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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-KSB (Mark One) x
    
    Annual Report Pursuant to Section 13 or 15(D) of the Securities Exchange Act of 1934
 For the Fiscal Year ended December 31, 2003 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. 
  Delaware
    
    22-3666899(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)
   
  Registrants telephone number (310) 577-8255 Securities registered under Section 12(b) of the Exchange Act: Title of Each Class
    
    Name of Each Exchange on Which RegisteredCommon Stock, par value $.0001 per share
Warrants
    
    Boston Stock Exchange
 Securities Registered under Section 12(g) of the Exchange Act: Common Stock, par value $.0001 per share 
  Warrants 
  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 past 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes x No o Indicate by check mark if there is no disclosure of delinquent filers
pursuant to Item 405 of Regulation S-B in this form and no disclosure will 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-KSB or any amendment to this Form 10-KSB. o For the year ended December 31, 2003, the revenues of the registrant were
$2,833,525 The aggregate market value of the voting Common Stock of the registrant
held by non-affiliates of the registrant, based on the closing price on the
Nasdaq Market on March 24, 2004 of $2.09 per share, was approximately
$26,835,397. As of March 24, 2004, the registrant has a total of 12,839,903 shares of
Common Stock outstanding, including 5,569 shares issuable pursuant to the
vendor compensation program. DOCUMENTS INCORPORATED BY REFERENCE NONE




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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
    
    
    15Item 3. Legal Proceedings
    
    
    15Item 4. Submission of Matters to a Vote of Security Holders
    
    
    15PART IIItem 5. Market for Common Equity and Related Stockholder Matters
    
    
    15Item 6. Managements Discussion and Analysis of Financial Condition
and Results of Operation
    
    
    18Item 7. Financial Statements
    
    
    29Item 8. Change in and Disagreements with Accountants on Accounting
and Financial Disclosure
    
    
    29Item 8A. Controls And Procedures
    
    
    29PART IIIItem 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act
    
    
    30Item 10. Executive Compensation
    
    
    32Item 11. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
    
    
    34Item 12. Certain Relationships and Related Transactions
    
    
    37Item 13. Exhibits, List and Reports on Form 8-K
    
    
    38Item 14. Principal Accountant Fees and Services
    
    
    40Exhibit 14.1Exhibit 21.1Exhibit 23.1Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  FORWARD-LOOKING STATEMENTS Certain statements made in this Annual Report on Form 10-KSB are
forward-looking statements within the meaning of Section 21E of the
Securities and Exchange Act of 1934 regarding the plans and objectives of
management for future operations and market trends and expectations. Such
statements involve known and unknown risks, uncertainties and other factors
that may cause our actual results, performance or achievements to be materially
different from any future results, performance or achievements expressed or
implied by such forward-looking statements. The forward-looking statements
included herein are based on current expectations that involve numerous risks
and uncertainties. Our plans and objectives are based, in part, on assumptions
involving the continued expansion of our business. Assumptions relating to the
foregoing involve judgments with respect to, among other things, future
economic, competitive and market conditions and future business decisions, all
of which are difficult or impossible to predict accurately and many of which
are beyond our control. Although we believe that our assumptions underlying the
forward-looking statements are reasonable, any of the assumptions could prove
inaccurate and, therefore, there can be no assurance that the forward-looking
statements included in this report will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, particularly in view of our early stage operations, the inclusion of
such information should not be regarded as a representation by us or
any other person that our objectives and plans will be achieved. The terms
we, our, us, or any derivative thereof, as used herein shall mean AdStar,
Inc., a Delaware corporation.




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PART I 
 Item 1. BUSINESS General AdStar, Inc., a Delaware corporation (AdStar) provides technology
services within the classified advertising industry. Our proprietary software
is an integrated suite of applications that electronically connects publishers
with the source of their advertising revenue. Our software applications allow
professional advertising agencies businesses and individuals to electronically
send ads to newspapers. This gives newspapers the ability to electronically
receive classified advertising insertions directly into their sophisticated
publishing systems. Our solutions are available in an application service
provider (ASP) model whereby we contract with publishers to design,
implement, host, and manage the on-line ad-taking capabilities of their Web
sites. We provide all the technical and application expertise, customer
support, and security measures that the publisher needs to install our
application modules and begin to generate revenue in a short time frame. Our
software solutions afford newspapers the ability to increase revenue and are
the application of choice for advertisers, because it affords them the ability
to effortlessly and quickly compose and format classified ads, price them,
schedule them, and electronically send them into the publishing system at
multiple newspapers. Corporate History AdStar was originally incorporated in New York as Ad-Star Services, Inc. a
privately held corporation. In 1999, we incorporated AdStar.com, Inc. in
Delaware and merged Ad-Star Services, Inc. into this entity. We completed an
initial public offering of AdStar.com, Inc. common stock in December 1999,
receiving net proceeds of approximately $5.4 million. This was followed in
September 2000, with another offering of common stock, receiving net proceeds
of approximately $2.8 million. In July 2001, we formally changed our name to
AdStar, Inc. to more accurately reflect our current business, products and our
plans for future growth. In October 2003 we acquired Edgil Associates, Inc.
for approximately $3.9 million in cash and common stock to add their
proprietary payment processing solutions to our suite of application products. The AdStar Software Solution The new AdStar e-business application suite is an enterprise class,
integrated software solution that allows print and on-line publications to
electronically receive completed classified advertising copy using the Internet
as the communication channel. This new application suite was developed in
conjunction with our existing customers, and in response to their need for a
software solution supporting both business-to-business (B-to-B) operations and
business-to-customer (B-to-C) operations. These software solutions enable our
customers to expand the relationships with their customers using a single
integrated platform, while increasing sales volumes at reduced costs. Our ASP
product provides our customers an opportunity to generate incremental revenue
from their on-line business while increasing the number of visitors to their
Web site. Our software allows newspapers to turn their on-line presence into an
e-commerce-enabled, revenue generating Web site. Our new e-business application suite includes four main products that can
be purchased separately or as a fully integrated software solution:  
    
    Professional software This technology is designed for use by
the professional marketplace. Specifically, the applications accept
transmissions from classified advertising agencies and large
corporations using advanced Web-based technology. The software
includes sophisticated 3




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pricing algorithms to provide for maximum flexibility and intricate
design resources to provide unlimited creative capabilities.
    
    ASP Web site technology This technology is a
publisher-specific ad-taking Web site service designed to enhance a
publications Web site by allowing the general public to execute
transactions to purchase classified advertising. Specifically, it is
an integrated application suite 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. This product allows a publication to completely outsource the
classified ad-taking power of their Web site whereby the publication
receives incremental revenue at a very low incremental cost. We
handle all functions associated with this revenue source. We furnish
and host the application suite, run the technology, monitor the
transactions throughout the session, handle the payment authorization
and settlement process, electronically deliver the ad text to the
newspaper, and provide customer service support to the newspapers
customers. We provide all the technical and application expertise,
customer support, and security measures that the publication needs to
get an application up and running in a short time. Typically, we are
able to process many more ads and do so much more quickly and
affordably than the publisher could do internally. In addition, this
software solution provides tools to evaluate performance, provide
additional customer care, and increase future revenue opportunities.
We provide the means to deliver highly personalized email
communications to existing customers for the purpose of creating
additional revenues and creating a profitable, long-term relationship
    
    XML Gateway (Application Programming Interface) This
technology allows third parties, internal newspaper applications,
niche web publishers to make use of Adstars infrastructure and
incorporate web based adtaking for print, or in combination with an
online ad into their applications, to facilitate the processing of
classified advertising.
    
    Credit Card Processing With the acquisition of Edgil
Associates in October of 2003, we have added the ability to offer to
newspapers credit card processing for use in phone rooms accepting
classified ads, subscription departments or for any other transaction
that requires a credit card. Edgil offers system integration
services, installation support, training and customer service.
Edgils proprietary Edgecapture payment processing software
processes over 12,000,000 million newspaper advertising and
circulation transactions annually for Tribune Company, Gannett
Company, Inc., Knight-Ridder, Inc., Copley Press, Inc., the New York
Times, Advance Publications, Inc., Cox Enterprises, Inc., and Village
Voice Media, Inc. as well as many independent daily and specialty
publications. Edgils product strategy focuses on providing
newspapers with the financial benefits afforded by reduced labor
costs and lower credit card processing discount rates. Edgils
experience with integration services has given Edgecapture product
line the technical differentiation to meet the specific credit card
processing requirements of the publishing industry. These software products allow transactions to be executed in a secure
infrastructure. Our application suite is designed to be quickly integrated into
our customers existing publishing software and readily expands as our
customers needs and business grows. Our Web products use a single platform to
connect and integrate transmissions between multiple browsers and multiple
technology standards. In continually ensuring that our AdStar software solution
works with all available technology standards, we solve the problems created
for our customers because advertisers create and deliver content using ever
changing technology with multiple standards, multiple browsers and evolving
network infrastructures. By bridging disparate technologies in a way that
seamlessly allows for communication and transmission of advertising copy, we
alleviate this obstacle for our customers, freeing them to focus on their
business. 4




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Our Web-based classified lines of business generate fees to customize the
AdStar software solution to the technical specifications for each publication.
In addition, we charge ongoing monthly fees to manage the ad-taking process,
provide technical support, supply a customer service phone room, and manage the
entire e-commerce function. The monthly fees include a small hosting fee plus
a fee based on transaction volumes and are structured in such a way that we
are, in essence, partnering with our customers. Therefore, when our customers
revenue increases, our revenue will also increase. With this structure, we are
able to offer superior service in a manner that is cost effective for
publishers of all sizes. Edgils credit card processing application currently operates in a license
mode with installation fees and ongoing license and support fees. We plan to
develop a transaction model for credit card processing hosted on Adstars
infrastruture and made available to both existing and new accounts. Background We began developing the professional software application in 1986, and
today have grown to become the preeminent software solution providing large
newspapers with the ability to electronically receive classified advertising
from advertising agencies and large corporations. Our professional software
application has seen numerous technological enhancements over the years, and is
still in place at the majority of installations. This technology enables
newspapers to reduce the amount of manual effort required to publish an ad and
eliminates newspaper typographical errors. Our software allows newspapers to
process more ads accurately while under tight time constraints at deadline and
thus realize greater revenue. Our remote entry version of this software is
currently in use at more than 40 large metropolitan newspapers linked to more
than 1,500 advertising agencies and numerous large corporations. Our customers
include such highly respected publications as the Los Angeles Times, the
Chicago Tribune, The Atlanta Journal-Constitution, and The Miami Herald. During 1999 and 2000, we designed, engineered, and marketed
Advertise123.com, a one-stop marketplace on the Web for advertisers to buy
classified ads. By accessing our Web site, we enable advertisers to plan,
schedule, compose, and purchase classified advertising from a large number of
print and on-line publishers using one simple interface. Our service permits
both advertising agencies and consumers, including the general public, to
create and submit to one or many publications any number of classified ads, 24
hours a day, seven days a week, using any standard Web browser. This Web-based service, Advertise123.com, is an outgrowth of our
historical business as the largest provider of remote entry for classified ads
into newspapers in the United States. Since 1986, we have offered advertising
agencies the ability to process classified ads electronically with a number of
the largest newspapers in the United States. Our historical business enables
professional advertisers to electronically input, format and price ads. It is
based on a software system that we developed which is currently installed 5




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on computers used by 43 newspapers and more than 1,500 advertising agency
and advertiser locations. Using this system, we have become the largest
provider of remote entry for classified ads into newspapers in the United
States. We estimate that in 2001, approximately $400 million in classified ads
were placed in newspapers using our remote entry system and in 2002 that number
has grown to greater than $400 million. We believe we have enjoyed our
leadership in the remote entry ad placement business because of the extremely
difficult process of properly formatting, pricing and scheduling an ad and
finding a way to send this ad to a classified system without seriously impeding
the processing demands of both the automated systems and human processes
involved. We received our first transaction fees from Internet business in June 1999
with one on-line publication available on the Advertise123.com site. At the end
of 1999, we had five print and one on-line publications available on the site.
By the end of 2000, we had over 280 print publications and newspaper networks
and 30 on-line publications available. In October 2000, we achieved our target
coverage in the top 100 designated market areas (DMAs) in the U.S. In
addition, in 1999 and 2000, we powered approximately $550,000 and $4,383,000,
respectively, of classified advertising through our classified advertising
marketplace, Advertise123.com, and private-label ad-taking sites built and
powered by us. Although the volume and dollar value of ads placed through our
Advertise123.com portal continued to grow, the margins on this business were
not sufficient to sustain a business. In an effort to minimize marketing
expenses and maintain the ongoing growth of Advertise123.com, in 2002 we
entered into an Agreement with the NAA. The NAA now markets and sells
Advertise123.com under its national brand bonafideclassifieds.com. Marketing During 2002, we successfully shifted our revenue to recurring, transaction
based sources. In 2002 the largest Knight-Ridder, Inc. newspapers and Tribune
Company major market newspapers contracted to install the ASP Web site
technology. By the end of 2002, 24 newspapers were operating under this new
model with additional implementations scheduled for 2003. Other large
newspapers were contracted with including: The Detroit News (www.detnews.com)
and Detroit Free Press (www.freep.com); and eight Southern California
newspapers owned by MediaNews Group, Inc. - the Los Angeles Daily News
(www.dailynews.com), Long Beach Press-Telegram (www.presstelegram.com), San
Gabriel Valley Tribune (www.sgvtribune.com), Pasadena Star News
(www.pasdenastarnews.com), San Bernardino County Sun (www.sbsun.com), Inland
Valley Daily Bulletin (www.dailybulletin.com), Whittier Daily News
(www.whittierdailynews.com) and the Redlands Daily Facts
(www.redlandsdailyfacts.com). We also enhanced our core platform by
implementing iPix photo technology, enabling our ASP Web site technology
customers to add photo up sell capability. In 2002, AdStar entered into a strategic relationship with Tribune Company
in which Tribune invested $1,800,000 in March 2002, $900,000 in December 2002
and $600,000 in March 2003 and AdStar agreed to build, host and manage Tribune
Companys integrated print and online employment web-based ad taking
technology. For its investment Tribune received the following:  (i)
    
    In March 2002, 1,443,457 shares of our Series A Preferred
Stock;(ii)
    
    In December 2002, 1,200,000 shares of our Series B-1 Preferred
Stock; and(iii)
    
    In March 2003, 800,000 shares of our Series B-2 Preferred
Stock plus an additional 1,200,000 shares of our Series B-2 Preferred
Stock, in exchange for all of the previously issued Series B-1
Preferred Stock and all accrued and unpaid dividends on those shares. Each of these transaction are described below in Item 5 under the subsection
entitled Recent Sales of Unregistered Securities. BonafideClassifieds.com In 2002 we entered into an
agreement with the Newspaper Association of America (NAA) to allow
the NAA to market and private label (operate under its name)
Advertise123.com, AdStars one-stop marketplace on the Web for
the general public to buy classified ads. Through this portal,
individuals and businesses can, on a 24/7 basis, compose
professional looking classified ads using one of several
pre-programmed templates, schedule the ad to run in one or several of
over 200 newspapers and 50 state newspaper associations, and purchase
the ad using a credit card. Beginning in 2003, AdStar expanded its
relationship with the NAA by authorizing the NAA to market a version
of AdStar's ASP Web site technology to its members. AdStar receives
set up and transaction fees for these businesses. The NAA is the
newspaper industrys trade association representing the
$55 billion newspaper industry and over 2,000 publishers in the
United States and Canada. 6




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Finally in 2003, we aggressively began marketing our
application-programming interface whereby we allow third parties to use AdStar
services. A variety of businesses have taken advantage of this interface, with
more implementations scheduled for 2004. The most notable agreement is with
Manheim Interactive, the technology services division of Manheim Auctions, Inc.
Manheim will develop ad transaction services using AdStars application
programming interface to help automotive dealerships compose, schedule and pay
for ads in print and online versions of newspapers. There are over 11,000
Tracker Dealer Management System users who could potentially take advantage of
this service. AdStar Business Strategy In 2003 we continued to transform our business to one generating ASP
revenues based largely on transaction volume or transaction revenue. For 2003
our revenues from transaction based fees increased 61% over the previous year.
ASP revenues now represent 52% of our total revenues compared to 42% for 2002 As part of this transformation we developed new ASP services supporting
high volume transactions. The XML Gateway (Application Programming Interface)
continued to attract large users of classifieds as well as an acquisition, in
late October 2003, of Edgil Associates, Inc. Edgil, through its EdgeCapture
product line offers credit card processing for the newspaper industry. This
service enables phone rooms and subscription departments to accept credit card
transactions fully integrated into publishers various systems. In 2002 Edgil
processed approximately 12 million transactions for its customers. While
currently operating as a license model we are developing a hosted solution for
publishers that would operate on a transaction model with a monthly fee and per
transaction fee. Our goal is to become the primary resource for E-Commerce to the newpaper
industry, providing applications for classified adtaking, credit card
processing , online subscriptions and any and all enhancements that can be
offered on-line or at the newspapers facilities. To maintain the momentum we created in 2003, we will continue to
aggressively pursue the following:  
    
    cross selling papers on Web-based ad-taking and credit card
processing;
    
    pursue third parties who can provide ad-taking capability to their
customers by using our XML Gateway;
    
    expand services to our existing account base with additional Adstar
products; and
    
    acquire technologies that offer enhancements to ad-taking such as
text messaging, sound, auction functions, order fulfillment and virtual
tours where we receive fees when advertisers access these services
through our transaction engine. Competition Our classified ad-taking processes compete with phone rooms and other
established methods for ad-taking at newspapers. However, we have not
experienced extensive competition from others offering electronic ad-taking
services though many newspapers have established such capabilities on their own
Web sites. As Web-based ad-taking has become more accepted in the industry,
other software vendors, including publishing system vendors have begun to
develop technologies that may compete directly with our products. Many of these
potential new competitors have longer operating histories, greater name
recognition, larger customer bases and significantly greater financial,
technical and marketing resources than us. We cannot guarantee that we will be
able to compete successfully against current or future competitors or that 7




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competitive pressures will not have a material and adverse effect on our
financial position, results of operations and cash flows. We also expect that
large media companies may decide to design, create, and program software
internally that will allow them to manage the Web-based classified ad-taking
process internally. Our ability to compete will also depend upon our ability to continually
improve our products and services, the enhancements we develop, the quality of
our customer service, and the ease of use, performance, price and reliability
of our products and services. Intellectual Property We regard our intellectual property as critical to our success, and we
rely upon trademark, and trade secret laws in the United States to protect our
proprietary rights. We have established trademark rights in various forms of
the mark ADSTAR and ADVERTISE123.COM, based on our use of these marks and our
ownership of incontestable United States trademark registrations. We seek to protect our proprietary rights through the use of
confidentiality agreements with employees, consultants, advisors and others. We
cannot guarantee that these agreements will provide adequate protection for our
proprietary rights in the event of any unauthorized use or disclosure, that our
employees, consultants, advisors or others will maintain the confidentiality of
proprietary information, or that proprietary information will not otherwise
become known, or be independently developed, by competitors. In the past, we have licensed elements of our trademarks, trade dress and
similar proprietary rights to third parties, and we expect to do so in the
future. While we attempt to ensure that the quality of our name and brand are
maintained by our business partners, we cannot guarantee that these partners
will not take actions that could materially and adversely affect the value of
our proprietary rights or the reputation of our software solutions and
technologies. Legal standards relating to the validity, enforceability and scope of
protection of certain proprietary rights in Internet-related industries are
uncertain and still evolving, and we cannot make any guarantees as to the
future viability or value of any of our proprietary rights or those of other
companies within the industry. We cannot guarantee that the steps taken by us
to protect our proprietary rights will be adequate or that third parties will
not infringe or misappropriate our proprietary rights. Any infringement or
misappropriation, should it occur, could have a materially adverse effect on
our business, our results of operations, and our financial condition.
Furthermore, we cannot guarantee that our business activities will not infringe
upon the proprietary rights of others, or that other parties will not assert
infringement claims against us. Employees As of March 15, 2004, we had a total of 36 employees. All of them are
full-time employees, including 4 in executive management, 1 in product
development, 13 in engineering, 8 in customer support, 3 in sales and
marketing, and 7 in finance and administration. We are not subject to any
collective bargaining agreements and we believe that our relations with our
employees are good. We believe that we are currently staffed at an appropriate
level to implement and carry out our business plan for the next 12 months. CERTAIN RISK FACTORS THAT MAY AFFECT GROWTH AND PROFITABILITY 8




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The following factors may affect the growth and profitability of AdStar
and should be considered by any prospective purchaser of AdStars securities: 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. It is uncertain as to whether we can transform our business to one
generating new significant revenues from our ASP services. The uncertainty
includes risks as to whether we will be able to:  
    
    attract a sufficient number of publishers for our new publisher
specific ASP ad-taking services to permit profitable operations;
    
    develop profitable pricing models for our volume related fees;
    
    respond effectively to competitive pressures; and
    
    attract, retain and motivate qualified personnel. Our failure to address these risks successfully could adversely affect our
ability to sustain our operations and ultimately attain profitability. Our Unproven On-Line Business Model May Not Generate Expected Revenues. Because we have limited Internet experience, we cannot accurately forecast
the source, magnitude or timing of our future revenues. Current expectations
are that we will generate revenue from:  
    
    hosting and transaction fees for ads processed through our ASP
product,
    
    installation fees from publishers installing our new publisher
specific ad-taking Web site services;
    
    fees from publishers to process classified advertising utilize
our professional software product. Our expectations with respect to future revenues are principally based on
our ability to attract advertisers and publications. In particular, our
assumption that we will not encounter any significant resistance by publishers
to accepting Web-based ads may be wrong. Publishers might view transactions in
which we charge a transaction fee as reducing the amounts they would receive if
they obtained the ads directly. Conversely, advertisers may be reluctant to pay
a mark-up to published classified advertising rates. If because of these
factors, the revenues are not generated in the amounts and within the time
periods necessary to sustain our operations, the prospects for our ASP, on-line
business will be seriously compromised. We Have A History Of Losses And Until We Are Able To Significantly Increase ASP
Revenues We Expect Continued Losses. We have incurred significant recurring net losses, and has used
substantial funds in its operations. For the years ended December 31, 2002 and
2003 we had net losses of $2,159,643 and $2,842,365, respectively. Our 2002 and
2003 net losses were principally attributable to our shift in focus from an
on-line business to an ASP business. We expect to continue to incur losses
until we are able to increase our revenues significantly from fees based on the
number of ad purchases transacted through our ASP product. Our operating
expenses are expected to remain constant in connection with our expanded
activities. Our future 9




