Adstar (ADST) 10QSB 2006 Q3 Quarterly report (small business)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB

(Mark One)

þ QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

o TRANSITION REPORT UNDER 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.

(Exact name of small business issuer as specified in its charter)

Delaware	22-3666899
(State or other jurisdiction of incorporation or	(I.R.S. Employer Identification No.)
organization)

4553 Glencoe Avenue, Suite 300, Marina del Rey, California 90292
(Address of principal executive offices)

Issuer’s telephone number (310) 577-8255

Check whether the issuer: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

Number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: As of August 15, 2006, the issuer had a total of 19,539,231 shares of Common Stock outstanding.

Transitional Small Business Disclosure Format (Check one): Yeso Noþ

ADSTAR, INC. AND SUBSIDIARY
Form 10-QSB Report

TABLE OF CONTENTS

	Page
PART I — FINANCIAL INFORMATION
Item 1. Interim condensed financial Statements (unaudited)
Balance Sheet — September 30, 2006		3
Statements of Operations for the three and nine month periods ended September 30, 2005 and 2006		4
Statements of Cash Flows for the nine month periods ended September 30, 2005 and 2006		5
Notes to Interim Financial Statements		6
Item 2. Management’s discussion and analysis or plan of operation		11
Item 3. Controls and Procedures		18
PART II — OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders		19
Item 6. Exhibits		19
Signatures		20
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

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AdStar, Inc. and Subsidiary

Consolidated Balance Sheet

As of September 30, 2006 (unaudited)

Assets
Current assets:
Cash and cash equivalents	$	2,811,000
Accounts receivable, net of allowance for doubtful accounts of $93,000		811,000
Notes receivable from officers — current portion		9,000
Prepaid and other current assets		167,000
Total current assets		3,798,000
Notes receivable from officers, net of current portion		209,000
Property and equipment, net		141,000
Capitalized and purchased software, net		695,000
Intangible assets, net		1,244,000
Goodwill		2,132,000
Other assets		41,000
Total assets	$	8,260,000
Liabilities and Stockholders’ Equity
Current liabilities:
Due to publications	$	1,633,000
Accounts payable and accrued expenses		556,000
Deferred revenue and customer deposits — current portion		247,000
Loans from stockholders — current portion		11,000
Capital lease obligations — current portion		6,000
Total current liabilities		2,453,000
Deferred revenues, net of current portion		27,000
Capital lease obligations, net of current portion		28,000
Total liabilities		2,507,000
Commitments and contingencies
Stockholders’ equity:
Preferred Stock, par value $0.0001; authorized 5,000,000 shares; 0 issued		—
Common Stock, par value $0.0001; authorized 40,000,000 shares; 19,539,231 issued		2,000
Additional paid-in capital		25,589,000
Treasury stock; 67,796 shares		(68,000	)
Accumulated deficit		(19,770,000	)
Total stockholders’ equity		5,753,000
Total liabilities and stockholders’ equity	$	8,260,000

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

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AdStar, Inc. and Subsidiary

Consolidated Statements of Operations

For the Three and Nine Months

Ended September 30, 2005 and 2006 (unaudited)

	Three months ended						Nine months ended
	September 30,						September 30,
	2005			2006			2005			2006
ASP, net	$	491,000		$	496,000		$	1,391,000		$	1,463,000
Licensing and software		640,000			657,000			1,930,000			1,861,000
Customization and other		262,000			243,000			650,000			588,000
Net revenues		1,393,000			1,396,000			3,971,000			3,912,000
Total cost of revenues		470,000			535,000			1,370,000			1,616,000
Gross profit		923,000			861,000			2,601,000			2,296,000
General and administrative expense		477,000			440,000			1,419,000			1,296,000
Product maintenance and development costs		211,000			212,000			657,000			631,000
Selling and marketing expense		161,000			300,000			520,000			1,068,000
Amortization of customer list		22,000			22,000			66,000			66,000
Profit (loss) from operations		52,000			(113,000	)		(61,000	)		(765,000	)
Beneficial interest and amortization of financing fees on convertible note		(408,000	)		—			(544,000	)		—
Interest income		3,000			3,000			10,000			10,000
Interest expense		(15,000	)		(1,000	)		(49,000	)		(3,000	)
Loss before income taxes		(368,000	)		(111,000	)		(644,000	)		(758,000	)
Provision for income taxes		3,000			2,000			10,000			9,000
Net loss		(371,000	)		(113,000	)		(654,000	)		(767,000	)
Deemed dividends on exercise of warrants		—			—			(98,000	)		—
Net loss applicable to common stockholders	$	(371,000	)	$	(113,000	)	$	(752,000	)	$	(767,000	)
Loss per share — basic and diluted	$	(0.02	)	$	(0.01	)	$	(0.05	)	$	(0.04	)
Weighted average number of shares — basic and diluted		15,483,143			19,539,231			15,337,215			19,266,843

