##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-KSB
  þ
    
    Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the fiscal year ended December 31, 2006
 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
    
    (I.R.S. Employer Identification No.)incorporation or organization)
 4553 Glencoe Avenue, Suite 300, Marina del Rey, California 90292
    Title of Each Class
    
    Name of Each Exchange on Which RegisteredCommon Stock, par value $.0001 per share
    
    The NASDAQ Stock Market LLC andWarrants to purchase Common Stock
    
    Boston Stock Exchange
  o
 þ o
 þ
 o þ
    DOCUMENTS INCORPORATED BY REFERENCE
  o þ




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##### 



ADSTAR, INC. AND SUBSIDIARY
Form 10-KSB Annual Report
 TABLE OF CONTENTS
 PagePART IItem 1.
    
    Business
    
    
    3Item 2.
    
    Description of Property
    
    
    12Item 3.
    
    Legal Proceedings
    
    
    12Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    12PART IIItem 5.
    
    Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities
    
    
    12Item 6.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operation
    
    
    13Item 7.
    
    Financial Statements
    
    
    22Item 8.
    
    Change in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    22Item 8A.
    
    Controls And Procedures
    
    
    22Item 8B.
    
    Other Information
    
    
    22PART IIIItem 9.
    
    Directors, Executive Officers, Promoters, Control Persons and Corporate Governance; Compliance With Section 16(a) of the Exchange Act
    
    
    23Item 10.
    
    Executive Compensation
    
    
    25Item 11.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    28Item 12.
    
    Certain Relationships and Related Transactions, and Director Independence
    
    
    30Item 13.
    
    Exhibits
    
    
    31Item 14.
    
    Principal Accountant Fees and Services
    
    
    33EXHIBIT 23.2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  FORWARD-LOOKING STATEMENTS
  2




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##### Table of Contents



PART I
 
 Item 1. BUSINESS
 General
  Corporate History
  AdStar Services
  
    
    Professional software This technology is our original service designed for use by
the professional marketplace. Specifically, the applications accept transmissions from
classified advertising agencies, municipalities and large corporations using desktop
software and Web-based communications. The software includes sophisticated pricing
algorithms to provide for maximum flexibility and intricate design resources to provide
unlimited creative capabilities.
    
    ASP website technology This technology is a publisher-specific ad-taking website
service designed to enhance a publications website by allowing the general public to
execute transactions to purchase classified advertising. We enable visitors to a
publishers website 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 service allows a
publication to completely outsource the classified ad-taking power of their website
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
 3




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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, we provide tools to
evaluate performance, provide additional customer care, and increase future revenue
opportunities.
    
    XML Gateway (Application Programming Interface) This technology allows third
parties, internal newspaper applications, and niche Web publishers to facilitate the
processing of classified advertising. The third party application interfaces with
AdStars platform to incorporate Web-based ad taking for print, online, or other
publishing channels.
    
    Credit Card Processing Through our Edgil Associates subsidiary, we offer to
publishers credit card processing services for processing classified ads charges,
subscription charges, or for any other transactions that require a credit card. Edgil
offers system integration services, installation support, training and customer
service. Edgils proprietary EdgCapture payment processing software processes over 12
million newspaper advertising and circulation transactions annually for many of the
largest newspaper publishers in the country, as well as independent daily and specialty
publications. Edgils product strategy focuses on providing publishers with the
financial benefits afforded by reduced labor costs and lower credit card processing
discount rates. Edgils experience with integration services has given the EdgCapture
product line the technical differentiation to meet the specific credit card processing
requirements of the publishing industry.
   Background
   4




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Marketing
    AdStar Business Strategy
   
    
    cross-selling newspaper publishers on Web-based ad-taking and credit card processing, on
an enterprise-level basis, and expanding services to our existing account base with
additional functions and capabilities;
    
    acquiring or partnering with 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;
    
    Expanding our platform functionality to include data feedback, such as the number of
actions taken by viewers of ads, so that advertisers can pay the publishers on a
performance basis. Under this
 5




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model, we can generate revenues as a percentage of the fee for the ad, rather than on a
transaction fee basis;
    
    pursuing additional third-party publishers who desire ad-taking and payment processing
capability for their advertisers by using our XML Gateway;
    
    Leveraging our existing customer base as a means to access local advertisers who desire
advertising campaigns involving multiple publishing channels.
 Competition
     Intellectual Property
    6




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Employees
  Research and Development
  CERTAIN RISK FACTORS THAT MAY AFFECT GROWTH AND PROFITABILITY
  Our Ability To Sustain Our Operations And Ultimately Attain Profitability Could Be Adversely
Affected If We Are Not Able To Generate New Significant ASP Revenues.
  
    
    attract a sufficient number of publishers for our publisher-specific ASP ad-taking
services to permit profitable operations;
    
    develop profitable pricing models for our fees;
    
    respond effectively to competitive pressures; and
    
    attract, retain and motivate qualified personnel.
  We Have A History Of Losses And Until We Are Able To Significantly Increase ASP Revenues We Expect
Continued Losses.
  7




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We May Be Unable To Obtain The Additional Capital Required To Grow Our Business Which Would Have An
Adverse Effect On The Successful Implementation Of Our Planned Business Expansion.
  We Are Vulnerable To Breakdowns In Service, Which Could Cause Our Customers And Prospective
Customers To Lose Faith In Our Ability To Service Their Needs.
  Our Ability To Compete Effectively And Operate Profitably Cannot Be Assured Because Our ASP
Business Competes With Established Methods For Ad-Taking.
  8




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Our Limited Experience May Affect Our Ability To Deal Effectively With Technological Change Which
Could Materially and Adversely Affect Our Business.
  
    
    rapidly changing technology;
    
    evolving industry standards;
    
    frequent new product and service announcements;
    
    introductions and enhancements; and
    
    changing customer demands.
  
    
    our ability to adapt the rapidly changing technologies to the needs of our
advertising and publishing clients; and
    
    our ability to continually improve the performance, features and reliability of our
on-line services.
  We May Be Unable To Manage Our Growth.
  We May Not Be Able To Retain Key Existing Employees Or Attract The Additional Employees Essential
To The Success Of Our Business.
  Our Business Could Be Adversely Affected If The Services Of Either Our Chief Executive Officer Or
Chief Technology Officer Become Unavailable To Us.
  9




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We Are Vulnerable To Potential Lawsuits Regarding Ad Content Or System Failure.
  We May Not Be Able To Protect Our Proprietary Rights.
   If Others Develop Alternate Technologies, Or Use Our Technology Without Our Authorization, Our
Business, Results Of Operation And Financial Position Could Be Materially And Adversely Affected.
  Natural Disasters Which Disrupt Our Services Could Have An Adverse Effect On Our Business, Results
Of Operations And Financial Condition.
  10




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Our Corporate Documents May Limit Rights of Stockholders.
  If Our Shares Of Common Stock Are Removed Or Delisted From The Nasdaq Capital Market, The Ability
Of Stockholders To Sell Our Common Stock And Warrants In The Secondary Market Could Be Restricted.
  If We Are Unable To Satisfy Nasdaqs Maintenance Requirements, Our Common Stock May Be Delisted
From Nasdaq Which Could Impair The Liquidity And The Value Of Our Common Stock.
  11




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Item 2. Description of Property
   
 Item 3. Legal Proceedings
  
 PART II
 
 Item 5. Market for Common Equity and Related Stockholder Matters
 Market Information
  Trade PriceQuarters within Last Two Fiscal Years
    
    High
    
    LowYear Ended December 31, 2005First quarter
    
    $
    1.14
    
    
    $
    0.61Second quarter
    
    $
    0.91
    
    
    $
    0.62Third quarter
    
    $
    2.55
    
    
    $
    0.99Fourth quarter
    
    $
    3.39
    
    
    $
    2.12Year Ended December 31, 2006First quarter
    
    $
    2.60
    
    
    $
    1.75Second quarter
    
    $
    2.18
    
    
    $
    0.85Third quarter
    
    $
    1.19
    
    
    $
    0.69Fourth quarter
    
    $
    2.50
    
    
    $
    0.76
 $
 Holders
  12




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Dividends
   
 Item 6. Managements Discussion and Analysis of Financial Condition and Results of Operation
 The following discussion of our financial condition and results of operations should be read in
conjunction with the consolidated financial statements and related notes to the consolidated
financial statements included elsewhere in this annual report. Certain statements in this
discussion and elsewhere in this report constitute forward-looking statements within the meaning of
Section 21E of the Securities and Exchange Act of 1934. See Forward-Looking Statements following
the Table of Contents of this 10-KSB. Because this discussion involves risk and uncertainties, our
actual results may differ materially from those anticipated in these forward-looking statements.
 Overview
   Recent developments
   13




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Results of Operations
  Year Ended December 31,2005
    
