UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended June 30, 2002
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
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 (IRS Employer Identification No.)
incorporation or organization)
4553 Glencoe Avenue, Suite 325, Marina del Rey, California 90292
(Address of principal executive offices)
(310) 577-8255
(Issuer's telephone number)
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of August 12, 2002 the Issuer had
outstanding 8,253,297 shares of its common stock, including 14,347 shares
issuable pursuant to the vendor compensation plan.
Check whether the issuer (1) 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. Yes |X| No |_|
Transitional Small Business Disclosure Format (Check one): Yes |_| No |X|
TABLE OF CONTENTS
FORM 10-QSB REPORT
June 30, 2002
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Interim Condensed Financial Statements
(Unaudited)
Balance Sheet - June 30, 2002 3
Statements of Operations
For the Three-Month and Six Month Periods
Ended June 30, 2001 and 2002 4
Statements of Cash Flows
For the Six-Month Periods Ended
June 30, 2001 and 2002 5
Notes to Interim Financial Statements 6
Item 2. Management's Discussion and Analysis or Plan of Operation 12
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 18
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
2
AdStar, Inc.
Balance Sheet
June 30, 2002 (unaudited)
Assets
Current assets:
Cash and cash equivalents $ 1,363,806
Restricted cash 5,535
Accounts receivable, net of allowance of $42,862 231,473
Prepaid and other current assets 180,825
------------
Total current assets 1,781,639
Property and equipment, net 1,898,001
Deferred contract costs 268,406
Intangible assets, net 67,141
Other assets 28,376
------------
Total assets $ 4,043,563
============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 616,988
Accrued expenses 337,935
Deferred revenue 216,550
Capital lease obligations 14,710
------------
Total current liabilities 1,186,183
Capital lease obligations 29,964
------------
Total liabilities 1,216,147
Commitments and contingencies
Stockholders' equity:
Preferred stock, par value $0.0001; authorized 5,000,000 shares;
1,443,457 shares issued and outstanding; liquidation preference
of $1,795,000 144
Common stock, par value $0.0001; authorized 20,000,000 shares;
8,253,297 shares issued and outstanding 825
Additional paid-in capital 12,742,482
Treasury stock, par value $0.0001; 67,796 shares (7)
Stockholder receivable (39,566)
Accumulated deficit (9,876,462)
------------
Total stockholders' equity 2,827,416
------------
Total liabilities and stockholders' equity $ 4,043,563
============
The accompanying notes are an integral part of these
interim financial statements.
3
AdStar, Inc.
Statements of Operations
For the three-month and six month periods
ended June 30, 2001 and 2002 (unaudited)
Three months ended Six months ended
June 30, June 30,
---------------------------- ----------------------------
2001 2002 2001 2002
------------ ------------ ------------ ------------
Revenues $ 531,551 $ 541,636 $ 971,794 $ 1,041,845
Cost of revenues 196,495 260,407 371,647 486,121
------------ ------------ ------------ ------------
Gross profit 335,056 281,229 600,147 555,724
Selling expenses 170,255 148,289 337,929 304,491
Administrative expenses 446,160 460,890 1,021,669 930,481
Development expenses 91,407 86,813 293,850 306,435
------------ ------------ ------------ ------------
Loss from operations (372,766) (414,763) (1,053,301) (985,683)
Other income -- 62,796 -- 62,796
Interest income (expense), net 15,564 6,813 18,965 10,487
------------ ------------ ------------ ------------
Loss before taxes (357,202) (345,154) (1,034,336) (912,400)
Provision for income taxes 518 1,866 2,050 3,630
------------ ------------ ------------ ------------
Net loss $ (357,720) $ (347,020) $ (1,036,386) $ (916,030)
============ ============ ============ ============
Loss per share - basic and
diluted $ (0.06) $ (0.04) $ (0.17) $ (0.11)
Weighted average number of
shares - basic and diluted 6,269,210 8,238,789 6,050,754 8,170,667
The accompanying notes are an integral part of these
interim financial statements.
4
AdStar, Inc.
Statements of Cash Flows
For the six-month periods
Ended June 30, 2001 and 2002 (unaudited)
2001 2002
----------- -----------
Cash flows from operating activities:
Net loss $(1,036,386) $ (916,030)
Adjustments to reconcile net loss to net cash used
in operating activities
Depreciation and amortization 147,188 274,120
Stock returned from settlement -- (67,789)
Stock based charges 54,520 24,802
Increase in reserve on accounts receivable -- 27,682
Loss on disposal of fixed assets 16,833 --
Changes in assets and liabilities:
Accounts receivable (153,653) (48,785)
Prepaid and other assets 35,548 (9,951)
Deferred contract expenses -- (268,406)
Accounts payable 88,791 262,722
Accrued expenses (206,758) (108,693)
Deferred revenue 148,776 63,337
----------- -----------
Net cash used in operating activities (905,141) (766,991)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (412,217) (234,649)
Proceeds from disposal of fixed assets 25,661 --
Repayment of stockholder receivable 4,500 3,554
----------- -----------
Net cash used in investing activities (382,056) (231,095)
----------- -----------
Cash flows from financing activities:
Restricted cash -- 39,922
Proceeds from leasing of property and equipment -- 34,943
Net proceeds from sale of common stock 365,333 151,552
Net proceeds from sale of preferred stock -- 1,727,840
Principal repayments on capital leases (44,613) (3,904)
----------- -----------
Net cash provided by (used in) financing
activities 2001 320,720 1,950,353
----------- -----------
Net increase (decrease) in cash and cash
equivalents (966,477) 952,267
Cash and cash equivalents at beginning of period 1,606,999 411,539
----------- -----------
Cash and cash equivalents at end of period $ 640,522 $ 1,363,806
=========== ===========
Supplemental cash flow disclosure:
Taxes paid $ 4,565 $ 6,645
Interest paid $ 2,645 $ 2,129
Non cash investing and financing activities
Conversion of note payable and accrued interest to
common stock $ 1,186,966 $ --
Conversion of accounts payable to common stock $ -- $ 62,469
The accompanying notes are an integral part of these
interim financial statements.