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

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AdStar, Inc. and Subsidiary

Consolidated Statements of Cash Flows

For the Nine Months

Ended September 30, 2005 and 2006 (unaudited)

	2005			2006
Cash flows from operating activities:
Net loss	$	(654,000	)	$	(767,000	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		574,000			459,000
Beneficial interest and amortization of financing fees on convertible note		544,000			—
Stock based charges		93,000			210,000
Bad debt provision		(6,000	)		13,000
Changes in assets and liabilities:
Accounts receivable		(37,000	)		(253,000	)
Prepaids and other assets		31,000			(63,000	)
Due to publications		275,000			319,000
Accounts payable and accrued expenses		(650,000	)		(121,000	)
Deferred revenue and customer deposits		(182,000	)		26,000
Net cash used in operating activities		(12,000	)		(177,000	)
Cash flows from investing activities:
Additions to capitalized and purchased software		(79,000	)		(12,000	)
Purchase of property, equipment and intangible assets		(39,000	)		(27,000	)
Repayment of officer note receivable		6,000			6,000
Net cash used in investing activities		(112,000	)		(33,000	)
Cash flows from financing activities:
Proceeds from issuance of common stock		—			1,440,000
Repayment of convertible debt		(411,000	)		—
Proceeds from exercise of options and warrants		921,000			256,000
Principal repayments on loans		(11,000	)		(10,000	)
Principal repayments on capital leases		(18,000	)		(3,000	)
Net cash provided by financing activities		481,000			1,683,000
Net increase in cash and cash equivalents		357,000			1,473,000
Cash and cash equivalents at beginning of period		1,093,000			1,338,000
Cash and cash equivalents at end of period	$	1,450,000		$	2,811,000
Supplemental cash flow disclosure:
Taxes paid	$	17,000		$	21,000
Interest paid	$	68,000		$	3,000
Supplemental disclosure on non-cash investing and financing activities:
Property and equipment acquired through capital lease financing		—		$	36,000

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

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AdStar, Inc. and Subsidiary

Notes to Consolidated Financial Statements

1.	General
	The interim financial statements for AdStar, Inc. (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with instructions to Form 10-QSB and Item 10 of Regulation S-B. Accordingly they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2005.
	The accompanying financial statements have been prepared assuming the Company will have liquidity to maintain its required minimum level of operations. At September 30, 2006, the Company’s accumulated deficit was $19,770,000, resulting from recurring net losses. For the years ended December 2004 and 2005, the net losses were $3,648,000 and $1,090,000 respectively, and for the three and nine months ended September 30, 2006, the net losses were $113,000 and $767,000, respectively. Net cash used in operations was $12,000 and $177,000, respectively. The 2004 and 2005 net losses were principally attributable to a continued shift of focus from an on-line business to an ASP business. In addition, the 2004 net losses included a one-time $1,203,000 loss from abandoned acquisitions, recorded in the fourth quarter of fiscal 2004. At September 30, 2006, the Company had working capital of $1,345,000 compared to negative working capital of $200,000 at December 31, 2005.
	Revenues for the nine month period ended September 30, 2006 have decreased from $3,971,000 to $3,912,000. While the Company is currently adding customers and revenues, such increases in revenues may be mitigated by losses of certain revenues from customers who elect to utilize other applications for processing their web-based advertising placements.
	The Company may continue to incur losses until it is able to increase revenues significantly from fees based on the number of purchases transacted through its ASP product. Although there can be no assurance, Company management believes that the cash on hand of $2,811,000 at September 30, 2006, along with expected increases in cash flows from operations, will be sufficient to meet its anticipated working capital needs through at least September 30, 2007. Cash flows from operations are anticipated to increase as a result of an expected increase in revenues.
	Management believes that the Company is in a position to take advantage of strategic acquisitions and revenue sharing arrangements, and is actively seeking such arrangements. The growing ASP business continues to be adopted by new customers in the marketplace. However, the ability to sell ASP business products and service offerings during the current year may be hampered by the current unstable climate in the advertising market relating to newspaper publishers and state of the economy in general. These factors, coupled with possible competition from other vendors, the extended selling cycle in the industry, and customer delays in customization and implementations, could delay its ability to increase revenue to a level sufficient to cover expenses. There is no assurance that management will be successful with its operating plan and, if events and circumstances occur such that they do not meet the plan as expected, and they are unable to raise additional financing; they 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.

