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 March 31, 2004

[  ] 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 incorporation or organization)	(IRS Employer Identification No.)

4553 Glencoe Avenue, Suite 325, Marina del Rey, California 90292
(Address of principal executive offices)

(310) 577-8255
(Issuer’s telephone number)

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 [  ]

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: As of May 06, 2004 the Issuer had outstanding 14,242,332 shares of its common stock, including 2,695 shares issuable to various vendors.

Transitional Small Business Disclosure Format (Check one): Yes [  ] No [X]

TABLE OF CONTENTS

FORM 10-QSB REPORT

March 31, 2004

	PAGE
PART I – FINANCIAL INFORMATION
Item 1. Interim condensed financial statements (unaudited)
Balance Sheet – March 31, 2004		3
Statements of Operations For the three month periods ended March 31, 2003 and 2004		4
Statements of Cash Flows For the three month periods ended March 31, 2003 and 2004		5
Notes to Interim Financial Statements		6
Item 2. Management’s discussion and analysis or plan of operation		15
Item 3. Controls and Procedures		23
PART II – OTHER INFORMATION
Item 2. Changes in securities and use of proceeds		24
Item 6. Exhibits and reports on form 8-K		24
SIGNATURES		25
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

2

AdStar, Inc. and Subsidiary

Consolidated Balance Sheet
March 31, 2004 (unaudited)

Assets
Current assets:
Cash and cash equivalents	$	1,882,774
Accounts receivable, net of allowance for doubtful accounts of $84,000		294,645
Notes receivable from officers – current portion		7,695
Prepaid and other current assets		195,668
Total current assets		2,380,782
Notes receivable from officers, net of current portion		230,391
Property and equipment, net		130,684
Capitalized and purchased software, net		1,926,759
Intangible assets, net		1,465,671
Goodwill		2,246,454
Other assets		37,656
Total assets	$	8,418,397
Liabilities and Stockholders’ Equity
Current liabilities:
Due to publications	$	1,453,970
Accounts payable and accrued expenses		1,003,708
Deferred revenue and customer deposits – current portion		270,259
Loans from Shareholders, current portion		21,000
Capital lease obligations – current portion		31,658
Total current liabilities		2,780,595
Deferred revenue – net of current portion		52,772
Capital lease obligations, net of current portion		10,086
Loans from Shareholders, net of current portion		42,000
Total liabilities		2,885,453
Commitments and contingencies
Stockholders’ equity:
Convertible Preferred stock, par value $0.0001; authorized 5,000,000 shares; issued and outstanding:
Series A, 1,443,457 issued and outstanding; liquidation preference of $2,069,932		1,697,840
Series B-2, 2,000,000 issued and outstanding; liquidation preference of $1,621,454		1,342,404
Common stock, par value $0.0001; authorized 20,000,000 shares; 12,840,563 shares issued and outstanding		1,284
Additional paid-in capital		17,267,508
Treasury stock, par value $0.0001; 67,796 shares		(67,796	)
Accumulated deficit		(14,708,296	)
Total stockholders’ equity		5,532,944
Total liabilities and stockholders’ equity	$	8,418,397

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

3

AdStar, Inc. and Subsidiary

Statements of Operations
For the three month periods ended
March 31, 2003 and 2004 (unaudited)

	Three months ended
	March 31,
	2003			2004
ASP, net	$	322,259		$	395,672
Licensing and software		215,702			547,989
Customization and other		55,132			103,825
Net Revenues - note 11		593,093			1,047,486
Cost of revenues, including depreciation and amortization of $144,417 and $186,188		334,911			417,321
Gross profit		258,182			630,165
General and administrative expense		288,990			437,859
Selling and marketing expense		161,138			327,618
Product maintenance and development expenses		252,841			375,658
Amortization		—			22,116
Loss from operations		(444,787	)		(533,086	)
Interest income (expense), net		935			(1,153	)
Loss before taxes		(443,852	)		(534,239	)
Provision for income taxes		(963	)		(7,620	)
Net loss	$	(444,815	)	$	(541,859	)
Loss per share – basic and diluted	$	(0.05	)	$	(0.04	)
Weighted average number of shares – basic and diluted		8,197,324			12,772,767