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profitability will depend on our ability to increase our transaction and
service revenues while controlling or reducing our costs. We may not be able to
achieve profitability. However, based on our current operating plan, cash on
hand, our ability to control costs and our historical record of achieving
financings, we believe we have sufficient resources available to see us through
March 30, 2005. The Growth Of Our Historical AdStar Business Is Limited And May Not Be Able To
Sustain Our Operations On Its Own. Our historical AdStar remote ad entry business is limited both in current
size and growth potential due principally to the installation, training and
on-going support costs at advertiser sites and the requirement that advertisers
separately dial-up each publication in which they intend to buy an ad. Our
ability to achieve sufficient revenues to justify the expectations of our
investors is dependent on the success of our professional software product
which we believe eliminates these barriers. Our belief that we can successfully
expand our business by migrating to an Internet delivery system and providing
publisher specific site design, customization, implementation and management
services may not be correct. 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. Our ability to grow depends significantly on our ability to attract
publishers to sign-up for AdStars suite of products, which means having an
adequate sales and marketing budget and adequate funds to continue to enhance
our Web sites and ad-taking technology. If the actual cost of attracting
publishers, and enhancing our Web sites and ad-taking technology are higher
than projected or the revenues from our operations fall below our current
expectations, we may need additional financing in the near future. In either
event, if our revenues are insufficient to provide the necessary cash flow for
ongoing operations, we will need to seek additional capital from public or
private equity or debt sources to fund our growth and operating plans and
respond to other contingencies. We may not be able to raise needed cash on
terms acceptable to us or at all. Financings may be on terms that are dilutive
or potentially dilutive to our stockholders. If sources of financing are
required, but are insufficient or unavailable, we will be required to modify
our growth and operating plans to the extent of available funding, 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. As a business delivering certain services via the Internet, we are
vulnerable to breakdowns and interruptions in Internet transmission which could
disrupt our ability to provide continued and sustained support to advertisers
and publishers. We have not yet suffered any serious breakdowns in service. If
because of interruptions our customers and prospective customers lose faith in
our ability to service their needs, they may choose more traditional means for
placing their classified ads, may turn to our competition, or may choose to no
longer outsource their Web-based ad-taking functions and instead perform the
services in-house. If this were to occur, we would not be successful in
building an on-line business. In March 2003 we entered into an arrangement with
Tribune Company to build out a fully functional back-up site at their AT&T
co-location in Redwood City, California. During 2003 we were able to fully test
the back-up site for most of our significant operations and expect the site to
be fully operational during the second quarter 2004. Our Ability To Compete Effectively And Operate Profitably Cannot Be Assured
Because Our ASP Business Competes With Established Methods For Ad-Taking. Our classified ad-taking processes compete with phone rooms and other
established methods for ad-taking at newspapers. We are unaware of any major
company that provides a centralized publisher specific 10




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ad-taking Web site services for the selection, transaction and processing
of classified ads or to multiple print and on-line publication technology
though many newspapers have established ad-taking capabilities on their own Web
sites. Those publishers that accept and process ads by traditional means like
telephone, facsimile transmission and printed copy submissions are potential
competitors. Our ability to compete successfully will depend on the perceived
convenience of our services, ease of use and the amount of fees we charge. In
addition, companies not now in the business of providing on-line remote ad
entry but possessing more capital resources than we do may seek to develop
their own technology and enter into the business of offering a similar broad
based, centralized on-line classified ad placement services to ours. Some of
these companies could have longer operating histories, greater name
recognition, larger customer bases and significantly greater technical and
marketing resources than we have. As a result, they may be able to respond more
quickly than we can to new or emerging technologies and can devote greater
resources than we can to development, promotion and sale of their services.
Faced with this type of competition, our ability to compete effectively and
operate profitably cannot be assured. Our Limited Experience May Affect Our Ability To Deal Effectively With
Technological Change Which Could Materially and Adversely Affect Our Business. Our on-line business is characterized by:  
    
    rapidly changing technology;
    
    evolving industry standards;
    
    frequent new product and service announcements;
    
    introductions and enhancements; and
    
    changing customer demands. These market characteristics are heightened by the emerging nature of the
Internet, Internet advertising, Internet transactional activity, and in
particular by our limited experience and short operating history in this
market. For these reasons, our future success depends on:  
    
    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. Furthermore, we do not know if we will have the experience and talent to
overcome technical difficulties that may arise from time to time that could
delay or prevent the successful design, development, testing, introduction or
marketing of software solutions, or that any new software solutions or
enhancements to existing software applications will adequately meet the
requirements of our current and prospective customers and achieve any degree of
significant market acceptance. If we are unable, for technological or any other
reasons, to develop and introduce new software solutions or enhancements to
existing software solutions in a timely manner or in response to changing
market conditions or customer requirements, or if our software solutions or
enhancements contain errors or do not achieve a significant degree of market
acceptance, our financial position, results of operations and cash flows could
be materially and adversely affected. 11




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We May Be Unable To Manage Our Growth. Our business plan contemplates a sizable increase in the advertisers and
publishers using our on-line services. In the event we need to increase the
number of our employees beyond current levels, the recruitment, training and
integration of these persons into our operations will place a significant
strain on our managerial, operational and financial resources. We cannot
guarantee that we will be able to manage effectively the expansion of our
operations, or that our personnel, systems, procedures and controls will be
adequate to meet our anticipated future operations. If this were to occur, it
would materially and adversely affect our business and prospects. We May Not Be Able To Retain Key Existing Employees Or Attract The Large Number
Of Additional Employees Essential To The Success Of Our New On-Line Business. Our performance is substantially dependent on the performance of our
management and key technical personnel and on our ability to attract the new
Internet-oriented employees required in the implementation of our business
plan. The competition for Internet-oriented people of the type we will be
seeking is intense and we may be hard pressed to find the personnel needed as
fast as we need them. If we are unable to retain our key existing employees or
to attract, hire and assimilate the qualified employees we will be seeking, the
growth of our on-line business will be arrested and we will not be able to meet
the projected revenue increases within the time period contemplated in our
business plan, if at all. 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 dependent on the continuing efforts of our President and Chief
Executive Officer, Leslie Bernhard, and our Executive Vice President and Chief
Technology Officer, Eli Rousso. Our business may be adversely affected if the
services of either officer become unavailable to us. While we have obtained a
key-man life insurance policy on the lives of both Leslie Bernhard and Eli
Rousso in the amount of $850,000 each, this amount may not be sufficient to
offset the loss of their services. We Are Vulnerable To Potential Lawsuits Regarding Ad Content Or System Failure. Because we facilitate the placement of advertisements in print and on-line
publications, potential claims may be asserted against us for negligence,
defamation or personal injury, or for reasons based on other theories, due to
the nature of the content of these advertisements. Our technology does not
contemplate our reviewing classified advertisement content processed on our Web
sites for libelous or other statements that might give rise to possible
liability. This role has been fulfilled historically by each publication and we
expect the publications will continue to monitor their ads. Although we carry
general and professional liability insurance, our coverage may not cover
potential claims or may not be adequate to indemnify us fully. Any imposition
of liability or legal defense expenses that are not covered by insurance or
that are in excess of our insurance coverage could place a strain on our
available cash resources, could seriously jeopardize the success of our
business plan and could materially and adversely affect our financial position,
results of operations and cash flows. Our On-Line Businesses Have A Limited History And May Not Be Successful. We did not begin to offer our technology over the Internet until June 1999
and offered only a limited number of publications from which to purchase
classified advertising until March 2000. Moreover, we know of no other major
company that accepts classified ads on-line for publication both on-line and in
print. Accordingly, we cannot guarantee that we will be able to generate the
public interest necessary to sustain our business model. 12




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We May Not Be Able To Protect Our Proprietary Rights. We believe that our future success will depend, in part, on our ability to
develop proprietary rights with respect to our systems and services including
domain names, trademarks, trade names, service marks and copyrights. This is
particularly true with respect to our Web-based service technology. We do not
currently own any patents or patent applications on our technology and we have
no assurance that our rights to that technology are patentable or otherwise
protectable. Moreover, there is no assurance that others might not develop
alternate technologies that might be more effective than ours regardless of
whether or not we obtain patent protection. Despite our existing trademark rights in the marks AD-STAR, ADSTAR, and
Advertise123.com, the marks remain susceptible to trademark infringement due to
the frequent illicit use and piracy of trademarks by cybersquatters on the
Internet. Although we own the domain names Advertise123.com and ADSTAR.com,
there remains the risk that third parties will seek to register our marks
AD-STAR and Advertise123 in the other top level domains, e.g., .org, .net,
and .gov, or that they will register close copies of our marks. Furthermore, we cannot guarantee that our business activities will not
infringe upon the proprietary rights of others, or that other parties will not
assert infringement claims against us. If for any of the above reasons we are
deprived of any proprietary rights to our technology or trade style, our
prospects for success may be seriously and adversely affected. 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. We do not currently own any patents or patent applications on our
technology and we have no assurance that it will not be used by others without
our authorization. Moreover, there is no assurance that others might not
develop alternate technologies that might be more effective than ours whether
or not we obtain patent protection. If others develop alternate technologies or
use our technology without our authorization, our results of operations and
financial position could be materially and adversely affected. Natural Disasters Which Disrupt Our Services Could Have An Adverse Effect On
Our Business, Results Of Operations And Financial Condition. Our operations and services depend on the extent to which our computer
equipment and the telecommunications infrastructure of our third-party network
providers is protected against damage from fire, earthquakes, power loss,
telecommunications failures, and similar events. A significant portion of our
computer equipment, including critical equipment dedicated to our Internet
access is located in the Los Angeles, California area. Despite precautions
taken by us and our third-party network providers, over which we have no
control, a natural disaster or other unanticipated problems at our network hub,
or a third-party network provider point of presence could cause interruptions
in the services that we provide. If disruptions occur, we may have no means of
replacing these network elements on a timely basis or at all. We do not
currently maintain back-up Internet services or facilities or other back-up
computing and telecommunications facilities. Extensive or multiple
interruptions in providing users with Internet access is a reason for user to
decide to stop using access services. Accordingly, any disruption of access
services in general, or our service specifically, due to systems failure could
have an adverse effect on our business, results of operations and financial
condition. Furthermore, we do not currently have any business disruption
insurance. 13




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Our Corporate Documents May Limit Rights Of Stockholders. Our Board of Directors has the authority to issue up to an additional
1,556,543 shares of preferred stock without any further vote or action by our
stockholders, and to determine the price, rights, preferences, privileges and
restrictions, including voting rights of these shares. Since the preferred
stock could be issued with voting, liquidation, dividend and other rights
superior to the rights accompanying shares of our common stock, the rights of
the holders of shares of common stock will be subject to, and may be adversely
affected by, the superior rights of the holders of preferred stock. The
issuance of preferred stock could also make it more difficult for a third party
to acquire a majority of our outstanding voting stock. Furthermore, certain
provisions of our Certificate of Incorporation, and certain provisions of our
Bylaws and of Delaware law, could have the effect of delaying or preventing a
change in control of the corporation which the stockholders may deem to be in
the best interests of AdStar. If Our Shares Of Common Stock Are Removed Or Delisted From The Nasdaq Small Cap
Market, The Ability Of Stockholders To Sell Our Common Stock And Warrants In
The Secondary Market Could Be Restricted. The Securities and Exchange Commission has adopted regulations which
generally define penny stock to be an equity security that has a market
price, as defined, of less than $5.00 per share or an exercise price of less
than $5.00 per share, subject to certain exceptions, including an exception of
an equity security that is quoted on The Nasdaq Stock Market. If our shares of
common stock are removed or delisted from The Nasdaq Small Cap Market, the
security may become subject to rules that impose additional sales practice
requirements on broker-dealers who sell these securities. For transactions
covered by these rules, the broker-dealer must make a special suitability
determination for the purchaser of such securities and have received the
purchasers written consent to the transactions prior to the purchase.
Additionally, for any transaction involving a penny stock, unless exempt, the
rules require the delivery, prior to the transaction, of a disclosure schedule
prepared by the Securities and Exchange Commission relating to the penny stock
market. The broker-dealer also must disclose the commissions payable to both
the broker-dealer and the registered underwriter, current quotations for the
securities and, if the broker-dealer is the sole market maker, the
broker-dealer must disclose this fact and the broker-dealers presumed control
over the market. Finally, among other requirements, monthly statements must be
sent disclosing recent price information for the penny stock held in the
account and information on the limited market in penny stocks. As such, the
penny stock rules, in the event our securities are delisted from The Nasdaq
Small Cap Market, may restrict the ability of stockholders to sell our common
stock and warrants in the secondary market. 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. While the shares of common stock met current Nasdaq listing requirements
when initially listed and are currently included on Nasdaq, there can be no
assurance that we will meet the criteria for continued listing. Continued
listing on Nasdaq generally requires that (i) we maintain at least $2,500,000
in stockholders equity, or $35,000,000 in market capitalization, or $500,000 in
net income for either the last fiscal year, or two out of the last three fiscal
years, (ii) the minimum bid price of the common stock be $1.00 per share, (iii)
there be at least 500,000 shares in the public float valued at $1,000,000 or
more, (iv) the common stock have at least two active market makers, and (v) the
Common Stock be held by at least 300 holders. If we are unable to satisfy
Nasdaqs maintenance requirements, our securities may be delisted from Nasdaq.
In that event, trading, if any, in the common stock and warrants would be
conducted in the over-the-counter market in the so-called pink sheets or the
NASDs OTC Bulletin Board. Consequently, the liquidity of our securities
could be impaired, not only in the number of securities which could be bought
and sold, but also through delays in the timing of transactions, reduction in
security analysts and new media coverage of AdStar, and lower prices for our
securities than might otherwise be obtained. 14




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Item 2. Description of Property Our offices are currently located in two separate facilities. The
principal office in Marina del Rey, California consists of an aggregate 10,000
square feet, of which approximately 5,000 has been sub-let. Offices for our
east coast wholly-owned subsidiary, Edgil Associates, Inc., are located in N.
Chelmsford, Massachusetts, consisting of approximately 9,000 square feet. In
July 2000, we entered into a lease consisting of approximately 1,700 square
feet in Lyndhurst, New Jersey. In May 2001, we assigned all rights in this
lease to Dominion Telecom, Inc., however we remain secondarily liable on this
lease. In December 2002 management executed a plan to close our east coast
offices, in Syosset, New York, and transfer the function performed at that
location to Marina del Rey. In December 2003 we sub-let this 1,400 square foot
space. These four existing leases expire on March 31, 2005, August 31, 2006,
November 30, 2005 and April 30, 2005, respectively. The aggregate monthly
rent, net of the current sub-leases and assignment, is approximately $11,300.
We believe that if these leases are not renewed, satisfactory alternative space
will be available. 
 Item 3. Legal Proceedings None. 
 Item 4. Submission of Matters to a Vote of Security Holders On Friday, October 10, 2003 at 10:00 a.m., Pacific Time we held our 2003
Annual Meeting of Stockholders for the purpose of electing directors and
independent auditors for fiscal 2003. At the meeting Leslie Bernhard, Eli
Rousso, Jeffrey Baudo, Stephen Zelnick and Richard Salute were re-elected as
directors of AdStar, Inc. for one year terms with 7,471,373, 7,471,373,
7,471,373, 7,486,873 and 7,483,873 votes cast in favor of their election,
respectively, 17,050, 17,050, 17,050, 1,550, and 1,550 votes against,
respectively and no votes were withheld. In addition, the appointment of BDO
Seidman LLP as our independent auditors for fiscal 2003 was ratified with
7,479,873 votes in favor,1,550 votes against and 7,000 votes withheld. In January 2004, the holders of a majority of the shares of our common
stock and preferred stock, voting together as one class, by written consent
ratified and approved the issuance of 1,311,350 shares of AdStar common stock
in connection with our acquisition of all of the assets of Edgil Associates,
Inc., a Massachusetts corporation (Edgil) through the merger of Edgil into
our wholly owned subsidiary. We provided a description of the matter voted
upon by filing a Current Report on Form 8-K with the Securities and Exchange
Commission on November 4, 2003 and an Information Statement further describing
the matter voted upon on March 8, 2004 pursuant to the requirements of Section
14(c) of the Securities Exchange Act of 1934 and Section 228(d) of the General
Corporation Law of the State of Delaware. 
 PART II 
 Item 5. Market for Common Equity and Related Stockholder Matters (a) Market Information AdStars Common Stock is traded on The Boston Stock Exchange and The
Nasdaq Small Cap Market under the symbol ADST. The following table sets
forth, for the periods indicated, the high and low bid information for AdStars
Common Stock. Such quotations reflect inter-dealer prices, without retail
mark-up, markdown or commission and may not necessarily represent actual
transactions. 15




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##### Table of Contents



Bid InformationPrice range of Common Stock
    
    High
    
    LowYear Ended December 31, 2002First quarter
    
    $
    1.44
    
    
    $
    0.45Second quarter
    
    $
    1.25
    
    
    $
    0.63Third quarter
    
    $
    1.64
    
    
    $
    0.75Fourth quarter
    
    $
    1.12
    
    
    $
    0.74Year Ended December 31, 2003First quarter
    
    $
    1.05
    
    
    $
    0.61Second quarter
    
    $
    1.22
    
    
    $
    0.68Third quarter
    
    $
    2.40
    
    
    $
    1.19Fourth quarter
    
    $
    2.24
    
    
    $
    1.50
 As of March 24, 2004, the closing bid price per share for our Common
Stock, as reported on the Nasdaq Small Cap Market was $2.09. (b) Holders As of March 24, 2004, the number of record holders of the Preferred and
Common Stock of AdStar was one and approximately 35, respectively. AdStar
believes that there are more than 800 beneficial holders of the Common Stock. (c) Dividends The holders of Common Stock are entitled to receive such dividends as may
be declared by AdStars Board of Directors. During the years ended 2002 and
2003, AdStar did not pay any dividends, and it does not expect to declare or
pay any dividends in the foreseeable future. Payment of future dividends will
be within the discretion of AdStars Board of Directors and will depend on,
among other factors, retained earnings, capital requirements, and the operating
and financial condition of AdStar. Recent Sales of Unregistered Securities. AdStar established a vendor payment plan whereby it may pay vendors who
are accredited investors, as defined under Rule 215 of the Securities Act of
1933, in shares of its common stock in lieu of cash. Under the plan, 400,000
shares are available for issuance. During 2002 and 2003, 63,000 (net of 68,000
returned) and 33,000 shares, respectively, were issued to vendors under the
plan relying upon the exemptions under Sections 4(2) and 4(6) of the Securities
Act of 1933 and which represented compensation of $10,000 (net of $68,000
returned) and $42,000, respectively. In January 2002, AdStar issued to Marina Co. a nominee of the partners of
Morse, Zelnick, Rose and Lander LLP, AdStars legal counsel, 114,545 shares of
restricted common stock, issued at fair market value as payment for $62,500 in
legal services accrued in December 31, 2001 financial statements. This sale was
exempt from registration, as it was a nonpublic offering, made pursuant to
Sections 4(2) and 4(6) of the Act. In February 2002, AdStar sold to an accredited investor (as previously
defined) 100,000 shares of its Common Stock at a price per share equal to 85%
of its per share closing price on January 31, 2002 ($0.50). In connection with
this sale AdStar issued warrants to purchase 10,000 shares of its Common Stock,
at $0.75 per share, as part of the placement agent fees. The warrants expire on
January 31, 2007 and have anti-dilution protection against capital changes.
This sale was exempt from registration, as it was a nonpublic offering, made
pursuant to Sections 4(2) and 4(6) of the Act. 16




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In March 2002, the Board of Directors approved the sale of 1,443,457
shares of our Series A Preferred Stock to Tribune Company for an aggregate
purchase price of $1.8 million. These shares currently convert on a 1:1 basis.
Shareholders of Series A Preferred Stock are entitled to vote on all matters
submitted to the stockholders for vote and as a single class with the Common
Stock. The holders of Series A Preferred Stock are entitled to one vote for
each share of Common Stock issuable upon conversion. This sale was exempt from
registration, as it was a nonpublic offering, made pursuant to Sections 4(2)
and 4(6) of the Act. In December 2002 the Board of Directors approved the sale of shares of its
Series B Preferred Stock to Tribune Company for an aggregate price of $1.5
million. The sale was split into two funding segments: (i) In December 2002, AdStar sold 1,200,000 shares of its Series B-1
Preferred Stock to Tribune Company for an aggregate purchase price of $900,000,
excluding $86,280 in costs of financing. These shares currently convert on a
1:1 basis. Shareholders of Series B-1 Preferred Stock are entitled to vote on
all matters submitted to the stockholders for vote and as a single class with
the Common Stock. The holders of Series B-1 Preferred Stock are entitled to one
vote for each share as set forth in (i)  and (ii) below
and were exempt from registration, as it was a nonpublic offering, made
pursuant to Sections 4(2) and 4(6) of the Act; and (ii) In March 2003, AdStar sold 800,000 shares of its Series B-2 Preferred
Stock to Tribune Company for an aggregate purchase price of $600,000 excluding
$71,317 in costs of financing. These shares currently convert on a 1:1 basis.
Shareholders of Series B-2 Preferred Stock are entitled to vote on all matters
submitted to the stockholders for vote and as a single class with the Common
Stock. The holders of Series B-2 Preferred Stock are entitled to one vote for
each share. In addition, on March 28, 2003, in exchange for all of the Series
B-1 Preferred Stock plus accrued and unpaid dividends on those shares, issued
in December 2002 to Tribune Company, AdStar issued an additional 1,200,000
shares of its Series B-2 Preferred Stock to the Tribune Company. In March 2003, AdStar issued to Marina Co. a nominee of the partners of
Morse, Zelnick, Rose and Lander LLP, AdStars legal counsel, 63,291 shares of
restricted common stock, issued at fair market value as payment for $50,000 in
legal services accrued at December 31, 2002. This sale was exempt from
registration, as it was a nonpublic offering, made pursuant to Sections 4(2)
and 4(6) of the Act. In September 2003 we sold through a private placement offering 1,590,000
shares of the shares of the Companys authorized but unregistered common stock
at a price of $1.25 per share. In connection with this offering the Company
paid a commission consisting of $198,750 in cash and issued warrants to
purchase 159,000 shares of its common stock, at $1.87. The warrants are
exercisable beginning on March 31, 2004 and expire on March 31, 2009. The
Company valued the warrants using the Black Scholes method, which resulted in a
value of $261,169. This amount is being offset against the proceeds from the
private placement as a cost of financing. The sale of these shares was
pursuant to the exemption under sections 4(2) and 4(6) of the Securities Act of
1933. On October 21, 2003 in connection with our acquisition of all of the
business and assets of Edgil Associates, Inc., a Massachusetts corporation
(Edgil), pursuant to an Agreement and Plan of Merger, we paid $1,520,000 cash
and issued 1,311,530 shares of our restricted common stock in exchange for all
the outstanding capital stock of Edgil. The number of shares issued was based
upon the closing price of the Common Stock on the Nasdaq SmallCap Market on
October 20, 2003 and was valued at $2,111,563 based upon the average closing
price of the Common Stock on the Nasdaq SmallCap Market for the 10 trading day
period beginning October 14, 2003. A complete description of the merger and
the merger documents can be found on the Current Report on Form 8-K that we
filed with the Securities and Exchange Commission on 17