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2.	Summary of Significant Accounting Policies
	Principles of Consolidation
	The 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.
	Concentration of Credit Risk and Major Customers
	Financial instruments that potentially subject the Company to significant concentrations of credit risk are principally comprised of trade accounts receivable.
	For the three months ended September 30, 2006 and 2005, one customer accounted for 12% and 10% of the Company’s revenues, respectively. For the nine months ended September 30, 2006 and 2005, one customer accounted for 12% and 10% of the Company’s revenues, respectively. At September 30, 2006, one customer accounted for 19% of the Company’s accounts receivable.
	The Company generally contracts with individual publication customers for its services, however, a number of publication customers fall under common enterprise ownership. For the three months ended September 30, 2006, three of such enterprises accounted for 10%, 13% and 15% of the Company’s revenues, respectively. For the nine months ended September 30, 2006, three of such enterprises accounted for 11%, 13% and 16% of the Company’s revenues, respectively. At September 30, 2006, three of such enterprises accounted for 14%, 37% and 42% of the Company’s accounts receivable, respectively.
	The majority of the Company’s customers have historically consisted of newspapers and publishers of classified advertisements. The Company’s customers on its Web site are the general public.
	Earnings (Loss) Per Share
	Basic 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 three and nine months ended September 30, 2006 and September 30, 2005 the weighted average shares outstanding as used in the calculation of diluted loss per share does not include options and warrants to purchase 2,376,798 and 1,463,047 shares of common stock, respectively and 2,000,000 shares of common stock issuable upon the conversion of series B-2 preferred stock to common stock, at September 30, 2005, as their inclusion would be antidilutive.
	Accounting for Stock-Based Compensation
	During the first quarter of fiscal 2006, the Company adopted the provisions of, and accounting for stock-based compensation in accordance with, the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards No. 123 — revised 2004 (“SFAS 123(R)”, “Share-Based Payment” which replaced` Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees.”

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	Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which 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) will have a material impact on the Company’s consolidated financial position, results of operations and cash flows. See Note 4 for further information regarding stock-based compensation assumptions and expenses, including pro forma disclosures for prior periods as if the Company had recorded stock-based compensation expense.
3.	Common Stock
	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 received the proceeds of the sale on February 17, 2006. Pursuant to the agreement, and a Registration Rights Agreement entered into on the same date, the Company filed a registration statement covering the resale of those shares on April 7, 2006, and caused the registration statement to be effective on May 18, 2006. The Company paid the placement agent a cash placement fee of 51/2 % of the amount raised, and warrants, exercisable for three years, to purchase 25,000 shares of its Common Stock at a price of $4.00 per share. Net proceeds from the sale were $1,440,000. The issuance was acquired for investment by an accredited investor and was issued without registration under the Securities Act of 1933, as amended, pursuant to the exemptions provided under sections 4(6) and 4(2) thereof and the exemption provided by Regulation D.
4.	Stock Based Compensation
	The Company’s stock option program is a long-term retention program that is intended to attract, retain and provide incentives for talented employees, officers and directors, and to align stockholder and employee interests. Currently, the Company grants options from either the 1999 Stock Option Plan or the 2004 Stock Option Plan (the “Plans”), under which options could be granted to all employees, including executive officers and non-employee directors of the Company.
	The Plans provide for issuance of nonqualified and incentive stock options to officers, key employees, consultants and non-employee directors 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 option granted to a 10% holder of the Company’s voting stock shall have an exercise price equal to or greater than 110% of the fair market value of the Common Stock on the date of grant. Each option generally has a term of five to ten years from the date of grant unless otherwise determined by the committee that administers the Plans. Option vesting periods are generally three years, and have five-year contractual terms. Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the Plans).
	Beginning with the first quarter of fiscal 2006, the Company adopted SFAS 123(R). See Note 2 for a description of the adoption of SFAS 123(R). The Company currently uses the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by the stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

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The Company estimates the expected term of options granted by taking an average of the mid-point between the vesting date and the expiration date of the option. The volatility of its common stock is determined by using historical volatility. The risk-free rate for periods within the contractual life of the option is based on the United States Treasury yield curve in effect at the time of grant. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option valuation model. Estimated forfeitures are required at the time of grant and those estimates are revised in subsequent periods if actual forfeitures differ from those estimates. The estimate of forfeitures is based on historical rates, adjusted for expected activity in the future. All stock-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.

As of September 30, 2006, there was $206,000 of unrecognized compensation cost, net of forfeitures, related to unvested share-based compensation arrangements. This compensation expense is expected to be recognized on a straight-line basis over the remaining weighted-average vesting period of approximately three years. At September 30, 2006, there were 137,937 shares available for future grants under the Plans. On November 3, 2006, shareholders approved an increase of 1,000,000 shares available for grant under the 2004 Plan.