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

4

AdStar, Inc. and Subsidiary

Statements of Cash Flows
For the three month periods ended
March 31, 2003 and 2004 (unaudited)

	2003			2004
Cash flows from operating activities:
Net loss	$	(444,815	)	$	(541,859	)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization		180,519			208,304
Stock based vendor payments		53,751			17,175
Changes in assets and liabilities:
Accounts receivable		1,111			45,227
Prepaid and other assets		(16,032	)		(73,931	)
Due to publications		426,513			369,997
Accounts payable and accrued expenses		(299,089	)		(189,717	)
Deferred revenue and customer deposits		28,727			133,258
Net cash used in operating activities		(69,315	)		(31,546	)
Cash flows from investing activities:
Purchase of Edgil Associates, Inc.		—			(85,000	)
Purchase of property and equipment		(19,891	)		(9,044	)
Additions to capitalized and purchased software		(230,436	)		(157,516	)
Additions to intangible assets		—			(4,000	)
Principal repayments of shareholder notes receivable		1,758			1,859
Net cash (used in) investing activities		(248,569	)		(253,701	)
Cash flows from financing activities:
Proceeds from issuance of note payable		200,000			—
Repayment of note payable		(200,000	)		—
Proceeds from issuance of Series B-2 preferred stock		534,578			—
Proceeds from exercises of options and warrants		—			83,801
Principal repayments on capital leases		(6,344	)		(8,256	)
Net cash provided by financing activities		528,234			75,545
Net increase (decrease) in cash and cash equivalents		210,350			(209,703	)
Cash and cash equivalents at beginning of period		940,378			2,092,477
Cash and cash equivalents at end of period	$	1,150,728		$	1,882,774
Supplemental cash flow disclosure:
Taxes paid	$	5,494		$	4,486
Interest paid	$	4,093		$	4,295
Non cash investing and financing activities
Conversion of accrued legal fees to common stock	$	50,000			—

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

5

AdStar, Inc. and Subsidiary

Notes To Interim Financial Statements
(Unaudited)

1.	General
	The interim financial statements for AdStar, Inc. (the “Company”) have been prepared in accordance with accounting principals 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 principals 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 nine-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. 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, 2003.
	For the three-month period ended March 31, 2004, the Company had incurred a cash outflow from operations of $32,000 and has negative working capital of $400,000. Although there can be no assurance, we believe that expected cash flow from the recent acquisition of Edgil Associates, Inc., the additional $1,500,000 in proceeds from a private placement of a 3-year secured convertible note funded in April, 2004 (see subsequent event note 14), our available funds, combined with cash generated from existing operations, new customers and the flexibility to cut back our work-force upon completion or delay of significant customization projects, will be sufficient to meet our anticipated working capital needs through March 31, 2005. In addition the Company continues to seek additional financings. 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 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.
	For the three months ended March 31, 2004 and 2003, one customer accounted for 7.0% and one customer accounted for 11.3% of the Company’s revenues. At March 31, 2004, 10 customers in the aggregate accounted for 51% of the Company’s accounts receivable. The majority of the Company’s customers have historically consisted of newspapers and publishers of classified advertisements.
	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.