    2006Net revenues
    
    
    100
    %
    
    
    100
    %Cost of revenues
    
    
    34
    %
    
    
    41
    %Gross Profit
    
    
    66
    %
    
    
    59
    %General and administrative expense
    
    
    37
    %
    
    
    37
    %Selling and marketing expense
    
    
    14
    %
    
    
    29
    %Product maintenance and development costs
    
    
    17
    %
    
    
    18
    %Amortization of customer list Restructuring
    
    
    2
    %
    
    
    2
    %Loss from operations
    
    
    -5
    %
    
    
    -27
    %Beneficial interest and amortization of financing fees on convertible note
    
    
    -15
    %
    
    
    0
    %Interest income (expense)
    
    
    -1
    %
    
    
    0
    %Loss before taxes
    
    
    -21
    %
    
    
    -27
    %Provision for taxes
    
    
    0
    %
    
    
    0
    %Net loss
    
    
    -21
    %
    
    
    -27
    %Deemed dividend
    
    
    -2
    %
    
    
    0
    %Net loss applicable to common shareholders
    
    
    -23
    %
    
    
    -27
    %
 Years Ended December 31, 2005 and 2006
 Revenues
    14




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Cost of revenues
   General and administrative expense
   Product maintenance and development costs
   15




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Selling and marketing expense
   Amortization of Customer List
  Beneficial interest and amortization of financing fees on Convertible Note
    Interest expense and income
  16




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Provision for taxes
     Deemed Dividend
  Liquidity and Capital Resources
    17




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New accounting pronouncements
   18




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Critical Accounting Policies and Estimates
  Revenue Recognition
   19




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Software Development Costs
  20




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Warranties and Product liability
   Allowance for doubtful accounts
  Income taxes
  Intangible Assets
  21




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Contractual Obligations, Commitments and Contingencies
   Payments due by PeriodBeyondContractual obligations
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    TotalEmployment agreements
    
    $
    586,000
    
    
    $
    404,000
    
    
    $
    404,000
    
    
    $
    404,000
    
    
    $
    1,798,000Operating lease commitments
    
    
    185,000
    
    
    
    200,000
    
    
    
    182,000
    
    
    
    122,000
    
    
    
    689,000Capital lease commitments
    
    
    10,000
    
    
    
    10,000
    
    
    
    10,000
    
    
    
    14,000
    
    
    
    44,000$
    781,000
    
    
    $
    614,000
    
    
    $
    596,000
    
    
    $
    540,000
    
    
    $
    2,531,000
 
 Item 7. Financial Statements
  
 Item 8. Change in and Disagreements with Accountants on Accounting and Financial Disclosure
  
 Item 8A. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
 Internal Control Over Financial Reporting.
 
 Item 8B. Other Information
  22




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PART III
 
 Item 9.
    
    Directors, Executive Officers, Promoters, Control Persons and Corporate Governance;
Compliance with Section 16(a) of the Exchange Act
  DirectorName
    
    Age
    
    Position
    
    SinceLeslie Bernhard
    
    
    62
    
    
    President, Chief Executive Officer and Director
    
    
    1991Eli Rousso
    
    
    70
    
    
    Executive Vice President, Chief Technology Officer,
Secretary, Treasurer, and Director
    
    
    1991Jeffrey Baudo
    
    
    60
    
    
    Senior Vice President, Chief Operating Officer, and Director
    
    
    2001James Linesch
    
    
    52
    
    
    Chief Financial OfficerPeter M. Zollman (2)
    
    
    53
    
    
    Director
    
    
    2005Michael Jackson (1)
    
    
    42
    
    
    Director
    
    
    2005John Rudy (1) (2)
    
    
    64
    
    
    Director
    
    
    2005Michael P. Dubreuil
(1)(2)
    
    
    47
    
    
    Director
    
    
    2005
 
 (1)
    
    Member of the audit committee of the Board of Directors.(2)
    
    Member of the compensation committee of the Board of Directors. Leslie Bernhard
 Eli Rousso
 Jeffrey Baudo
 Peter M. Zollman
 Michael Jackson
 23




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




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




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Outstanding Equity Awards at December 31, 2006
  EquityIncentivePlanAwards:Number of
    
    Number of
    
    Number ofSecurities
    
    Securities
    
    SecuritiesUnderlying
    
    Underlying
    
    UnderlyingUnexercised
    
    Unexercised
    
    Unexercised
    
    Option
    
    OptionOptions
    
    Options
    
    Unearned
    
    Exercise
    
    ExpirationName
    
    Exercisable (1)
    
    Unexerciseable
    
    Options
    
    Price
    
    DateLeslie
    
    
    75,000
    
    
    
    
    
    
    
    
    
    
    
    0.60
    
    
    
    01/27/07Bernhard
    
    
    75,000
    
    
    
    
    
    
    
    
    
    
    
    0.60
    
    
    
    01/27/0729,151
    
    
    
    
    
    
    
    
    
    
    
    0.73
    
    
    
    01/27/1033,075
    
    
    
    
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1083,333
    
    
    
    
    
    
    
    
    
    
    
    3.50
    
    
    
    12/20/1083,333
    
    
    
    
    
    
    
    
    
    
    
    3.00
    
    
    
    12/20/1050,259
    
    
    
    
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/10Eli
Rousso
    
    
    75,000
    
    
    
    
    
    
    
    
    
    
    
    0.60
    
    
    
    01/27/0775,000
    
    
    
    
    
    
    
    
    
    
    
    0.60
    
    
    
    01/27/0729,151
    
    
    
    
    
    
    
    
    
    
    
    0.73
    
    
    
    01/27/1041,925
    
    
    
    
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1033,075
    
    
    
    
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1075,000
    
    
    
    
    
    
    
    
    
    
    
    3.00
    
    
    
    12/20/1075,000
    
    
    
    
    
    
    
    
    
    
    
    3.50
    
    
    
    12/20/10Jeff
Baudo
    
    
    75,000
    
    
    
    
    
    
    
    
    
    
    
    0.60
    
    
    
    01/27/0775,000
    
    
    
    
    
    
    
    
    
    
    
    0.60
    
    
    
    01/27/0726,260
    
    
    
    
    
    
    
    
    
    
    
    0.73
    
    
    
    01/27/1032,705
    
    
    
    
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1033,962
    
    
    
    
    
    
    
    
    
    
    
    2.38
    
    
    
    12/20/1066,667
    
    
    
    
    
    
    
    
    
    
    
    3.00
    
    
    
    12/20/1066,667
    
    
    
    
    
    
    
    
    
    
    
    3.50
    
    
    
    12/20/10James
Linesch
    
    
    
    
    
    
    50,000
    (2)
    
    
    
    
    
    
    2.25
    
    
    
    02/19/11
 26




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(1)
    
    Fully vested(2)
    
    Vest ratably over three years beginning on February 20, 2007 at 16,667 shares per year. Employment Contracts and termination of employment and change-in-control arrangements
   Director Compensation
  OptionName
    
    Awards (1)
    
    TotalMichael Dubreuil
    
    $
    15,846
    
    
    $
    15,846Michael Jackson
    
    $
    15,846
    
    
    $
    15,846John Rudy
    
    $
    15,846
    
    
    $
    15,846Peter M. Zollman
    
    $
    15,846
    
    
    $
    15,846
 
 (1)
    
    Amounts calculated utilizing the provisions of Statement of Financial Accounting
Standards (SFAS) No. 123R, Share-based Payments. See Note 11 of the consolidated
financial statements included with this Annual Report on Form 10-KSB for the year ended
December 31, 2006 regarding assumptions underlying valuation of equity awards. At December
31, 2006 the aggregate number of option awards outstanding for each director was options
for 50,000 shares. Limitation of Directors Liability and Indemnification
  27




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Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
  Shares ofCommon StockBeneficially
    
    Percentage ofName of Beneficial Owner (1)
    
    Owned (2)
    
    OwnershipLeslie Bernhard (3)
    
    
    632,151
    
    
    
    3.1
    %Eli Rousso (4)
    
    
    646,988
    
    
    
    3.2
    %Jeffrey Baudo (5)
    
    
    241,261
    
    
    
    1.2
    %James Linesch (6)
    
    
    31,667
    
    
    
    *Michael Jackson (7)
    
    
    50,000
    
    
    
    *John Rudy (7)
    
    
    50,000
    
    
    
    *Michael Dubreuil (7)
    
    
    50,000
    
    
    
    *Peter M. Zollman (7)
    
    
    62,799
    
    
    
    *Tribune Company
    
    
    3,443,457
    
    
    
    17.1
    %All Directors and Officers (8 persons) as a group
    
    
    1,764,866
    
    
    
    8.6
    %
 
 *
    
    less than 1%1)
    