5
AdStar, Inc.
Notes To Interim Financial Statements
(Unaudited)
1. General
The interim financial statements for AdStar, Inc. (the "Company")
have been prepared in accordance with generally accepted accounting
principles 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
generally accepted accounting principles 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-month period ended June 30, 2002 are not necessarily
indicative of the results that may be expected for the year ending
December 31, 2002. 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/A for the year ended
December 31, 2001.
For the six-month period ended June 30, 2002, the Company had
incurred cash outflow from operations of approximately $767,000 and
as of June 30, 2002, the Company had working capital of only
$595,000. Based on the Company's current operating plans, management
believes existing cash resources, including the proceeds from the
sale of the preferred stock in March 2002, and cash forecasted by
management to be generated by operations will be sufficient to meet
working capital and capital requirements through June 30, 2003.
Also, management's plans to attain profitability and generate
additional cash flows include expansion of services under existing
and new contracts, while containing any increase to operating
expenditures necessary to accommodate this expansion. There is no
assurance that management will be successful with these plans.
However, if events and circumstances occur such that the Company
does not meet its current operating 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.
2. Summary of Significant Accounting Policies
Concentration of Credit Risk and Major Customers
Financial instruments that potentially subject the Company to
significant concentrations of credit risk consist principally of
trade accounts receivable. Also, at times, cash balances held in
financial institutions are in excess of FDIC insurance limits.
For the three months ended June 30, 2002 and 2001, no customer
accounted for 10% of the Company's revenues. At June 30, 2002 nine
customers in the aggregate accounted for 61% of the Company's
accounts receivable. The majority of the Company's customers have
historically consisted of newspapers and publishers of classified
advertisements.
6
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Revenue Recognition
The Company derives revenue from several products and services as
follows:
Technology services revenue - The Company receives revenue from
technology service contracts that generally contain multiple
elements such as software customization services, monthly fees and
post-contract customer support (PCS). Revenue from these
arrangements is recognized in accordance with Statement of Position
("SOP") 97-2, "Software Revenue Recognition", and SOP 98-9,
"Software Revenue Recognition with Respect to Certain Transactions".
Accordingly, revenue is allocated to each element within the
contract based on the relative fair values of those elements using
vendor specific objective evidence. Revenue from monthly fees and
PCS under software maintenance arrangements is based upon renewal
rates and is recognized ratably over the term of the arrangement.
Revenue from software customization services is recognized as the
services are performed, using a percentage of completion methodology
based on labor hours. The Company also provides customization
services at the customers' request and recognizes revenue as the
services are performed, using a percentage of completion methodology
based on labor hours.
Areas requiring management's judgment include 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 quarterly results
of operations. The corresponding cost of revenue charge is derived
based upon the same labor input measurements and our existing cost
structure. If the Company does not accurately estimate the resources
required under the contract or the scope of the work to be
performed, or if the Company does not manage its projects properly
within the prescribed timeframe, future margins may be significantly
and adversely affected. If increases in projected costs-to-complete
are sufficient to create a loss contract, the entire estimated loss
is charged to operations in the period the loss first becomes known.
The complexity of the estimation process and uncertainties inherent
in software customization activities may affect the percentages
derived under the percentage-of-completion accounting method, which
in turn may affect the amounts reported in the financial statements.
ASP revenue - The Company receives revenue from providing an
application service provider ("ASP") product that allows customers
to use the Company's software applications on a "shared system" over
the Internet. This technology is a publisher-specific ad-taking Web
site service that offers visitors to a newspaper's Web page the
opportunity to buy classified ads, for both the print and/or on-line
editions of the newspaper, in real-time, on a 24/7 basis. The
Company receives monthly fees for hosting
7
the transactions and providing customer support, and recognizes the
fees ratably over the contract period.
Web site revenue - The Company receives revenue from fees charged to
customers who transact business on the Advertise123.com Web site.
This site permits the general public to plan, schedule, compose and
purchase advertising from many print and on-line publishers. Under
the guidance provided by the Securities Exchange Commission Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition" and the
Emerging Issues Task Force ("EITF") Abstract No. 99-19 "Reporting
Revenue Gross as a Principal versus Net as an Agent" ("EITF 99-19"),
the Company is, in substance, acting as an agent for the publishers
and therefore recognizes as revenue only the net fees realized on
the transactions. The Company recognizes revenues on a
per-transaction basis when the ad is placed through their system and
collection from the customer is probable.
Development Costs
Costs incurred in the development of products are expensed as
incurred.