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	Computation of Earnings 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 years ended three months ended March 31, 2004 diluted loss per share does not include 1,370,207 and 2,241,500 respectively, of options and warrants to purchase common stock and 1,443,457 and 2,000,000 respectively, of shares issuable upon the conversion of Series A and B-2 preferred stock to common stock, as their inclusion would be antidilutive.
	Reclassifications
	Certain reclassifications have been made to prior period balances in order to conform to the current period presentation.
	New accounting pronouncements
	On December 17, 2003, the SEC’s Office of the Chief Accountant and Division of Corporation Finance issued Staff Accounting Bulletin (SAB) 104, Revenue Recognition. The SAB updates portions of the interpretive guidance included in Topic 13 of the codification of staff accounting bulletins (SAB 103 codification) in order to make the guidance consistent with current authoritative accounting literature. The principal revisions relate to the incorporation of certain sections of the staff s FAQ document on revenue recognition into Topic 13. The Company does not expect the adoption of SAB 104 to have a material effect on our financial statements.
3.	Goodwill
	In accordance with SFAS No. 142, the Company recorded goodwill of $2,246,454 from the purchase of Edgil Associates, Inc. (Edgil). The Company does not amortize goodwill in accordance with SFAS 142. However the Company evaluates goodwill at least on an annual basis for impairment. The Company performed an impairment test of goodwill using the public company market multiple method and concluded that goodwill was not impaired. In future periods if goodwill is determined to be impaired, the Company will recognize a non-cash charge equal to the excess of the carrying value over the fair value. There can be no assurance that future evaluations of goodwill will not result in impairment and a charge to earnings.
4.	Significant Contracts
	On March 18, 2002, the Company entered into a series of agreements with Tribune Company (“Tribune”). In accordance with these agreements, the Company sold 1,443,457 shares of Series A convertible preferred stock to Tribune Company for approximately $1.8 million before the deduction of related expenses. The Company has recorded the $1.8 million investment in the Series A convertible preferred stock at cost which approximated fair value. The rights and preferences of the Series A

7

	preferred stock are described in Note 5 below. Additionally, the Company agreed to develop and customize a version of its Web software applications to Tribune specifications in exchange for earning volume-based transaction fees in the future by providing Web-based recruitment ad sales technology to all major market Tribune newspapers and on-line services. This customization will provide a platform that allows Tribune owned newspapers, together with CareerBuilder, L.L.C., to receive recruitment advertising from agencies, corporate customers, and the general public. On completion of the development and customization effort, the Company will manage the related transactions and receive a volume-based ASP fee with a guaranteed monthly minimum. Costs incurred in the customization effort after technological feasibility is obtained, are included in property and capitalized and purchased software in the balance sheet.
	As of March 31, 2004, $294,063 in development and customization costs associated with the FlexAds application have been capitalized net of a write down of $316,462 in December 31, 2003. As of March 31, 2004 the Company had launched the FlexAds® service on eight Tribune newspapers and commenced full amortization of the cost of the development and customization effort over the maximum 5 year period of the contract. Under terms of the agreement the Company receives $7,500 minimum monthly payments for up to 60 months; comprised of a 36-month contract with two 12-month options which automatically renew unless Tribune provides 180-day notice. The Company commenced recognition of revenue from the $7,500 minimum monthly fee under the agreement on a straight-line basis during August 2002.
	In December 2002 the Company entered into an agreement with Tribune Company for an additional investment by Tribune of $1,500,000. As part of the transaction, AdStar developed additional features that expand the capabilities of its generic service and the customized services that were launched in August 2002. The investment is in the form of an initial purchase by Tribune of 1,200,000 shares of Series B-1 preferred stock for $900,000 which funded in December 2002 and a subsequent purchase, of 800,000 shares of Series B-2 preferred stock for $600,000. In addition, on the second closing the series B-1 shares, plus additional shares issued for accrued dividends on Series B-1 converted to series B-2. The purchase price for each share of the Series B-1 and Series B-2 preferred stock was $0.75 at or below the fair market value of AdStar common stock at the time of the respective closing. These shares carry a liquidation preference that includes a dividend of 7% per year available only upon liquidation and currently convert on a 1:1 basis. Shareholders of Series B Preferred Stock are entitled to vote on all matters submitted to the stockholders for vote and vote as a single class with the shareholders of our Common Stock. The holders of Series B preferred stock are entitled to one vote for each share of common issuable upon conversion.
5.	Convertible preferred stock
	The Company has authorized 5,000,000 shares of preferred stock, par value $0.0001 per share, of which 1,443,457 shares have been designated as Series A, convertible preferred stock (“Series A preferred stock”), 1,200,000 shares have been designated as Series B-1, convertible preferred stock and 2,000,000 shares have been designated as Series B-2, convertible preferred stock (“Series B preferred stock”). The remaining authorized shares have not been designated.
	In March 2003, AdStar sold 800,000 shares of its Series B-2 Preferred Stock to Tribune Company for an aggregate purchase price of $600,000. These shares