    The addresses of the persons named in this table are as follows: Leslie Bernhard, Eli Rousso,
and Jeffrey Baudo, c/o AdStar, Inc., 4553 Glencoe Avenue, Suite 300, Marina del Rey, CA 90292;
and Tribune Company, 435 N. Michigan Ave. Chicago IL, Attn: General Counsel; Michael A. Roth
and Brian J. Stark, 3600 South Lake Drive, St. Francis, WI 53235; Peter M. Zollman, c/o
Classified Intelligence, 402 Spring Valley Road, Altamonte Springs, FL 32714; Michael
Dubreuil, c/o Brainhunter Global Solutions, 2 Sheppard Ave. E., Suite 700, Toronto, Ontario,
M2N 5Y7; Michael Jackson, c/o Agency.com Corporate Headquarters, 488 Madison Avenue,
22nd Floor, New York, NY 10022; John Rudy, c/o Beacon Consulting Associates, P.O.
Box 894,169 Main Street, Matawan, NJ 07747.2)
    
    A person is deemed to be a beneficial owner of securities that can be acquired by such person
within 60 days from the filing of this report upon the exercise of options and warrants or
conversion of convertible securities. Each beneficial owners percentage ownership is
determined by assuming that options, warrants and convertible securities that are held by such
person (but not held by any other person) and that are exercisable or convertible within 60
days from March 7, 2007 have been exercised or converted. Except as otherwise indicated,
and subject to applicable community property and similar laws, each of the persons named has
sole voting and investment power with respect to the shares shown as beneficially owned. On
March 7, 2007 20,204,647 shares of Common Stock were outstanding.3)
    
    Includes options to purchase 294,151 shares of AdStar Common Stock at prices between $0.73
and $3.50, exercisable within 60 days.4)
    
    Includes options to purchase 269,151 shares of AdStar Common Stock at prices between $0.73
and $3.50, exercisable within 60 days. 28




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5)
    
    Includes options to purchase 241,261 shares of AdStar Common Stock, at prices between $0.73
and $3.50, exercisable within 60 days.6)
    
    Includes options to purchase 65,000 shares of AdStar Common Stock, at prices between $2.25
and $2.54, exercisable within 60 days.7)
    
    Includes options to purchase 50,000 shares of AdStar Common Stock at prices between $0.83
and $1.29, exercisable within 60 days. Securities Authorized for Issuance Under Equity Compensation Plans
 2004 Stock Option Plan
  1999 Stock Option Plan
   29




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Equity Compensation Plan TableNumber of securitiesremaining availablefor future 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
(the 2004 plan and
the 1999 Plan)
    
    
    1,929,844
    
    
    $
    1.74
    
    
    
    969,101Equity Compensation
Plans Not Approved
By Security Holders
    
    
    541,134
    
    
    $
    2.38
    
    
    
    Total
    
    
    2,470,978
    
    
    $
    1.88
    
    
    
    969,101
  
 
 
  
 Item 12. Certain Relationships and Related Transactions, and Director Independence
  30




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##### Table of Contents



Director Independence
    
 Item 13. Exhibits
 Exhibits:
 ExhibitNo.
    
    Description3.1
    
    Certificate of Incorporation of AdStar (1)3.1a
    
    Amendment to Certificate of Incorporation, as filed with the Secretary of State of Delaware
on July 11, 2001 (2)3.1b
    
    Amendment to Certificate of Incorporation, as filed with the Secretary of State of Delaware
on November 11, 2004 (3)3.2
    
    By-Laws of AdStar (1)4.1
    
    Specimen Stock Certificate (1)4.6
    
    Form of 5-year warrant issued in connection with the Private Placement of AdStar Common Stock
in September 2003 (4)10.1**
    
    1999 Stock Option Plan (1)10.2**
    
    2004 Stock Option Plan (5)10.3**
    
    Employment Agreement between AdStar and Leslie Bernhard, dated December 21, 2005 (7)10.4**
    
    Employment Agreement Amendment between AdStar and Leslie Bernhard, dated December 21, 2005 (7)10.5**
    
    Employment Agreement between AdStar and Eli Rousso, dated December 21, 2005 (7)10.6**
    
    Employment Agreement Amendment between AdStar and Eli Rousso, dated December 21, 2005 (7)14.1
    
    Code of Ethics (6)21.1
    
    Subsidiaries(6)23.2
    
    Consent of Holtz Rubenstein Remnick LLP *31.1
    
    Chief Executive Officer Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002*
 31




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##### Table of Contents



ExhibitNo.
    
    Description31.2
    
    Chief Financial Officer Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002*32.1
    
    Chief Executive Officer Certification pursuant to section 906 of the Sarbanes-Oxley Act of 2002*32.2
    
    Chief Financial Officer Certification pursuant to section 906 of the Sarbanes-Oxley Act of 2002*
 
 Notes to exhibits*
    
    Filed herewith**
    
    Indicates a management contract or compensatory plan or arrangement(1)
    
    Filed on October 1999 as an exhibit with the same number to Registration Statement on Form
SB-2 (No. 333-84209), and incorporated herein by reference.(2)
    
    Filed as an exhibit to Quarterly Report on Form 10QSB for the period ended September 30, 2001
and incorporated herein by reference.(3)
    
    Filed as an exhibit to the Annual Report on Form 10KSB for the period ended December 31, 2004
and incorporated herein by reference.(4)
    
    Filed on October 16, 2003 as an exhibit with the same number to Registration Statement on
Form S-3 (No. 333-109757) and incorporated herein by reference.(5)
    
    Filed on October 13, 2004 as Appendix A to the Schedule 14A Proxy Statement and incorporated
herein by reference.(6)
    
    Filed as an exhibit to the Annual Report on Form 10KSB for the period ended December 31, 2003
and incorporated herein by reference.(7)
    
    Filed as an exhibit to the Annual Report on Form 10KSB for the period ended December 31, 2005
and incorporated herein by reference. 32




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##### Table of Contents



Item 14. Principal Accountant Fees and Services
 :
 2005 (1)
    
    
    2006Audit fees
    
    $
    125,000
    
    
    $
    90,000Audit related fees
    
    
    28,000
    
    
    
    10,000Total audit and audit related fees
    
    $
    153,000
    
    
    $
    100,000Tax fees
    
    
    19,000
    
    
    
    20,000All other fees
    
    
    
    
    
    
    Total fees
    
    $
    172,000
    
    
    $
    120,000
 
 (1)
    
    Includes $45,000 of audit fees paid to our previous accounting firm, BDO Seidman, LLP. Audit-Related Fees
  Tax Fees
  All Other Fees
   Audit Committee Pre-Approval Policies and Procedures
  33




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##### Table of Contents



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




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##### Table of Contents



Index To Financial Statements
 PageReport of Independent Registered Public Accounting Firm
    
    
    F-2Financial Statements:Consolidated Balance Sheet as of December 31, 2006
    
    
    F-3Consolidated Statements of Operations for the two years ended December 31, 2006
    
    
    F-4Consolidated Statements of Stockholders Equity for the two years ended December 31, 2006
    
    
    F-5Consolidated Statements of Cash Flows for the two years ended December 31, 2006
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7
 F-1




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##### Table of Contents



Report of Independent Registered Public Accounting Firm
 
      
 F-2




---



##### Table of Contents



AssetsCurrent assets:Cash and cash equivalents
    
    $
    2,545,000Accounts receivable, net of allowance for doubtful accounts of $88,000
    
    
    472,000Notes receivable from officers  current portion
    
    
    9,000Prepaid and other current assets
    
    
    210,000Total current assets
    
    
    3,236,000Notes receivable from officers, net of current portion
    
    
    207,000Property and equipment, net
    
    
    127,000Capitalized and purchased software, net
    
    
    607,000Intangible assets, net
    
    
    1,222,000Goodwill
    
    
    2,132,000Other assets
    
    
    29,000Total assets
    
    $
    7,560,000Liabilities and Stockholders EquityCurrent liabilities:Due to publications
    
    $
    1,181,000Accounts payable and accrued expenses
    
    
    670,000Deferred revenue and customer deposits  current portion
    
    
    279,000Capital lease obligations  current portion
    
    
    6,000Total current liabilities
    
    
    2,136,000Deferred revenues, net of current portion
    
    
    26,000Capital lease obligations, net of current portion
    
    
    27,000Total liabilities
    
    
    2,189,000Commitments and contingenciesStockholders equity:Preferred Stock, par value $0.0001; authorized 5,000,000 shares; 0
issued and outstanding
    
    
    Common Stock, par value $0.0001; authorized 40,000,000 shares;
19,639,051 issued and outstanding
    
    
    2,000Additional paid-in capital
    
    
    25,833,000Treasury stock; 67,796 shares
    
    
    (68,000
    )Accumulated deficit
    
    
    (20,396,000
    )Total stockholders equity
    
    
    5,371,000Total liabilities and stockholders equity
    
    $
    7,560,000
  F-3




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##### Table of Contents



AdStar, Inc. and Subsidiary
 
 Consolidated Statements of Operations
 For the Two Years
 Ended December 31, 2006
 2005
    