The assumptions used to value option grants for the nine months ended September 30, 2006 are as follows:

Risk-free interest rate	4.59	%
Expected lives (years)	3.5
Dividend yield	0.0	%
Expected volatility	81.75	%

Total stock-based compensation recognized on our consolidated statement of operations for the quarter and nine months ended September 30, 2006 is $76,000 and $210,000 respectively. The following table sets forth the pro forma amounts of net income and net income per share for the prior year periods, which would have resulted if we had accounted for our employee stock plans under the fair value recognition provisions of SFAS 123:

	Quarter Ended			Nine Months Ended
	September 30, 2005			September 30, 2005
Net loss — applicable to common shareholders
As reported	$	(371,000	)	$	(752,000	)
Add: Stock based employee compensation included in reported loss		—			—
Deduct: Employee compensation expense		(46,000	)		(155,000	)
Pro forma net loss	$	(417,000	)	$	(907,000	)
Loss per share:
As reported	$	(0.02	)	$	(0.05	)
Pro forma	$	(0.02	)	$	(0.06	)
Risk-free interest rate					4.35	%
Expected lives (years)					3.5
Dividend yield					0.0	%
Expected volatility					80.1	%

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The following table summarizes all stock option activity for the nine months ended September 30, 2006 and includes all options currently outstanding under the Plans including 789,889 non-qualified options.

				Weighted Average
	Shares			Exercise Price
Outstanding at December 31, 2005		2,166,827		$	1.69
Granted		202,500			1.90
Exercised		(238,944	)		0.85
Forfeited		(31,205	)		1.12
Outstanding at September 30, 2006		2,099,178			1.74
Options exercisable at September 30, 2006		1,667,349		$	1.72

The following table summarizes information about stock options outstanding at September 30, 2006:

							Options Exercisable at
	Options Outstanding at September 30, 2006						September 30, 2006
			Weighted Average		Weighted
	Number of		Remaining		Average		Number of		Weighted
Range of	Shares		Contractual Life		Exercise		Shares		Average
Exercise Price	Outstanding		(years)		Price		Exercisable		Exercise Price
$0.01 - $0.99		744,901		1.42	$	0.66		681,403	$	0.64
$1.00 - $1.99		314,276		3.22	$	1.30		269,945	$	1.30
$2.00 - $2.99		590,001		3.98	$	2.46		266,001	$	2.33
$3.00 - $3.50		450,000		4.22	$	3.25		450,000	$	3.25
		2,099,178						1,667,349
Aggregate Intrinsic value	$	128,160					$	127,314

During the quarter ended September 30, 2006, there were no stock options or warrants exercised. During the nine months ended September 30, 2006, 238,944 stock options were exercised, with net cash receipts of $202,226; and 50,000 warrants were exercised, with net cash receipts of $53,500.

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Item 2. Management’s discussion and analysis or plan of operation

Results of Operations

The following table sets forth the results of operations expressed as a percentage of net revenues.

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2005			2006			2005			2006
ASP, net		35	%		36	%		35	%		37	%
Licensing and software		46	%		47	%		49	%		48	%
Customization and other		19	%		17	%		16	%		15	%
Net revenues		100	%		100	%		100	%		100	%
Cost of revenues		34	%		38	%		35	%		41	%
Gross Profit		66	%		62	%		65	%		59	%
General and administrative expense		34	%		32	%		36	%		33	%
Product maintenance and development costs		15	%		15	%		17	%		16	%
Selling and marketing expense		12	%		21	%		13	%		27	%
Amortization of customer list		2	%		2	%		2	%		2	%
Income (loss) from operations		4	%		(8	%)		(2	%)		(20	%)
Beneficial interest and amortization of financing fees on convertible note		(29	%)		—			(14	%)		—
Interest income		—			—			—			—
Interest expense		(1	%)		—			(1	%)		—
Loss before taxes		(26	%)		(8	%)		(16	%)		(20	%)
Provision for taxes		—			—			(2	%)		—
Net loss		(26	%)		(8	%)		(19	%)		(20	%)

Three month periods ended September 30, 2006 and 2005

Revenues

     Net revenues for the three months ended September 30, 2006 increased to $1,396,000 from $1,393,000 during the three months ended September 30, 2005, a net increase of $3,000. The net revenues for 2006 increased by $5,000 in ASP revenues and $17,000 in Licensing and Software revenues; offset by a decrease of $19,000 in Customization & Other revenues.