8

	currently convert on a 1:1 basis. Shareholders of Series B-2 Preferred Stock are entitled to vote on all matters submitted to the stockholders for vote and as a single class with the Common Stock. The holders of Series B-2 Preferred Stock are entitled to one vote for each share. In addition, on March 28, 2003, in exchange for all of the Series B-1 Preferred Stock plus accrued and unpaid dividends on those shares, issued in December 2002 to Tribune Company, AdStar issued an additional 1,200,000 shares of its Series B-2 Preferred Stock to the Tribune Company.
	At March 31, 2004, the Company has reserved 1,443,457 and 2,000,000 shares of common stock, respectively for issuance upon the conversion of the Series A and Series B preferred stock. The Series A and B preferred stock have the following characteristics:
	Voting Rights – Each holder of the Series A and B preferred stock is entitled to the number of votes equal to the number of shares of common stock into which such holder’s shares are convertible. The Company cannot amend its certificate of incorporation amending the rights of the Series A and B preferred stockholders, enter into any capital stock or equity agreements with rights ranking the same or above the rights of the Series A preferred stock or liquidate the Company without the approval of at least a majority of the holders of the Series A preferred stock then outstanding.
	Liquidation Preference – In the event of any liquidation, dissolution or winding up of the affairs of the Company, the holders of the Series A and B preferred stock will be entitled to receive in preference to the holders of the common stock, an amount per share equal to $1.244 and $0.75 plus accrued and unpaid dividends, respectively. After such payment, the Series A and B preferred stockholders share equally with the common stockholders in any remaining assets or funds of the Company.
	Conversion – Each share of the Series A and B preferred stock is convertible at anytime at the option of the holder into shares of common stock pursuant to a ratio of one share of common stock for each share of Series A and B preferred stock, subject to certain stock split and stock dividend adjustments. In addition, the conversion ratio is subject to adjustment, as defined in the agreement, in the event that the Company issues common stock at a per share price less than $1.244 per share for series A and $0.75 for series B. All Series A preferred stock will automatically convert to common stock on the first day after March 18, 2004 for which the market price of the Company’s common stock exceeds $2.25 per share. All Series B preferred stock will automatically convert to common stock on the first day after December 23, 2005 for which the market price of the Company’s common stock exceeds $1.50 per share. On April 1, 2004 all of the Series A preferred stock was converted to common stock, see subsequent event footnote 14.
	Dividends – Dividends on the Series A and B preferred stock shall accrue cumulatively at 7% per annum through the date of liquidation or conversion. In the event of conversion all accrued and unpaid dividends will be waived. The 7% cumulative dividend has not been shown as a deduction from net loss applicable to common shareholders, since the dividends are only to be paid if a liquidation event occurs and the dividends would be accrued from the original issuance date to the date of the liquidating event. If the Series A preferred stock is converted into common stock, the right to the cumulative dividends will be waived.
6.	Options and warrants