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##### Table of Contents



November 4, 2003. The issuance of these shares was pursuant to the
exemptions under sections 4(2) and 4(6) of the Securities Act of 1933. In November 2003, we sold 1,257,692 shares of our common stock at a price
of $1.30 per share to accredited investors in a private placement offering
raising gross proceeds of approximately $1,635,000 excluding $56,104 in costs
of financing. This sale was exempt from registration, as it was a nonpublic
offering, made pursuant to Sections 4(2) and 4(6) of the Act. In December 2003, AdStar issued to Marina Co. a nominee of the partners of
Morse, Zelnick, Rose and Lander LLP, AdStars legal counsel, 34,615 shares of
restricted common stock, issued at fair market value as payment for $45,000 in
legal services provided during 2003. This sale was exempt from registration,
as it was a nonpublic offering, made pursuant to Sections 4(2) and 4(6) of the
Act. All shares issued in the
transaction described hereinabove bore an appropriate restrictive
legend. 
 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 discussion
involves risk and uncertainties, our actual results may differ materially from
those anticipated in these forward-looking statements. Overview In 2001 we repositioned our products, moving away from the idea of the
Internet as a stand-alone business category, and moving towards the idea of the
Internet as an extremely efficient and flexible communication channel. We
recognized that this technology can be utilized to greatly enhance the
functionality of the software we licensed to our existing customer base, as
well as expand into new areas where our technology can be used to connect
advertising outlets with advertisers. During 2002, we began to execute our
business plan and spent virtually the entire year on successfully enhancing and
integrating our existing technology and new products into the existing and new
customers. While some of our historical business has migrated to our new
transaction based model, it continues to be used by hundreds of recruitment
agencies and volume advertisers. We anticipate continuing customer requested
enhancements to our existing applications and expect to monetize the roll-outs
to a greater extent in 2003 as more publications adapt the new robust
applications available to them. In working with our customers, we recognized there was a great demand for
our Web-based technology within the newspaper industry to run the online
classified ad-taking abilities at our customers Web sites under a private
label branded site concept. Therefore, we revised our business model to embrace
these concepts, and we focused on the immediate needs of our customers. While
doing this, we also made sure that our technology remained flexible to allow
for changes as the needs of our customers change and as we develop product
extensions and new lines of business based on our existing technology and
expertise. We adopted our marketing and sales strategies to our new Web-based
ad-taking ASP product, and began marketing the product in June 2001 and found
that it was well received by our customers. During 2001, we implemented our
Web-based classified ad-taking ASP product at 14 new metropolitan newspapers. 18




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Given the severe downturn in advertising revenue in 2001, we were told by
many potential customers that implementing our ASP product will need to wait
until their advertising revenue has returned to more normal levels. In 2002,
despite a slow economy we contracted with an additional 16 newspapers to use
our Web-based classified ad-taking ASP product. In 2003 we formalized our marketing effort behind our XML Gateway.
(Application Programming Interface) With third parties and publishers alike
looking to incorporate classified print advertising into their applications,
the Gateway proved to be an easy way to accomplish it. Publishers are beginning to realize the revenue potential of offering
print in combination with online advertising. Being able to accomplish it has
been problematic due to old legacy systems that cannot accommodate this
offering. Referred to as reverse publishing, it addresses the users who
currently go online to buy an online ad for a reasonable upcharge they can
include a print ad in their advertising package. The strength of a combination
print and online ad assures the advertiser of maximum exposure. Publishers now
receive classified advertising from a myriad of sources transmitted in a myriad
of ways, each offereing their own challenges to process in a quick an efficient
way. The XML Gateway allows a paper to provide a common, single point of
entry to whoever wants to send ads and easily drive them directly into their
publishing systems. This year also saw the release our our new USER INTERFACE for Web based
ad-taking.This new interface accommodates a variety of customized upsells for
an advertiser. Included our bold headlines, borders, background shading,
pictures and graphic attention getters. The user is able to create in real time
an ad with a unique look and feel. As important as upsells are to newspapers for additional revenue, what is
more important is the platform we have created that can expand to offer new and
unique capabilities. The future of classifieds rest with the online side.
While print classifieds are two dimensional online classifieds will offer all
that technology can provide. In the future we will be able to provide sound,
text messaging, voice recognition, auction function and order fulfillment for
items sold etc. All these capabilities will ultimately be provided by our ever
expanding suite of products. We will partner with these technologies or we will
acquire to ensure our leadership role as the E-Commerce provider to the
newspaper industry. In October of 2003 we acquired Edgil Associates, Inc. Edgil provides
credit card processing to the newspaper industry. Key to their service is
providing seemless integration of these transactions into billing systems and
circulation systems alike. Currently operating in a license model we look
forward to offering this service in a hosted environment with monthly fees and
transaction fees in line with Adstars current model. Edgils account base offers fertile ground for cross selling opportunities
for Web-based ad-taking. In addition to transitioning to a recurring revenue model and expanding
our newspaper customers, we are now in a position to reduce our operating costs
on a go forward basis. There can be no assurance that our new product offerings
or the arrangement with Tribune Company will be successful in generating
revenues sufficient to support our operating expenses. Prior to the development of our Web business, revenues had been generally
sufficient to support our historic business. In developing our Web-based system
we began to incur significant losses that could not be offset by the revenues
generated by our historic business. These expenses caused us to incur
significant losses from 1998 through 2003. Our future success is dependent upon
our ability to substantially grow revenues and control costs to the point where
we can fund the level of operations necessary to serve the anticipated customer
base. To this end, our plans have included expanding the products and services
offered 19




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##### Table of Contents



to our customers by building on our proprietary software processes and
unique position within the industry. We feel that there is significant
opportunity to increase revenues by offering the Web software and services that
we had initially developed for ourselves to print publications as an
application service provider (ASP). In addition we have already taken steps
to control or in some case reduce costs on an ongoing basis. (see Business in
part I). Results of Operations The following table sets forth the results of operations expressed as a
percentage of net revenues. Year Ended December 31,2002
    
    2003Net revenues
    
    
    100
    %
    
    
    100
    %Cost of revenues
    
    
    49
    %
    
    
    77
    %Gross Profit
    
    
    51
    %
    
    
    23
    %General and administrative expense
    
    
    64
    %
    
    
    47
    %Selling and marketing expense
    
    
    33
    %
    
    
    27
    %Product development costs
    
    
    38
    %
    
    
    44
    %Restructuring
    
    
    14
    %
    
    
    4
    %Amortization of customer list
    
    
    0
    %
    
    
    1
    %Loss from operations
    
    
    -99
    %
    
    
    -100
    %Other income
    
    
    2
    %
    
    
    0
    %Interest income (expense)
    
    
    1
    %
    
    
    0
    %Loss before taxes
    
    
    -96
    %
    
    
    -100
    %Provision for taxes
    
    
    
    
    
    
    Net loss
    
    
    -96
    %
    
    
    -100
    %
 Years Ended December 31, 2003 and 2002 Revenues Net revenues increased to $2,834,000 in 2003 from $2,241,000 in 2002, a
net increase of $593,000 or 26%. The increase in net revenue for 2003 is
primarily comprised of a net increase of $554,000 or 61% in response to our
strategic shift from our old software and licensing model to our application
service provider (ASP) product, as well as a $21,000 or 8% increase in one
time customization and other fees. The increase in 2003 ASP revenues is
primarily comprised of a $270,000 increase in transaction volumes from existing
customers, approximately $218,000 of revenues from 7 existing licensing and
software customers who converted to our new transaction based ASP product
during late 2002 and 2003, and a net increase of 7 new customers totaling
$59,000. Licensing and software revenues increased to $1,087,000 in 2003 from
$1,070,000 in 2002, a net increase of $17,000 or 2% for 2003 over 2002. The
increase is primarily comprised of an increase of $245,000 from our newly
acquired wholly owned subsidiary Edgil Associates, Inc. (Edgil) offset by a
$45,000 decrease from 4 customers who terminated the use of our outmoded
licensed fax technology as the industry continues to move toward a web-based
product, offset by $168,000 from the aforementioned migration of existing
customers to the ASP model and $17,000 in one-time renewal fees for 2002 not
charged during 2003. 20




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Cost of revenues Cost of revenue consists primarily of the costs to customize and install
the AdStar software applications, configure end-user software, install
Web-based ad-taking software, amortization of internally developed application
modules, royalties, and co-location costs. Cost of revenues increased to
$2,180,000 in 2003 from $1,107,000 in 2002, a net increase of $1,073,000 or
97%. The increase during 2003 was primarily related to a $883,000 one time
impairment write-down of our contract web and FlexAd internally developed software applications and
the reserve for direct costs of contractual obligations to service said
software, primarily based on a product line evaluation undertaken in
December 2003 in connection with the integration of AdStars Edgil
acquisition and new information with respect to future revenues from
customer utilization of the FlexAd software. The remaining $190,000 increase is primarily comprised of an
increase in amortization of capitalized software of $250,000 related to AdStar
products, an increase of approximately $89,000 related to Edgil, offset by a
reduction of $71,000 in direct labor and $52,000 in hardware, and a $23,000
reduction in royalties. The increase in amortization is primarily related to
our focus on the completion of our strategic development for ASP activities and
for the CareerBuilder project. The reduction in direct labor and hardware are a
byproduct of AdStar and industry moving from one-time customizations toward our
ASP based solution. The reduction in royalties is a direct result of 4
customers terminating the use of our outmoded licensed fax technology. If the
adjustment related to the impairment is excluded, the gross profit margin for
2003 would be 55% compared to 51% in 2002. The actual gross profit
was 23% in 2003 compared 51% in 2002 due to the impairment
write-off. General and administrative expense General and administrative expense consists primarily of the cost of
executive, administrative, professional fees, accounting, and finance
personnel. General and administrative expenses decreased to $1,343,000 in 2003
from $1,440,000 in 2002, a net decrease of $97,000 or 7%. The net decrease was
primarily related to a $150,000 reduction in legal and accounting fees, a
$65,000 non-cash reduction in vendor stock compensation, a $41,000 reduction in
executive reimbursements and a $22,000 one time cost associated with a accounts
receivable line of credit, offset by general and administrative expense
incurred by Edgil of $176,000. Management believes that our existing executive and administrative
personnel are sufficient to allow for significant growth without the need to
add significant additional systems or personnel related costs for the near
future. As we continue to grow and contemplate future acquisition candidates
we may need to add additional support or mid-management level staffing. Product maintenance and development costs Product maintenance and development expenses consist of expenses to
identify functional requirements, to plan, identify and conceptually design the
required technical infrastructure, and to perform Web-site maintenance and
other general routine fixes. The costs consist primarily of personnel related
expenses for technical and design functions including outside consultants.
Product maintenance and development expense increased to $1,242,000 in 2003
from $852,000 in 2002, a net increase of $390,000 or 46%. The increase is
primarily related to the shifting and reduction of technical staffing costs
from capitalized projects to product maintenance and development as we
completed major software enhancement projects, primarily our infrastructure and
CareerBuilder projects. From mid April through September 30, 2003 we had a net reduction of 7 full
time equivalent technical staff. In addition during December 2003 we
identified an additional 4 technical staffing positions that were eliminated on
January 5, 2004. We believe this lowered level of technical staffing will be
sufficient for the near future. Conversely, we may need to increase technical
staffing in the short term if we obtain additional customers more quickly than
currently expected or an unexpected increase in customer 21




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demand for customization projects. However, an increase in customer
demand requiring an increase in technical staffing costs are generally offset
by increased revenues for such services. Selling and marketing expense Selling and marketing expense consists primarily of direct charges for
advertising, sales promotion, marketing, and trade shows, as well as the cost
for business development. Selling expense was essentially flat at $750,000 in
2003 compared to $750,000 in 2002. Although total costs are flat there was a
$131,000 increase attributable to Edgil and an increase of $42,000 in
tradeshows and newsletters offset by net of $173,000 reduction in sales
personnel and consulting costs.The decrease in personnel and consulting fees is
primarily the result of the elimination of the consulting position during June
2003 resulting in a $110,000 cost reduction of the $173,000 reduction.. In 2004 we expect an increase in selling and marketing expenses as
compared to the related periods of 2003 as we continue the development and
implementation of our strategic marketing plan and continue to build upon our
existing relationships with Tribune Company, Knight-Ridder, Inc.,
CareerBuilder, L.L.C., Manheim Interactive, Inc. and other potential strategic
partners. Restructuring costs Restructuring costs consists primarily of direct costs associated with
repositioning our products, moving away from the idea of the Internet as a
stand-alone business category, integrating our products and services with those
of Edgil Associates, Inc. our newly acquired wholly owned subsidiary, and
moving towards the idea of the Internet as an extremely efficient and flexible
communication channel. These costs are primarily comprised of direct expensing
and reserves for consolidation of personnel, equipment and associated software,
as well as professional fees to more efficiently service our growing ASP
applications and products. During 2003 we continued executing our ASP model while maintaining the
existing infrastructure and personnel responsible for the historical licensing
and software and portal model, while executing a formal transition plan. The plan contemplated among other things the closure of the New York
office during 2003, a related reduction in force of 4 related to technology
staff, and the abandonment of an externally created customized billing software
module. In addition, during 2003 we completed the major application
enhancements associated with Career Builder and other major software
development projects. Accordingly, we identified an additional reduction in
force of 4 technology staff and related equipment and office space. During 2002, management recorded direct restructuring write-offs and
reserves totaling $323,000, and during 2003 we recorded an additional $125,000.
The additional amounts recorded during 2003 are primarily comprised of
severance and bonus of $50,000, equipment impairment write-downs of $58,000 and
abandonment of office space of $16,000. Other income (expense) Other income (expense) has historically been comprised of net interest
income (expense). During the second quarter 2002 AdStar finalized the
termination of the Kodak licensing agreement whereby Kodak returned 67,796
shares of AdStar common stock resulting in a non-cash gain of approximately
$63,000. 22




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During 2003 AdStar paid $10,000 as a termination fee to a financial
consultant for a failed arrangement to secure private financing for us. Net interest income decreased $9,000 during 2003 compared to 2002. This
decrease in net interest is attributable to a reduction in cash held in
interest bearing accounts as we utilized cash to fund development projects and
operating deficits, and to acquire Edgil, leaving a net lower cash account
balance available in short-term time deposits and money market accounts at
commercial banks, as well as an increase in interest expense during 2003
relating to capital leases and notes payable to the former founders of Edgil. We are currently in a loss carry-forward position for federal income
taxes, primarily due to the operating losses incurred through December 31,
2003. The federal net operating loss carry-forwards balance as of December 31,
2003 was approximately $15,431,000, compared to $9,653,000 in the prior year.
The net operating loss carry-forward is available to offset future taxable
income through 2020. Our net operating loss carryforwards may be limited due to ownership
changes as defined under section 382 of the internal revenue code of 1986. The major temporary tax differences that are expected to reverse next year
are deferred revenue, allowance for doubtful accounts, and accrued vacation.
However, we expect new temporary differences to be established in these years,
which will either reduce or exceed the reversing temporary differences. We evaluate annually the realization of the net deferred tax asset, taking
into consideration prior earnings history, projected operating results, and the
reversal of temporary tax differences. At December 31, 2003, we evaluated the
net deferred tax asset, taking into consideration operating results, and
determined that a valuation allowance of $5,302,000 should be maintained. Liquidity and Capital Resources Prior to 1999 we financed our business primarily from cash generated by
operations. Subsequently, we have financed our business through a combination
of cash generated from operations and debt and equity financing. In 2003 and
2002, we raised net proceeds of $2,622,000 and $3,831,000, respectively, in
equity and debt financings to fund operations and enhance and expand the
product line we provide our customers, including the acquisition of Edgil. As of December 31, 2003, we had cash and cash equivalents of approximately
$2,092,000 compared to $1,115,000, including $175,000 in restricted cash, as of
December 31, 2002 a combined net increase of $977,000. The net increase in cash
and cash equivalents and cash resulted from net proceeds of $4,230,000, net of
a $175,000 decrease in restricted cash, from financing activities offset by
$797,000 used in operations and $2,281,000 used in investing activities, of
which $1,558,000 was used to acquire Edgil and $729,000 was to enhance our ASP
products and services. Net cash used in operations during 2003 was approximately $797,000
compared with $533,000 during 2002, a $264,000 increase. The increase in cash
used in operations is primarily the result of a $390,000 increase in product
maintenance and development costs offset by $150,000 in legal and accounting
fees. The increase in product maintenance and development is primarily related
to the shifting and reduction of technical staffing costs from capitalized
projects to product maintenance and development as we completed major software
enhancement projects, primarily our infrastructure and CareerBuilder projects.
The reduction in legal and accounting fees is a result of a renegotiation of
recurring legal costs and the change in Auditors from PricewaterhouseCoopers,
LLP to BDO Seidman, LLP. 23




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Net cash used in investing activities increased to $2,281,000 during 2003
compared with $1,537,000 during 2002. The increase of $744,000 is primarily the
result of our using $1,558,000 to acquire Edgil offset by a $603,000 reduction
in costs to enhance our existing ASP software. During 2003 we completed all
major aspects of the CareerBuilder agreement, and expect a significant
reduction in ongoing upgrades and enhancements of existing software during the
first quarter of 2004 by AdStar. As part of the integration of Edgil and the
ongoing restructuring and repositioning of our products and services we
anticipate some material product enhancements as a joint arrangement between
AdStar and Edgil. These enhancements will most likely be handled by and
recorded in Edgil. Such enhancements are contemplated to include the
conversion of Edgils EdgeCapture payment processing software from a
stand-alone server based application to a web-based application available to
all AdStar and Edgil customers, as well as new customers. In addition we are
likely to recommit to convert AdStars historical server based contract
application to a web-based application as well. Net cash provided by financing activities increased to $4,230,000 during
2003 compared with $2,599,000 during 2002. The 2003 proceeds were primarily
comprised of net proceeds $3,303,000 from the closing of 2 private placements
during September and December 2003, net proceeds from the issuance of $529,000
of Series B-2 Preferred Stock to Tribune Company in March 2003, net proceeds of
$253,000 from the exercise of options and warrants from June through December
2003 and the release of $174,000 of restricted cash in March 2003. The
proceeds were offset by $29,000 in principal repayments of capital leases. At December 31, 2003, we had an accumulated deficit of $14,166,000. We
have incurred significant recurring net losses for the years ended December
2002 and 2003 of $2,160,000 and $2,842,000. Our 2002 and 2003
net losses were principally attributable to our shift in focus from an on-line
business to an ASP business. We expect to continue to incur losses until we are
able to increase revenues significantly from fees based on the number of
purchases transacted through our ASP product. We believe cash on hand of
$2,092,000 at December 31, 2003 coupled with our recent acquisition of Edgil,
which is currently generating positive cash flows, AdStars reduction in
personnel at the beginning of January 2004 and expected increase in revenues
from our continued success in growing our ASP business will generate sufficient
capital to meet our cash needs through the next twelve months. We are
in the process of closing an additional $1,500,000 in convertible debt during the second
quarter of 2004 to further enhance our ability to grow organically and position
us to take advantage of additional strategic acquisitions and revenue sharing
arrangements should they present themselves We are optimistic that our growing ASP business will continue to be
accepted in the marketplace. However, our ability to sell ASP business
products and service offerings during the current year may be hampered by the
current unstable climate in the advertising market, the geo-political climate,
including the war in Iraq, and state of the economy in general. These factors,
coupled with unproven ability of our newly acquired subsidiary, Edgil, to
continue to generate positive cash flow, possible competition from other
vendors, the extended selling cycle in our industry, and customer delays in
customization and implementations, could delay our ability to increase revenue
to a level sufficient to cover our expenses. We currently have no additional borrowings available to us under any
credit arrangement, and we are continuing to look for additional financing.
Adequate funds may not be available or may not be available on terms favorable
to us or at all. If additional funds are raised through the issuance of equity
securities, dilution to existing stockholders may result. If funding is
insufficient at any time in the future, we may be unable to develop or enhance
our products or services, take advantage of business opportunities or respond
to competitive pressures, any of which could have a material adverse effect on
our financial position, results of operations and cash flows. 24




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New accounting pronouncements In July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146), effective for exit or
disposal activities initiated after December 31, 2003. SFAS 146 addresses the
financial accounting and reporting for certain costs associated with exit or
disposal activities, including restructuring actions. SFAS 146 excludes from
its scope severance benefits that are subject to an on-going benefit
arrangement governed by SFAS 112, Employers Accounting for Post employment
Benefits, and asset impairments governed by SFAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. The adoption of SFAS 146 did not
have a material impact on our financial statements. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock Based
Compensation  an Amendment of SFAS No. 123 (SFAS 148). This statement amends
SFAS No. 123 to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We will
retain the intrinsic method of accounting for stock based awards granted to
employees and make the required disclosures. In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This Interpretation elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also clarifies that a guarantor is required to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The disclosure requirements of this Interpretation are
currently effective and did not affect our financial position and results of
operations. The initial recognition and initial measurement provisions of this
Interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2003. In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation
of Variable Interest Entities (FIN 46). This Interpretation requires that
variable interest entities created after January 31, 2003, and variable
interest entities in which an interest is obtained after that date, be
evaluated for consolidation into an entitys financial statements. This
interpretation also applies, beginning July 1, 2003 for the Company, to all
variable interest entities in which an enterprise holds an interest that it
acquired before February 1, 2003. We adopted provisions of FIN 46 and
determined there was no effect on our financial position and results of
operations. In April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, which amends SFAS 133 for
certain decisions made by the FASB Derivatives Implementation Group. In
particular, SFAS 149 (1) clarifies under what circumstances a contract with an
initial net investment meets the characteristic of a derivative, (2) clarifies
when a derivative contains a financing component, (3) amends the definition of
underlying to conform it to language used in FASB interpretation number (FIN)
45, and (4) amends certain other existing pronouncements. SFAS 149 is effective
for contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. In addition, most provisions of
SFAS 149 are to be applied prospectively. We have no derivative contracts and
accordingly the adoption of SFAS 149 does not have a material impact on our
financial position or results of operations. In May 2003, the FASB issued SFAS No. 150 Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150
establishes standards for how an issuer 25