     The increase in ASP revenues during the 2006 three month period is primarily due to a net increase of seven publication customers serviced, and to an increase in transaction volumes. The increase in Licensing and Software revenues is primarily due to the addition of two customers on our payment processing software. The decrease in Customization & Other Revenues is due to a lower number of customization projects in 2006, as compared to 2005.

Cost of revenues

     Cost of revenues consists primarily of the costs to customize and install software applications, configure end-user software, install Web-based ad-taking software, provide technical customer training and

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end-user support, amortization of internally developed application modules, depreciation of production servers and related software, royalties, and co-location costs.

     Cost of revenues increased to $535,000 in the three months ended September 30, 2006 from $470,000 during the three months ended September 30, 2005, a net increase of $65,000 or 14%. Our gross profit margin for the three months ended September 30, 2006 decreased to 62% from 66% for the three months ended September 30, 2005. The increase in costs during the three month period, when compared to the prior year period, is primarily due to a relief of labor accrual in 2005 that did not recur in 2006, of $52,000 related to an estimated loss accrual originally recorded in 2003. Labor costs associated with installation projects and customer support increased by $37,000 in 2006, from the prior year period, and facilities and insurance costs increased by $17,000. Cost of revenue increases were offset by a decrease in amortization of capitalized software development costs and depreciation of $40,000, as compared to the prior year period.

General and administrative expense

     General and administrative expense consists primarily of the cost of executive, administrative, and finance personnel, as well as professional fees and accounting. General and administrative expenses decreased to $440,000 during the three months ended September 30, 2006 from $477,000 during the three months ended September 30, 2005, a net decrease of $37,000 or 8%. The decrease in 2006 is primarily due to net decreases in accounting and legal fees of $26,000, other professional fees of $44,000, insurance costs of $24,000, and compensation costs of $22,000. Such decreases were partially offset by increases in stock compensation expense of $63,000 in 2006, with no corresponding cost in 2005, and an increase in facilities and depreciation costs of $16,000.

     Management believes that our existing executive staffing levels are sufficient to allow for moderate growth without the need to add personnel and related costs for the foreseeable future. However, the impact of complying with and maintaining compliance with Sarbanes-Oxley and SAS 70 has not been fully analyzed at this time and may require the addition of personnel and/or systems to adequately meet the requirements.

Selling and marketing expenses

     Selling and marketing expenses consist primarily of direct charges for advertising, sales promotion, marketing, and trade shows, as well as the cost of business development. Selling and marketing costs increased to $300,000 in the three months ended September 30, 2006 from $161,000 in the comparable period in 2005, a net increase of $139,000 or 86%. The increase during the quarter, as compared to the prior year, is primarily due to increases in the costs of advertising and trade shows of $19,000, compensation and travel costs of $98,000, facilities and depreciation costs of $13,000, and stock option expenses of $9,000.

     Our sales and marketing expenditures are directed toward the expansion of the volume of third-party users of our software and to the development of new markets for our services, both domestic and international.

Product maintenance and development costs

     Product maintenance and development expenses consist of expenses to identify functional requirements, to plan, identify and conceptually design the required technical infrastructure, and to perform other general routine fixes. The costs consist primarily of personnel-related expenses for technical and design functions including outside consultants. Product maintenance and development expenses increased to $212,000 during the three months ended September 30, 2006 from $211,000 during the three months ended September 30, 2005, a net increase of $1,000. The decrease in 2006, as compared to the 2005 period, is primarily due to an increase in compensation related costs including travel of $8,000; offset by a decrease in facilities costs of $7,000.

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     We monitor technical staffing levels closely and believe that our current level of technical staffing will be sufficient for the near future. If we are able to accelerate the attraction of new customers, we may need to increase technical staffing in the short term for customization projects. However, such an increase in technical staffing costs would be generally offset by increased revenues for such services.

Beneficial interest and amortization of financing fees on Convertible Note

     Beneficial interest expenses and amortization of financing fees consists of the amortization of the beneficial conversion and financing fees associated with the Laurus Master Fund Convertible Note that was converted into equity shares in 2005. In connection with the $1.5 million Note, we had recorded a debt discount consisting of the intrinsic value of the beneficial conversion and the portion of the proceeds allocated to the warrants issued to the lenders.

     During the three months ended September 30, 2006 there was no interest expense related to the Laurus Master Fund Convertible Note, as compared to approximately $408,000 of financing fees and debt discount that were amortized as interest expense during the three months ended September 30, 2005.

Interest income and expense

     Interest income was $3,000 during the three months ended September 30, 2006, as compared to $3,000 during the comparable 2005 period. Interest income consists of interest income from notes receivable from officers and a minor certificate of deposit account maintained as security on certain credit cards.