Computation of Earnings Per Share
Basic earnings (loss) per share is computed by dividing the net
income (loss) 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) 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. Potential common
shares are excluded from the computation when their effect is
antidilutive. For the three months ended June 30, 2001 and 2002,
diluted loss per share does not include 1,788,164 and 3,380,476,
respectively, of options and warrants to purchase common stock and 0
and 1,443,457, respectively, of shares issuable upon the conversion
of Series A preferred stock to common stock, as their inclusion
would be antidilutive.
3. Significant Contracts
On March 18, 2002, the Company entered into a series of agreements
with Tribune Company ("Tribune"). In accordance with these
agreements, the Company sold 1,443,457 shares of Series A
convertible preferred stock to the Tribune Company for approximately
$1.8 million. The Company has recorded the $1.8 million investment
in the Series A convertible preferred stock at cost which
approximated fair value. The rights and preferences of the Series A
preferred stock are described in Note 4 below. Additionally, the
Company agreed to develop and customize a version of its Web
software applications to Tribune specifications in exchange for
earning volume-based transaction fees in the future by providing
Web-based recruitment ad sales technology to all major market
Tribune newspapers and on-line services. This customization will
provide a platform that allows Tribune owned newspapers, together
with a Tribune affiliated company, CareerBuilder, Inc.
(www.careerbuilder.com), to receive recruitment advertising from
agencies, corporate customers, and the general public. After the
Company completes the development and customization effort, it will
manage the related transactions and receive a volume-based ASP fee
with a guaranteed monthly minimum. As the Company incurs cost
associated with the customization effort, amounts will be
8
reflected as deferred contract costs in the balance sheet. Through
June 30, 2002, $268,406 in development and customization costs have
been deferred. The Company will amortize the cost of the development
and customization effort over the expected period of the agreement,
currently estimated to be five years from completion of the
development and customization effort. The Company currently believes
that the cost of the development and customization effort will not
exceed the anticipated monthly minimum payments under the agreement
totaling $450,000. Should it be determined that the costs to develop
and customize the software applications under the agreement exceed
estimated total revenues from the contract, the estimated loss will
be charged to cost of revenues in the period the loss first becomes
known. The Company will recognize in revenue the minimum monthly
fees under the agreement on a straight-line basis commencing on the
completion of the development and customization effort. To the
extent that transaction based fees exceed the monthly minimum
payments, the Company will record the excess in revenue when earned.
4. Series A Convertible Preferred Stock
The Company has authorized 5,000,000 shares of preferred stock, par
value $0.0001 per share, of which 1,443,457 shares have been
designated as Series A convertible preferred stock ("Series A
preferred stock"). The remaining authorized shares have not been
designated. At June 30, 2002, the Company has reserved 1,443,457
shares of common stock for issuance upon the conversion of the
Series A preferred stock. The Series A preferred stock has the
following characteristics:
Voting Rights - Each holder of the Series A preferred stock is
entitled to the number of votes equal to the number of shares of
common stock into which such holder's shares are convertible. The
Company cannot amend its certificate of incorporation amending the
rights of the Series A preferred stockholders, enter into any
capital stock or equity agreements with rights ranking the same or
above the rights of the Series A preferred stock or liquidate the
Company without the approval of at least a majority of the holders
of the Series A preferred stock then outstanding.
Liquidation Preference - In the event of any liquidation,
dissolution or winding up of the affairs of the Company, the holders
of the Series A preferred stock will be entitled to receive in
preference to the holders of the common stock, an amount per share
equal to $1.244 plus accrued and unpaid dividends. After such
payment, the Series A preferred stockholders share equally with the
common stockholders in any remaining assets or funds of the Company.
Conversion - Each share of the Series A preferred stock is
convertible at anytime at the option of the holder into shares of
common stock pursuant to a ratio of one share of common stock for
each share of Series A preferred stock, subject to certain stock
split and stock dividend adjustments. In addition, the conversion
ratio is subject to adjustment, as defined in the agreement, in the
event that the Company issues common stock at a per share price less
than $1.244 per share. All Series A preferred stock will
automatically convert to common stock on the first day after March
18, 2004 for which the market price of the Company's common stock
exceeds $2.25 per share.
9
Dividends - Dividends on the Series A preferred stock shall accrue
at 7% per annum through the date of liquidation or conversion. In
the event of conversion all accrued and unpaid dividends will be
waived.
The Company is requesting stockholder approval and ratification of
this transaction because the anti-dilution provisions associated
with the Series A Preferred (described above under the paragraph
beginning with "Conversion") can potentially result in the issuance
of greater than 20% of our Common Stock outstanding on March 18,
2002 and at a price below its then market value of $1.15 (based on
the closing bid price on March 15, 2002) upon conversion of all the
Series A Preferred. As a result, the Nasdaq has advised us that
approval of this transaction by holders of our Common Stock would be
necessary to be in compliance with their shareholder approval
requirement for such issuances and to avoid being subject to
delisting proceedings. The annual proxy statement has been filed
with this matter to be voted on by shareholders of record as of
August 8, 2002.
5. Issuance of Common Stock
In January 2002, the Company sold an additional 300,000 shares of
common stock at a price of $0.50 per share. These shares were sold
as part of a 1,300,000 share private placement made pursuant to
Sections 4(2) and 4(6) of the Act, of which 1,000,000 shares were
sold prior to December 31, 2001. In connection with this offering
the Company issued warrants to purchase 130,000 shares of its common
stock, at a per share price of $0.75, as part of the placement agent
fees. The warrants expire on January 16, 2007.