    
    2006ASP, net
    
    $
    1,815,000
    
    
    $
    1,908,000Licensing and software
    
    
    2,534,000
    
    
    
    2,477,000Customization and other
    
    
    890,000
    
    
    
    729,000Net revenues
    
    
    5,239,000
    
    
    
    5,114,000Cost of revenues, including depreciation and
amortization of $595,000 and $432,000
    
    
    1,779,000
    
    
    
    2,112,000Gross profit
    
    
    3,460,000
    
    
    
    3,002,000General and administrative expense
    
    
    1,959,000
    
    
    
    1,900,000Product maintenance and development costs
    
    
    901,000
    
    
    
    934,000Selling and marketing expense
    
    
    750,000
    
    
    
    1,468,000Amortization of customer list
    
    
    88,000
    
    
    
    88,000Loss from operations
    
    
    (238,000
    )
    
    
    (1,388,000
    )Beneficial interest and amortization of financing
fees on convertible note
    
    
    (802,000
    )
    
    
    Interest income
    
    
    13,000
    
    
    
    13,000Interest expense
    
    
    (51,000
    )
    
    
    (5,000
    )Loss before income taxes
    
    
    (1,078,000
    )
    
    
    (1,380,000
    )Provision for income taxes
    
    
    (12,000
    )
    
    
    (13,000
    )Net loss
    
    
    (1,090,000
    )
    
    
    (1,393,000
    )Deemed dividends on exercise of warrants
    
    
    (98,000
    )
    
    
    Net loss applicable to common stockholders
    
    $
    (1,188,000
    )
    
    $
    (1,393,000
    )Loss per share  basic and diluted
    
    $
    (0.07
    )
    
    $
    (0.07
    )Weighted average number of shares  basic and diluted
    
    
    16,133,000
    
    
    
    19,339,000
  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, 2006
 TotalAdditional
    
    
    Accumulated
    
    
    StockholdersCommon Stock
    
    
    Preferred Stock Series B-2
    
    
    Treasury Stock
    
    
    PaidIn Capital
    
    
    Deficit
    
    
    EquityShares
    
    
    Amount
    
    
    Shares
    
    
    Amount
    
    
    Shares
    
    
    AmountBalance, December 31, 2004
    
    
    14,513,546
    
    
    $
    2,000
    
    
    
    2,000,000
    
    
    $
    1,342,000
    
    
    
    67,796
    
    
    
    (68,000
    )
    
    
    20,089,000
    
    
    
    ( 17,815,000
    )
    
    
    3,550,000Conversion
of Preferred Series B-2 To Common Stock
    
    
    2,000,000
    
    
    
    
    
    
    
    (2,000,000
    )
    
    
    (1,342,000
    )
    
    
    
    
    
    
    
    
    
    
    1,342,000
    
    
    
    
    
    
    
    Conversion of Laurus debt
To Common Stock
    
    
    435,470
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    999,000
    
    
    
    
    
    
    
    999,000Warrants repriced and exercised
    
    
    702,850
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    580,000
    
    
    
    
    
    
    
    580,000Preferential dividend
on repriced warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    98,000
    
    
    
    (98,000
    )
    
    
    Shares issued for services
    
    
    127,449
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    94,000
    
    
    
    
    
    
    
    94,000Options exercised
    
    
    470,972
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    481,000
    
    
    
    
    
    
    
    481,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,090,000
    )
    
    
    (1,090,000
    )Balance, December 31, 2005
    
    
    18,250,287
    
    
    
    2,000
    
    
    
    
    
    
    
    
    
    
    
    67,796
    
    
    
    (68,000
    )
    
    
    23,683,000
    
    
    
    (19,003,000
    )
    
    
    4,614,000Common Stock sale,
net of offering costs
    
    
    1,000,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,440,000
    
    
    
    
    
    
    
    1,440,000Non-cash financing cost of
warrants issued in connection
with Common Stock sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,000
    )
    
    
    
    
    
    
    (20,000
    )Warrants issued in connection
with Common Stock sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,000
    
    
    
    
    
    
    
    20,000Warrants exercised
    
    
    91,486
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    85,000
    
    
    
    
    
    
    
    85,000Options exercised
    
    
    297,278
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    265,000
    
    
    
    
    
    
    
    265,000Stock option compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    360,000
    
    
    
    
    
    
    
    360,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,393,000
    )
    
    
    (1,393,000
    )Balance, December 31, 2006
    
    
    19,639,051
    
    
    $
    2,000
    
    
    
    
    
    
    
    
    
    
    
    67,796
    
    
    $
    (68,000
    )
    
    $
    25,833,000
    
    
    $
    (20,396,000
    )
    
    $
    5,371,000
  F-5




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##### Table of Contents



AdStar, Inc. and Subsidiary
 
 Consolidated Statements of Cash Flows
 For the Two Years
 Ended December 31,
 2005
    
    
    2006Cash flows from operating activities:Net loss
    
    $
    (1,090,000
    )
    
    $
    (1,393,000
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation and amortization
    
    
    738,000
    
    
    
    593,000Beneficial interest and amortization of financing
fees on convertible note
    
    
    803,000
    
    
    
    Stock based charges
    
    
    94,000
    
    
    
    360,000Bad debt provision
    
    
    (7,000
    )
    
    
    8,000Changes in assets and liabilities:Accounts receivable
    
    
    21,000
    
    
    
    91,000Prepaids and other assets
    
    
    (1,000
    )
    
    
    (67,000
    )Due to publications
    
    
    16,000
    
    
    
    (133,000
    )Accounts payable and accrued expenses
    
    
    (713,000
    )
    
    
    (7,000
    )Deferred revenue and customer deposits
    
    
    (113,000
    )
    
    
    31,000Net cash used in operating activities
    
    
    (252,000
    )
    
    
    (517,000
    )Cash flows from investing activities:Additions to capitalized and purchased software
    
    
    (68,000
    )
    
    
    (19,000
    )Purchase of property and equipment
    
    
    (53,000
    )
    
    
    (25,000
    )Additions to intangible assets
    
    
    
    
    
    
    (5,0000
    )Repayment of officer receivable
    
    
    8,000
    
    
    
    8,000Net cash used in investing activities
    
    
    (113,000
    )
    
    
    (41,000
    )Cash flows from financing activities:Sale of common stock, net of costs
    
    
    
    
    
    
    1,440,000Repayment of convertible debt
    
    
    (411,000
    )
    
    
    Proceeds from exercise of options and warrants
    
    
    1,061,000
    
    
    
    350,000Principal repayments on loans from shareholders
    
    
    (21,000
    )
    
    
    (21,000
    )Principal repayments on capital leases
    
    
    (19,000
    )
    
    
    (4,000
    )Net cash provided by financing activities
    
    
    610,000
    
    
    
    1,765,000Net increase in cash and cash equivalents
    
    
    245,000
    
    
    
    1,207,000Cash and cash equivalents at beginning of year
    
    
    1,093,000
    
    
    
    1,338,000Cash and cash equivalents at end of year
    
    $
    1,338,000
    
    
    $
    2,545,000
  F-6




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##### Table of Contents



AdStar, Inc. and Subsidiary
 
 Notes to Consolidated Financial Statements
 1.
    
    Organization and BusinessAdStar, Inc. (the Company or AdStar) (formerly AdStar.com, Inc. and AdStar-Services,
Inc.) was incorporated in the State of New York on June 29, 1991 as an S-Corporation under
the Internal Revenue Code. In 1999, the Company reincorporated as a C-Corporation in
Delaware.The Companys original core business was the licensing of proprietary software systems and
supplying the related support and maintenance. This professional software system allows
large commercial advertising agencies and corporations to directly enter classified
advertisements into the publishing systems at the Companys customers, through modems on a
dial-up basis and through the Internet. The Companys customers are principally located in
the United States.In 2001, the Company introduced its AdStar e-business application services. Using the
Companys proprietary software solution platform, the Company enables both print and on-line
publications to electronically receive completed classified advertising copy using the
Internet as the communication channel. The services are provided on an application service
provider (ASP) basis, enabling publishers to expand their relationships with advertising
customers using a single integrated platform, while increasing sales volumes at reduced
costs.On October 21, 2003, AdStar acquired all of the business and assets of Edgil Associates,
Inc. (Edgil). Edgil was incorporated in the State of Massachusetts on February 22, 1984 as
a C-Corporation. Edgil, based in North Chelmsford, Massachusetts, is a provider of complete
automated payment processing systems and content processing solutions for the publishing
industry. Edgils core business has been licensing proprietary software systems and
supplying the related support and maintenance.Edgil develops software applications primarily for the newspaper publishing industry. Its
management and personnel combine extensive knowledge of newspaper publishing systems with
technical expertise in database management systems, electronic commerce, and Web application
development. Edgil offers system integration services, installation support, training, and
customer service. Edgils 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 publishers with the financial benefits
afforded by reduced labor costs and lower credit card processing discount rates. Edgils
experience with integration services has given the EdgCapture product line the technical
differentiation to meet the specific credit card processing requirements of the publishing
industry.2.
    