     Interest expense was $1,000 during the three months ended September 30, 2006, as compared to $15,000 during the comparable 2005 period. The interest expense during 2005 consisted primarily of $15,000 interest on the Laurus Master Fund Convertible Note, which was paid in 2005, with the remainder associated with capitalized leases and notes payable to the founders of Edgil in connection with the purchase.

Provision for Income Taxes

     The provision for income taxes is comprised primarily of state taxes for Edgil. Federal income taxes are consolidated and, due to the nature of the merger agreement between AdStar and Edgil are treated as separate taxable entities for State income tax purposes. AdStar is currently in a loss carry-forward position for federal income taxes, primarily due to the operating losses incurred through December 31, 2005. The federal net operating loss carry-forward balance as of December 31, 2005 was approximately $16,920,000, compared to $16,036,000 in the prior year. The net operating loss carry-forward is available to offset future taxable income through 2026.

Nine month periods ended September 30, 2006 and 2005

Revenues

     Net revenues for the nine months ended September 30, 2006 decreased to $3,912,000 from $3,971,000 during the nine months ended September 30, 2005, a net decrease of $59,000 or 1%. The net revenues for 2006 increased by $72,000 in ASP revenues, offset by a decrease of $69,000 in Licensing and Software revenues and a decrease of $62,000 in Customization & Other revenues.

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     The increase in ASP revenues during the 2006 nine month period is primarily due to a net increase of eight publication customers serviced, and to an increase in transaction volumes. The decrease in Licensing and Software revenues is primarily due to the loss of three customers on our legacy software. The decrease in Customization & Other Revenues is due to a lower number of customization projects in 2006, as compared to 2005.

Cost of revenues

     Cost of revenues increased to $1,616,000 in the nine months ended September 30, 2006 from $1,370,000 during the nine months ended September 30, 2005, a net increase of $246,000 or 18%. Our gross profit margin for the nine months ended September 30, 2006 decreased to 59% from 65% for the nine months ended September 30, 2005. The increase in costs during the nine month period, when compared to the prior year period, is primarily due to relief of labor accruals in 2005 that did not recur in 2006, of $137,000 related to an estimated loss accrual originally recorded in 2003 and a $31,000 adjustment to contingent pre-acquisition contract costs on the Edgil product line. Labor costs associated with installation projects and customer support increased by $155,000 in 2006, from the prior year period, and facilities and insurance costs increased by $55,000. Cost of revenue increases were offset by a decrease in amortization of capitalized software development costs and depreciation of $132,000, as compared to the prior year period.

General and administrative expense

     General and administrative expenses decreased to $1,296,000 during the nine months ended September 30, 2006 from $1,419,000 during the nine months ended September 30, 2005, a net decrease of $123,000 or 9%. The decrease in 2006 is primarily due to net decreases in accounting and legal fees of $18,000, other professional fees of $126,000, insurance costs of $76,000, and compensation costs of $35,000. Such decreases were partially offset by increases in stock compensation expense of $88,000 in 2006, with no corresponding cost in 2005, and an increase in facilities and depreciation costs of $44,000.

Selling and marketing expenses

     Selling and marketing costs increased to $1,068,000 in the nine months ended September 30, 2006 from $520,000 in the comparable 2005 period, a net increase of $548,000 or 105%. The increase during the nine month period, as compared to the prior year, is primarily due to increases in the costs of advertising and trade shows of $95,000, compensation and travel costs of $300,000, facilities and depreciation costs of $54,000, and stock option expenses of $99,000.

Product maintenance and development costs

     Product maintenance and development expenses decreased to $631,000 during the nine months ended September 30, 2006 from $657,000 during the nine months ended September 30, 2005, a net decrease of $26,000 or 4%. The decrease in 2006, as compared to the 2005 period, is primarily due to a decrease in compensation related costs including travel of $6,000 and a decrease in facilities costs of $20,000.

Beneficial interest and amortization of financing fees on Convertible Note

     During the nine months ended September 30, 2006 there was no interest expense related to the Laurus Master Fund Convertible Note, as compared to approximately $544,000 of financing fees and debt discount that were amortized as interest expense during the nine months ended September 30, 2005.

Interest income and expense

     Interest income was $10,000 during the nine months ended September 30, 2006, as compared to $10,000 during the comparable 2005 period. Interest income consists of interest income from notes

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receivable from officers and a minor certificate of deposit account maintained as security on certain credit cards.

     Interest expense was $3,000 during the nine months ended September 30, 2006, as compared to $49,000 during the comparable 2005 period. The interest expense during 2005 consisted primarily of $15,000 interest on the Laurus Master Fund Convertible Note, which was paid in 2005, with the remainder associated with capitalized leases and notes payable to the founders of Edgil in connection with the purchase.