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classifies and measures certain financial instruments with characteristics
of both liabilities and equity. It requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances). Many of these instruments were previously classified as
temporary equity. SFAS No. 150 will be effective for financial instruments
entered into or modified after May 31, 2003, and otherwise shall be effective
at the beginning of the first interim period beginning after June 15, 2003.
For financial instruments created before the issuance date of SFAS No. 150 and
still existing at the beginning of the interim period of adoption, transition
shall be achieved by reporting the cumulative effect of a change in accounting
principle by initially measuring the financial instruments at fair value or
other measurement attribute required by SFAS No. 150. Instruments with
characteristics of both liabilities and equity not addressed in SFAS No. 150
will be addressed in the next phase of the project. The adoption of SFAS No.
150 does not have a material impact on our consolidated financial position,
results of operations or cash flows. In November 2002, the EITF reached a consensus on EITF 00-21, Revenue
Arrangements with Multiple Deliverables, related to the separation and
allocation of consideration for arrangements that include multiple
deliverables. The EITF requires that when the deliverables included in this
type of arrangement meet certain criteria they should be accounted for
separately as separate units of accounting. This may result in a difference in
the timing of revenue recognition but will not result in a change in the total
amount of revenue recognized in a bundled sales arrangement. The allocation of
revenues to the separate deliverables is based on the relative fair value of
each item. If the fair value is not available for the delivered items then the
residual method must be used. This method requires that the amount allocated
to the undelivered items in the arrangement is their full fair value. This
would result in the discount, if any, being allocated to the delivered items.
This consensus is effective prospectively for arrangements entered into in
fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 does
not have a material impact on our financial statements at this time. On December 17, 2003, the SECs Office of the Chief Accountant and
Division of Corporation Finance issued Staff Accounting Bulletin (SAB) 104,
Revenue Recognition. The SAB updates portions of the interpretive guidance
included in Topic 13 of the codification of staff accounting bulletins (SAB 103
codification) in order to make the guidance consistent with current
authoritative accounting literature. The principal revisions relate to the
incorporation of certain sections of the staff s FAQ document on revenue
recognition into Topic 13. We do not expect the adoption of SAB 104 to have a
material effect on our financial statements. Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of
operations are based upon our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements require that we make estimates
and judgments that affect the reported amounts of assets, liabilities,
revenues, expenses, and related disclosure. On an on-going basis, we
re-evaluate our estimates, including those relating to revenue recognition,
uncollectible accounts receivable, intangible assets and contingent expenses
and revise reported amounts prospectively. We base our estimates on historical
experiences, combined with anticipated activity and various other assumptions
that we believe to be reasonable under the circumstances. When combined, this
body of knowledge forms the basis for making judgments about the carrying value
of assets and liabilities. Actual results may differ from these estimates under
different assumptions or conditions. Financial Reporting Release No. 60, which was recently issued by the
Securities and Exchange Commission, requires all companies to include a
discussion of critical accounting policies or methods used in preparation of
financial statements. The following is a brief discussion of our most critical
accounting policies, including those methods affected by our more complex
judgments and estimates. 26




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Revenue Recognition  We derive revenue from several products and services as follows:ASP revenue  We receive revenue by providing an application service
provider (ASP) product that allows customers to use our software
applications on a shared system over the Internet. This technology is a
publisher-specific ad-taking Web site 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. We receive monthly fees for hosting the transactions and providing
customer support, and recognizes the fees ratably over the contract
period.Web site revenue  The Company receives revenue from fees charged to
customers who transact business on the Advertise123.com Web site. This
site permits the general public to plan, schedule, compose and purchase
advertising from many print and on-line publishers. 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 recognizes 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  We generate
revenue from technology service contracts that generally contain multiple
elements such as software customization services, monthly fees and
post-contract customer support (PCS). Revenue from these arrangements is
recognized in accordance with Statement of Position (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. We also provide customization services at the
customers request and recognizes revenue 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 historical AdStar
and 25 years and 3 to 5 years on historical Edgil, respectively. Deferred
revenue on the 25-year license arrangements are $106,000, PCS contracts
paid in advance and prepaid customer deposits are $80,000 for year ended
December 31, 2003. Revenue from software customization services is
recognized upon the completion of services. As part of the integration of
Edgil into AdStars business model we are currently offering new Edgil
contracts on terms and conditions similar to AdStar, generally one year or
less in duration.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 27




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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 we do not
accurately estimate the resources required under the contract or the scope
of the work to be performed, or if we do not manage our 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 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. Software Development Costs  Costs to establish the technological feasibility of software applications
developed by us are charged to expense as incurred. Certain costs incurred
subsequent to achieving technological feasibility are capitalized.
Accordingly, we capitalizes a portion of the internal labor costs and
external consulting costs associated with essential Web site 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. During the year we capitalized $635,000,
amortized $627,000, expensed $1,242,000 in capitalized software
development and maintenance costs. In addition during the December 2003
we wrote off $883,000 in capitalized software costs, including an
additional $185,000 estimated loss on the related customer contracts. Warranties and Product liability  We warrant that our products conform to their respective functional
specifications. Our 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 us. Direct costs
associated with the initial period of service have been insignificant and
are generally covered by upfront fees.We currently carry product liability insurance. We believe the amount of
insurance is adequate to cover its risks. To further mitigate its risks,
ours 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. Allowance for doubtful accounts  We maintain an allowance for doubtful accounts using estimates that we
make based on factors we believe appropriate such as the composition of
the accounts receivable aging, historical bad debts, changes in payment
patterns, customer creditworthiness and current economic trends. If we
used different assumptions, or if the financial condition of the customers
were to deteriorate, resulting in an impairment of their ability to make
payments, additional provisions for doubtful accounts would be required
and would increase our bad debt expense. 28




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Contractual Obligations, Commitments and Contingencies We have contractual obligations and commitments primarily with regards to
employment agreements for 3 of our executives, certain non-cancelable operating
lease obligations for office space and equipment, and capital lease obligations
for computer equipment and office furniture. The following table aggregates our expected contractual obligations and
commitments subsequent to December 31, 2003: Payments due by PeriodBeyondContractual obligations
    
    2004
    
    2005
    
    20062008
    
    2008
    
    TotalEmployment agreements (1)
    
    $
    785,300
    
    
    $
    425,600
    
    
    $
    212,800
    
    
    $
    
    
    
    $
    1,423,700Capital Lease commitments
    
    
    39,251
    
    
    
    19,465
    
    
    
    126
    
    
    
    
    
    
    
    58,842Operating lease
commitments (2)
    
    
    413,695
    
    
    
    207,708
    
    
    

    59,382
    
    
    
    
    
    
    
    680,785Loans from stockholders
    
    
    21,000
    
    
    
    21,000
    
    
    
    21,000
    
    
    
    
    
    
    
    63,000$
    1,259,246
    
    
    $
    673,773
    
    
    $
    293,308
    
    
    $
    
    
    
    $
    2,226,327
   (1)
    
    Includes employment agreements entered into puruant to the Merger
agreement whereby the two stockholders of Edgil entered into employment
agreements, each receives a monthly salary of $7,000 for six months
commencing October 21, 2003.(2)
    
    Excludes sublet office agreement of $2,400 and $11,000 per month
through April and May 2005 respectively. 
 Item 7. Financial Statements See Index to Financial Statements below, beginning on page F-1. 
 Item 8. Change in and Disagreements with Accountants on Accounting and Financial Disclosure Previously reported on a Current Report on Form 8-K filed with the
Securities Exchange Commission on February 24, 2003. 
 Item 8A. Controls And Procedures a) Evaluation of Disclosure Controls and Procedures. The Companys
management, with the participation of the chief executive officer and the chief
financial officer, carried out an evaluation of the effectiveness of the
Companys disclosure controls and procedures (as defined in the Securities
Exchange Act of 1934 (the Exchange Act) Rules 13a-15(e) and 15-d-15(e)) as of
the end of the period covered by this report (the Evaluation Date). Based
upon that evaluation, the chief executive officer and the chief financial
officer concluded that, as of the Evaluation Date, the Companys disclosure
controls and procedures are effective, providing them with material information
relating to the Company as required to be disclosed in the reports the Company
files or submits under the Exchange Act on a timely basis. b) Changes in Internal Control over Financial Reporting. There were no
changes in the Companys internal controls over financial reporting, known to
the chief executive officer or the chief financial officer, that occurred
during the Companys fiscal fourth quarter that has materially affected, or is
reasonably likely to materially affect, the Companys internal control over
financial reporting. 29




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##### Table of Contents



PART III 
 Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act Our executive officers and directors and their respective ages are as
follows: DirectorName
    
    Age
    
    Position
    
    SinceLeslie Bernhard
    
    
    59
    
    
    President, Chief Executive Officer and Director
    
    
    1991Eli Rousso
    
    
    67
    
    
    Executive Vice President, Chief Technology Officer,
Secretary, Treasurer, and Director
    
    
    1991Jeffrey Baudo
    
    
    57
    
    
    Senior Vice President, Chief Operating Officer, and Director
    
    
    2001Anthony J. Fidaleo
    
    
    45
    
    
    Vice President and Chief Financial OfficerStephen A. Zelnick (1)
    
    
    66
    
    
    Director
    
    
    2002Richard Salute (1)(2)
    
    
    58
    
    
    Director
    
    
    2003
   (1)
    
    Members of the compensation committee and the audit committee of the
Board of Directors.(2)
    
    Mr. Salute was elected to AdStars Board in January 2003. Leslie Bernhard, one of our co-founders, has served as our President and
Chief Executive Officer since the organization of our predecessor in 1986. Ms.
Bernhard holds a B.S. degree from St. Johns University. Ms. Bernhard is the
sister of Mr. Baudo. Eli Rousso, our other co-founder, has served as our Executive Vice
President and Chief Technology Officer since the organization of our
predecessor in 1986. Mr. Rousso holds a B.S. degree in Electrical Engineering
from Massachusetts Institute of Technology (MIT) and has completed graduate
work at the Polytechnic Institute (New York). Jeffrey Baudo joined us as Chief Operating Officer in January 2001 and
became a director in February 2001. Prior to joining AdStar, Mr. Baudo, served
as president and COO of the publishing division of United Advertising
Publications. Mr. Baudo holds a B.A. degree from St. Johns University. Mr.
Baudo is the brother of Ms. Bernhard. Anthony J. Fidaleo joined us as Chief Financial Officer in June 2002 and
became Vice President of Finance in September 2002. Prior to joining AdStar,
Mr. Fidaleo served in a consulting capacity, as acting Chief Financial Officer
or Vice President Controller, over the past 5 years primarily servicing the
technology sector with Companies such as Autobytel.Inc. and L90. Inc. Between
1992 and 1997 Mr. Fidaleo served as Chief Financial Officer of privately held
national companies American Dawn, Inc. and Vagabond Inns, Inc. Mr. Fidaleo was
in public accounting from 1982 through 1992, primarily with BDO Seidman, LLP
where he attained the level of audit senior manager. Mr. Fidaleo is a CPA and
holds a B.S. degree in Accounting from California State University at Long
Beach. 30




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##### Table of Contents



Stephen A. Zelnick, a director, has been a partner in the law firm Morse,
Zelnick, Rose & Lander, LLP since its inception in August 1995. Mr. Zelnick
also serves on the Board of Directors of DAG Media, Inc. a publisher of
classified telephone directories. Mr. Zelnick holds a B.S. degree in Economics
with an accounting major from the Wharton School of the University of
Pennsylvania in 1957 and an LLB from Yale Law School in 1960. Richard
Salute, a director, has been a partner in J.H. Cohn, a public
accounting firm, since February 2004. Previously, since January 2002,
he was a private investor. Prior thereto he was a partner with Arthur
Andersen for more than five years. Mr. Salute has been nominated to the Board of Directors of Copytel,
Inc., a developer and distributor of flat panel displays and encryption
devices. He is a Certified Public Accountant, licensed to practice in New
York, New Jersey and Connecticut. Mr. Salute holds a B.A. degree from Adelphi
University. All directors hold office until the next annual meeting of stockholders
and until their successors are duly elected and qualified. Officers are elected
to serve, subject to the discretion of the Board of Directors, until their
successors are appointed. AdStars Board of Directors has established compensation and audit
committees. The Compensation Committee reviews and recommends to the Board of
Directors the compensation and benefits of all the officers of AdStar, reviews
general policy matters relating to compensation and benefits of employees of
AdStar, and administers the issuance of stock options to AdStars officers,
employees, directors and consultants. The Audit Committee meets with management
and AdStars independent auditors to determine the adequacy of internal
controls and other financial reporting matters. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires AdStars
officers and directors, and persons who own more than ten percent (10%) of a
registered class of AdStars equity securities to file reports of ownership and
changes in ownership with the Securities and Exchange Commission (SEC).
Officers, directors and greater than ten percent (10%) stockholders are
required by SEC regulations to furnish AdStar with copies of all Section 16(a)
forms they file. To the best of AdStars knowledge, based solely on review of the copies of
such forms furnished to it, or written representations that no other forms were
required, AdStar believes that all Section 16(a) filing requirements applicable
to its officers, directors and greater than ten percent (10%) stockholders were
complied with during 2003 with the following exceptions: (i) Richard Salute, a
Non-employee Director, did not timely file his Initial Statement of Beneficial
Ownership of Securities on Form 3; (ii) Anthony J. Fidaleo, our Chief Financial
Officer, did not timely file one Change in Beneficial Ownership on Form 4. With
respect to any former directors, officers, and ten percent (10%) stockholders
of AdStar, AdStar does not have any knowledge of any known failures to comply
with the filing requirements of Section 16(a). Audit Committee Financial Expert The Board has determined that Richard Salute qualifies as our audit
committee financial expert, as that term is defined in Item 401(e) of
Regulation S-B, and independent as that term is used
in Item 7 (d) (3)(iv) of
schedule 14A under the Securities Exchange Act of 1934. 31




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##### Table of Contents



Code of Ethics We have adopted a code of ethics that applies to our principal executive
officer, principal financial officer and other persons performing similar
functions, as well as all of our other employees and directors. This code of
ethics is posted on our website at www.adstar.com and is filed as Exhibit 14.1
to this report. 
 Item 10. Executive Compensation. The following Summary Compensation Table sets forth all compensation
earned, in all capacities, during the fiscal years ended December 31, 2001,
2002 and 2003 by our (i) Chief Executive Officer, and (ii) executive officers,
other than the CEO, whose salary for the 2003 fiscal year as determined by
Regulation S-B, Item 402, exceeded $100,000 (the individuals falling within
categories (i) and (ii) are collectively referred to as the Named
Executives). Summary Compensation Table AnnualCompensation
    
    Long-Term CompensationAwards
    
    PayoutsCommon Stock
    
    All OtherUnderlying Options
    
    CompensationName and Principal Position
    
    Year
    
    Salary ($)
    
    (#)
    
    ($)Leslie Bernhard,
    
    
    2003
    
    
    $
    212,800
    
    
    
    0
    
    
    $
    0President & Chief Executive
    
    
    2002
    
    
    $
    211,250
    
    
    
    150,000
    
    
    
    0Officer
    
    
    2001
    
    
    
    251,680
    
    
    
    100,000
    
    
    
    0Eli Rousso
    
    
    2003
    
    
    $
    212,800
    
    
    
    0
    
    
    $
    0Executive Vice President &
    
    
    2002
    
    
    $
    209,450
    
    
    
    150,000
    
    
    
    0Chief Technology Officer
    
    
    2001
    
    
    
    240,371
    
    
    
    100,000
    
    
    
    0Jeffrey Baudo
    
    
    2003
    
    
    $
    191,700
    
    
    
    0
    
    
    $
    0Chief Operating Officer
    
    
    2002
    
    
    $
    191,700
    
    
    
    150,000
    
    
    
    02001
    (1)
    
    
    197,872
    
    
    
    100,000
    
    
    
    0Anthony J. Fidaleo
    
    
    2003
    
    
    $
    125,000
    
    
    
    20,000
    
    
    $
    0Vice President Finance &
    
    
    2002
    (2)
    
    
    65,104
    
    
    
    30,000
    
    
    
    0Chief Financial Officer
   (1)
    
    Since commencement of employment on January 22, 2001.(2)
    
    Since commencement of employment on June 24, 2002 Stock Options The following tables show certain information with respect to incentive
and non-qualified stock options granted in 2003 to the Named Executives under
AdStars 1999 Stock Option Plan who received options and the aggregate value at
December 31, 2003 of such options. The per share exercise price of all options
is equal to the fair market value of a share of Common Stock on the date of
grant. No options granted to any Named Executives have been exercised. 32




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##### Table of Contents



Option Grants in 2003 Individual Grants of Options Number ofShares of
    
    Percent of TotalCommon Stock
    
    Options GrantedUnderlying
    
    to Employees in
    
    Exercise PriceName
    
    Option #
    
    2003
    
    ($/Sh)
    
    Expiration DateAnthony J. Fidaleo (1)
    
    
    20,000
    
    
    
    5.9
    %
    
    $
    2.06
    
    
    December 2008
  (1)
    
    The options vest 1/3 on the each of the 3 one-year anniversary dates of
the grant.  Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values Number of Shares Underlying
    
    Dollar Value of UnexercisedNumber of Shares
    
    Dollar Value
    
    Unexercised Options at fiscal
    
    In-the-Money Options at fiscalUnderlying
    
    Realized on
    
    Year-End(1)
    
    Year-End(1)Name
    
    Options Exercised
    
    Exercise
    
    Exercisable
    
    Nonexercisable
    
    Exercisable
    
    NonexercisableLeslie Bernhard
    
    
    
    
    
    $
    
    
    
    
    250,000
    
    
    
    
    
    
    $
    84,514
    
    
    $
    Eli Rousso
    
    
    
    
    
    $
    
    
    
    
    250,000
    
    
    
    
    
    
    $
    84,514
    
    
    $
    Jeffrey Baudo
    
    
    
    
    
    $
    
    
    
    
    216,667
    
    
    
    33,333
    
    
    $
    85,667
    
    
    $
    20,593Anthony J. Fidaleo
    
    
    
    
    
    $
    
    
    
    
    10,000
    
    
    
    40,000
    
    
    $
    5,239
    
    
    $
    10,478
   (1)
    
    Based on the closing price of the AdStars common stock on December 31,
2003 of $2.00. Employment Contracts On July 1, 2002, AdStar entered into four-year employment agreements with
each of Leslie Bernhard and Eli Rousso. Their prior agreements expired on June
30, 2002. Pursuant to her employment agreement, Leslie Bernhard was retained as
our Chief Executive Officer and her total annual compensation was reduced to
$212,800. Pursuant to his employment agreement, Eli Rousso was retained as our
Executive Vice President and his total annual compensation was reduced to
$212,800. Each agreement provides, among other things, for participation in an
equitable manner in any profit-sharing or retirement, separation and disability
plans for employees or executives and for participation in other employee
benefits applicable to employees and executives of AdStar. Each agreement
further provides for fringe benefits which commensurate with the executives
duties and responsibilities. Under each agreement, employment may be terminated
by us with cause or by the executive with good reason. Termination by us
without cause, or by the executive for good reason, would subject us 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. In January 2001, AdStar entered into a 2-year employment contract with Mr.
Jeffrey Baudo. 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 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. Mr.
Baudo is the brother of Leslie Bernhard. 33




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##### Table of Contents



Pursuant to the Merger agreement the two stockholders of Edgil entered
into employment agreements whereby each receives a monthly salary of $7,000 for
six months from October 21, 2003. Compensation of Directors In 2003, one of our non-employee directors received options to purchase
75,000 shares of our common stock exercisable at the fair market value on the
date of grant. 50,000 options vest on the date of grant and 25,000 on the 1st
anniversary of the date of grant, provided the grantee is still a director on
such date. Limitation of Directors Liability and Indemnification The Delaware General Corporation Law (the DGCL) authorizes corporations
to limit or eliminate the personal liability of directors to corporations and
their shareholders for monetary damages for breach of directors fiduciary duty
of care. The AdStars Certificate of Incorporation limits the liability of its
directors to AdStar or its stockholders to the fullest extent permitted by
Delaware law. AdStars Certificate of Incorporation provides mandatory indemnification
rights to any officer or director of AdStar who, by reason of the fact that he
or she is an officer or director of AdStar, is involved in a legal proceeding
of any nature. Such indemnification rights include reimbursement for expenses
incurred by such officer or director in advance of the final disposition of
such proceeding in accordance with the applicable provisions of the DGCL.
Insofar as indemnification for liabilities under the Securities Act of 1933
(the Act) may be provided to officers and directors or persons controlling
AdStar, AdStar has been informed that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. 
  Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters. The following table, together with the accompanying footnotes, sets forth
information, as of March 24, 2004, regarding stock ownership of all persons
known by AdStar to own beneficially more than 5% of AdStars outstanding Common
Stock, Named Executives, all directors, and all directors and officers of
AdStar as a group: Shares ofCommon StockBeneficially
    
    Percentage ofName of Beneficial Owner (1)
    
    Owned (2)
    
    OwnershipLeslie Bernhard (3)
    
    
    860,054
    
    
    
    6.6
    %Eli Rousso (3)
    
    
    887,891
    
    
    
    6.8
    %Jeffrey Baudo (4)
    
    
    253,800
    
    
    
    2.0
    %Anthony J. Fidaleo (8)
    
    
    10,000
    
    
    
    *Stephen A. Zelnick (5)
    
    
    149,477
    
    
    
    1.2
    %Richard Salute(9)
    
    
    75,000
    
    
    
    1.0
    %Chester L. F. Paulson (6)
    
    
    1,727,499
    
    
    
    13.8
    %Tribune Company (7)
    
    
    3,443,457
    
    
    
    21.3
    %Edward P. Hopey
    
    
    655,765
    
    
    
    5.2
    %Gilbert Wolsky
    
    
    655,765
    
    
    
    5.2
    %All Directors and Officers (8 persons) as a group
    
    
    2,256,307
    
    
    
    17.5
    %
   *
    
    less than 1% 34




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##### Table of Contents



(1)
    
    The addresses of the persons named in this table are as follows:
Leslie Bernhard, Eli Rousso, Jeffrey Baudo, and Anthony Fidaleo, c/o
AdStar, Inc., 4553 Glencoe Avenue, Suite 325, Marina del Rey, CA 90292;
Stephen A. Zelnick, c/o Morse Zelnick, Rose & Lander, 405 Park Avenue,
New York, NY 10022; Richard Salute, 7 Lori Court, Woodbury, New York,
11797; Chester L. F. Paulson, c/o Paulson Capital Corp. 811 SW Naito
Parkway, Suite 200, Portland, OR 97204; Tribune Company, 435 N. Michigan
Ave. Chicago IL, Attn: General Counsel; and Edward P. Hopey and Gilbert
Wolsky, c/o Edgil Associates, Inc., 15 Tyngsboro Road, North Chelmsford,
Massachusetts 01863.  (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 January 30, 2004 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 January 30, 2004, 12,802,928 shares of
Common Stock were outstanding.  (3)
    
    Includes an aggregate of 110,054 shares in respect of which Ms.
Bernhard and Mr. Rousso have voting power. Additionally, Ms. Bernhard
and Mr. Rousso each have options to purchase 100,000 and 150,000 shares
of AdStar common stock at $0.81 and $0.60 per share, respectively,
exercisable within 60 days.  (4)
    