In January 2002, the Company issued 114,545 of its authorized but
unregistered shares of common stock in full settlement of a $62,500
liability, payable to Morse, Zelnick, Rose & Lander, LLP. The shares
were registered in June 2002.
In February 2002, AdStar sold 100,000 shares of its common stock at
$0.50 per share. In connection with this sale, the Company issued
warrants to purchase 10,000 shares of its common stock, at a per
share price of $0.75, as part of the placement agent fees. The
warrants expire on January 31, 2007.
6. Settlement and return of Common Stock
In November 2000, Adstar entered in a one-year strategic alliance
agreement with Eastman Kodak Company (Kodak) whereby Adstar issued
67,796 shares of its common stock valued at $100,000. As of December
2001 the parties had not been able to complete the provisions of the
agreement to both parties satisfaction, whereby Kodak notified
Adstar of its intention to terminate the agreement as of February
28, 2002. After protracted settlement discussions the parties agreed
to a mutual termination and release agreement entered into during
May 2002. As part of the agreement Kodak returned Adstar's common
stock, valued at $67,789 and Adstar agreed not to pursue any further
actions for performance against Kodak.
7. Subsequent events
In July 2002, AdStar entered into four-year employment agreements
with each of Leslie Bernhard and Eli Rousso. Their prior agreements
expired on June 30, 2002. Pursuant to
10
her employment agreement, Leslie Bernhard was retained as our Chief
Executive Officer and her total annual compensation was reduced to
$212,800. Pursuant to his employment agreement, Eli Rousso was
retained as Executive Vice President and his total annual
compensation was reduced to $212,800. Each agreement provides, among
other things, for participation in an equitable manner in any
profit-sharing or retirement, separation and disability plans for
employees or executives and for participation in other employee
benefits applicable to employees and executives of AdStar. Each
agreement further provides for fringe benefits which commensurate
with the executive's duties and responsibilities. Under each
agreement, employment may be terminated by Adstar with cause or by
the executive with good reason. Termination without cause, or by the
executive for good reason, would subject Adstar to liability for
liquidated damages in an amount equal to the terminated executive's
base salary for the remaining term of his or her employment
agreement or 12 months, whichever is greater.
In July 2002, AdStar entered into a loan transaction with Leslie
Bernhard and Eli Rousso 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 payable on a monthly basis, with all remaining outstanding
principal and interest amounts due on July 31, 2022. Concurrently,
an outstanding note from Ms. Bernhard in the amount of $39,566 was
restructured under the same terms and conditions as the
aforementioned new note.
In July 2002, for the six-month period ended June 30, 2002, 8,861
shares were issued to vendors under the AdStar Vendor Payment Plan
relying upon the exemption under sections 4(2) and 4(6) of the
Securities Act of 1933 and which represented compensation for the
period of $7,500. The vendors have taken the shares for investment.
In August 2002, AdStar was informed by Chase Merchant Services,
L.L.C (Chase), AdStar's merchant bank providing credit card
processing services, that it required the Company to maintain a
restricted cash balance of $175,000. Chase indicated the primary
reason for the reserve was the significant increase in dollar volume
during the second quarter from AdStar's transactions. AdStar
believes the reserve is unnecessary and has commenced negotiations
to have the reserve significantly reduced or removed altogether.
Should negotiations fail AdStar has identified another reputable
credit card merchant services provider who has indicated it would
not require a reserve.
11
Item 2. Management's Discussion and Analysis or Plan of Operation
The following discussion of our financial condition and results of operations
should be read in conjunction with the financial statements and related notes to
the financial statements included elsewhere in this quarterly 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 and are subject to the "Risk Factors" included in our
Annual Report on Form 10-KSB/A for our fiscal year ended December 31, 2001 and
in our registration statement on form S-3 filed with the Securities and Exchange
Commission on January 24, 2002. Because this discussion involves risk and
uncertainties, our actual results may differ materially from those anticipated
in these forward-looking statements.
Overview
During the First quarter of 2002, we focused our efforts on raising equity
capital and the development and customization arrangements with the Tribune
Company. In January 2002, we completed the private placement that had been in
process at year-end, raising an additional $150,000 in gross proceeds. In
February 2002, we raised an additional $50,000 in gross proceeds from a
subsequent private placement. Combined, these two transactions raised
approximately $157,000 in net proceeds. In March 2002, we entered into a series
of significant contracts with the Tribune Company. Under these agreements, we
sold 1,443,457 shares of Series A preferred stock to the Tribune Company for net
proceeds totaling approximately $1,728,000. Additionally, we agreed to develop
and customize a version of our Web software applications to provide for
Web-based technology for recruitment classified advertising sales to all major
market Tribune newspapers and on-line services in exchange for earning
volume-based ASP fees for ads placed through the Web using our customized
software. This customization will provide a platform that allows Tribune owned
newspapers, together with a Tribune affiliated company, CareerBuilder, Inc.
(www.careerbuilder.com), to receive recruitment advertising from agencies,
corporate customers, and the general public. From a practical standpoint, the
customization work will need to be substantially completed before they will be
able to begin processing the recruitment advertising and perform the related
transactions. Therefore, we will incur significant expenditures to complete the
customization effort prior to the point in time when we begin to earn the ASP
fees from this arrangement. We believe that the value we will realize from these
arrangements far exceeds the up-front expenditures required to complete the
customization effort and also enhances our position in the marketplace.
Our ASP business is continuing to demonstrate approval in the marketplace.