9

	During the three months ended March 31, 2004 option and warrant holders exercised 23,806 options and 30,000 warrants for which the company received net proceeds of $23,801 and $60,000 respectively.
7.	Loans from shareholders
	Pursuant to the Merger agreement the notes payable to the two former stockholders of Edgil were restated whereby each stockholder received $51,500 in principal payments upon the closing and the remaining $31,500 note balance, for each Stockholder, is to be repaid in six equal payments of principal along with all interest at a rate of 8% per annum, with the first payment to be made on the six month anniversary of the Effective Date (October 21, 2003) and each of the next five payments to be paid each six months thereafter, with the final payment to be made on the third anniversary of the Closing Date. Accordingly $21,000 in minimum principal pay downs are due during each of the years ending December 31, 2004, 2005, and 2006.
8.	Officers notes receivable
	In July 2002, AdStar entered into a loan transaction with Leslie Bernhard, President and Chief Executive Officer and Eli Rousso, Executive Vice President and Chief Technical Officer for $110,434 and $100,000, respectively. As part of the transaction, Ms. Bernhard and Mr. Rousso each issued to AdStar an unsecured, non-negotiable promissory note bearing interest at 5.56% with monthly principal and interest payments of $763 and $691, respectively. The note is payable on a monthly basis, with all remaining outstanding principal and interest amounts due on July 31, 2022. Concurrently, an outstanding note from Ms. Bernhard in the amount of $39,566 was restructured under the same terms and conditions as the aforementioned new note. The loans are forgiven if there is a change in control in AdStar or if the loan holder is dismissed for other than cause as defined by the loan and employment agreements. At March 31, 2004 the outstanding notes receivable was $238,086.
9.	Due to publications
	The Company processes credit cards on behalf of certain of its customers as part of ASP services provided. The Company receives net proceeds daily on behalf of these customers for third party ads placed via credit card. These transactions are reconciled monthly and submitted to the publication, net of processing fees, generally within 35 days from the month end.
10.	Stock based compensation
	The Company has adopted the disclosure only provisions of SFAS No. 123. If compensation cost associated with the Company’s stock-based compensation plan had been determined using the fair value prescribed by SFAS No. 123, the Company’s net loss for the three months ended March 31, 2003 and 2004 would have increased to the pro forma amounts indicated below:

		Three months ended March 31,
		2003			2004
Net loss – applicable to common stockholders	As reported	$	(444,815	)	$	(541,859	)

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		Three months ended March 31,
		2003			2004
	Add: Stock based employee
	compensation
	included in
	reported loss		-0-			-0-
	Deduct: Employee
	compensation
	expense		(68,153	)		(83,501	)
	pro forma		(512,967	)		(625,360	)
Loss per share -	As reported	$	(0.05	)	$	(0.04	)
	pro forma	$	(0.06	)	$	(0.05	)

	Because additional stock options are expected to be granted each year, the above pro forma disclosures are not representative of pro forma effects on reported financial results for future years.
11.	Related party transactions
	During the three months ended March 31, 2003 and 2004 the Company total revenues derived from related parties were $129,963 and $157,979 respectively.
12.	Restructuring costs
	During 2001 the Company critically examined the processing capabilities of its existing software modules and identified potential new commercial applications that could be developed using our existing technology as a starting point. With these changes in mind, we repositioned our products, moving away from the idea of the Internet as a stand-alone business category, and moving towards the idea of the Internet as an extremely efficient and flexible communication channel.
	The plan contemplated among other things the closure of the New York office within approximately nine months, a related reduction in force of the 4 technology staff as of December 31, 2002 and the abandonment of an externally created customized billing software module. While the strategy had been in play for several months, including the addition of office space in the corporate offices to facilitate the transition, Management formally approved the final strategy in December 2002. During December 2002 the Company hired a seasoned industry executive to transfer the software programs and intellectual knowledge from the New York office to the corporate office, identify and begin training existing personnel in anticipation of the reduction-in-force, and abandoned the billing software system. The corporate office will assume full revenue responsibilities concurrently with the closing of the New York office.
	During 2003 the Company completed the major enhancement of is products and the major requirements under the terms of the Tribune Agreements. In addition the Company acquired Edgil Associates, Inc., and immediately commenced an overall product line evaluation as part of the integration. As described in prior quarter financials management approved a reduction-in-force during the forth quarter, evaluated excess computer equipment and paid a bonus associated the successful transition of the New York office.
	The following table summarizes the restructuring activity for the three months ended March 31, 2004; these costs are included in accrued expenses on the balance sheet:

