 2007 the balance outstanding on the notes receivable was $206,000.10.
    
    Commitments and ContingenciesOperating and Capital Lease CommitmentsThe Company has certain non-cancelable operating lease obligations for office space and
equipment, and capital lease obligations for computer equipment and office furniture. The
operating leases are for office space located in California and Massachusetts, and expire
through November 2009. The leases contain certain escalation clauses based on certain
charges that the landlords of the properties may incur over the base year, as defined in the
lease agreements.Future minimum lease payments under the non-cancelable operating and capital leases as of
December 31, 2007 are as follows:
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Operating
    
    
    CapitalYears Ending December 31,
    
    Leases(a)
    
    
    Leases2008
    
    $
    210,000
    
    
    $
    10,0002009
    
    
    161,000
    
    
    
    9,0002010
    
    
    66,000
    
    
    
    9,0002011
    
    
    56,000
    
    
    
    4,0002012
    
    
    
    
    
    
    Total minimum obligations
    
    $
    493,000
    
    
    
    32,000Less: Amounts representing interest
    
    
    
    
    
    
    (6,000
    )Present value of minimum obligations
    
    
    
    
    
    
    26,000Less: Current portion
    
    
    
    
    
    
    (6,000
    )Non-current portion
    
    
    
    
    
    $
    20,000
 
  Rent expense for the years ended December 31, 2006 and 2007 was approximately $240,000 and
$263,000, respectively, including month-to-month rentals.In the normal course of business, various claims and lawsuits may, from time-to-time, be
filed against the Company. There are no claims or lawsuits outstanding at December 31,
2007.Employment AgreementsOn December 21, 2005, the Company entered into four-year employment agreements with each of
Leslie Bernhard and Eli Rousso. The employment agreements extend through December 20, 2009,
and contain automatic annual one-year extensions to the term, effective on each anniversary
date of the agreement. Pursuant to her employment agreement, Leslie Bernhard was retained
as the Chief Executive Officer and her total annual compensation is $212,800. Pursuant to
his employment agreement, Eli Rousso was retained as the Executive Vice President and his
total annual compensation is $212,800. Under each agreement, the Company may terminate
employment with cause or by the executive with good reason. Termination without cause, or by
the executive for good reason, would subject the Company to liability for liquidated damages
in an amount equal to the terminated executives base salary for the remaining term of his
or her employment agreement or 12 months, whichever is greater. Each executive also
executed an employment agreement amendment, both dated December 21, 2005, that voluntarily
reduces their individual salaries to $202,160 per year, unless the executive provides 10
days written notice that the reduction is no longer in effect.In January 2001, AdStar entered into a 2-year employment contract with Mr. Jeffrey Baudo,
its Chief Operating Officer. Pursuant to his employment agreement, Mr. Baudo was retained as
our Chief Operating Officer at an annual rate of $213,000 per year, and granted options to
purchase 100,000 shares of AdStars Common Stock. Subsequently, as of July 1, 2002, Mr.
Baudo agreed to an amendment to his employment agreement reducing his annual rate of
compensation to $191,700. Mr. Baudos contract was extended for one year with successive
one-year terms for the same salary under essentially the same terms and conditions,
effective January 22, 2003. On December 21, 2005, Mr. Baudo executed an employment
agreement amendment that voluntarily reduced his salary to $182,115 per year, unless he
provides 10 days written notice that the reduction is no longer in effect. Mr. Baudo is the
brother of Leslie Bernhard.
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Mr. Linesch, the Companys Chief Financial Officer, is entitled to severance compensation in
the event of a change in ownership or control of the Company or termination for convenience,
in an amount equivalent to approximately six months of his aggregate monthly compensation at
the time of termination.11.
    
    Related party transactionsAt December 31, 2007, the Tribune Company owned 3,443,457 shares of AdStar common stock.
During the years ended December 31, 2007 and 2006 the Companys total revenues derived from
Tribune Company agreements were $884,000 and $849,000 respectively.12.
    
    Employee Benefit PlanThe Company maintains a defined contribution 401(k) plan that covers substantially all
employees. Contributions to the Plan may be made by the Company (which are discretionary) or
by plan participants through elective salary reductions. During the years ended December 31,
2007 and 2006, contribution expense was $23,000 and $18,000 respectively.13.
    
    Subsequent EventOn March 18, 2008, AdStar, Inc. (the Company) received a staff determination notice from
the NASDAQ Stock Market (NASDAQ) indicating that the Company failed to regain compliance
with the $1.00 minimum closing bid price per share requirement for continued listing or
demonstrate that it meets the criteria for initial listing during the compliance period of
180 calendar days (expiring on March 17, 2008) previously afforded to the Company on
September 17, 2007 pursuant to NASDAQ Marketplace Rules 4310(c)(8)(D) and 4310(c)(4).
According to the notice, the Companys securities will be subject to suspension and
delisting from the Nasdaq Capital Market at the opening of business on March 27, 2008 unless
the Company requests a hearing to appeal this determination by 4:00 p.m. Eastern Time on
March 25, 2008 pursuant to the procedures set forth under the applicable NASDAQ Marketplace
Rule. At this time, the Company does not plan on appealing this determination and expects
its securities to continue trading on the OTC Bulletin Board at such time.
 F-21