During the quarter we experienced large increases in Web-based transaction
volumes on behalf of our existing customers as well as substantial increases in
volume from the new Knight-Ridder publications set up during the fourth quarter
2001. Revenue earned from our new ASP business improved substantially quarter
over quarter, increasing 24% this quarter compared to the first quarter 2002 and
124% this quarter from the fourth quarter 2001. We expect this increase to
continue throughout the year. During the second quarter 2002, on behalf of our
customers we processed a total of 46,500 transactions through our web site
generating gross billings in excess of $3,840,000. We recognized revenues of
$221,000 on these transactions. For the same quarter in 2001 we processed a
total of 25,000 transactions generating gross billings in excess of $1,992,000
for which we recognized $58,000 of revenues. For the six months ended June 30,
2002 we processed a total of 78,500 transactions generating gross billings in
excess of $6,047,000 for which we recognized $399,000 of revenues. For the six
months ended June 30, 2001 a total of 41,000 transactions were processed
generating gross billings in excess of $3,310,000 for which we recognized
$86,000 of revenues. We
12
are delighted with the level of incremental revenue our customers are able to
generate using our software applications and we believe that this success gives
us the opportunity to enter into arrangements to provide Web-based ad-taking
technology for new customers. This success serves to confirm that we have
developed a viable foundation that exploits our proprietary software products,
extensive industry knowledge, and unique position within the marketplace. As we
are early in the life cycle of our ASP business, we are continuing to critically
evaluate all products, their profit contributions, and potential line extensions
that may be of benefit to our existing customers as well as our potential
customers. Customization services, which traditionally had been a large
percentage of our revenue, were significantly down for the first two quarters of
2002 from the same quarters in 2001. This reflects reduced capital spending at
newspapers resulting from lower advertising revenues caused by the general
economic downturn since the fourth quarter of 2001. As we continue to add more
newspapers as ASP customers, we will be better positioned to weather economic
downturns.
Description of Business
Under our ASP business model we developed a new e-business application
suite that is an enterprise class software solution allowing print and on-line
publications to electronically receive completed classified advertising copy
using the Internet as the communication channel. This new application suite was
developed in conjunction with our existing customers, and in response to their
need for a software solution supporting both business-to-business (B-to-B)
operations and business-to-customer (B-to-C) operations. These software
solutions enable our customers to expand the relationships with their customers
using a single integrated platform, while increasing sales volumes at reduced
costs. Our software allows newspapers to turn their on-line presence into an
e-commerce-enabled, revenue generating Web site. We believe that our ASP product
and services provide our customers an opportunity to generate incremental
revenue from their on-line business while increasing the number of visitors to
their Web site.
Our new e-business application suite includes two main products that can
be purchased separately or as a fully integrated software solution:
o Professional software ("Professional Product") - This technology is
designed for use by the professional marketplace. Specifically, our
software allows publishers to receive transmissions from classified
advertising agencies and corporations using advanced Web-based
technology. The software includes sophisticated pricing algorithms
to provide for maximum flexibility and intricate design resources to
provide unlimited creative capabilities. The recently released Web
version of this software has been favorably received. This software
solution utilizes the Internet as the communication method, which
significantly improves the intuitive nature of the application and
allows the advertiser to increase the speed of each transmission by
utilizing existing high-speed Internet connections. Should a
high-speed Internet connection not be available, the advertiser can
install a desktop version of this software that utilizes modem
communication.
o ASP Web site technology ("ASP Product") - This technology is a
publisher-specific ad-taking Web site service designed to enhance a
publication's Web site by allowing the general public to execute
transactions to purchase classified advertising. Specifically, it is
an integrated application suite that offers visitors to a
newspaper's Web page the opportunity to buy classified ads, for both
the print and/or on-line editions of the newspaper, in real-time, on
a 24/7 basis. This product allows a publication to completely
outsource the classified ad-taking power of their Web site whereby
the publication receives incremental revenue at a very low
incremental cost. We handle all functions associated with this
revenue source. We furnish and host the application suite, run the
technology, monitor the transactions throughout the session, handle
the payment authorization and settlement process, electronically
deliver
13
the ad text to the newspaper, and provide customer service support
to the newspaper's customers. We provide all the technical and
application expertise, customer support, and security measures that
the publication needs to get an application up and running in a
short time. Typically, we are able to process many more ads and do
so much more quickly and affordably than the publisher could do
internally. In addition, this software solution provides tools to
evaluate performance, provide additional customer care, and increase
future revenue opportunities. We provide the means to deliver highly
personalized email communications to existing customers for the
purpose of creating additional revenues and creating a profitable,
long-term relationship.
Both software products allow transactions to be executed through the
Internet. Our application suite is designed to be quickly integrated into our
customer's existing publishing software and readily expands as our customer's
needs and business grows. Our products use a single platform to connect and
integrate transmissions between multiple browsers and multiple technology
standards. In continually ensuring that our AdStar software solution works with
all available technology standards, we solve the problems created for our
customers because advertisers create and deliver content using ever changing
technology with multiple standards, multiple browsers and evolving network
infrastructures. By bridging disparate technologies in a way that seamlessly
allows for communication and transmission of advertising copy, we alleviate this
obstacle for our customers, freeing them to focus on their business.