    Basis of Presentation and Summary of Significant Accounting PoliciesBasis of 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, 2006, we had
an accumulated deficit of $20,396,000. We have incurred significant recurring net losses.
For the years ended December 2005 and 2006 we had net losses of $1,090,000 and $1,393,000.
Our 2006 net losses were principally attributable to our business development costs. At
December 31, 2006, the Company had working capital of $1,100,000.
 F-7




---



##### Table of Contents



We expect to continue to incur losses until we are able to increase revenues significantly
from fees transacted through our ASP product. Although there can be no assurance, we believe
that cash on hand of $2,545,000 at December 31, 2006, combined with revenues from operating
activities, will be sufficient to meet our anticipated working capital needs through
December 31, 2007. In addition, the Company will continue to seek additional financings as
needed.Although the Company is optimistic that its growing ASP business will continue to be
accepted in the marketplace, timing is not assured. The Companys ability to sell ASP
business products and service offerings during the current year may be hampered by continued
sluggishness in the newspaper publishing industry, resulting in declining print circulation.
These factors, coupled with the extended selling cycle in the Companys industry and
customer delays in customization and implementations, could delay its 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.Principles of ConsolidationThe accompanying consolidated financial statements include the accounts of AdStar, Inc. and
its wholly owned subsidiary Edgil Associates, Inc. All intercompany transactions and
balances have been eliminated in consolidation.Use of EstimatesThe preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.Cash and Cash EquivalentsThe Company considers all highly liquid investments purchased with an initial maturity of
three months or less to be cash equivalents. Cash and cash equivalents are carried at cost,
which approximates fair value. At December 31, 2006, the company had cash balances held at a
financial institution which exceed FDIC insurance limits by $2,445,000.
 F-8




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##### Table of Contents



Supplemental schedule of noncash investing and financing activities for the two years ended
December 31, 2006:
 2005
    
    2006Supplemental cash flow disclosure:Taxes paid
    
    $
    17,000
    
    
    $
    15,000Interest paid
    
    $
    72,000
    
    
    $
    5,000Non-cash investing and financing activities:Conversion of 1,443,457 shares of Series A Preferred Stock to
equivalent shares of Common net of expenses
    
    
    
    
    
    
    Conversion of 2,000,000 shares of Series B-2 Preferred Stock to
equivalent shares of Common net of expenses
    
    $
    1,342,000
    
    
    
    Amortization of beneficial conversion feature and finance
costs on warrants issued in conjunction with convertible debt
    
    $
    621,000
    
    
    
    Conversion of convertible debt into shares of Common Stock
    
    $
    819,000
    
    
    
    Issuance of Common Stock to legal counsel as a finders fee for
securing convertible debt
    
    
    
    
    
    
    Issuance of Common Stock for legal expenses
    
    $
    94,000
    
    
    
    Issuance of Common Stock to technical consultants
    
    
    
    
    
    
    
 Concentration of Credit Risk and Major CustomersFinancial instruments that potentially subject the Company to significant concentrations of
credit risk are principally comprised of cash, trade accounts receivable and shareholder
loans.For the year ended December 31, 2005, two customers accounted for 28% of net revenues. As of
December 31, 2005, three customers accounted for 60% of the Companys accounts receivable.For the year ended December 31, 2006, three customers accounted for 40% of net revenues. As
of December 31, 2006, three customers accounted for 41% 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 website are the
general public.Accounts Receivable and Allowance for Doubtful AccountsWe regularly evaluate the collectibility of our trade receivables based on a combination of
factors. When a customers account 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, due to a bankruptcy filing, deterioration in the customers
operating results or financial position or other material events impacting their business,
we record a specific reserve for bad debt to reduce the related receivable to the amount we
expect to recover given all information presently available. We also record reserves for bad
debts for all other customers based on certain other factors including length of time the
receivables are past due and historical collection experience with individual customers. If
circumstances related to specific customers change, our estimates of the recoverability of
receivables could materially change.Property and EquipmentProperty and equipment are stated at cost less accumulated depreciation and amortization.
When such items are retired or otherwise disposed of, the cost and related accumulated
depreciation and amortization are relieved from the accounts and the resulting gain or loss
is reflected in operations. Depreciation and
 F-9




---



##### Table of Contents



amortization are provided using the straight-line method over the estimated useful lives of
the assets. The depreciation and amortization periods by asset category are as follows:
 Furniture and fixtures
    
    7 yearsComputer equipment
    
    3 yearsComputer Software
    
    3 to 5 yearsLeasehold improvements
    
    Shorter of useful life or remaining lease term
 Maintenance and minor replacements are charged to expense as incurred while renewals and
improvements are capitalized. Leasehold improvements are amortized over their estimated
useful lives or the remaining lives of the related leases, whichever is shorter.Software Development CostsIn March 2000, the Financial Accounting Standards Boards Emerging Issue Task Force (EITF)
issued EITF No. 00-2 Accounting for Web Site Development Costs, which provides guidance
with respect to capitalization of certain costs incurred in connection with Web development
activities and references Statement of Financial Accounting Standards (SFAS) No. 86
Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise Marketed. In
accordance with these pronouncements, costs to establish the technological feasibility of
software applications developed by the Company are charged to expense as incurred. Certain
costs incurred subsequent to achieving technological feasibility are capitalized.
Accordingly, the Company capitalizes a portion of the internal labor costs and external
consulting costs associated with essential website development and enhancement activities.
Costs associated with conceptual design and feasibility assessments as well as maintenance
and routine changes are expensed as incurred. Capitalized costs are amortized based on
current or future revenue for each product with an annual minimum equal to the straight-line
basis over the estimated economic lives of the applications, not to exceed 5 years. In
accordance with this policy, the Company has capitalized expenditures incurred to enhance
the AdStar ASP application suite of products. At December 31, 2006, the Company has
capitalized software development costs of $3,369,000, with associated accumulated
amortization of $2,762,000.Intangible AssetsIntangible assets are comprised of purchased customer list, trademarks, license agreements
and proprietary technology and are carried at cost less accumulated amortization.
Amortization is calculated on a straight-line basis over the estimated useful lives of the
intangible assets of 5 and 17 years.Long-Lived AssetsThe carrying value of long-lived assets, as defined under SFAS 144, is periodically reviewed
by management and impairment losses, if any are recognized when the expected undiscounted
future operating cash flows derived from such assets are less than their carrying value.GoodwillIn accordance with SFAS No. 142, the Company recorded goodwill of $2,132,000 from the
purchase of Edgil Associates, Inc. In accordance with SFAS 142 the Company does not
amortize goodwill. However the Company will evaluate goodwill at least on an annual basis
for impairment or when there are indications of impairment. In future periods if goodwill
is determined to be impaired, the Company will recognize a non-cash charge equal to the
excess of the carrying value over the fair value. There can be no assurance that future
evaluations of goodwill will not result in impairment and a charge to earnings.The Company completed its annual impairment analysis including obtaining an independent
outside
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appraisal and such analysis indicated that the amount of goodwill is not impaired.
 Fair Value of Financial InstrumentsCash and cash equivalents, accounts receivable, shareholder notes receivable, accounts
payable, deferred revenue, notes payable, capital leases and accrued expenses approximates
their fair value because of the short-term maturity or the current lending rates of these
instruments.Revenue RecognitionThe Company derives revenue from several products and services as follows:ASP revenue  The Company receives revenue from providing an application service provider
(ASP) product that allows customers to use the Companys software applications on a
shared system over the Internet. This technology is a publisher-specific ad-taking
website service that offers visitors to a newspapers Web page the opportunity to buy
classified ads, for both the print and/or on-line editions of the newspaper, in real-time,
on a 24/7 basis. The Company receives monthly fees for hosting the transactions and
providing customer support, and recognizes the fees ratably over the contract period. Under
the guidance provided by the Securities Exchange Commission Staff Accounting Bulletin
(SAB) No. 101, Revenue Recognition and the Emerging Issues Task Force (EITF) Abstract
No. 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent (EITF 99-19), we
are, in substance, acting as an agent for the publishers and therefore recognize as revenue
only the net fees realized on the transactions. We recognize revenue on a per-transaction
basis when the ad is placed through their system and collection from the customer is
probable.Licensing and Software; Customization and other revenues  The Company generates revenue
from technology service contracts that generally contain multiple elements such as software
customization services, monthly fees and PCS. Revenue from these arrangements is recognized
in accordance with SOP 97-2, Software Revenue Recognition, and SOP 98-9, Software Revenue
Recognition with Respect to Certain Transactions. Accordingly, revenue is allocated to each
element within the contract based on the relative fair values of those elements using vendor
specific objective evidence. Revenue from monthly fees and PCS under software maintenance
arrangements is based upon renewal rates and is recognized ratably over the term of the
arrangement. Revenue from software customization services is recognized as the services are
performed, using a percentage of completion methodology based on labor hours. 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 deferred revenues from long-term License and Software
contracts, PCS maintenance arrangements prepaid annually and customization and other
revenues billed and paid in advance. Revenues from upfront license fees, monthly fees and
PCS under software maintenance arrangements is based upon renewal rates and is recognized
ratably over the term of the arrangement, licenses and maintenance generally range from
month-to-month up to 10 years on AdStar and 1 year up to 25 on Edgil, respectively. At
December 31, 2006, deferred revenues are $250,000, revenues from PCS contracts paid in
advance and prepaid customer deposits are $55,000. Revenue from software customization
services is recognized upon the completion of services.Areas requiring managements judgment includes revenue recognition and cost estimation on
the fixed fee software customization element of the contracts. Revenue is recognized on
these contracts using a percentage-of-completion methodology, based upon labor input
measures and an estimate of time to completion. Monthly, technical management reviews the
estimate of labor hours required to complete the customization and the effect of any change
in estimate is reflected in the period in which the change is first known. Such changes in
estimates have not been material to our results of operation. The corresponding cost of
revenue charge is derived based upon the same labor input measurements and our existing cost
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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.Income TaxesThe Company utilizes the liability method of accounting for income taxes. Under this
method, deferred tax liabilities and assets are determined based on the difference between
the financial statement and tax bases of assets and liabilities using enacted tax rates in
effect for the period in which the differences are expected to reverse. Valuation allowances
are established, when necessary, to reduce the deferred tax assets to the amounts expected
to be realized.Advertising CostsThe Company expenses the costs of advertising in the periods in which those costs are
incurred. Advertising expense was approximately $4,000 and $60,000 for the years ended
December 31, 2005 and 2006, respectively.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, 2005 and 2006, diluted earnings (loss) per share does not
include 2,494,447 and 2,445,978, respectively of options and warrants to purchase Common
Stock, as their inclusion is antidilutive.Comprehensive IncomeThe Company discloses comprehensive income in accordance with the provisions of 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 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 or loss
items and, accordingly, net loss equals comprehensive loss for all periods 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
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service have been insignificant and are generally covered by upfront fees. At December 31,
2005 and 2006 all costs associated with contract service were recorded directly into cost of
revenues.We currently carry product liability insurance. We believe the amount of insurance is
adequate to cover our risks. To further mitigate our risks, our standard service agreement
expressly limits its liabilities and warranties of its products and services in accordance
with accepted provisions of the Uniform Commercial Code as adopted in most states.Accounting for Stock-Based CompensationDuring 2006, the Company adopted the provisions of, and accounting for stock-based
compensation in accordance with, the Financial Accounting Standards Boards (FASB)
Statement of Financial Accounting Standards No. 123  revised 2004 (SFAS 123(R),
Share-Based Payment which replaced` Statement of Financial Accounting Standards No. 123
(SFAS 123), Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25
(APB 25), Accounting for Stock Issued to Employees.Under the fair value recognition provisions of this statement, stock-based compensation cost
is measured at the grant date based on the fair value of the award and is recognized as
expense on a straight-line basis over the requisite service period, which is the vesting
period.The Company elected the modified-prospective method, under which prior periods are not
revised for comparative purposes. The valuation provisions of SFAS 123(R) apply to new
grants and to grants that were outstanding as of the effective date and are subsequently
modified. Estimated compensation for grants that were outstanding as of the effective date
will be recognized over the remaining service period using the compensation cost estimated
for the SFAS 123 pro forma disclosures.The adoption of SFAS 123(R) has had a material impact on the Companys consolidated
financial position, results of operations and cash flows. See Note 11 for further
information regarding stock-based compensation assumptions and expenses.Fair Value DisclosuresThe fair value of each option grant was determined using the Black-Scholes option-pricing
model. The Company calculated the fair value of each option granted on the date of grant
using the minimum value method or Black-Scholes model as prescribed by SFAS No. 123 using
the following assumptions:
 Year Ended December 31,2005
    