    Consists of options to purchase 100,000 and 150,000 shares of AdStar
common stock, at $1.25 and $0.60 per share, exercisable within 60 days.  (5)
    
    Includes: (i) options to purchase 50,000 shares of common stock of
AdStar, at $0.60 per share, and warrants to purchase 25,000 shares of
AdStar common stock, at $1.07 per share, exercisable within 60 days; and
(ii) 24,477 shares of common stock of AdStar which represents Mr.
Zelnicks proportionate interest in 97,906 shares beneficially owned by
a nominee of Morse, Zelnick, Rose & Lander, LLP, of which Mr. Zelnick is
a member. The filing of this report shall not be construed as an
admission that Mr. Zelnick is the beneficial owner of any of the shares
owned by the nominee for the purposes of Section 13(d) or 13(g) of the
Securities Exchange Act of 1934, as amended.  (6)
    
    Consists of 919,183 shares of common stock of AdStar and the
currently exercisable common stock purchase warrants listed below:  (i)
    
    24,116 exercisable at $0.75(ii)
    
    350,000 exercisable at $1.07(iii)
    
    165,200 exercisable at $1.80(iv)
    
    80,000 exercisable at $1.87(v)
    
    139,000 exercisable at $7.20(vi)
    
    50,000 exercisable at $9.00  (7)
    
    Consists of 1,443,457 shares of Series A and 2,000,000 of Series B-2
Preferred Stock, which currently convert into Common Stock on a 1 for 1
basis.(8)
    
    Consists of options to purchase 10,000 shares of common stock of
Adstar at $1.06 per share, exercisable within 60 days. 35




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##### Table of Contents



(9)
    
    Consists of options to purchase 75,000 shares of common stock of
Adstar at $0.94 per share exercisable within 60 days. Securities Authorized for Issuance Under Equity Compensation Plans To attract and retain the personnel necessary for our success, we adopted
our 1999 Stock Option Plan (the Plan) and reserved 1,500,000 shares of stock
for future grants under it. Pursuant to the Plan, our officers, directors and
key employees and consultants are eligible to receive grants of incentive
and/or non-incentive stock options covering up to 1,500,000 shares of Common
Stock. The purpose of the Plan is to provide a flexible framework that permits
the Board to develop and implement stock-based incentive compensation programs
based on changing needs in our competitive market. In addition, the Plan
provides that the maximum term for options granted under the plan is 10 years
and that the exercise price for the options may not be less than the fair
market value of our Common Stock on the date of grant. Options granted to
stockholders owning more than 10% of our outstanding Common Stock must be
exercised within five years from the date of grant and the exercise price must
be at least 110% of the fair market value of our Common Stock on the date of
the grant. The following table summarizes as of December 31, 2003 the (i) options
granted under the Plan and (ii) all other securities subject to contracts,
options, warrants and rights or authorized for future issuance outside the
Plan. The shares covered by outstanding options or authorized for future
issuance are subject to adjustment for changes in capitalization stock splits,
stock dividends and similar events. Equity Compensation Plan TableNumber of securitiesremaining availablefor future issuanceNumber of securities
    
    
    
    
    
    under equityto 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
    
    
    1,139,619
    
    
    $
    1.05
    
    
    
    285,687Equity Compensation
Plans Not Approved
By Security Holders
    
    
    909,000
    
    
    $
    2.97
    
    
    
    201,882
    (1)Total
    
    
    2,048,619
    
    
    $
    1.90
    
    
    
    487,569
   (1)
    
    Reflect shares of AdStar Common Stock under the Vendor Plan described
below. The equity compensation not approved by security holders referred to in the
table above includes:  Grants of an aggregate of 180,000 non-qualified Common Stock purchase
options to certain consultants for Investor Relation services and to our
non-employee directors for their services. The details of the grants are as
follows: (1) 25,000 options to a consultant exercisable at $10.00 per share,
expiring in March 2005, (2) 30,000 options to a consultant exercisable at $1.99
per share, expiring in November 2008, (3) 50,000 options exercisable at $0.60
per share, expiring on the earlier of thirty days from such directors 36




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##### Table of Contents



termination of his position or January 27, 2007 and (4) 75,000 options
exercisable at $0.94 per share, expiring on the earlier of thirty days from
such directors termination of his position or on January 28, 2008.  An issuance of 50,000 Common Stock Purchase warrants exercisable at
$2.00 per share, expiring on October 1, 2005, to a consultant for services to
be rendered.  Issuances of an aggregate of 679,000 Common Stock Purchase warrants for
services rendered by the Underwriter in our public offerings, and the Placement
Agent in our private offerings, of securities. The details of the warrants are
as follows: (1) 200,000 Common Stock Purchase warrants exercisable at $7.20 per
share, expiring on December 16, 2004; (2) 200,000 Common Stock Purchase
warrants exercisable at $1.80 per share, expiring on September 25, 2005; (3)
120,000 Common Stock Purchase warrants exercisable at $0.75 per share, expiring
on January 16, 2007; and (4) 159,000 Common Stock Purchase warrants exercisable
at $1.87 per share, expiring on March 31, 2009.  In addition we established a plan (the Vendor Plan) to pay vendors,
who are accredited investors (as defined under Rule 215 of the Securities Act
of 1933), in shares of our Common Stock, valued at fair market value, for goods
or services. Up to 400,000 shares may be issued under the Vendor Plan. Under
the Vendor Plan, as of December 31, 2003, an aggregate of 199,661 shares of
Common Stock had been issued leaving 201,882 shares available for future
issuance. 
 Item 12. Certain Relationships and Related Transactions In January 2002, AdStar issued to Marina Co. a nominee of the partners of
Morse, Zelnick, Rose and Lander LLP, (a related party) AdStars legal counsel,
114,545 shares of restricted common stock, at fair market value as payment in
full for $62,500 legal expenses accrued at December 31, 2002. In January 2002,
the Company sold an additional 300,000 shares of common stock at a price of
$0.50 per share. These shares were sold as part of a 1,300,000 share private
placement made pursuant to Sections 4(2) and 4(6) of the Act, of which
1,000,000 were sold prior to December 31, 2002. In connection with this
offering the Company issued warrants to purchase 130,000 shares of its common
stock, at $0.75 as part of the placement agent fees, of which 22,137 were
issued to Paulson Investment Company, Inc. The warrants expire on January 16,
2007. Also, in connection with this offering AdStar paid $65,000 to Paulson
Investment Company, Inc., which Chester Paulson is the controlling shareholder,
as part of the placement agent fees. In January 2002, AdStar issued to Marina Co. a nominee of the partners of
Morse, Zelnick, Rose and Lander LLP, (a related party) AdStars legal counsel,
114,545 shares of restricted common stock, at fair market value as payment in
full for $62,500 legal expenses accrued at December 31, 2002. In January 2002,
the Company sold an additional 300,000 shares of common stock at a price of
$0.50 per share. These shares were sold as part of a 1,300,000 share private
placement made pursuant to Sections 4(2) and 4(6) of the Act, of which
1,000,000 were sold prior to December 31, 2002. In connection with this
offering the Company issued warrants to purchase 130,000 shares of its common
stock, at $0.75 as part of the placement agent fees. The warrants expire on
January 16, 2007 In March 2002, the Board of Directors approved the sale of 1,443,457
shares of our Series A Preferred Stock to Tribune Company for an aggregate
purchase price of approximately $1.8 million. These shares carry a liquidation
preference that includes a dividend of 7% per year available only upon
liquidation and currently convert on a 1:1 basis. Shareholders of Series A
Preferred Stock are entitled to vote on all matters submitted to the
stockholders for vote and vote as a single class with the shareholders of our
Common Stock. The holders of Series A preferred stock are entitled to one vote
for each share of common issuable upon conversion. 37




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##### Table of Contents



In December 2002 the Board of Directors approved the sale of shares of its
Series B Preferred Stock to Tribune Company for an aggregate price of $1.5
million. The sale was split into two funding segments: (i) In December 2002, AdStar sold 1,200,000 shares of its Series B-1
Preferred Stock to Tribune Company for an aggregate purchase price of $900,000.
These shares currently convert on a 1:1 basis. Shareholders of Series B-1
Preferred Stock are entitled to vote on all matters submitted to the
stockholders for vote and as a single class with the Common Stock. The holders
of Series B-1 Preferred Stock are entitled to one vote for each share; and (ii) In March 2003, AdStar sold 800,000 shares of its Series B-2 Preferred
Stock to Tribune Company for an aggregate purchase price of $600,000. These
shares currently convert on a 1:1 basis. Shareholders of Series B-2 Preferred
Stock are entitled to vote on all matters submitted to the stockholders for
vote and as a single class with the Common Stock. The holders of Series B-2
Preferred Stock are entitled to one vote for each share. In addition, on March
28, 2003, in exchange for all of the Series B-1 Preferred Stock plus accrued
and unpaid dividends on those shares, issued in December 2002 to Tribune
Company, AdStar issued an additional 1,200,000 shares of its Series B-2
Preferred Stock to the Tribune Company. In September 2003 the Company sold through a private placement offering
1,590,000 shares of its common stock to accredited investors, raising
$1,987,500 in capital. In connection with this offering the Company paid a
commission consisting of $198,750 in cash to Paulson Investment Company, Inc.,
which Chester Paulson is the controlling shareholder, as part of the placement
agent fees, and issued warrants to purchase 159,000 shares of its common stock,
of which 88,505 were issued to Paulson Investment Company, Inc. and 17,448 were
issued to Chester Paulson. In December 2003, AdStar issued to Marina Co. a nominee of the partners of
Morse, Zelnick, Rose and Lander LLP, AdStars legal counsel, 34,615 shares of
restricted common stock, issued at fair market value as payment for $45,000 in
legal services provided during 2003. 
 Item 13. Exhibits, List and Reports on Form 8-K (a) Exhibits: ExhibitNo.
    
    Description2.1
    
    Agreement and Plan of Merger dated October 21, 2003(1)3.1
    
    Certificate of Incorporation of AdStar (2)3.1a
    
    Amendment to Certificate of Incorporation, as filed with the
Secretary of State of Delaware on July 11, 2001 (3)3.1b
    
    Series A Preferred Stock Certificate of Designation as filed with
the Secretary of State of Delaware on March 15, 2002 (4)3.1c
    
    Series B-1 Preferred Stock Certificate of Designation as filed with
the Secretary of State of Delaware on December 20, 2002, effective
December 23, 2002 (5)3.1d
    
    Series B-2 Preferred Stock Certificate of Designation as filed with
the Secretary of State of Delaware on March 28, 2003, effective
March 28, 2003(6)3.2
    
    By-Laws of AdStar (2)4.1
    
    Specimen Stock Certificate (2)4.2
    
    Revised Form of Underwriters Warrant (7)
 38




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##### Table of Contents



ExhibitNo.
    
    Description4.3
    
    Form of 5-year warrant issued in the Private Placement of units on
April 6, 2001 (8)4.4
    
    Form of 5-year warrant issued in connection with the Private
Placement of AdStar Common Stock during the period of October 2001
through January 2002(9)4.5
    
    Form of 3-year warrant issued to C.C.R.I. Corporation in connection
with an agreement between it and AdStar, dated as of October 2,
2001(9)4.6
    
    Form of 5-year warrant issued in connection with the Private
Placement of AdStar Common Stock in September 2003 (10)4.7
    
    Registration Rights Agreement by and among the Company and the Edgil
Stockholders, dated October 21, 2003 (11)10.1
    
    1999 Stock Option Plan (2)10.2
    
    Employment Agreement between AdStar and Leslie Bernhard (6)10.3
    
    Employment Agreement between AdStar and Eli Rousso (6)10.4
    
    Employment Agreement between AdStar and Jeffrey Baudo(6)10.5
    
    Series A Preferred Stock Purchase Agreement, dated March 18, 2002,
by and between AdStar, Inc. and Tribune Company(4)10.6
    
    Software Development and Deployment Agreement, dated March 18, 2002,
by and between AdStar, Inc. and Tribune Company(4)10.7
    
    Registration Rights Agreement, dated March 18, 2002, by and between
AdStar, Inc. and Tribune Company (4)10.8
    
    Governance Agreement, dated March 18, 2002, by and among AdStar,
Inc., Leslie Bernhard, Eli Rousso and Tribune Company(4)10.9
    
    Series B Preferred Stock Purchase Agreement, dated December 23,
2002, by and between AdStar, Inc. and Tribune Company(5)10.10
    
    Second Software Development and Deployment Agreement, dated December
23, 2002, by and between AdStar, Inc. and Tribune Company(5)10.11
    
    Amended and Restated Registration Rights Agreement, dated December
23, 2002, by and between AdStar, Inc. and Tribune Company (5)10.12
    
    Amended and Restated Governance Agreement, dated December 23, 2002,
by and among AdStar, Inc., Leslie Bernhard, Eli Rousso and Tribune
Company (5)14.1
    
    Code of Ethics*16.1
    
    Letter from PricewaterhouseCoopers LLP dated February 20, 2003.(12)20.1
    
    Notification to AdStar, Inc. stockholders of action taken by written
consent of the holders of a majority of outstanding shares (13)21.1
    
    Subsidiaries*22.1
    
    Published reports containing information called for by Item 4 of
Part I of this report (See Exhibit 20.1 above)*23.1
    
    Consent of BDO Seidman, LLP *31.1
    
    Chief Executive Officer Certification pursuant to section 302 of the
Sarbanes-Oxley Act of 2002*31.2
    
    Chief Executive 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 Executive Officer Certification pursuant to section 906 of the
Sarbanes-Oxley Act of 2002*
 39




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##### Table of Contents



Notes to exhibits*
    
    Filed herewith(1)
    
    Filed on November 4, 2003 as an exhibit with the same number to
Current Report on Form 8-K and incorporated herein by reference.(2)
    
    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.(3)
    
    Filed as an exhibit to Quarterly Report on Form 10QSB for the period
ended September 30, 2001 and incorporated herein by reference.(4)
    
    Filed on March 25, 2002 as an exhibit to the Current Report on Form
8-K filed and incorporated herein by reference.(5)
    
    Filed on December 31, 2002 as an exhibit to the Current Report on
Form 8-K filed and incorporated herein by reference.(6)
    
    Filed as an exhibit to the Annual Report on Form 10KSB for the
period ended December 31, 2002 and incorporated herein by reference.(7)
    
    Filed in September 2000 as an exhibit with the same number to
Registration Statement on Form SB-2 (No. 333-43408) and incorporated
herein by reference.(8)
    
    Filed on May 10, 2001 as an exhibit to Registration Statement on
Form S-3 No. 333-60664 and incorporated herein by reference.(9)
    
    Filed on January 24, 2002 as an exhibit to Registration Statement on
Form S-3 No. 333-81338 and incorporated herein by reference.(10)
    
    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.(11)
    
    Filed on November 4, 2003 as an exhibit to the Current Report on
Form 8-K and incorporated herein by reference.(12)
    
    Filed on February 24, 2003 as an exhibit to the Current Report on
Form 8-K filed and incorporated herein by reference.(13)
    
    Filed on March 9, 2004 by a Schedule 14C Information Statement.
 (b) Reports on Form 8-K:  (i)
    
    On October 16, 2003, AdStar filed a Current Report on Form 8-K
in accordance with Item 5 of such report;(ii)
    
    On November 4, 2003, AdStar filed a Current Report on Form 8-K
in accordance with item 2 of such report; and(iii)
    
    On January 5, 2004, AdStar filed a Current Report on Form
8-K/A in accordance with item 2 of such report; 
 Item 14. Principal Accountant Fees and Services The aggregate fees billed by our principal accounting firm, BDO Seidman,
LLP, for fees billed for fiscal years ended December 31, 2003 and 2002 are as
follows: 2003
    
    2002(1)Audit fees
    
    $
    90,611
    
    
    $
    81,867Audit related fees
    
    
    41,586
    (1)
    
    
    37,983Total audit and audit related fees
    
    $
    132,197
    
    
    $
    119,850Tax fees
    
    
    6,900
    
    
    
    7,598All other fees
    
    
    
    
    
    
    Total fees
    
    $
    139,097
    
    
    $
    127,448
 (1) Includes
fees paid to PricewaterhouseCoopers LLP. Audit-Related Fees Audit Related Fees set forth in the table above consist primarily of
consulting on regulatory filings, acquisition audits of EDGIL, and consulting and
research on specific accounting issues that pertained to our on-going
operations and the audit, including, technical research associated with revenue recognition,
preferred and common financings, and purchase accounting rules. Tax Fees The Tax Fees set forth in the table above are the aggregate fees paid by
us for tax services including, the preparation of corporate tax returns. All Other Fees All
other fees were zero for the periods presented. 40




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##### Table of Contents



Each of the permitted non-audit services has been pre-approved by the
Audit Committee or the Audit Committees Chairman pursuant to delegated
authority by the Audit Committee, other than de minimus non-audit services for
which the pre-approval requirements are waived in accordance with the rules and
regulations of the SEC. Audit Committee Pre-Approval Policies and Procedures The Audit Committee charter provides that the Audit Committee will
pre-approve audit services and non-audit services to be provided by our
independent auditors before the accountant is engaged to render these services.
The Audit Committee may consult with management in the decision-making process,
but may not delegate this authority to management. The Audit Committee may
delegate its authority to pre-approve services to one or more committee
members, provided that the designees present the pre-approvals to the full
committee at the next committee meeting. 41




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##### Table of Contents



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. AdStar, Inc.By:
    /s/ Leslie BernhardLeslie Bernhard,President and Chief Executive Officer Date: March 30, 2004 In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Registrant and in the capacities
indicated on March 30, 2004. Signature
    
    TitlePrincipal Executive Officer/s/ Leslie Bernhard
    
    President and Chief Executive Officer and DirectorLeslie BernhardPrincipal Financial Officer/s/ Anthony J. Fidaleo
    
    Chief Financial OfficerAnthony J. FidaleoDirectors/s/ Eli Rousso
    
    DirectorEli Rousso/s/ Jeffrey Baudo
    
    DirectorJeffrey Baudo/s/ Stephen Zelnick
    
    DirectorStephen Zelnick/s/ Richard Salute
    
    DirectorRichard Salute
 42




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##### Table of Contents



Index To Financial Statements PageReports of Independent Certified Public Accountants
    
    
    F-2Financial Statements:Consolidated Balance Sheet as of December 31, 2003
    
    
    F-3Consolidated Statements of Operations for the two years ended December 31, 2003
    
    
    F-4Consolidated Statements of Stockholders Equity (Deficit) for the two
years ended December 31, 2003
    
    
    F-5Consolidated Statements of Cash Flows for the two years ended December 31, 2003
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7
 F-1




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##### Table of Contents



Report of Independent Certified Public Accountants Board of Directors
Adstar, Inc. and Subsidiary
Marina del Rey, California We have audited the accompanying consolidated balance sheet of Adstar, Inc. and
Subsidiary (the Company) as of December 31, 2003 and the related consolidated
statement of operations, stockholders equity, and cash flows for the two years
then ended. 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 in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits 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. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Adstar, Inc. and Subsidiary at December 31,
2003, and the results of its operations and its cash flows for the two years
then ended in conformity with accounting principles generally accepted in the
United States of America. /s/ BDO Seidman, LLP Los Angeles, California
March 5, 2004 F-2




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##### Table of Contents



AdStar, Inc. and Subsidiary
Consolidated Balance Sheet
As of December 31, 2003 AssetsCurrent assets:Cash and cash equivalents
    
    $
    2,092,477Accounts receivable, net of allowance for doubtful accounts of $84,470
    
    
    339,871Notes receivable from officers  current portion
    
    
    7,589Prepaid and other current assets
    
    
    121,738Total current assets
    
    
    2,561,675Notes receivable from officers, net of current portion
    
    
    232,356Property and equipment, net
    
    
    142,451Capitalized and purchased software, net
    
    
    1,927,969Intangible assets, net
    
    
    1,490,439Goodwill
    
    
    2,161,454Other assets
    
    
    37,656Total assets
    
    $
    8,554,000Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    164,513Due to publications
    
    
    1,083,973Accrued expenses
    
    
    1,028,914Deferred revenue and customer deposits  current portion
    
    
    83,904Loans from stockholders  current portion
    
    
    19,608Capital lease obligations  current portion
    
    
    31,715Total current liabilities
    
    
    2,412,627Deferred revenues, net of current portion
    
    
    105,869Loans from stockholders, net of current portion
    
    
    43,392Capital lease obligations, net of current portion
    
    
    18,285Total liabilities
    
    
    2,580,173Commitments and contingencies (Note 15)Stockholders equity:Convertible Preferred stock, par value $0.0001; authorized 5,000,000 shares;
issued and outstanding:Series A, 1,443,457 issued and outstanding; liquidation preference
of $2,034,810
    
    
    1,697,840Series B-2, 2,000,000 issued and outstanding; liquidation preference
of $1,593,943
    
    
    1,342,404Common stock, par value $0.0001; authorized 20,000,000 shares; 12,778,531 issued
and outstanding
    
    
    1,278Additional paid-in capital
    
    
    17,166,539Treasury stock; 67,796 shares
    
    
    (67,796
    )Accumulated deficit
    
    
    (14,166,438
    )Total stockholders equity
    
    
    5,973,827Total liabilities and stockholders equity
    
    $
    8,554,000
 The accompanying notes are an integral part of these consolidated
financial statements. F-3




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##### Table of Contents



AdStar, Inc. and Subsidiary
Consolidated Statements of Operations
For the Two Years
Ended December 31, 2003 2002
    
    2003ASP, (including related party revenue of $292,621 and $433,757) net note 7
    
    $
    915,819
    
    
    $
    1,470,260Licensing and software (including related party revenue of $210,759 and $47,079)
    
    
    1,070,341
    
    
    
    1,087,097Customization and other (including related party revenue of $89,200 and $30,000)
    
    
    255,332
    
    
    
    276,168Net revenues
    
    
    2,241,492
    
    
    
    2,833,525Cost of revenues, including of amortization of $400,023 and $683,300
    
    
    1,106,502
    
    
    
    1,296,883Loss on write-down of capitalized software
    
    
    
    
    
    
    883,060Total cost of revenues
    
    
    1,106,502
    
    
    
    2,179,943Gross profit
    
    
    1,134,990
    
    
    
    653,582General and administrative expense
    
    
    1,440,376
    
    
    
    1,343,395Product maintenance and development costs
    
    
    852,312
    
    
    
    1,241,957Selling and marketing expense
    
    
    749,766
    
    
    
    750,128Restructuring expenses
    
    
    322,604
    
    
    
    124,774Amortization of customer list
    
    
    
    
    
    
    17,315Loss from operations
    
    
    (2,230,068
    )
    
    
    (2,823,987
    )Other income (expense)
    
    
    62,796
    
    
    
    (10,000
    )Interest income (expense), net
    
    
    14,389
    
    
    
    5,472Loss before income taxes
    
    
    (2,152,883
    )
    
    
    (2,828,515
    )Provision for income taxes
    
    
    (6,760
    )
    
    
    (13,850
    )Net loss
    
    $
    (2,159,643
    )
    
    $
    (2,842,365
    )Deemed dividend on issuance of series B-1 preferred stock
    
    
    (204,000
    )
    
    
    Net loss applicable to common stockholders
    
    $
    (2,363,643
    )
    
    $
    (2,842,365
    )Loss per share  basic and diluted
    
    $
    (0.29
    )
    
    $
    (0.31
    )Weighted average number of shares  basic and diluted
    
    
    8,193,132
    
    
    
    9,030,764
 The accompanying notes are an integral part of these consolidated financial statements. F-4




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##### Table of Contents



AdStar, Inc. and Subsidiary
Consolidated Statements of Stockholders Equity
For the Two Years
Ended December 31, 2003 Common Stock
    
    Preferred Stock Series A
    
    Preferred Stock Series B-1Shares
    
    Amount
    
    Shares
    
    Amount
    
    Shares
    
    AmountBalance, December 2001
    
    
    7,729,852
    
    
    $
    773
    
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    Net proceeds from
Preferred Series A
    
    
    
    
    
    
    
    
    
    
    1,443,457
    
    
    
    1,697,840
    
    
    
    
    
    
    
    Net Proceeds from
Preferred Series B-1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,200,000
    
    
    
    609,720Common stock and
warrants issued
in private placement
    
    
    400,000
    
    
    
    40
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock issued
for services
    
    
    131,076
    
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Warrants issued for
Services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Restructure of
stockholder loan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Kodak shares returned
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Deemed dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    204,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance, December 2002
    
    
    8,260,928
    
    
    
    826
    
    
    
    1,443,457
    
    
    
    1,697,840
    
    
    
    1,200,000
    
    
    
    813,720Conversion of Preferred
Series B-1 to B-2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,200,000
    )
    
    
    (813,720
    )Net Proceeds from
Preferred Series B-2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock and warrants
issued in private
placement
    
    
    1,590,000
    
    
    
    159
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock issued for
purchase of Edgil
Associates, Inc.
    