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	Bonus and			Office			Legal and
Accrued restructuring	Severance			Lease			Other		Total
Balance December 31, 2003	$	25,311		$	58,608		$	15,653	$	99,572
Charges for the period		(25,311	)		(3,916	)		—		(29,227	)
Balance March 31, 2004	$	—		$	54,692		$	15,653	$	70,345

13.	Acquisition of Edgil Associates, Inc.
	On October 21, 2003 the Company acquired Edgil Associates, Inc. (Edgil) through a forward triangular merger pursuant to an Agreement and Plan of Merger, dated as of the Effective Date, by and among AdStar, Edgil, EDG, and Edward P. Hopey and Gilbert Wolsky, the stockholders of Edgil (collectively, the “Edgil Stockholders”).
	Pursuant to the Merger Agreement, the Company paid $1,520,000 cash and issued 1,311,530 shares of common stock, in exchange the business and assets of Edgil. Based upon the average closing price of the Common Stock on the Nasdaq SmallCap Market for the 10 trading day period beginning October 14, 2003 the value of the Edgil Shares was $2,111,563. In addition the Company issued 63,397 AdStar options valued at $68,926 using the Black-Scholes method as replacement options for fully vested Edgil employee options recorded an estimated $285,000 in Legal, Accounting and other fees as part of the cost of the acquisition
	The acquisition of Edgil adds to AdStar’s suite of e-commerce services: Edgil’s EdgCapture, an integrated payment processing solution that interfaces directly with publishers’ classified and circulation systems; and EdgFlow, a content processing solution that allows publishers to deliver media content such as articles, technical documents, advertisements, wire stories, etc., to multiple channels in a variety of formats. Edgil’s products and services will continue to be offered under the Edgil brand, and AdStar will maintain Edgil’s Massachusetts-based headquarters.
	The acquisition of Edgil is accounted for as a purchase business combination in accordance with the Statement of Financial Accounting Standards (SFAS) no. 141, “Business Combinations.” The total purchase price related to the acquisition of Edgil was $3,985,489. Edgil will operate as a wholly owned subsidiary of AdStar and the Company’s financial statements will include the results of Edgil from the closing date of the acquisition (October 21, 2003). The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The allocation of the purchase price is based in part on independent third-party valuation of certain intangible assets. The excess purchase price over the estimated fair value of the assets acquired and liabilities assumed is recorded as goodwill. The estimated cost of the acquisition, and accordingly the amount of goodwill, was increased by $85,000 since December 31, 2003 as a result of underestimating professional costs associated with Nasdaq and SEC requirements.
	At October 21, 2003

Current assets	$	381,887
Purchased software		311,000
Customer list		1,500,000
Goodwill		2,934,634
Total assets acquired		5,127,521
Current liabilities		390,852

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Deferred tax liability		688,180
Notes payable Shareholders		63,000
Total liabilities assumed		1,142,032
Net assets acquired	$	3,985,489

The purchased software is comprised of internally created software which was valued by the independent third-party who assigned an expected useful life of 5 years.

The customer list of $1,500,000 is primarily comprised of value of the recurring revenue stream associated with long-term customers, valued by the independent third-party who assigned an expected life of 17 years.

The excess of the purchase price over the estimated fair value of the assets acquired and the liabilities assumed was recorded as goodwill. There is no step up in basis of the assets for tax purposes therefore the goodwill is not deductible for tax purposes.