    2006Risk-free interest rate
    
    
    4.35
    %
    
    
    4.65
    %Expected lives (years)
    
    
    3.5
    
    
    
    3.5Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected volatility
    
    
    80.1
    %
    
    
    73.65
    %Forfeiture rate
    
    
    10
    %
    
    
    10
    %
 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 2005 would have increased
to the pro forma amounts indicated below:
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2005Net loss 
applicable to
Common Stockholders
    
    As Reported
    
    $
    (1,188,000
    )Add: Stock based employee compensation included in reported loss
    
    
    Deduct: Employee compensation expense
    
    
    (1,091,000
    )Pro Forma
    
    $
    (2,279,000
    )Basic and Fully
Diluted Loss per
share -
    
    As Reported
    
    $
    (0.07
    )Pro Forma
    
    $
    (0.14
    )
 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.New accounting pronouncementsIn March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial
Assetsan amendment of FASB Statement No. 140 (SFAS No. 156). SFAS No. 156 requires an
entity to recognize a servicing asset or liability each time it undertakes an obligation to
service a financial asset by entering into a servicing contract if a) a transfer of the
servicers assets meets the requirements for sale accounting b) a transfer of the servicers
financial assets to a qualifying special-purpose entity in a guaranteed mortgage
securitization in which the transferor retains all of the resulting securities and c) an
acquisition or assumption of an obligation to service a financial asset does not relate to
financial assets of the servicer or its consolidated affiliates. Further, SFAS No. 156
requires all separately recognized servicing asset and liabilities to be initially measured
at fair value, if practicable. SFAS No. 156 must be adopted as of the first fiscal year that
begins after September 15, 2006. The adoption of SFAS No. 156 did not have an impact on the
Companys financial statements.In September 2006, the FASB issued SFAS No. 157, Fair Value Measures (SFAS No. 157).
SFAS No. 157 defines fair value, establishes a framework for measuring fair value and
enhances disclosures about fair value measures required under other accounting
pronouncements, but does not change existing guidance as to whether or not an instrument is
carried at fair value. SFAS No. 157 is effective for fiscal years beginning after November
15, 2007, the year beginning January 1, 2008 for the Company. The adoption of SFAS No. 157
is not anticipated to have an impact on the Companys financial statements.In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits entities to choose to
measure many financial assets and financial liabilities at fair value. Unrealized gains and
losses on items for which the fair value option has been elected will be reported in
earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The
adoption of SFAS No. 159 is not anticipated to have an impact on the Companys financial
statements.In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin
No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements
in Current Year Financial Statements (SAB No. 108), which provides interpretive guidance
on the consideration of the effects of prior year misstatements in quantifying current year
misstatements for the purpose of a materiality assessment. SAB 108 is effective as of the
end of our 2006 fiscal year, allowing a one-time transitional cumulative effect adjustment
to beginning retained earnings as of January 1, 2006 for errors
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##### Table of Contents



that were not previously deemed material, but are material under the guidance in SAB No.
108. The adoption of SAB No. 108 did not have an impact on the Companys financial
statements.In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income
Taxes (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprises financial statements in accordance with SFAS No. 109,
Accounting for Income Taxes. This Interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. This Interpretation also provides
guidance on derecognition, classification, interest and penalties, accounting in interim
periods, and disclosure. FIN 48 is effective for fiscal years beginning after December 15,
2006. The Company is in the process of evaluating the financial impact of adopting FIN 48.
 3.
    
    Property and EquipmentProperty and equipment consisted of the following at December 31, 2006:
 Computer equipment
    
    $
    408,000Production equipment
    
    
    224,000Furniture and fixtures
    
    
    97,000Leasehold improvements
    
    
    10,000739,000Less: Accumulated depreciation and amortization
    
    
    612,000Property and equipment, net
    
    $
    127,000
 Computer equipment and furniture and fixtures include equipment held under capital leases of
$36,000. Depreciation and amortization expense for December 31, 2005 and 2006 was
approximately $69,000 and $61,000 including amortization of computer equipment and furniture
and fixtures held under capital leases of approximately $6,000 and $1,000. Accumulated
depreciation on property and equipment held under capital leases was $69,000 and $4,000 at
December 31, 2005 and 2006, respectively.4.
    
    Capitalized and Purchased SoftwareCapitalized and purchased software consisted of the following at December 31, 2006:
 Capitalized software
    
    $
    2,799,000Purchased software
    
    
    570,0003,369,000Less: Accumulated depreciation and amortization
    
    
    2,762,000Capitalized and purchased software, net
    
    $
    607,000
 Amortization expense for capitalized and purchased software for the years ended December 31,
2005 and 2006 was approximately $581,000 and $444,000, respectively. During 2005 and 2006,
the Company wrote off capitalized software totaling approximately $12,000 and $0,
respectively.
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5.
    