Both lines of business require fees to customize the AdStar software
solution to the technical specifications for each publication. In addition, we
charge ongoing monthly fees to manage the ad-taking process, provide technical
support, supply a customer service phone room, and manage the entire e-commerce
function. The monthly fees include a small hosting fee plus a fee based on
transaction volumes and structured in such a way that we are, in essence
partnering with our customers. Therefore, when our customer's revenue volume
increases, our revenue will also increase. With this structure, we are able to
offer superior service in a manner that is cost effective for publishers of all
sizes.
In developing our Web-based system we began to incur expenses in 1998 that
could not be offset by the revenues generated by our historical business. These
expenses caused us to incur losses in 1998, 1999, 2000, 2001 and first two
quarters of 2002. Our future success is dependent upon our ability to
substantially grow revenues to the point where we can fund the current level of
operations. To this end, our plans include expanding the products and services
offered to our customers by building on our (i) proprietary software processes,
(ii) established customer relationships, and (iii) unique position within the
industry. We feel that there is significant opportunity to increase revenues by
offering the Web software and customer support services that we had initially
developed for our Web-based national portal, "Advertise123.com," to print
publications under the ASP business model.
In addition to the AdStar software solution, we have also developed
Advertise123.com, a one-stop marketplace on the Web for the general public to
buy classified ads. Through Advertise123.com, the general public can compose
professional looking classified ads using one of several pre-programmed
templates, schedule the ad to run in one or several of over 200 newspapers and
50 state newspaper associations, and purchase the ad using a credit card, all on
a 24/7 basis. We receive a small fee for this service.
During July 2002 AdStar and DynAccSys entered a strategic Marketing
Agreement whereby Adstar will incorporate DynAccSys's Virtual AdTaker into its
existing E-Commerce Product Suite. With Virtual AdTaker, AdStar's publishing
customers can accept several types of display ads via the Web, including
in-column ads with photos, obituary, funeral and legal notices, and gallery ads.
14
Results of Operations
The following table sets forth the results of operations expressed as a
percentage of revenues:
Three months ended Six months ended
June 30, June 30,
-------------------------------------------
2001 2002 2001 2002
---- ---- ---- ----
Revenues 100% 100% 100% 100%
Cost of revenues 37% 48% 38% 47%
---- ---- ---- ----
Gross profit 63% 52% 62% 53%
Selling expense 32% 27% 35% 29%
Administrative expenses 84% 85% 105% 89%
Development expenses 17% 16% 30% 29%
---- ---- ---- ----
Loss from operations -70% -76% -108% -94%
Interest income (expense) 3% 13% 2% 7%
---- ---- ---- ----
Loss before taxes -67% -63% -106% -87%
Provision for income taxes -- -- -- --
---- ---- ---- ----
Net loss -67% -64% -106% -87%
Three-and six Month Periods Ended June 30, 2002 and 2001
Revenues. - Net revenues for the second quarter 2002 increased 2% to
$542,000 compared to second quarter 2001 net revenues of $532,000. Fees from our
ASP Product increased 282% to $221,000 during the second quarter 2002 from
$58,000 in the second quarter 2001. Revenue from software customization services
decreased 70% during the second quarter 2002 to $37,000 from $123,000 in the
second quarter 2001. Revenues from miscellaneous and non-recurring items
decreased 77% during the second quarter 2002 to $14,000 from $60,000 in the
second quarter 2001. Fees from our Professional Product decreased 7% to $269,000
during the second quarter 2002 from $290,000 during the second quarter 2001.
Net revenues for the six months ended June 30, 2002 increased 7% to
$1,042,000 compared to $972,000 for the six months ended June 30, 2001. ASP fees
for the six months ended June 30, 2002 increased 362% to $399,000 from $86,000
for the six months ended June 30, 2001. Customization revenue for the six months
ended June 30, 2002 decreased 81% to $39,000 from $205,000 for the six months
ended June 30, 2001. Revenue from miscellaneous and non-recurring items for the
six months ended June 30, 2002 decreased 49% to $60,000 from $118,000 for the
six months ended June 30, 2001. Fees from our Professional Product decreased to
3% $543,000 during the second quarter 2002 from $562,000 during the second
quarter 2001. The decrease in software customization is a by-product of the
trend to defer capital expenditures in the publishing industry due to the
general economic climate, we anticipate the deferral to continue through the
rest of the year. The decrease in Professional Product is primarily due to the
transition of existing customers from the Professional Product line to our ASP
Product; this trend is expected to continue. We expect that revenue from our ASP
Product will continue to increase as we increase both the number of customers
and the transaction volume we process on behalf of those customers.
Cost of Revenues - Cost of revenue consists primarily of the costs to
customize and install the AdStar software applications, configure end-user
software, install Web-based ad-taking software,
15
provide customer training and end-user support, amortization of internally
developed application modules, royalties, and Co-location costs. These costs
increased to approximately $260,000 for the second quarter of 2002 compared with
$196,000 for the second quarter 2001. Our gross profit margin decreased to 52%
during the second quarter 2002, from 63% during the second quarter 2001. This
increase in cost of revenues primarily resulted from an increase in the
amortization of software development costs to $88,000 in the second quarter 2002
from $35,000 in the second quarter 2001.
Cost of revenues for the six months ended June 30, 2002 increased to
$486,000 from $372,000 for the six months ended June 30, 2001. Our gross profit
margin for the six months ended June 30, 2002 decreased to 53% from 62% for the
six months ended June 30, 2001. This increase primarily resulted from an
increase in the amortization of software development costs to $174,000 for the
six months ended June 30, 2002 from $67,000 for the six months ended June 30,
2001. Given our current level of Web automation, we will be able to manage
significantly greater transaction volumes with limited increases to our current
staffing levels. Accordingly, we expect a corresponding increase in cash to be
generated from our gross profits.