    
    1,311,530
    
    
    
    131
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options issued as
replacement options in
purchase of Edgil
Associates, Inc.
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock issued in
private placement
    
    
    1,257,693
    
    
    
    127
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Warrants exercised
    
    
    152,501
    
    
    
    15
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options issued for services
    
    
    131,185
    
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options exercised
    
    
    74,694
    
    
    
    7
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance, December 2003
    
    
    12,778,531
    
    
    $
    1,278
    
    
    
    1,443,457
    
    
    $
    1,697,840
    
    
    
    
    
    
    $
    
   [Continued from above table, first column(s) repeated] Preferred Stock Series B-2
    
    Treasury StockShares
    
    Amount
    
    Shares
    
    AmountBalance, December 2001
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    Net proceeds from
Preferred Series A
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net Proceeds from
Preferred Series B-1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock and
warrants issued
in private placement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock issued
for services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Warrants issued for
Services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Restructure of
stockholder loan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Kodak shares returned
    
    
    
    
    
    
    
    
    
    
    67,796
    
    
    
    (67,796
    )Deemed dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance, December 2002
    
    
    
    
    
    
    
    
    
    
    67,796
    
    
    
    (67,796
    )Conversion of Preferred
Series B-1 to B-2
    
    
    1,200,000
    
    
    
    813,720
    
    
    
    
    
    
    
    Net Proceeds from
Preferred Series B-2
    
    
    800,000
    
    
    
    528,683
    
    
    
    
    
    
    
    Common stock and warrants
issued in private
placement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock issued for
purchase of Edgil
Associates, Inc.
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options issued as
replacement options in
purchase of Edgil
Associates, Inc.
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Common stock issued in
private placement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Warrants exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options issued for services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance, December 2003
    
    
    2,000,000
    
    
    $
    1,342,404
    
    
    
    67,796
    
    
    $
    (67,796
    )
   [Continued from above table, first column(s) repeated] TotalAdditional
    
    Shareholder
    
    Accumulated
    
    StockholdersPaid-In Capital
    
    Receivable
    
    Deficit
    
    EquityBalance, December 2001
    
    $
    10,843,795
    
    
    $
    (43,120
    )
    
    $
    (8,960,430
    )
    
    $
    1,841,018Net proceeds from
Preferred Series A
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,697,840Net Proceeds from
Preferred Series B-1
    
    
    204,000
    
    
    
    
    
    
    
    
    
    
    
    813,720Common stock and
warrants issued
in private placement
    
    
    151,522
    
    
    
    
    
    
    
    
    
    
    
    151,562Common stock issued
for services
    
    
    77,456
    
    
    
    
    
    
    
    
    
    
    
    77,469Warrants issued for
Services
    
    
    17,302
    
    
    
    
    
    
    
    
    
    
    
    17,302Restructure of
stockholder loan
    
    
    
    
    
    
    43,120
    
    
    
    
    
    
    
    43,120Kodak shares returned
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (67,796
    )Deemed dividend
    
    
    
    
    
    
    
    
    
    
    (204,000
    )
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    (2,159,643
    )
    
    
    (2,159,643
    )Balance, December 2002
    
    
    11,294,075
    
    
    
    
    
    
    
    (11,324,073
    )
    
    
    2,414,592Conversion of Preferred
Series B-1 to B-2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net Proceeds from
Preferred Series B-2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    528,683Common stock and warrants
issued in private
placement
    
    
    1,723,511
    
    
    
    
    
    
    
    
    
    
    
    1,723,670Common stock issued for
purchase of Edgil
Associates, Inc.
    
    
    2,111,432
    
    
    
    
    
    
    
    
    
    
    
    2,111,563Options issued as
replacement options in
purchase of Edgil
Associates, Inc.
    
    
    68,926
    
    
    
    
    
    
    
    
    
    
    
    68,926Common stock issued in
private placement
    
    
    1,578,769
    
    
    
    
    
    
    
    
    
    
    
    1,578,896Warrants exercised
    
    
    197,362
    
    
    
    
    
    
    
    
    
    
    
    197,378Options issued for services
    
    
    136,987
    
    
    
    
    
    
    
    
    
    
    
    137,000Options exercised
    
    
    55,477
    
    
    
    
    
    
    
    
    
    
    
    55,484Net loss
    
    
    
    
    
    
    
    
    
    
    (2,842,365
    )
    
    
    (2,842,365
    )Balance, December 2003
    
    $
    17,166,539
    
    
    $
    
    
    
    $
    (14,166,438
    )
    
    $
    5,973,827
 The accompanying notes are an integral part of these consolidated financial statements. F-5




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AdStar, Inc. and Subsidiary
Consolidated Statements of Cash Flows
For the Two Years
Ended December 31, 2003 2002
    
    2003Cash flows from operating activities:Net loss
    
    $
    (2,159,643
    )
    
    $
    (2,842,365
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation and amortization
    
    
    612,425
    
    
    
    877,947Allowance for doubtful accounts
    
    
    34,672
    
    
    
    (15,202
    )Stock based charges
    
    
    94,771
    
    
    
    137,000Kodak shares returned
    
    
    (67,796
    )
    
    
    Loss on write-down of capitalized software
    
    
    
    
    
    
    883,060Loss on disposal of equipment and purchased software
    
    
    128,379
    
    
    
    Changes in assets and liabilities:Accounts receivable
    
    
    20,539
    
    
    
    63,211Prepaids and other assets
    
    
    23,953
    
    
    
    3,459Accounts payable
    
    
    511,925
    
    
    
    44,808Due to publications
    
    
    197,764
    
    
    
    59,298Accrued expenses
    
    
    109,188
    
    
    
    (84,800
    )Deferred revenue and customer deposits
    
    
    (39,642
    )
    
    
    76,202Net cash used in operating activities
    
    
    (533,465
    )
    
    
    (797,382
    )Cash flows from investing activities:Purchase of Edgil Associates, Inc., net of cash received
    
    
    
    
    
    
    (1,558,388
    )Additions to capitalized and purchased software
    
    
    (1,232,112
    )
    
    
    (634,145
    )Purchase of property and equipment
    
    
    (100,394
    )
    
    
    (95,406
    )Notes from officers
    
    
    (210,434
    )
    
    
    Repayment of officer receivable
    
    
    6,430
    
    
    
    7,179Net cash used in investing activities
    
    
    (1,536,510
    )
    
    
    (2,280,760
    )Cash flows from financing activities:(Increase) decrease to restricted cash
    
    
    (129,461
    )
    
    
    174,918Proceeds from issuance of notes payable
    
    
    300,000
    
    
    
    200,000Repayment of notes payable
    
    
    (300,000
    )
    
    
    (200,000
    )Net proceeds from sale of stock in private placements
    
    
    151,562
    
    
    
    3,302,566Net proceeds from issuance of series A preferred stock
    
    
    1,697,840
    
    
    
    Net proceeds from issuance of series B preferred stock
    
    
    813,720
    
    
    
    528,683Proceeds from exercise of options and warrants
    
    
    
    
    
    
    252,861Proceeds from capital leases
    
    
    79,752
    
    
    
    Principal repayments on capital leases
    
    
    (14,599
    )
    
    
    (28,787
    )Net cash provided by financing activities
    
    
    2,598,814
    
    
    
    4,230,241Net increase in cash and cash equivalents
    
    
    528,839
    
    
    
    1,152,099Cash and cash equivalents at beginning of period
    
    
    411,539
    
    
    
    940,378Cash and cash equivalents at end of period
    
    $
    940,378
    
    
    $
    2,092,477
 The accompanying notes are an integral part of these consolidated financial statements. 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 core business has been licensing 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. The Companys customers are principally located in the United
States. In June 1999, the Company commenced offering a one-stop
marketplace on the World Wide Web for advertisers to buy classified ads.
This service enables advertisers to plan, schedule, compose and purchase
classified advertising from many print and on-line publishers, using one
interface.In 2001, the Company formally introduced its new AdStar e-business
application suite. This is an enterprise class, integrated software
solution that allows print and on-line publications to electronically
receive completed classified advertising copy using the Internet as the
communication channel. These software solutions enable customers to expand
the relationships with their customers using a single integrated platform,
while increasing sales volumes at reduced costs. This suite includes an
updated version of the Companys core Professional software product that
utilizes the Internet as the communication channel. In addition, the
Company has added an application service provider (ASP) product that
provides its customers an opportunity to generate incremental revenue from
classified ad sale transactions completed on-line, while increasing the
number of visitors to the customers Web site.On October 21, 2003 (the Effective Date), AdStar acquired all of the
business and assets of Edgil pursuant to an Agreement and Plan of Merger
(the Merger Agreement), dated as of the Effective Date, by and among
AdStar, Edgil, EDG, and Edward P. Hopey and Gilbert Wolsky, the
stockholders of Edgil (collectively, the Edgil Stockholders).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 proprietary EdgCapture
payment processing software processes over 10,000,000 newspaper
advertising and circulation transactions annually for Tribune Company,
Gannett Company, Inc., Knight-Ridder, Inc., Copley Press, Inc., New York
Times Company, Advance Publications, Inc., Cox Enterprises, Inc., and
Village Voice Media, Inc., as well as many independent daily and specialty
publications.Edgils product strategy focuses on providing newspapers 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.Edgil Associates, Inc. (the Company or Edgil) was incorporated in the
State of Massachusetts on February 22, 1984 as a C-Corporation under the
Internal Revenue Code. Edgil, based in North Chelmsford, Massachusetts, is
a provider of complete automated payment F-7




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##### Table of Contents



processing systems and
content processing solutions for the publishing industry. The Companys
core business has been licensing proprietary software systems and
supplying the related support and maintenance.Edgil, based in North Chelmsford, Massachusetts, is a provider of complete
automated payment processing systems and content processing solutions for
the publishing industry. The Companys core business has been licensing
proprietary software systems and supplying the related support and
maintenance.2.
    
    Basis of Presentation and Summary of Significant Accounting PoliciesBasis of Presentation and Managements PlanThe accompanying financial statements have been prepared assuming the
Company will have liquidity to maintain its required minimum level of
operations. At December 31, 2003, we had an accumulated deficit of
$14,166,000. We have incurred significant recurring net losses. For the
years ended December 2002 and 2003 we had net losses of $2,160,000 and
$2,842,000. Our 2002 and 2003 net losses were principally attributable to
our continued shift of focus from an on-line business to an ASP business.
We expect to continue to incur losses until we are able to increase
revenues significantly from fees based on the number of purchases
transacted through our ASP product. We are not assured that we will
generate sufficient capital to meet our cash needs through December 31,
2004. Although there can be no assurance, we believe that expected cash flow from the recent acquisition of
Edgil Associates, Inc., the additional $1,635,000 raised through the sale
of 1,257,693 common shares through a private placement in December 2003,
our available funds, combined with cash generated from existing
operations, new customers, and the flexibility to cut back our work-force upon
completion or delay of significant customization projects, will be
sufficient to meet our anticipated working capital needs through December
31, 2004. In addition the Company continues to seek additional
financings. Management has received approval, pending final
documentation, from a lender to secure $1,500,000 in convertible debt
financing, which is expected to be funded in April, 2004. See subsequent
event note 18.Although we are optimistic that our growing ASP business will continue to
be accepted in the marketplace timing is not assured. Our ability to sell
ASP business products and service offerings during the current year may be
hampered by continued sluggishness in the advertising market, the
geo-political climate, including the war in Iraq, and state of the economy
in general. These factors, coupled with the extended selling cycle in our
industry and customer delays in customization and implementations, could
delay our ability to increase revenue to a level sufficient to cover our
expenses. There is no assurance that management will be successful with
its operating plan and, if events and circumstances occur such that the
Company does not meet its the plan as expected, and the Company is unable
to raise additional financing, 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.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. F-8




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##### Table of Contents



Cash and Cash Equivalents  The 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, 2003, the company has cash balances held at 2 financial
institutions which exceed FDIC insurance limits by $1,872,477.  Restricted cash  In August 2002, AdStar was informed by Chase Merchant Services, L.L.C
(Chase), a merchant bank that provides credit card processing services for
AdStar, that it required the Company to maintain a restricted cash balance
of $175,000. During 2003 the Company has entered into a new arrangement
with another merchant banker whereby the terms and conditions do not
require AdStar to provide a reserve.  Supplemental schedule of noncash investing and financing activities for
the two years ended December 31, 2003: 2002
    
    2003Supplemental cash flow disclosure:Taxes paid
    
    $
    9,739
    
    
    $
    7,643Interest paid
    
    $
    9,159
    
    
    $
    14,558Noncash investing and financing activities:Issuance of Common stock for legal expenses
    
    $
    62,500
    
    
    $
    95,000Restructuring of shareholder receivable
    
    $
    43,120
    
    
    $
    
  The Company purchased all of the common stock of Edgil Associates, Inc..
Pursuant to the Merger Agreement, the Company paid $1,520,000 cash and
issued 1,311,530 shares of common stock, in exchange the business and
assets of Edgil. Based upon the average closing price of the Common Stock
on the Nasdaq SmallCap Market for the 10 trading day period beginning
October 14, 2003 the value of the Edgil Shares was $2,111,563. In
addition the Company issued 63,397 AdStar options valued at $68,926 using
the Black-Scholes method as replacement options for fully vested Edgil
employee options (Note 12) recorded an estimated $200,000 in Legal,
Accounting and other fees as part of the cost of the acquisition. In
conjunction with the acquisition, liabilities were assumed as follows: Fair value of assets acquired
    
    $
    5,042,523Issuance of common stock for purchase of Edgil Associates, Inc.
    
    
    (2,111,563
    )Issuance of common stock to replace Edgil vested employee options
    
    
    (68,928
    )Cash paid for the common stock
    
    
    (1,520,000
    )Professional fees and other costs of the acquisition
    
    
    (200,000
    )Liabilities assumed
    
    $
    1,142,032
  Concentration of Credit Risk and Major Customers  Financial instruments that potentially subject the Company to significant
concentrations of credit risk are principally comprised of trade accounts
receivable and shareholder loans.  For the year ended December 31, 2002, two different customers accounted
for 9% and 7% respectively of the Companys net revenues. As of December
31, 2003, eight customers, in the aggregate, accounted for 55% of the
Companys accounts receivable. F-9




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For the year ended December 31, 2003, one customer accounted for 11% and
two different customers accounted for 7% net revenues. As of December 31,
2003, twelve customers, in the aggregate, accounted for 52% of the
Companys accounts receivable.  The majority of the Companys customers have historically consisted of
newspapers and publishers of classified advertisements. The Companys
customers on its Web site are the general public.  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 become 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, such as 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 lease term
  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 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 Web site
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 F-10




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##### Table of Contents



incurred to enhance the AdStar ASP application suite of products. At
December 31, 2003, the Company has capitalized software development costs
of $2,611,373, net of a write down to net realizable value, with
associated accumulated amortization of $1,146,240.As part of the ongoing internal review of the carrying value of
capitalized software, in conjunction with an overall product line
evaluation undertaken as part of the integration of our newly acquired
subsidiary, Edgil Associates, Inc., management determined that certain
internally developed software products had impairment losses. In December
2003 the Company recognized $883,060 in in impairment losses capitalized
software and related service contracts of which $698,060 relates to the
write-down of two software applications to their net realizable value.
The write-down is comprised of $381,598 and $316,462 for our contract web
and FlexAd software applications, respectively.Contract web is a web-based application developed over the past 3 years to
replace our legacy software which is still being used, via stand alone
servers. The application was carried on the balance sheet at a total cost
of $626,633 with accumulated amortization of $245,036. The application
was based on old technology and had latency issues that we unsuccessfully
continued to attempt to correct through November 2003. Contract web was
never fully adopted by our customers and we received minimal incremental
revenues from it. While we have essentially abandoned this version of the
software we still believe the future of our legacy software resides on a
web-based application. As such and in conjunction with the acquisition of
Edgil we now have access to additional software engineering experts and
are the process of leveraging Edgils expertise in re-engineering this
product for re-introduction in the future. In addition to the write down
of the capitalized software we reserved an additional $15,000 as estimated
costs to support this application under existing maintenance contracts
until we can move customers to a new version or back to the old
application.FlexAd software is a web-based application that allows certain Tribune
Company Newspapers to accepted real print and online versions of the same
ad simultaneously into the News Paper and Careerbuilder website. In
addition to the write down of the capitalized software we recorded an
additional $170,000 estimated loss on the related customer contract.
Notes 7 and 17.Intangible AssetsIntangible assets comprise 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 is periodically reviewed by
management and impairment losses, if any are recognized when the expected
non-discounted future operating cash flows derived from such assets are
less than their carrying value.As part of this policy management determined that 2 internally developed
software products were permanently impaired and required a write down to
net realizable value. See Notes 2, 7 and 17.Fair Value of Financial InstrumentsCash and cash equivalents, accounts receivable, shareholder notes
receivable, accounts payable, deferred revenue, notes payable, capital
leases and accrued expenses are carried at cost which approximates their
fair value because of the short-term maturity or the current lending rates
of these instruments. F-11




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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 Web site 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.Web site revenue  The Company receives revenue from fees charged to
customers who transact business on the Advertise123.com Web site. This
site permits the general public to plan, schedule, compose and purchase
advertising from many print and on-line publishers. 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), the Company is, in substance, acting as
an agent for the publishers and therefore recognizes as revenue only the
net fees realized on the transactions. The Company recognizes revenues 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 post-contract customer support (PCS). Revenue from these arrangements
is recognized in accordance with Statement of Position (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. The Company also provides customization services at
the customers request and recognizes revenue as the services are
performed, using a percentage of completion methodology based on labor
hours. Deferred revenue consists primarily of License and Software prepaid
annually and customization and other revenues billed and paid in advance.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 historical AdStar
and 25 years and 3 to 5 years on historical Edgil, respectively. Deferred
revenue on the 25-year license arrangements are $106,000, PCS contracts
paid in advance and prepaid customer deposits are $80,000 for year ended
December 31, 2003. Revenue from software customization services is
recognized upon the completion of services. As part of the integration of
Edgil into AdStars business model the Company is currently offering new
Edgil contracts on terms and conditions similar to AdStar, generally one
year or less in duration.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 F-12




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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 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.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.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 none and
$29,000 for the years ended December 31, 2002 and 2003.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, 2002 and 2003, diluted earnings (loss)
per share does not include 6,041,932 and 7,009,576 of options and warrants
to purchase common stock, and preferred stock as their inclusion is
antidilutive.Comprehensive IncomeThe Company discloses comprehensive income in accordance with the
provisions of Statement of Financial Accounting Standards (SFAS) No.
130, Reporting Comprehensive Income. This statement establishes
standards for reporting and disclosing comprehensive income and its
components in a full set of general purpose financial statements.
Comprehensive income generally F-13




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represents all changes in stockholders
equity (deficit) during the period except those resulting from
investments by, or distributions to, stockholders. The Company has no
other comprehensive income items and, accordingly, net income (loss)
equals comprehensive income (loss) for all periods presented.Segment ReportingThe Company determines and discloses its segments in accordance with SFAS
No. 131, Disclosures about Segments of an Enterprise and Related
Information, which uses a management approach for determining segments.
The management approach designates the internal organization that is used
by management for making operating decisions and assessing performance as
the source of a companys reportable segments. SFAS No. 131 also requires
disclosures about products or services, geographic areas and major
customers. The Companys management reporting structure provides for only
one reportable segment and accordingly, no separate segment information is
presented.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,
2002 and 2003 all costs associated with contract service were recorded
directly into cost of revenues.The Company currently product liability insurance. Management believes
that the amount of insurance is adequate to cover its risks. To further
mitigate its risks, the Companys 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 CompensationThe Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees, and has
elected the disclosure-only provisions of SFAS No. 123, Accounting for
Stock-Based Compensation. Under APB No. 25, compensation expense is based
on the difference, if any, on the date of grant, between the fair value of
the Companys stock for financial reporting purposes and the exercise
price of the option. The Company accounts for equity instruments issued to
non-employees in accordance with the provisions of SFAS No. 123 or EITF
96-18 at fair value.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 31,2002
    
    2003Risk-free interest rate
    
    
    1.75
    %
    
    
    1.75
    %Expected lives (years)
    
    
    3.5
    
    
    
    3.5
 F-14




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Year Ended December 31,2002
    
    2003Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected volatility
    
    
    190.0
    %
    
    
    68.5
    %
  The Company has adopted the disclosure only provisions of SFAS No. 123. If
compensation cost associated with the Companys stock-based compensation
plan had been determined using the fair value prescribed by SFAS No. 123,
the Companys net loss for 2002 and 2003 would have increased to the pro
forma amounts indicated below: Year Ended December 31,2002
    
    2003Net loss  applicable to
common tockholders as reported
    
    $
    (2,363,643
    )
    