    Intangible AssetsIntangible assets are comprised of the following at December 31, 2006:
 Customer list
    
    $
    1,500,0000Trademarks
    
    
    202,0001,702,000Less: Accumulated amortization
    
    
    480,000Intangible assets, net
    
    $
    1,222,000
 Amortization expense for the years ended December 31, 2005 and 2006 was approximately
$88,000 and $88,000, respectively. Amortization of intangibles is as follows for the years
ending            December 31,:
 2007
    
    $
    88,0002008
    
    
    88,0002009
    
    
    88,0002010
    
    
    88,0002011
    
    
    88,000Thereafter
    
    
    782,000Total
    
    $
    1,222,000
 6.
    
    GoodwillIn accordance with SFAS No. 142, the Company recorded goodwill of $2,132,000 from the
purchase of Edgil. In accordance with SFAS 142, the Company does not amortize goodwill.
However, the Company evaluates goodwill at least on an annual basis for impairment. The
Company performed an impairment test of goodwill 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.The Company completed its annual impairment analysis including obtaining an independent
outside appraisal and such analysis indicated that the amount of goodwill is fairly stated.7.
    
    Convertible DebtIn September 2005, AdStar offered Laurus Master Fund the opportunity to convert the balance
of its convertible note at a price of $1.88 per share (82.5% of the closing price on the
date of offer) during the 20 trading day period commencing on the delivery of the offer but,
without AdStars written consent, no more than 250,000 shares during the first 10 trading
days following such delivery. The offer was cancelable or deferrable by AdStar prior to the
end of the initial 10-day period with respect to the second 10-day period. Under the terms
of the offer Laurus Master Fund opted to convert $818,000 in note principal, the remaining
balance, into 435,470 shares of AdStar common stock.As an inducement to convert their note into shares of AdStar common stock, the Company
offered to convert the notes at a price of $1.88, which was below the fair market value at
the closing price of the Companys stock on the dates of conversion. As such the Company
recorded additional non-cash interest expense of approximately $181,000 on the dates of
conversion. The Company calculated the additional non-cash interest as the difference
between the fair market value of the Companys common stock and the fixed conversion price
(82.5% of the closing price on the date of offer) of the convertible note on the dates the
Company received and accepted the conversion notices.
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During 2005, approximately $203,000 of prepaid financing fees and debt discount was
amortized as interest expense, including a non-cash portion of approximately $164,000. The
non-cash portion was comprised of approximately $156,000 debt discount and $8,000 in prepaid
finder fees amortized during the period. In addition the conversion of $818,000 in
principal accelerated the realization of approximately $418,000 of prepaid financing fees
and debt discount as interest expense, including a non-cash portion of approximately
$339,000. The non-cash portion was comprised of approximately $321,000 debt discount and
$18,000 in prepaid finder fees.8.
    
    Notes PayablePursuant 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 nine month anniversary of the Effective Date (October 21,
2003) and each of the next five payments to be paid each nine months thereafter, with the
final payment to be made on the third anniversary of the Closing Date. Accordingly, a
payment of $10,500 was made in October 2005, and $10,500 payments were made in March and
October 2006. At December 31, 2006 the note was fully paid.9.
    
    Due to publicationsThe Company processes credit cards on behalf of certain of its customers as part of ASP
services provided. Due to publications is a result of contractual customer arrangements
whereby the Company receives net proceeds daily on behalf of these customers for third party
ads placed via credit card. These transactions are collected, reconciled monthly and
submitted to the publication, net of processing fees, generally within 30 days from the
month end.10.
    
    Income TaxesProvision for income taxes consist of the following:
 December 31,2005
    
    
    2006Current taxesFederal
    
    $
    
    
    
    $
    State
    
    
    12,000
    
    
    
    13,000DeferredFederal
    
    
    (66,000
    )
    
    
    (516,000
    )State
    
    
    (230,000
    )
    
    
    (94,000
    )Total deferred taxes
    
    
    (296,000
    )
    
    
    (610,000
    )Change in valuation allowance
    
    
    296,000
    
    
    
    610,000Income tax provision
    
    $
    12,000
    
    
    $
    13,000
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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, 2006 consisted of
the following:
 2006Deferred tax assets:Net operating loss carry forwards
    
    $
    6,944,000Other
    
    
    183,000Gross deferred tax asset
    
    
    7,127,000Deferred tax liabilityDepreciation and amortization
    
    
    (420,000
    )Gross deferred tax liabilities
    
    
    (420,000
    )Net Deferred tax asset
    
    
    6,707,000Less: Valuation allowance
    
    
    (6,707,000
    )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, 2006, the Company has federal net operating loss carry forwards of
approximately $18,234,000, and has state net operating loss carry forwards of approximately
$8,171,000. The federal and state net operating loss carry forwards will begin to expire in
2018 and 2006, respectively. The Companys ability to utilize net operating loss carry
forwards may be limited in the event that a change in ownership, as defined in the Internal
Revenue Code, occurs in the future.The provision for income taxes for the years ended December 31, 2005 and 2006 differs from
the amount that would result from applying the federal statutory rate as follows:
 2005
    
    2006Statutory regular federal income tax rate
    
    
    (34.0
    %)
    
    
    (34.0
    %)State taxes, net of federal benefit
    
    
    (3.6
    %)
    
    
    (4.1
    %)Change in valuation allowance
    
    
    36.5
    %
    
    
    37.1
    %(1.1
    %)
    
    
    (1.0
    %)
 11.
    
    CapitalizationCommon StockIn November 2004, the shareholders approved an increase to the number of authorized shares
of the Companys Common Stock from 20,000,000 to 40,000,000.On February 16, 2006, the Company entered into a Securities Purchase Agreement to sell to a
single accredited institutional investor one million (1,000,000) shares of its Common Stock
at an aggregate purchase price of $1,650,000. The Company filed a registration statement
covering the resale of those shares on April 7, 2006, and caused the registration statement
to be effective on May 18, 2006. The
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Company paid the placement agent a cash placement fee of
51/2% of the amount raised, and warrants, exercisable for
three years, to purchase 25,000 shares of its Common Stock at a price of $4.00 per share.
Net proceeds from the sale were $1,440,000. The issuance was acquired for investment by an
accredited investor and was issued without registration under the Securities Act of 1933, as
amended, pursuant to the exemptions provided under sections 4(6) and 4(2) thereof and the
exemption provided by Regulation D.Stock Options and Employee Benefit PlansIn 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 that have been authorized for issuance under the Plan. In 2004, the Board of
Directors adopted the 2004 Stock Option Plan (the 2004 Plan) in order to have adequate
options available to continue to attract and retain officers, other key employees,
consultants and non-employee directors of the Company. The 2004 Plan as approved by
shareholders during 2004 has an aggregate of 2,200,000 shares of Common Stock authorized for
issuance under the Plan, 1,000,000 of which was approved by shareholders as an increase in
November 2006.The Plans provide 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
Plans.Incentive stock options shall have an exercise price equal to or greater than the fair value
of the Common Stock on the date of grant provided that incentive stock 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 Plans. All options granted from 1999 through 2004 have
a five-year term.Upon the occurrence of a change in control, as defined in the Plans, each option granted
under the Plans shall thereupon become fully vested and exercisable.During the year ended December 31, 2006, the company issued options to purchase a total of
381,500 shares of Company common stock to directors, officers and certain employees. These
awards are authorized by the 2004 Plan and therefore reduce the number of grants available
under that plan. The options were valued at the market close price for the Companys stock
on the date of grant. The shares vest over one to three year terms according to each
individual award. Accordingly, the Company recorded compensation expense for the full value
less estimated forfeiture of these restricted shares over the respective vesting periods.
During the year ended December 31, 2006 option holders exercised 297,278 options for which
the company received net proceeds of $265,000.The following table summarizes all stock option activity and includes all options issued
under the Plans, together with 280,000 non-qualified options issued outside the Plans, for
the years ended December 31, 2005 and 2006:
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WeightedWeighted
    
    
    Average
    
    
    AggregateAverage
    
    
    Remaining
    
    
    IntrinsicExercise
    
    
    Contractual
    
    
    ValueShares
    
    
    Price
    
    
    Term
    
    
    ($000)Outstanding at December 31, 2004
    
    
    1,323,563
    
    
    $
    1.00Granted
    
    
    1,378,667
    
    
    
    2.13Exercised
    
    
    (470,972
    )
    
    
    1.04Forfeited
    
    
    (64,431
    )
    
    
    1.55Outstanding at December 31, 2005
    
    
    2,166,827
    
    
    $
    1.69Granted
    
    
    381,500
    
    
    
    1.62Exercised
    
    
    (297,278
    )
    
    
    .89Forfeited
    
    
    (41,205
    )
    
    
    1.10Outstanding at December 31, 2006
    
    
    2,209,844
    
    
    $
    1.80
    
    
    
    2.93
    
    
    $
    1,655Options exercisable at December 31, 2006
    
    
    1,840,429
    
    
    $
    1.75
    
    
    