Selling Expense. - Selling expense consists primarily of direct charges
for advertising, sales promotion, marketing, and trade shows, as well as the
cost for business development. Selling expense decreased 13% during the second
quarter 2002 to $148,000 from $170,000 during the second quarter 2001. The 13%
decrease primarily resulted from the reduction of personnel related expenses to
$110,000 during the second quarter 2001 from $134,000 for the second quarter
2001.
Selling expense for the six months ended June 30, 2002 decreased 10% to
$304,000 from $338,000 for the six months ended June 30, 2001. Personnel related
expenses for the six months ended June 30, 2002 decreased 7% to $261,000 from
$280,000 for the six months ended June 30, 2001. Direct charges for the six
months ended June 30, 2002 decreased 26% to $43,000 from $58,000 for the six
months ended June 30, 2001. In future quarters, we can expect to see some
incremental increase in selling expenses as compared to the last two quarters as
we continue the development of our strategic relationships with Tribune Company,
Knight-Ridder, Inc., CareerBuilder, Inc., DynAccSys, and other potential
strategic partners.
Administrative Expenses. - Administrative expense consists primarily of
the cost of executive, administrative, professional fees, accounting, finance
and information technology personnel. Administrative expenses increased 3%
during the second quarter 2002 to $461,000 from $446,000 during the second
quarter 2001. The increase was primarily related to professional fees and other
non-personnel related expenses.
Administrative expenses for the six months ended June 30, 2002 decreased
9% to $930,000 from $1,022,000 for the six months ended June 30, 2001. Personnel
related expenses for the six months ended June 30, 2002 decreased to $258,000
from $461,000 for the six months ended June 30, 2001. Legal fees for the six
months ended June 30, 2002 increased to $155,000 from $21,000 for the six months
ended June 30, 2002. This is primarily due to a significant increase in outside
legal expenses during the first quarter 2002 related to financing negotiations
and general corporate advise. Although we expect that quarterly administrative
expenses overall will be lower in comparison to the prior year, during the
remainder of 2002, personnel related expenses may increase incrementally from
the first two quarters, as we have added some additional administrative
headcount, and anticipate increases in Directors & Officers insurance and health
care costs as dictated by current market conditions.
Development Expenses. - Development expenses consist of expenses to
identify functional requirements, to plan, identify and conceptually design the
required technical infrastructure, and to
16
perform Web-site maintenance and other general routine fixes. The costs consist
primarily of personnel related expenses for technical and design personnel and
consultants. Development expense for the second quarter 2002 decreased 5% to
$87,000 from $91,000 during the second quarter 2001. Personnel related expenses
decreased to $62,000 in the second quarter 2002, as compared to $86,000 for the
second quarter 2001.
Development expense for the six months ended June 30, 2002 increased to
$306,000 from $294,000 for the six months ended June 30, 2001. The increase was
due to approximately $44,000 in one-time costs for outside consultants to create
the conceptual design and feasibility study for the Tribune Company product
prior to execution of our agreement with them during the first quarter of 2002,
offset by a decrease in personnel related expenses for the six months ended June
30, 2002 to $262,000 from $286,000 for the six months ended June 30, 2001.
Other Income (Expense) - Other income expense has historically been
comprised of net interest income (expense). During the second quarter 2002
AdStar finalized a settlement with Kodak, Inc. whereby Kodak returned 67,796
shares of AdStar common stock resulting in a non-cash gain of approximately
$63,000. Net interest income decreased 56% during the second quarter 2002 to
$7,000 from $16,000 during the second quarter 2001. This decrease is
attributable to a general reduction of interest rates available in short-term
time deposits and money market accounts at commercial banks, as well as an
increase in interest expense during the quarter relating to the addition of
capital leases. Net interest income for the six months ended June 30, 2002
decreased to $10,000 from $19,000 for the six months ended June 30, 2001.
Liquidity and Capital Resources
As of June 30, 2002, we had cash and cash equivalents of approximately
$1,364,000. Net cash used in operations was approximately $766,000 for the six
months ending June 30, 2002 compared with $905,000 for the comparable 2001
period. The favorable $138,000 difference is due primarily to a $120,000 smaller
net loss, an increase in depreciation and amortization of $127,000, a decrease
in other non-cash items totaling $87,000, decrease in accounts receivable of
$105,000, and increase in deferred contract costs of 268,000, an increase in
accounts payable and accrued expenses of $272,000, a decrease in deferred
revenue of $87,000, and a decrease in prepaid expenses of $46,000 for the six
months ended June 30, 2002 as compared to the six months ended June 30, 2001.
Net cash used in investing activities decreased to $231,000 in the second
quarter 2002 compared with $382,000 in the same period in 2001. This is a result
of reduced spending on capitalized software in general and the shifting of
resources to deferred contract expenditures primarily related to the
CareerBuilder project. Net cash provided by financing activities increased by
$1,630,000 in the second quarter 2002 compared with $321,000 in the same period
in 2001. The increase is primarily due to the net proceeds of $1,727,000 from
the issuance of Series A preferred stock to Tribune Company as compared to the
comparable period in 2001.