    $
    (2,842,365
    )Add: Stock based employee
compensation included in
reported loss
    
    
    -0-
    
    
    
    -0-Deduct: Employee
compensation expense
    
    
    (242,755
    )
    
    
    (286,877
    )pro forma
    
    
    (2,606,398
    )
    
    
    (3,129,242
    )Loss per share  as reported
    
    $
    (0.29
    )
    
    $
    (0.31
    )pro forma
    
    $
    (0.32
    )
    
    $
    (0.35
    )
  Because additional stock options are expected to be granted each year, the
above pro forma disclosures are not representative of pro forma effects on
reported financial results for future years.GoodwillGoodwill represents the excess of the purchase price for acquisitions over
the fair value of identifiable assets and liabilities acquired. We use
estimates and make assumptions to determine the fair value of acquired
assets and liabilities. If estimates or assumptions change in the future,
we may be required to record goodwill impairment charges. In future
periods, if goodwill is determined to be impaired we will recognize a
non-cash charge equal to the excess of the carrying value over the
determined fair value. There can be no assurance that future goodwill
impairment tests will not result in a charge to earnings.ReclassificationsCertain reclassifications have been made to prior year balances in order
to conform to the current year presentation.New accounting pronouncementsIn July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146), effective for
exit or disposal activities initiated after December 31, 2003. SFAS 146
addresses the financial accounting and reporting for certain costs
associated with exit or disposal activities, including restructuring
actions. SFAS 146 excludes from its scope severance benefits that are
subject to an on-going benefit arrangement governed by SFAS 112,
Employers Accounting for Post employment Benefits, and asset impairments
governed by SFAS 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. The adoption of SFAS 146 did not have a material impact
on the Companys financial statements. F-15




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In December 2002, the FASB issued SFAS No. 148, Accounting for Stock Based
Compensation  an Amendment of SFAS No. 123 (SFAS 148). This statement
amends SFAS No. 123 to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this statement amends
the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect
of the method used on reported results. The Company will retain the
intrinsic method of accounting for stock based awards granted to employees
and make the required disclosure.In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This Interpretation elaborates on
the disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under certain guarantees that
it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value
of the obligation undertaken in issuing the guarantee. The disclosure
requirements of this Interpretation are currently effective and did not
affect the Companys financial position and results of operations. The
initial recognition and initial measurement provisions of this
Interpretation are applicable on a prospective basis to guarantees issued
or modified after December 31, 2003.In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation
of Variable Interest Entities (FIN 46). This Interpretation requires
that variable interest entities created after January 31, 2003, and
variable interest entities in which an interest is obtained after that
date, be evaluated for consolidation into an entitys financial
statements. This interpretation also applies, beginning July 1, 2003 for
the Company, to all variable interest entities in which an enterprise
holds an interest that it acquired before February 1, 2003. The company
adopted the provisions of FIN 46 and determined there was no effect on our
financial position and results of operations.In April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, which amends SFAS 133 for
certain decisions made by the FASB Derivatives Implementation Group. In
particular, SFAS 149 (1) clarifies under what circumstances a contract
with an initial net investment meets the characteristic of a derivative,
(2) clarifies when a derivative contains a financing component, (3) amends
the definition of underlying to conform it to language used in FASB
interpretation number (FIN) 45, and (4) amends certain other existing
pronouncements. SFAS 149 is effective for contracts entered into or
modified after June 30, 2003, and for hedging relationships designated
after June 30, 2003. In addition, most provisions of SFAS 149 are to be
applied prospectively. The Company has no derivative contracts and
accordingly the adoption of SFAS 149 does not have a material impact on
the Companys financial position or results of operations.In May 2003, the FASB issued SFAS No. 150 Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No.
150 establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that
is within its scope as a liability (or an asset in some circumstances).
Many of these instruments were previously classified as temporary equity.
SFAS No. 150 will be effective for financial instruments entered into or
modified after May 31, 2003, and otherwise shall be effective at the
beginning of the first interim period beginning after June 15, 2003. For
financial instruments created before the issuance date of SFAS No. 150 and
still existing at the beginning of the interim period of adoption,
transition shall be achieved by reporting the cumulative effect of a
change in accounting principle by initially measuring the financial
instruments at fair value or other measurement attribute required by SFAS
No. 150. Instruments with characteristics of both liabilities and equity
not addressed in SFAS No. 150 will be addressed in the next phase of the
project. The adoption of SFAS No. 150 does not have F-16




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##### Table of Contents



a material impact on
the Companys consolidated financial position, results of operations or
cash flows.In November 2002, the EITF reached a consensus on EITF 00-21, Revenue
Arrangements with Multiple Deliverables, related to the separation and
allocation of consideration for arrangements that include multiple
deliverables. The EITF requires that when the deliverables included in
this type of arrangement meet certain criteria they should be accounted
for separately as separate units of accounting. This may result in a
difference in the timing of revenue recognition but will not result in a
change in the total amount of revenue recognized in a bundled sales
arrangement. The allocation of revenues to the separate deliverables is
based on the relative fair value of each item. If the fair value is not
available for the delivered items then the residual method must be used.
This method requires that the amount allocated to the undelivered items in
the arrangement is their full fair value. This would result in the
discount, if any, being allocated to the delivered items. This consensus
is effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. The adoption of EITF 00-21 does not have a
material impact on our financial statements at this time.On December 17, 2003, the SECs Office of the Chief Accountant and
Division of Corporation Finance issued Staff Accounting Bulletin (SAB)
104, Revenue Recognition. The SAB updates portions of the interpretive
guidance included in Topic 13 of the codification of staff accounting
bulletins (SAB 103 codification) in order to make the guidance consistent
with current authoritative accounting literature. The principal revisions
relate to the incorporation of certain sections of the staff s FAQ
document on revenue recognition into Topic 13. The Company does not
expect the adoption of SAB 104 to have a material effect on the Companys
financial statements.  3.
    
    Property and Equipment  Property and equipment consisted of the following at December 31: 2003Computer equipment
    
    $
    502,065Furniture and fixtures
    
    
    43,297Leasehold improvements
    
    
    40,832586,194Less: Accumulated depreciation and amortization
    
    
    (443,741
    )Net property and equipment
    
    $
    142,453
  Computer equipment and furniture and fixtures include equipment held under
capital leases of $98,114. Depreciation and amortization expense for
December 31, 2002 and 2003 was approximately $593,000 and $808,000
including amortization of computer equipment and furniture and fixtures
held under capital leases of approximately $13,829 and $46,884. F-17




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##### Table of Contents



4.
    
    Capitalized and Purchased Software  Capitalized and purchased software consisted of the following at December
31: 2003Capitalized software
    
    $
    2,608,678Purchased software
    
    
    444,7443,053,422Less: Accumulated depreciation and amortization
    
    
    (1,125,455
    )Net capitalized and purchased software
    
    $
    1,927,967
  Amortization expense for capitalized and purchased software for the years
ended December 31, 2002 and 2003 was approximately $400,000 and $683,000,
respectively. During 2003, the Company wrote off capitalized software of
$883,060 related to two products. See further discussion at Notes 2, 7 and
17.  5.
    
    Intangible Assets  Intangible assets are comprised of the following at December 31: 2003Customer list
    
    $
    1,500,000Trademarks
    
    
    197,9581,697,958Less: Accumulated amortization
    
    
    (207,519
    )$
    1,490,439
  Amortization expense for the years ended December 31, 2002 and 2003 was
approximately $40,000 and $57,000, respectively. Amortization of
intangibles for the years ending December 31,: 2004
    
    $
    95,9892005
    
    
    88,2352006
    
    
    88,2352007
    
    
    88,2352008
    
    
    88,235Thereafter
    
    
    1,041,509Total
    
    $
    1,490,439
  6.
    
    Goodwill  In accordance with SFAS No. 142, the Company recorded goodwill of
$2,161,454 from the purchase of Edgil Associates, Inc. (Edgil). The
Company does not amortize goodwill in accordance with SFAS 142. However
the Company evaluates goodwill at least on an annual basis for impairment.
The Company performed an impairment test of goodwill using the public
company market multiple method and concluded that goodwill was not
impaired. 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. F-18




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##### Table of Contents



7.
    
    Significant Contracts  On March 18, 2002, the Company entered into a series of agreements with
Tribune Company (Tribune). In accordance with these agreements, the
Company sold 1,443,457 shares of Series A convertible preferred stock to
Tribune Company for approximately $1.8 million before the deduction of
related expenses. The Company has recorded the $1.8 million investment in
the Series A convertible preferred stock at cost which approximated fair
value. The rights and preferences of the Series A preferred stock are
described in Note 8 below. Additionally, the Company agreed to develop and
customize a version of its Web software applications to Tribune
specifications in exchange for earning volume-based transaction fees in
the future by providing Web-based recruitment ad sales technology to all
major market Tribune newspapers and on-line services. This customization
will provide a platform that allows Tribune owned newspapers, together
with CareerBuilder, L.L.C., to receive recruitment advertising from
agencies, corporate customers, and the general public. On completion of the development and customization
effort, the Company will manage the related transactions and receive a
volume-based ASP fee with a guaranteed monthly minimum. Costs incurred in
the customization effort after technological feasibility is obtained, are
included in property and capitalized and purchased software in the balance
sheet.As of December 31, 2003, $294,063 in development and customization costs
associated with the FlexAds application have been capitalized net of a
write down of $316,462, Notes 2 and 17. As of December 31, 2003 the
Company had launched the FlexAds® service on eight Tribune newspapers
and commenced full amortization of the cost of the development and
customization effort over the maximum 5 year period of the contract. Under
terms of the agreement the Company receives $7,500 minimum monthly
payments for up to 60 months; comprised of a 36-month contract with two
12-month options which automatically renew unless Tribune provides 180-day
notice. The Company commenced recognition of revenue from the $7,500
minimum monthly fee under the agreement on a straight-line basis during
August 2002.The monthly transactions have not exceeded the contracted minimums during
any month since inception and have essentially stabilized at less than 20% of
the guaranteed minimum resulting in amortization exceeding revenues
recognized by $13,778. In November 2003 Tribune Company indicated to
AdStar that a significant change in the programming was required to meet
their internal requirements. Under the terms of the agreement, AdStar has
to provide up to 2 full time equivalent programmers for such modifications
at no additional charge. In accordance with Company policy management
determined the carrying value of the FlexAd software application
(Notes 2 and 17) and the related service contract have a
permanent impairment in value. As such management estimated that the
expected future revenues were never likely to exceed total costs, and that
under the existing transaction levels there is no assurance that Tribune
would exercise its options to extend the contract. As such we
recorded an additional $170,000 in estimated costs to complete the additional
programming requirement. The write-down is included in the
statement of operations under cost of revenues as part of the loss on
write down of capitalized software. See notes 2 and 17.In December 2002 the Company entered into an agreement with Tribune
Company for an additional investment by Tribune of $1,500,000. As part of
the transaction, AdStar will develop additional features that expand the
capabilities of its generic service and the customized services that were
launched in August 2002. The investment is in the form of an initial
purchase by Tribune of 1,200,000 shares of Series B-1 preferred stock for
$900,000 which funded in December 2002 and a subsequent purchase, of
800,000 shares of Series B-2 preferred stock for $600,000. In addition,
on the second closing the series B-1 shares, plus additional shares issued
for accrued dividends on F-19




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##### Table of Contents



Series B-1 converted to series B-2. The purchase
price for each share of the Series B-1 and Series B-2 preferred stock was
$0.75 at or below the fair market value of AdStar common stock at the time
of the respective closing. These shares carry a liquidation preference
that includes a dividend of 7% per year available only upon liquidation
and currently convert on a 1:1 basis. Shareholders of Series B Preferred
Stock are entitled to vote on all matters submitted to the stockholders
for vote and vote as a single class with the shareholders of our Common
Stock. The holders of Series B preferred stock are entitled to one vote
for each share of common issuable upon conversion.  8.
    
    Convertible Preferred Stock  The Company has authorized 5,000,000 shares of preferred stock, par value
$0.0001 per share, of which 1,443,457 shares have been designated as
Series A, convertible preferred stock (Series A preferred stock),
1,200,000 shares have been designated as Series B-1, convertible preferred
stock and 800,000 shares have been designated as Series B-2, convertible
preferred stock (Series B preferred stock). The remaining authorized
 shares have not been designated.At December 31, 2003, the Company has reserved 1,443,457 shares of common
stock for issuance upon the conversion of the Series A and 2,000,000
Series B preferred stock. The Series A and B preferred stock have the
following characteristics:Voting Rights Each holder of the Series A and B preferred stock is
entitled to the number of votes equal to the number of shares of common
stock into which such holders shares are convertible. The Company cannot
amend its certificate of incorporation amending the rights of the Series A
and B preferred stockholders, enter into any capital stock or equity
agreements with rights ranking the same or above the rights of the Series
A preferred stock or liquidate the Company without the approval of at
least a majority of the holders of the Series A preferred stock then
outstanding.Liquidation Preference In the event of any liquidation, dissolution or
winding up of the affairs of the Company, the holders of the Series A and
B preferred stock will be entitled to receive in preference to the holders
of the common stock, an amount per share equal to $1.244 and $0.75 accrued
and unpaid dividends, respectively. After such payment, the Series A and B
preferred stockholders share equally with the common stockholders in any
remaining assets or funds of the Company.Conversion Each share of the Series A and B preferred stock is
convertible at anytime at the option of the holder into shares of common
stock pursuant to a ratio of one share of common stock for each share of
Series A and B preferred stock, subject to certain stock split and stock
dividend adjustments. In addition, the conversion ratio is subject to
adjustment, as defined in the agreement, in the event that the Company
issues common stock at a per share price less than $1.244 per share for
series A and $0.75 for series B. All Series A preferred stock will
automatically convert to common stock on the first day after March 18,
2004 for which the market price of the Companys common stock exceeds
$2.25 per share. All Series B preferred stock will automatically convert
to common stock on the first day after December 23, 2005 for which the
market price of the Companys common stock exceeds $1.50 per shareDividends Dividends on the Series A and B preferred stock shall accrue
cumulatively at 7% per annum through the date of liquidation or
conversion. In the event of conversion all accrued and unpaid dividends
will be waived. The 7% cumulative dividend has not been shown as a
deduction from net loss applicable to common shareholders, since the
dividends are only to be paid if a liquidation event occurs and the
dividends would be accrued from the original issuance date to the date of
the liquidating event. If the Series A preferred stock is converted into
common stock, the right to the cumulative dividends will be waived. F-20




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##### Table of Contents



9.
    
    Notes PayableDuring December 2002, the Company entered into a 7% $300,000 unsecured
bridge note payable agreement with Tribune Company pending the closing of
the $900,000 funding on the Series B-1 preferred stock transaction. During
December 2002 the note was repaid out of the proceeds from the $900,000,
see Note 5.During March 2003, the Company entered into a 7% $200,000 unsecured bridge
note payable agreement with Tribune Company pending the closing of the
$600,000 funding on the Series B-2 preferred stock transaction. During
March 2003 the note was repaid out of the proceeds from the $600,000, see
Note 5.Pursuant to the Merger agreement the notes payable to the two former
stockholders of Edgil were restated whereby each stockholder received
$51,500 in principal payments upon the closing and the remaining $31,500
note balance, for each Stockholder, is to be repaid in six equal payments
of principal along with all interest at a rate of 8% per annum, with the
first payment to be made on the six month anniversary of the Effective
Date (October 21, 2003) and each of the next five payments to be paid each
six months thereafter, with the final payment to be made on the third
anniversary of the Closing Date. Accordingly $21,000 in minimum principal
paydowns are due during each of the years ending December 31, 2004, 2005,
and 2006.10.
    
    Due to publicationsThe Company processes credit cards on behalf of certain of its customers
as part of ASP services provided. The Company receives net proceeds daily
on behalf of these customers for third party ads placed via credit card.
These transactions are reconciled monthly and submitted to the
publication, net of processing fees, generally within 35 days from the
month end.11.
    
    Income TaxesProvision for income taxes consist of the following: December 31,2002
    
    2003Current taxesFederal
    
    $
    
    
    
    $
    State
    
    
    6,760
    
    
    
    13,850DeferredFederal
    
    
    680,300
    
    
    
    348,200State
    
    
    183,500
    
    
    
    100,700Total deferred taxes
    
    
    863,800
    
    
    
    448,900Change in valuation allowance
    
    
    (863,800
    )
    
    
    (448,900
    )Income tax provision
    
    $
    6,760
    
    
    $
    13,850
 F-21




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##### Table of Contents



Prior to June 30, 1999, the Company was taxed as an S-Corporation.
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,
consisted of the following: 2003Deferred tax assets:Net operating loss carryforwards
    
    $
    5,683,000Depreciation and amortization
    
    
    189,000Deferred revenue
    
    
    45,000Other
    
    
    73,000Gross deferred tax asset
    
    
    5,990,000Deferred tax liabilityDepreciation and amortization
    
    
    (688,000
    )Gross deferred tax liabilities
    
    
    (688,000
    )Net Deferred tax asset
    
    
    5,302,000Less: Valuation allowance
    
    
    (5,302,000
    )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, 2003, the Company has federal net operating loss
carryforwards of approximately $15,431,000. As of December 31, 2003, the
Company has state net operating loss carryforwards of approximately
$7,296,000. The federal and state net operating loss carryforwards will
begin to expire in 2020 and 2005, respectively. The Companys ability to
utilize net operating loss carryforwards 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, 2002 and
2002 differs from the amount that would result from applying the federal
statutory rate as follows: 2002
    
    2003Statutory regular federal income tax rate
    
    
    (34.0
    %)
    
    
    (34.0
    %)Change in valuation allowance
    
    
    34.4
    %
    
    
    36.8
    %State taxes, net of federal benefit
    
    
    (3.0
    %)
    
    
    (3.0
    %)Other
    
    
    2.5
    %
    
    
    .2
    %(0.0
    %)
    
    
    (0.0
    %)
  12.
    
    CapitalizationCommon StockIn June 2001, the shareholders approved an increase to the number of
authorized shares of the Companys common stock from 10,000,000 to
20,000,000. F-22




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In December 1999, the Company established a vendor compensation plan
whereby it may compensate vendors who are accredited investors, as defined
under Rule 215 of the Securities Act of 1933, in shares of its common
stock in lieu of cash. Under the plan, 400,000 shares are available for
issuance. AdStar established a vendor payment plan whereby it may pay
vendors who are accredited investors, as defined under Rule 215 of the
Securities Act of 1933, in shares of its common stock in lieu of cash.
Under the plan, 400,000 shares are available for issuance. During 2002 and
2003, 63,000 (net of 68,000 returned) and 34,822 shares, respectively, were
issued to vendors under the plan relying upon the exemptions under
Sections 4(2) and 4(6) of the Securities Act of 1933 which represented
compensation of $10,000 (net of $68,000 returned) and $31,500,
respectively. In addition, during 2001 warrants to purchase 50,000 shares
at $1.50 per share and 50,000 shares at $2.00 per share were issued to a
vendor. The Black-Scholes value of these warrants was $25,000.In February 2001 the Company issued 593,483 common shares to satisfy a
note, dated October 21, 1999, in full payment of principal and accrued
interest totaling $1,186,966. In April 2001, the Company completed a
private offering and raised net proceeds of approximately $328,000 through
the issuance of 400,000 units comprising two shares of the Companys
authorized but unregistered common stock and one warrant to purchase an
additional share of common stock at a per share price of $1.07. In October
2001, the Company initiated a private placement offering of up to
1,300,000 shares of the Companys authorized but unregistered common stock
at $0.50 per share. Through December 31, 2002, the Company had raised
gross proceeds of $500,000, of the planned $650,000, with the remaining
investment raised in January 2002.In January 2002, AdStar issued to Marina Co. a nominee of the partners of
Morse, Zelnick, Rose and Lander LLP, (a related party) AdStars legal
counsel, 114,545 shares of restricted common stock, at fair market value
as payment in full for $62,500 legal expenses accrued at December 31,
2002. In January 2002, the Company sold an additional 300,000 shares of
common stock at a price of $0.50 per share. These shares were sold as
part of a 1,300,000 share private placement made pursuant to Sections 4(2)
and 4(6) of the Act, of which 1,000,000 were sold prior to December 31,
2002. In connection with this offering the Company issued warrants to
purchase 130,000 shares of its common stock, at $0.75 as part of the
placement agent fees. The warrants expire on January 16, 2007.On February 1, 2002, AdStar sold to an accredited investor 100,000 shares
of its common stock at a price per share equal to 85% of its per share
closing price on January 31, 2002 ($0.50). In connection with this sale
the Company issued warrants to purchase 10,000 shares of its common stock,
at a per share price equal to 110% of the closing price of the stock on
January 17, 2002, as part of the placement agent fees. The warrants expire
on January 31, 2007.In November 2000, AdStar entered in a one-year strategic alliance
agreement with Eastman Kodak Company (Kodak) whereby AdStar issued 67,796
shares of its common stock valued at $100,000, which was capitalized and
amortized over the life of the contract. As of December 2001 the parties
had not been able to complete the provisions of the agreement to both
parties satisfaction, whereby Kodak notified AdStar of its intention to
terminate the agreement as of February 28, 2002. After protracted
settlement discussions the parties agreed to a mutual termination and
release agreement entered into during May 2002. As part of the agreement
Kodak returned AdStars common stock, valued at $67,796, which AdStar
recorded as a gain on the return of common stock shares and included in
other income and AdStar agreed not to pursue any further actions for
performance against Kodak.In March 2002, the Board of Directors approved the sale of 1,443,457 shares of our Series A Preferred Stock to Tribune Company for an aggregate
purchase price of $1.8 million. These shares currently convert on a 1:1
basis. Shareholders of Series A Preferred Stock are entitled to vote on
all matters submitted to the stockholders for vote and as a single class
with the Common Stock. The F-23