    2.71
    
    
    $
    1,506
 At December 31, 2006, there were 10,164 options available for future grant under the
1999 ESOP Plan, and 958,937 options available for grant under the 2004 ESOP Plan. The
weighted-average grant-date fair value of options granted during 2006 was $0.92 per share.
The total intrinsic value of options exercised during 2006 was $366,000.As of December 31, 2006, there was $151,000 of total unrecognized compensation cost related
to nonvested options granted under the Plans. That cost is expected to be recognized over a
weighted-average period of 1.8 years. The total fair value of shares vested during the year
ended December 31, 2006 was $317,000.The following table summarizes information about stock options outstanding at December 31,
2006:
 Options Exercisable atOptions Outstanding at December 31, 2006
    
    
    December 31, 2006Weighted Average
    
    
    WeightedNumber of
    
    
    Remaining
    
    
    Average
    
    
    Number of
    
    
    WeightedRange of
    
    Shares
    
    
    Contractual Life
    
    
    Exercise
    
    
    Shares
    
    
    AverageExercise Price
    
    Outstanding
    
    
    (years)
    
    
    Price
    
    
    Exercisable
    
    
    Exercise Price$0.01 - $0.99
    
    
    742,234
    
    
    
    1.17
    
    
    $
    0.66
    
    
    
    674,736
    
    
    $
    0.64$1.00 - $1.99
    
    
    427,609
    
    
    
    3.76
    
    
    $
    1.33
    
    
    
    369,692
    
    
    $
    1.35$2.00 - $2.99
    
    
    590,001
    
    
    
    3.73
    
    
    $
    2.46
    
    
    
    346,001
    
    
    $
    2.40$3.00 - $3.50
    
    
    450,000
    
    
    
    3.97
    
    
    $
    3.25
    
    
    
    450,000
    
    
    $
    3.252,209,844
    
    
    
    
    
    
    
    
    
    
    
    1,840,429
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WarrantsThe following table summarizes activity for the years ended December 31, 2005 and 2006:
 WeightedAverage ExerciseShares
    
    
    PriceOutstanding at December 31, 2004
    
    
    1,066,270
    
    
    $
    1.81Issued
    
    
    
    
    
    
    Exercised
    
    
    (702,850
    )
    
    
    0.85Forfeited
    
    
    (35,800
    )
    
    
    7.53Outstanding at December 31, 2005
    
    
    327,620
    
    
    $
    2.02Issued
    
    
    25,000
    
    
    
    4.00Exercised
    
    
    (91,486
    )
    
    
    0.92Forfeited
    
    
    
    
    
    
    Outstanding at December 31, 2006
    
    
    261,134
    
    
    $
    2.60Warrants exercisable at December 31, 2005
    
    
    327,620
    
    
    $
    2.02Warrants exercisable at December 31, 2006
    
    
    261,134
    
    
    $
    2.60Weighted average fair value of warrants issued
in 2005
    
    
    
    
    
    
    Weighted average fair value of warrants issued
in 2006
    
    
    
    
    
    
    
 The following table summarizes the outstanding warrants, all of which are currently
exercisable, to purchase Common Stock at December 31, 2006:
 Number
    
    Exercise Price
    
    Expiration Date20,798
    
    $
    0.75
    
    
    January 200715,336
    
    $
    1.87
    
    
    March 2009120,000
    
    $
    2.58
    
    
    April 201180,000
    
    $
    2.80
    
    
    April 201125,000
    
    $
    4.00
    
    
    February 2009
 During the year ended December 31, 2006 warrant holders exercised 91,486 warrants for which
the company received net proceeds of $85,000. The warrants had been issued certain
individuals, primarily as compensation for their services had exercise prices ranging from
$0.75 to $1.07 and expiration dates ranging from April 5, 2006 to January 16, 2007. The
Company issued 25,000 warrants during 2006, in connection with the sale of 1,000,000 shares
of common stock. In January 2007, 20,000 warrants were exercised at a price of $0.75 per
share.12.
    
    Shareholder receivableIn July 2002, AdStar entered into a loan transaction with Leslie Bernhard, President and
Chief Executive Officer and Eli Rousso, Executive Vice President and Chief Technical Officer
for $110,434 and $100,000, respectively. As part of the transaction, Ms. Bernhard and Mr.
Rousso each issued to AdStar an unsecured, non-negotiable promissory note bearing interest
at 5.56% with monthly principal and interest payments of $763 and $691, respectively. The
notes are payable on a monthly basis, with all remaining outstanding principal and interest
amounts due on July 31, 2022. Concurrently, an outstanding note from Ms. Bernhard in the
amount of $39,566 was restructured under the same terms and conditions as the aforementioned
new
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note. The loans are forgiven if there is a change in control in AdStar or if the loan holder
is dismissed for other than cause as defined by the loan and employment agreements. At
December 31, 2006 the balance outstanding on the notes receivable was $215,000.
 13.
    
    Commitments and ContingenciesOperating and Capital Lease CommitmentsThe Company has certain non-cancelable operating lease obligations for office space and
equipment, and capital lease obligations for computer equipment and office furniture. The
operating leases are for office space located in California and Massachusetts, and expire
through November 2009. The leases contain certain escalation clauses based on certain
charges that the landlords of the properties may incur over the base year, as defined in the
lease agreements.Future minimum lease payments under the non-cancelable operating and capital leases as of
December 31, 2006 are as follows:
 Operating
    
    
    CapitalYears Ending December 31,
    
    Leases
    
    
    Leases2007
    
    $
    185,000
    
    
    $
    10,0002008
    
    
    200,000
    
    
    
    10,0002009
    
    
    182,000
    
    
    
    10,0002010
    
    
    122,000
    
    
    
    10,0002011
    
    
    
    
    
    
    4,000Total minimum obligations
    
    $
    689,000
    
    
    
    44,000Less: Amounts representing interest
    
    
    
    
    
    
    (11,000
    )Present value of minimum obligations
    
    
    
    
    
    
    33,000Less: Current portion
    
    
    
    
    
    
    (6,000
    )Non-current portion
    
    
    
    
    
    $
    27,000
 Rent expense for the years ended December 31, 2005 and 2006 was approximately $214,000 and
$240,000, respectively, including month-to-month rentals.In the normal course of business, various claims and lawsuits may, from time-to-time, be
filed against the Company. There are no claims or lawsuits outstanding at December 31,
2006.Employment AgreementsOn December 21, 2005, the Company entered into four-year employment agreements with each of
Leslie Bernhard and Eli Rousso. The employment agreements extend through December 20, 2009,
and contain automatic annual one-year extensions to the term, effective on each anniversary
date of the agreement. Pursuant to her employment agreement, Leslie Bernhard was retained
as the Chief Executive Officer and her total annual compensation is $212,800. Pursuant to
his employment agreement, Eli Rousso was retained as the Executive Vice President and his
total annual compensation is $212,800. Under each agreement, the Company may terminate
employment with cause or by the executive with good reason. Termination without cause, or by
the executive for good reason, would subject the Company to liability for liquidated damages
in an amount equal to the terminated executives base salary for the remaining term of his
or her employment agreement or 12 months, whichever is greater. Each executive also
executed an employment agreement amendment, both dated December 21, 2005, that voluntarily
reduces their individual salaries to $202,160 per year, unless the executive provides 10
days written notice that the reduction is no longer in effect.
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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
his employment agreement reducing his annual rate of compensation to $191,700. Mr. Baudos
contract was extended for one year with successive one-year terms for the same salary under
essentially the same terms and conditions, effective January 22, 2003. On December 21, 2005,
Mr. Baudo executed an employment agreement amendment that voluntarily reduced his salary to
$182,115 per year, unless he provides 10 days written notice that the reduction is no longer
in effect. Mr. Baudo is the brother of Leslie Bernhard.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, 2005 and 2006, the Company paid royalties of
approximately $44,000 and $39,000, respectively.14.
    
    Related party transactionsAt December 31, 2006, the Tribune Company owned 3,443,457 shares of AdStar common stock.
During the years ended December 31, 2005 and 2006 the Companys total revenues derived from
Tribune Company agreements were $811,000 and $849,000 respectively.15.
    
    Employee Benefit PlanThe Company maintains a defined contribution 401(k) plan that covers substantially all
employees. Contributions to the Plan may be made by the Company (which are discretionary) or
by plan participants through elective salary reductions. During the years ended December 31,
2005 and 2006, contribution expense was $4,000 each year.16.
    
    Subsequent EventIn January 2007, 541,644 stock options were exercised, at an average price of $0.62 per
share. On January 29, 2007, the Company issued options for 225,000 shares of Common Stock
to employees and consultants, at an average exercise price of $2.58 per share. On February
13, 2007, the Company issued a ten year warrant to Nokia Corporation to purchase 100,000
shares of its Common Stock, at a price of $2.45 per share.
 F-23