Deemed Dividend

     In January 2005, the Company offered an inducement to its warrant holders to exercise their warrants at a price which was below the fair market value. As this offer only benefited a selected group of common shareholders and was not broadly available to all common shareholders, the Company determined that the deemed dividend treatment was most appropriate. In the three months ended September 30, 2005, AdStar recorded a deemed dividend in the amount of $98,000. Such event was isolated, and did not recur in 2006.

Liquidity and Capital Resources

     At September 30, 2006, we had an accumulated deficit of $19,770,000. We have incurred significant recurring net losses. For the years ended December 2004 and 2005 we had net losses applicable to common shareholders of $3,648,000 and $1,188,000, respectively. We anticipate that we will continue to incur losses until we are able to increase revenues significantly from fees based on the number of purchases transacted through our ASP and payment processing products.

     Although there can be no assurance, we believe that the cash on hand of $2,811,000 at September 30, 2006, along with an expected increase in cash flows from operations, will be sufficient to meet our anticipated working capital needs through at least September 30, 2007. In addition, we will continue to seek additional financings as needed.

     We believe that we are in a position to take advantage of strategic acquisitions and revenue sharing arrangements should they present themselves. We are optimistic that our growing ASP business will continue to be accepted in the marketplace. However, our ability to sell ASP business products and service offerings during the current year may be hampered by the current unstable climate in the advertising market relating to newspaper publishers and state of the economy in general. These factors, coupled with possible competition from other vendors, the extended selling cycle in our industry, and customer delays in customization and implementations, could delay our ability to increase revenue to a level sufficient to cover our expenses. There is no assurance that management will be successful with its operating plan and, if events and circumstances occur such that we do not meet our plan as expected, and we are unable to raise additional financing, we may be required to further reduce certain discretionary spending, which could have a material adverse effect on AdStar’s ability to achieve our intended business objectives.

     We have historically financed our business through a combination of cash generated from operations and debt and equity financings. At September 30, 2006, we had working capital of $1,345,000 compared to negative working capital of $200,000 at December 31, 2005, a $1,545,000 improvement. The improvement in working capital is primarily a result of the sale of one million shares of our Common Stock in February 2006, for net proceeds of $1,440,000, and the exercise of 288,944 stock options and warrants during the nine months ended September 30, 2006, for net proceeds of $256,000.

     As of September 30, 2006, we had cash and cash equivalents of approximately $2,811,000 compared to $1,338,000 as of December 31, 2005, a net increase of $1,473,000. The net increase in cash and cash

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equivalents was the result of $1,719,000 provided by financing activities; offset by $177,000 used in operating activities and $69,000 used in investing activities.

     Net cash used in operations during the nine months ended September 30, 2006 was approximately $177,000 compared with $12,000 used in operations during the nine months ended September 30, 2005, a $165,000 decrease. This was primarily due to the higher loss in the 2006 period.

     Net cash used in investing activities decreased to $69,000 during the nine months ended September 30, 2006 compared with $112,000 during the prior year period. The decrease of $43,000 is primarily the result of reduced spending on capitalized and purchased software.

     Net cash provided by financing activities was $1,719,000 during the nine months ended September 30, 2006 compared with $481,000 during the prior year period. In February 2006, we sold one million (1,000,000) shares of our Common Stock for net proceeds of $1,440,000. Net proceeds from the exercise of stock options and warrants were $256,000 in the nine months ended September 30, 2006, as compared to $921,000 in the prior year period. In the nine months ended September 30, 2005, $411,000 in principal repayments were made on the Laurus Master Fund Convertible Note, which did not recur in the current year period.

     We currently have no additional borrowings available to us under any credit arrangement. We will continue to look for additional financing when it may be required. Adequate funds may not be available or may not be available on terms favorable to us. If additional funds are raised through the issuance of equity securities, dilution to existing stockholders may result. If funding is insufficient at any time in the future, we may be unable to develop or enhance our products or services, take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our financial position, results of operations and cash flows.

Critical Accounting Policies and Estimates

     The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the unaudited Consolidated Condensed Financial Statements and accompanying notes. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts, percentage completion on certain contracts, and income taxes. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions.

     AdStar believes there have been no significant changes, during the three month period ended September 30, 2006, to the items disclosed as critical accounting policies and estimates in Management’s Discussion and Analysis or Plan of Financial Condition and Results of Operations in their Annual Report on Form 10-KSB for the year ended December 31, 2005.

New accounting pronouncements

     During the first quarter of fiscal 2006, we adopted the provisions of, and account 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. We 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

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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) will have a material impact on our future consolidated financial position, results of operations and cash flows.