As a result of the equity raised during the first quarter 2002, we expect
our available funds, combined with the cash generated from existing operations
and new customers, and the flexibility to cut back our work-force should
anticipated significant customization projects be delayed or terminated, will be
sufficient to meet our anticipated working capital needs through June 30, 2003.
We have generated operating losses during the past four years, and we cannot
guarantee that the assumed increases in revenue will occur in a timely manner,
that we will be able to contain our costs in accordance with our plans, nor that
we have accurately estimated the resources required to fulfill our obligations
to the Tribune Company. Although we are optimistic that our new ASP business
will be accepted in the marketplace and we will fulfill our obligations to the
Tribune Company in a timely manner, the timing is not assured. Our ability to
sell ASP business products and service offerings
17
during the current year may be hampered by the current downturn in the
advertising market and state of the economy in general. These factors, coupled
with the extended time frame required for software sales, customization, and
implementation, could delay our ability to increase revenue to a level
sufficient to cover our expenses.
In August 2002, AdStar was informed by Chase Merchant Services, L.L.C
(Chase), AdStar's merchant bank providing credit card processing services, that
it requires us to maintain a restricted cash balance of $175,000. Chase
indicated the primary reason for the reserve was the significant increase in
dollar volume during the second quarter from AdStar's transactions. AdStar
believes the reserve is unnecessary and has commenced negotiations to have the
reserve significantly reduced or removed altogether. Should negotiations fail
Adstar has identified another reputable credit card merchant services provider
who has indicated it would not require a reserve.
We currently have no additional borrowings available to us under any
credit arrangement, and we are continuing to look for additional debt and equity
financing. 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.
PART II
Item 2. Changes in Securities and Use of Proceeds
Recent Sales of Unregistered Securities.
AdStar established a vendor payment plan whereby it may compensate
vendors in shares of its common stock in lieu of cash. Under the plan, 400,000
shares are available for issuance. In the six-month period ended June 30, 2002,
8,861 shares were issued to vendors under the plan relying upon the exemption
under sections 4(2) and 4(6) of the Securities Act of 1933 and which represented
compensation for the period of $7,500. The vendors have taken the shares for
investment.
In January 2002, AdStar completed a private placement of 1,300,000 shares
of its common stock at a price of $0.50 per share, through the sale of the
remaining 300,000 shares. 1,000,000 shares were sold during the period of
October 2001 through December 2001. These shares were sold to accredited
investors, as defined under Rule 215 of the Securities Act of 1933, and required
a minimum investment of $25,000. In connection with this offering AdStar issued
warrants to purchase 130,000 shares of its common stock, at $0.75 per share, as
part of the placement agent fees. The warrants expire on January 16, 2007 and
have anti-dilution protection against capital changes. In addition, AdStar
issued to Morse, Zelnick, Rose and Lander LLP, AdStar's legal counsel, 114,545
shares of restricted common stock, issued at fair market value in full
settlement of a $62,500 liability. These offerings were exempt from registration
made pursuant to Sections 4(2) and 4(6) of the Act.
In February 2002, AdStar sold to an accredited investor (as previously
defined) 100,000 shares of its common stock at a price per share equal to 85% of
its per share closing price on January 31, 2002 ($0.50). In connection with this
sale AdStar issued warrants to purchase 10,000 shares of its Common Stock, at
$0.75 per share, as part of the placement agent fees. The warrants expire on
January 31, 2007 and have anti-dilution protection against capital changes. This
sale was exempt from registration made pursuant to Sections 4(2) and 4(6) of the
Act.
18
In March 2002, AdStar sold 1,443,457 shares of its Series A Preferred
Stock to Tribune Company for an aggregate purchase price of $1.8 million. These
shares currently convert on a 1:1 basis. Shareholders of Series A Preferred
Stock are entitled to vote on all matters submitted to the stockholders for vote
and as a single class with the common stock. The holders of Series A Preferred
Stock are entitled to one vote for each share of common stock issuable upon
conversion. We are requesting shareholder approval and ratification of this
transaction.
We are requesting shareholder approval and ratification of the Tribune
Company transaction because the anti-dilution provisions associated with the
Series A Preferred can potentially result in the issuance of greater than 20% of
our Common Stock outstanding on March 18, 2002 and at a price below its then
market value of $1.15 (based on the closing bid price on March 15, 2002) upon
conversion of all the Series A Preferred. As a result, the Nasdaq has advised us
that approval of this transaction by holders of our Common Stock would be
necessary to be in compliance with their shareholder approval requirement for
such issuances and to avoid being subject to delisting proceedings. The annual
proxy statement has been filed with this matter to be voted on by shareholders
of record as of August 8, 2002.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits:
Exhibit No. Description
----------- -----------
99.1 Chief Executive Officer Certification pursuant to 18
U.S.C. Section 1350, as adopted pursuant to section 906
of the Sarbanes-Oxley Act of 2002, filed with the
Securities and Exchange Commission on the date hereof.
99.2 Chief Financial Officer Certification pursuant to 18
U.S.C. Section 1350, as adopted pursuant to section 906
of the Sarbanes-Oxley Act of 2002, filed with the
Securities and Exchange Commission on the date hereof.
b. Reports on Form 8-K:
None
19
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 August 14, 2002 /s/ Leslie Bernhard
---------------------------------- -----------------------
President & CEO
Date August 14, 2002 /s/ Anthony J. Fidaleo
---------------------------------- -----------------------
Chief Financial Officer
20