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holders of Series A Preferred Stock are
entitled to one vote for each share of Common Stock issuable upon
conversion. This sale was exempt from registration, as it was a nonpublic
offering, made pursuant to Sections 4(2) and 4(6) of the Act.In December 2002 the Board of Directors approved the sale of shares of its
Series B Preferred Stock to Tribune Company for an aggregate price of $1.5
million. The sale was split into two funding segments:  (i)     In December 2002, AdStar sold 1,200,000 shares of its Series B-1
Preferred Stock to Tribune Company for an aggregate purchase price
of $900,000 excluding $86,200 in costs of financing. These shares
currently convert on a 1:1 basis. Shareholders of Series B-1
Preferred Stock are entitled to vote on all matters submitted to the
stockholders for vote and as a single class with the Common Stock.
The holders of Series B-1 Preferred Stock are entitled to one vote
for each share; and(ii)     In March 2003, AdStar sold 800,000 shares of its Series B-2
Preferred Stock to Tribune Company for an aggregate purchase price
of $600,000 excluding $71,317 in costs of financing. These shares
currently convert on a 1:1 basis. Shareholders of Series B-2
Preferred Stock are entitled to vote on all matters submitted to the
stockholders for vote and as a single class with the Common Stock.
The holders of Series B-2 Preferred Stock are entitled to one vote
for each share. In addition, on March 28, 2003, in exchange for all
of the Series B-1 Preferred Stock plus accrued and unpaid dividends
on those shares, issued in December 2002 to Tribune Company, AdStar
issued an additional 1,200,000 shares of its Series B-2 Preferred
Stock to the Tribune Company.  These sales were exempt from registration, as it was a nonpublic offering,
made pursuant to Sections 4(2) and 4(6) of the Act.In March 2003, AdStar issued to Marina Co. a nominee of the partners of
Morse, Zelnick, Rose and Lander LLP, AdStars legal counsel, 63,291 shares
of restricted common stock, issued at fair market value as payment for $
50,000 in legal services accrued at December 31, 2002. This sale was
exempt from registration, as it was a nonpublic offering, made pursuant to
Sections 4(2) and 4(6) of the Act.In September 2003 the Company sold through a private placement offering
1,590,000 shares of the shares of the Companys authorized but
unregistered common stock at a price of $1.25 per share. In connection
with this offering the Company paid a commission consisting of $198,750 in
cash and issued warrants to purchase 159,000 shares of its common stock,
at $1.87. The warrants are exercisable beginning on March 31, 2004 and
expire on March 31, 2009. The Company valued the warrants using the Black
Scholes method, which resulted in a value of $261,169. This amount is
along with $65,080 in other costs are being offset against the proceeds
from the private placement as a cost of financing.On October 21, 2003 (the Effective Date), AdStar acquired all of the
business and assets of Edgil pursuant to an Agreement and Plan of Merger
(the Merger Agreement), dated as of the Effective Date, by and among
AdStar, Edgil, EDG, and Edward P. Hopey and Gilbert Wolsky, the
stockholders of Edgil (collectively, the Edgil Stockholders).Pursuant to the Merger Agreement, we paid $1,520,000 cash and issued
1,311,530 shares of common stock, in exchange for the business and all of
the assets of Edgil. Based upon the average closing price of the Common
Stock on the Nasdaq SmallCap Market for the 10 trading day period
beginning October 14, 2003 the value of the Edgil Shares was $2,111,563.
The Company issued authorized but previously unissued shares of Common
Stock in the acquisition. F-24




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##### Table of Contents



In November 2003 the Company sold through a private placement offering
1,257,693 shares of the Companys authorized but unregistered common stock
at a price of $1.30 per share, less costs of $56,104, for a net amount of
$1,578,896.During 2002 and 2003 the Company issued 16,531 and 19,886 shares of common
stock with a fair market value of $15,000 and $27,000, respectively, under
our vendor compensation plan to a vendor for software engineering services
performed on month-to-month contract.In December 2003, AdStar issued to Marina Co. a nominee of the partners of
Morse, Zelnick, Rose and Lander LLP, AdStars legal counsel, 34,615 shares
of restricted common stock, issued at fair market value as payment for
$45,000 in legal services provided during 2003. This sale was exempt from
registration, as it was a nonpublic offering, made pursuant to Sections
4(2) and 4(6) of the Act.Stock OptionsIn 1999, the Board of Directors adopted the 1999 Stock Option Plan (the
Plan) in order to attract and retain officers, other key employees,
consultants and non-employee directors of the Company. The plan as amended
during 2002 has an aggregate of 1,500,000 shares of common stock has been
authorized for issuance under the Plan.The Plan provides for issuance of nonqualified and incentive stock options
to officers, key employees, consultants and non-employee directors to 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 Plan.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 options 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 to ten years from the date of grant unless
otherwise determined by the committee that administers the Plan. All
options granted in from 1999 through 2003 have a five-year term.Upon the occurrence of a change in control, as defined in the Plan, each
option granted under the Plan shall thereupon become fully vested and
exercisable.Pursuant to the Merger agreement, at the Closing, AdStar replaced each
Edgil vested option with a corresponding AdStar option (based on the
merger consideration received by the Edgil Stockholders) as follows: (a)
each holder of an option to purchase shares of Edgil Common Stock at $0.92
per share received in replacement therefor an option to purchase that
number of shares of AdStar Common Stock as equaled the number of shares of
Edgil Common Stock which such optionee had a right to purchase, multiplied
by 0.4858, at a price per share of $0.73; (b) each holder of an option to
purchase shares of Edgil Common Stock at $1.02 per share received in
replacement therefor an option to purchase that number of shares of AdStar
Common Stock as equaled the number of shares of Edgil Common Stock which
such optionee had a right to purchase, multiplied by 0.4858, at a price
per share of $0.94; (c) each holder of an option to purchase shares of
Edgil Common Stock at $1.16 per share received in replacement therefor an
option to purchase that number of shares of AdStar Common Stock as equaled
the number of shares of Edgil Common Stock which such optionee had a right
to purchase, multiplied by 0.4858, at a price per share of $1.23. A total
of 63,397 AdStar options were issued as replacements. The AdStar
replacement options were valued at $68,926 using the Black-Scholes method
and were included in the purchase price of Edgil. Note 16. F-25




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##### Table of Contents



During the year ended December 31, 2003 option holders exercised 74,694
options for which the company received net proceeds of $55,484.The following table summarizes all stock option activity and includes all
options under the Plan and 155,000 non-qualified options for the years
ended December 31, 2002 and 2003: WeightedAverageExerciseShares
    
    PriceOutstanding at December 31, 2001
    
    
    468,461
    
    
    $
    1.58Granted
    
    
    720,444
    
    
    $
    0.87Exercised
    
    
    
    
    
    
    Forfeited
    
    
    (55,431
    )
    
    $
    2.59Outstanding at December 31, 2002
    
    
    1,133,474
    
    
    $
    0.95Granted
    
    
    369,173
    
    
    $
    1.38Exercised
    
    
    (74,694
    )
    
    $
    0.78Forfeited
    
    
    (133,334
    )
    
    $
    1.29Outstanding at December 31, 2003
    
    
    1,294,619
    
    
    $
    1.05Options exercisable at December 31, 2002
    
    
    645,052
    
    
    $
    0.95Options exercisable at December 31, 2003
    
    
    986,118
    
    
    $
    0.94Options available for future grant (1)
    
    
    285,687Weighted average fair value of options granted in 2003
    
    
    
    
    
    $
    1.33Weighted average fair value of options granted in 2002
    
    
    
    
    
    $
    0.67
       (1) Excludes the 155,000 non-qualified options issued to the outside
directors and consultants. The 155,000 is comprised of 50,000 options issued
to Steve Zelnick for services rendered as an outside member of the board of
directors, exercisable at $0.60 per share, expiring on January 27, 2007, 50,000
and 25,000 options issued to Richard Salute for services rendered as an outside
member and as an independent financial expert for the Board of Directors,
respectively, exercisable at $0.94 per share, expiring on January 28, 2008 and
30,000 options issued to an Investor Relations firm for services rendered as,
exercisable at $1.99 per share, expiring on November 24, 2008,  The following table summarizes information about stock options outstanding
at December 31, 2003: Options Exercisable atOptions Outstanding at December 31, 2003
    
    December 31, 2003WeightedAverage
    
    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
    
    
    900,803
    
    
    
    2.42
    
    
    $
    0.71
    
    
    
    802,137
    
    
    $
    0.68$1.00 - $2.99
    
    
    337,704
    
    
    
    1.48
    
    
    $
    1.47
    
    
    
    127,869
    
    
    $
    1.21$3.00 - $5.99
    
    
    8,889
    
    
    
    0.33
    
    
    $
    4.77
    
    
    
    8,889
    
    
    $
    4.77$6.00 - $7.20
    
    
    17,223
    
    
    
    0.67
    
    
    $
    6.77
    
    
    
    17,223
    
    
    $
    6.771,264,619
    
    
    
    
    
    
    
    
    
    
    
    956,118
 F-26




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##### Table of Contents



WarrantsThe following table summarizes activity for the years ended December 31,
2002 and 2003: WeightedAverageExerciseShares
    
    PriceOutstanding at December 31, 2001
    
    
    2,175,002
    
    
    $
    6.15Issued
    
    
    140,000
    
    
    $
    0.75Exercised
    
    
    
    
    
    $
    0.00Forfeited
    
    
    (33,334
    )
    
    $
    6.00Outstanding at December 31, 2002
    
    
    2,281,668
    
    
    $
    5.83Issued
    
    
    159,000
    
    
    $
    1.87Exercised
    
    
    (152,501
    )
    
    $
    1.29Forfeited
    
    
    (16,667
    )
    
    $
    6.00Outstanding at December 31, 2003
    
    
    2,271,500
    
    
    $
    5.85Warrants exercisable at December 31, 2002
    
    
    2,281,668
    
    
    $
    5.83Warrants exercisable at December 31, 2003
    
    
    2,271,500
    
    
    $
    5.85Weighted average fair value of warrants issued in 2003
    
    
    
    
    
    $
    0.98Weighted average fair value of warrants issued in 2002
    
    
    
    
    
    $
    0.38
  The following table summarizes the outstanding warrants, all of which are
currently exercisable, to purchase common stock at December 31, 2003: Number
    
    Exercise Price
    
    Expiration Date1,150,000
    
    $
    9.00
    
    
    December 2004200,000
    
    $
    7.20
    
    
    December 200425,000
    
    $
    10.00
    
    
    March 2005200,000
    
    $
    1.80
    
    
    September 200550,000
    
    $
    2.00
    
    
    October 2005400,000
    
    $
    1.07
    
    
    April 200687,500
    
    $
    0.75
    
    
    January 2007159,000
    
    $
    1.87
    
    
    March 2009
  During the year ended December 31, 2003 warrant holders exercised 152,501
warrants for which the company received net proceeds of $197,377.  13.
    
    Shareholder receivable  In 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 note is 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 F-27




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##### Table of Contents



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, 2003 the outstanding notes receivable was $239,995. See Note
16.  14.
    
    Restructuring costsDuring 2001 the Company critically examined the processing capabilities of
its existing software modules and identified potential new commercial
applications that could be developed using our existing technology as a
starting point. With these changes in mind, we repositioned our products,
moving away from the idea of the Internet as a stand-alone business
category, and moving towards the idea of the Internet as an extremely
efficient and flexible communication channel.The plan contemplated among other things the closure of the New York
office within approximately nine months, a related reduction in force of
the 4 technology staff as of December 31, 2002 and the abandonment of an
externally created customized billing software module. While the strategy
had been in play for several months, including the addition of office
space in the corporate offices to facilitate the transition, Management
formally approved the final strategy in December 2002. During December
2002 the Company hired a seasoned industry executive to transfer the
software programs and intellectual knowledge from the New York office to
the corporate office, identify and begin training existing personnel in
anticipation of the reduction-in-force, and abandoned the billing software
system. The corporate office will assume full revenue responsibilities
concurrently with the closing of the New York office.During 2003 the Company completed the major enhancement of is products and
the major requirements under the terms of the Tribune Agreements. In
addition the Company acquired Edgil Associates, Inc., and immediately
commenced an overall product line evaluation as part of the integration.
As described in prior quarter financials management approved a
reduction-in-force during the forth quarter, evaluated excess computer
equipment and paid a bonus associated the successful transition of the New
York office.The following table summarizes the restructuring activity for the year
ended December 31, 2003; these costs are included in accrued expenses on
the balance sheet: Bonus and
    
    Office
    
    Equip-
    
    Legal andAccrued restructuring
    
    Severance
    
    Lease
    
    ment
    
    Other
    
    TotalBalance December 31, 2002
    
    $
    
    
    
    $
    75,550
    
    
    $
    
    
    
    $
    118,674
    
    
    $
    194,224Additions for 2003 restructuring
    
    
    50,311
    
    
    
    16,000
    
    
    
    58,463
    
    
    
    
    
    
    
    124,774Charges for 2002 and 2003
    
    
    (25,000
    )
    
    
    (32,942
    )
    
    
    (58,463
    )
    
    
    (103,021
    )
    
    
    (219,426
    )Balance December 31, 2003
    
    $
    25,311
    
    
    $
    58,608
    
    
    $
    
    
    
    $
    15,653
    
    
    $
    99,572
  15.
    
    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 New York, California, Massachusetts, and New Jersey and expire
through November 2005. The leases contain certain escalation clauses based
on certain F-28




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charges that the landlords of the properties may incur over the base year,
as defined in the lease agreements.  In June 2001, the Company assigned the lease for its New Jersey office to
a third party, whereby that party would be primarily responsible and the
Company would be secondarily liable for lease payments through the end of
the lease agreement. F-29




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##### Table of Contents



Future minimum lease payments under the non-cancelable operating and
capital leases as of December 31, 2003 are as follows: Operating
    
    CapitalYears Ending December 31,
    
    Leases
    
    Leases2004
    
    $
    413,695
    
    
    $
    39,2512005
    
    
    207,709
    
    
    
    19,4652006
    
    
    59,382
    
    
    
    126Total minimum obligations
    
    $
    680,785
    
    
    
    58,842Less: Amounts representing interest
    
    
    
    
    
    
    (8,842
    )Present value of minimum obligations
    
    
    
    
    
    
    50,000Less: Current portion
    
    
    
    
    
    
    (31,715
    )Non-current portion
    
    
    
    
    
    $
    18,285
  Rent expense for the years ended December 31, 2002 and 2003 was
approximately $181,700 and $154,700, respectively, including
month-to-month rentals. Beginning in March 2001, the Company entered in an
agreement to sub-lease a portion of its corporate office space to a third
party for $10,750 per month for the first 18-months which increased to
$11,012 for the remaining 30 months. Beginning in December 2003 the
Company entered into an agreement to sub-lease its New York office space
for $2,418 per month through April 2005. For the years ended December
31, 2002 and 2003, the Company received approximately $135,900 and
$143,300, respectively, of sublease income, which is included in General
and administrative expense on the statement of operations.In the normal course of business, various claims and lawsuits have been
filed or are pending against the Company. Management believes the outcome
of any such suits will not have a material adverse effect on the Companys
financial condition or results of operations.Employment AgreementsOn July 1, 2002, AdStar entered into four-year employment agreements with
each of Leslie Bernhard and Eli Rousso. Their prior agreements expired on
June 30, 2002. Pursuant to her employment agreement, Leslie Bernhard was
retained as our Chief Executive Officer and her total annual compensation
was reduced to $212,800. Pursuant to his employment agreement, Eli Rousso
was retained as our Executive Vice President and his total annual
compensation was reduced to $212,800. Each agreement provides, among other
things, for participation in an equitable manner in any profit-sharing or
retirement, separation and disability plans for employees or executives
and for participation in other employee benefits applicable to employees
and executives of AdStar. Each agreement further provides for fringe
benefits which commensurate with the executives duties and
responsibilities. Under each agreement, employment may be terminated by us
with cause or by the executive with good reason. Termination by us without
cause, or by the executive for good reason, would subject us 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.In January 2001, AdStar entered into a 2-year employment contract with Mr.
Jeffrey Baudo. 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 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. Mr. Baudo is the brother of Leslie
Bernhard. F-30




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##### Table of Contents



Pursuant to the Merger agreement the two stockholders of Edgil entered
into employment agreements whereby each receives a monthly salary of
$7,000 for six months from the effective date, October 31, 2003. Employment contract Payments due by PeriodBeyond2004
    
    2005
    
    2006
    
    2007
    
    Total$785,300
    
    $
    425,600
    
    
    $
    212,800
    
    
    $
    
    
    
    $
    1,423,700
  License AgreementIn April 1996, the Company entered into an exclusive license agreement
with a software company that developed the facsimile technology available
as a feature within the Companys historical software product. This
agreement provides that the Company pays royalties of up to 50% of net
revenues generated by the Company on license fees, implementation fees and
maintenance fees. This agreement is for an initial term of 20 years,
though it can be terminated by the Company upon six months notice or by
the software company in certain circumstances. For the years ended
December 31, 2002 and 2003, the Company paid royalties of approximately
$47,000 and $24,000, respectively.16.
    
    Acquisition of Edgil Associates, Inc.On October 21, 2003 (the Effective Date), the Company acquired Edgil
Associates, Inc. (Edgil) through a forward triangular merger pursuant to
an Agreement and Plan of Merger (the Merger Agreement), dated as of the
Effective Date, by and among AdStar, Edgil, EDG, and Edward P. Hopey and
Gilbert Wolsky, the stockholders of Edgil (collectively, the Edgil
Stockholders).Pursuant to the Merger Agreement, the Company paid $1,520,000 cash and
issued 1,311,530 shares of common stock, in exchange the business and
assets of Edgil. Based upon the average closing price of the Common Stock
on the Nasdaq SmallCap Market for the 10 trading day period beginning
October 14, 2003 the value of the Edgil Shares was $2,111,563. In
addition the Company issued 63,397 AdStar options valued at $68,926 using
the Black-Scholes method as replacement options for fully vested Edgil
employee options (Note 12) recorded an estimated $200,000 in Legal,
Accounting and other fees as part of the cost of the acquisition. The
Company issued authorized but previously unissued shares of Common Stock
in the acquisition. The cash and number of shares of Common Stock issued
to the Edgil Stockholders was determined in an arms-length negotiation
and the transaction was unanimously approved by our Board. Prior to the
Effective Date, neither we nor any of our affiliates, nor any of our
officers or directors and any of their associates had any material
relationship with Edgil, except that AdStar was a customer of Edgil.In connection with the Merger Agreement we and the Edgil Stockholders
entered into a Registration Rights Agreement, dated as of October 21,
2003, pursuant to which we agreed to file a Registration Statement on Form
S-3, for the purposes of registering under the Securities Act of 1933 the
re-sale by the Edgil Stockholders of the Edgil Shares, and AdStar entered
into six-month employment agreements with each of the Edgil Stockholders
effective as of the Effective Date.REASONS FOR THE ACQUISITION OF EDGILThe acquisition of Edgil adds to AdStars suite of e-commerce services:
Edgils EdgCapture, an integrated payment processing solution that
interfaces directly with publishers classified and circulation systems;
and EdgFlow, a content processing solution that allows publishers to
deliver F-31




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##### Table of Contents



media content such as articles, technical documents, advertisements, wire
stories, etc., to multiple channels in a variety of formats. Edgils
products and services will continue to be offered under the Edgil brand,
and AdStar will maintain Edgils Massachusetts-based headquarters.ACCOUNTING TREATMENTThe acquisition of Edgil is accounted for as a purchase business
combination in accordance with the Statement of Financial Accounting
Standards (SFAS) no. 141, Business Combinations. The total purchase
price related to the acquisition of Edgil was $3,899,859. Edgil will
operate as a wholly owned subsidiary of AdStar and the Companys financial
statements will include the results of Edgil from the closing date of the
acquisition (October 21, 2003).The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition. The
allocation of the purchase price is based in part on independent
third-party valuation of certain intangible assets. The excess purchase
price over the estimated fair value of the assets acquired and liabilities
assumed is recorded as goodwill  At October 21, 2003 Current assets

    
    $
    381,887Purchased software
    
    
    311,000Customer list
    
    
    1,500,000Goodwill
    
    
    2,849,634Total assets acquired
    
    
    5,042,521Current liabilities
    
    
    390,852Deferred tax liability
    
    
    688,180Notes payable Shareholders
    
    
    63,000Total liabilities assumed
    
    
    1,142,032Net assets acquired
    
    $
    3,900,489
  The purchased software is comprised of internally created software which
was valued by the independent third-party who assigned an expected useful
life of 5 years.The customer list of $1,500,000 is primarily comprised of value of the
recurring revenue stream associated with long-term customers, valued by
the independent third-party who assigned an expected life of 17 years.The excess of the purchase price over the estimated fair value of the
assets acquired and the liabilities assumed was recorded as goodwill.
There is no step up in basis of the assets for tax purposes therefore the
goodwill is not deductible for tax purposes.Since there is no step up in basis of the acquired Edgil assets for tax
purposes amortization of purchased software and customer list is not
deductible for tax purposes. The $688,180 deferred tax liability is
calculated at Edgils 38% blended tax rate assigned by the independent
third-party appraiser and applied to the $311,000 purchased software and
$1,500,000 customer list. At December 31, 2003 in accordance with SFAS
141, the deferred tax liability is expected to be realized over the term
as the deferred tax asset, therefore the deferred tax liability was offset
against the deferred tax asset on AdStar, Inc. (AdStar) as part of the
consolidated income tax provision. As F-32




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##### Table of Contents



a result of this transaction, AdStars deferred tax asset valuation
allowance was reduced. In accordance with SFAS 109, the change in the
valuation allowance was offset against goodwill. Accordingly, the
deferred tax assets and liabilities of the Company has a 100% valuation
allowance recorded.The following summarized pro forma consolidated results of operations are
presented as if the acquisition of Edgil had occurred on January 1, 2002.
The unaudited pro forma results are not necessarily indicative of future
earnings or earnings that would have been reported had the acquisition
been completed as presented. Years Ended December 312002
    
    2003Revenue
    
    $
    4,746,203
    
    
    $
    4,878,051Net Loss
    
    
    (2,222,093
    )
    
    
    (2,537,610
    )Loss per share  basic and diluted
    
    $
    (0.23
    )
    
    $
    (0.28
    )
  17.
    
    Significant fourth quarter adjustmentsDuring the fourth quarter of fiscal 2003 the Company recorded
a $883,060 one time impairment write-down of our contract web and
FlexAd internally developed software applications and a related
reserve for direct costs of contractual obligations to service said
software, primarily based on a product line evaluation undertaken in
December 2003 in connection with the integration of AdStars
Edgil acquisition and new information supplied by the customer for
FlexAds in November 2003 with respect to its future utilization of
that software. A summary of the composition of the write-down is as
follows:In December 2003 the Company recognized $698,060 in
impairment losses and wrote-down two software applications to their
net realizable value. The write down is comprised of $381,598 and
$316,462 for our contract web and FlexAd software applications,
respectively. In addition in November 2003 we entered into
discussions with Tribune Company to materially modify the
FlexAd application. As a result of information provided by Tribune in
these conversations management estimated that the expected future
revenues from the FlexAd application were never likely to exceed
total costs. As such, we recorded an additional $170,000 estimated
loss to service the related customer contract. An additional $15,000
in estimated costs was recorded to support the contract web
application under existing maintenance contracts until we can move
customers to a new version or back to the old application. (See Notes
2 and 7.)The above adjustments increased the loss per common share from $.21 to
$.3118.
    
    Subsequent EventIn February 2004, AdStar entered into negotiations on a $1,500,000
convertible debt arrangement with a lender. On March 5, 2004 the company
signed a proposal letter and is in good faith negotiations to complete
the final terms and conditions. The funding is expected
to close in early April 2004. F-33