     In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (“SFAS 157”), “Fair Value Measurements,” which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. We are currently evaluating the impact of SFAS 157, but do not expect the adoption of SFAS 157 to have a material impact on our consolidated financial position, results of operations or cash flows.

     In July 2006, the FASB issued Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109” (“FIN 48”), which is a change in accounting for income taxes. FIN 48 specifies how tax benefits for uncertain tax positions are to be recognized, measured, and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for uncertain tax positions should be classified on the balance sheet; and provides transition and interim period guidance, among other provisions. FIN 48 is effective for fiscal years beginning after December 15, 2006 and as a result, is effective for AdStar in the first quarter of fiscal 2007. We are currently evaluating the impact of FIN 48 on our consolidated financial position, results of operations, and cash flows.

     In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155 (“SFAS 155”), “Accounting for Certain Hybrid Financial Instruments” which amends Statement of Financial Accounting Standards No. 133 (“SFAS 133”), “Accounting for Derivative Instruments and Hedging Activities” and Statement of Financial Accounting Standards No. 140 (“SFAS 140”), “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. We will adopt SFAS 155 in the first quarter of fiscal 2007. We do not expect the adoption of SFAS 155 to have a material impact on our consolidated financial position, results of operations or cash flows.

Contractual Obligations, Commitments and Contingencies

     We have contractual obligations and commitments primarily with regards to employment agreements for three of our current and one of our former executives, a convertible note due in equal monthly principal installments payable through October 2006, certain non-cancelable operating lease obligations for office space and equipment, and capital lease obligations for computer equipment.

     The following table aggregates our expected contractual obligations and commitments subsequent to September 30, 2006:

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	Payments due by Periods for one year ending September 30,
							Beyond
Contractual obligations	2007		2008		2009		2009		Total
Employment agreements	$	587,000	$	404,000	$	404,000	$	404,000	$	1,799,000
Operating lease commitments		179,000		198,000		204,000		150,000		731,000
Capital lease commitments		10,000		10,000		10,000		16,000		46,000
Notes payable to former stockholders		10,000		—		—		—		10,000
	$	786,000	$	612,000	$	618,000	$	570,000	$	2,586,000

Item 3. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.AdStar’s management, with the participation of the Chief Executive Officer and the Chief Financial Officer, carried out an evaluation of the effectiveness of AdStar’s “disclosure controls and procedures” (as defined in the Exchange Act Rules 13a-15(e) and 15-d-15(e)) as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, as of the Evaluation Date, AdStar’s disclosure controls and procedures are effective, to ensure that information required to be disclosed by them in the reports that they file or submit under the Exchange Act (i) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (ii) is accumulated and communicated to their management, including the chief executive and chief financial officers, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting.There were no changes in AdStar’s internal controls over financial reporting, known to the Chief Executive Officer or the Chief Financial Officer, that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, AdStar’s internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

     We held an Annual Meeting of stockholders on November 3, 2006 to consider the election of directors, amendment to the 2004 Stock Option Plan, and the ratification of the appointment by the Board of Directors of Holtz Rubenstein Reminick LLP as the Company’s independent accountants for the year ending December 31, 2006.

     The following seven individuals were elected by the stockholders to serve as directors for terms expiring at our 2007 Annual Meeting or until their successors are elected and qualified:

Name	Votes Cast For		Abstentions
Leslie Bernhard		15,906,008		1,613,448
Eli Rousso		15,941,878		1,577,578
Jeffrey Baudo		15,937,542		1,581,914
John Rudy		15,941,597		1,577,859
Michael Jackson		15,950,162		1,569,294
Peter M. Zollman		15,941,097		1,578,359
Michael Dubreuil		15,942,097		1,577,359

     At the Annual Meeting, the stockholders also approved a proposal to amend the AdStar, Inc. 2004 Stock Option Plan to increase the shares subject to the Plan by 1,000,000 shares by the following vote: 6,258,492 shares were voted in favor, 2,025,723 shares were voted against, and 1,834 shares were held in abstention. The stockholders also ratified the appointment of Holtz Rubenstein Reminick LLP as independent accountants for the year ending December 31, 2006 by the following vote: 17,380,279 shares were voted in favor, 13,510 shares were voted against, and 125,666 shares were held in abstention.

Item 6. Exhibits

     Exhibits:

Exhibit No.		Description
	31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

     In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	AdStar, Inc. (Registrant)
Date: November 14, 2006	/s/ Leslie Bernhard
	Leslie Bernhard
	President and Chief Executive Officer
Date: November 14, 2006	/s/ James Linesch
	James Linesch
	Chief Financial Officer (Principal Financial Officer)

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