Since there is no step up in basis of the acquired Edgil assets for tax purposes amortization of purchased software and customer list is not deductible for tax purposes. The $688,180 deferred tax liability is calculated at Edgil’s 38% blended tax rate assigned by the independent third-party appraiser and applied to the $311,000 purchased software and $1,500,000 customer list. At December 31, 2003 in accordance with SFAS 141, the deferred tax liability is expected to be realized over the term as the deferred tax asset, therefore the deferred tax liability was offset against the deferred tax asset on AdStar, Inc. (AdStar) as part of the consolidated income tax provision. As a result of this transaction, AdStar’s deferred tax asset valuation allowance was reduced. In accordance with SFAS 109, the change in the valuation allowance was offset against goodwill. Accordingly, the deferred tax assets and liabilities of the Company has a 100% valuation allowance recorded.

The following summarized pro forma consolidated results of operations are presented as if the acquisition of Edgil had occurred on January 1, 2003. The unaudited pro forma results are not necessarily indicative of future earnings or earnings that would have been reported had the acquisition been completed as presented.

	The three
	month ended
	March 31,
	2003
Revenue	$	1,268,693
Net Loss		(363,101	)
Loss per share – basic and diluted	$	(0.04	)

14.	Subsequent event
	Convertible Note:
	On April 12, 2004, we closed on a $1.5 million private placement of a 3-year secured convertible note (the “Note”) and 7-year warrants to purchase 200,000 shares (the

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“Warrants”) of our common stock (the “Common Stock”) with Laurus Master Fund, Ltd., a New York City based institutional fund and an accredited investor (“Laurus Master Fund”).

The Note bears interest at the prime rate minus one percentage point and is convertible into Common Stock at an initial fixed conversion price of $2.25 per share (the “Fixed Conversion Price”), 105% of the average closing price of the Common Stock (“Average Closing Price”) during the 22 trading days preceding the closing date. The Note has limited anti-dilution protection for capital changes and, on a weighted average basis, for issuance of Common Stock below the Fixed Conversion Price, excluding shares issued in mergers, acquisition or strategic relationships, shares underlying compensatory options, shares issued on conversion or exercise of outstanding securities and other exceptions.

The shares underlying the Note are covered by an effective registration statement and subject to certain limitations based on market volume for the Common Stock and Laurus Master Fund’s aggregate holdings, Laurus Master Fund is required to convert all monthly installments of principal and interest into Common Stock if the Average Closing Price is more than 10 percent above the Fixed Conversion Price. Additionally, we may redeem the Note by paying 125 percent of the then outstanding principal balance plus accrued interest. The Note is secured by a first lien on all of our assets.

Of the Warrants, 120,000 are exercisable at $2.58 and 80,000 are exercisable at $2.80 (120% and 130% of the Average Closing Price during the 22 trading days preceding the closing).

Pursuant to the terms of the Note and the Warrants, Laurus Master Fund may not receive shares of Common Stock on conversion of the Note or exercise of the Warrants to the extent such conversion or exercise would result in Laurus Master Fund beneficially owning in excess of 4.99% of the issued and outstanding shares of Common Stock.

The net proceeds from the financing will be added to our working capital. We believe that with this added working capital we can more quickly achieve the goals of our business plan and accelerate our strategic acquisition program.

During May 2004, pursuant to the terms of the Note, Laurus Master Fund elected to convert $225,000 of the Note into 100,000 shares of Common Stock.

Conversion of Series A convertible preferred stock:

Pursuant to provisions of the Tribune Company agreement, 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. On April 1, 2004, pursuant to the automatic conversion provision as defined in the agreement, all of the 1,443,457 shares of Series A convertible preferred stock outstanding was converted into an equivalent number of the Company’s Common Stock at a ratio of one share of common stock for each share of Series A preferred stock from the Company’s authorized but unissued shares reserved for issuance.

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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 for our fiscal year ended December 31, 2003. Because this discussion involves risk and uncertainties, our actual results may differ materially from those anticipated in these forward-looking statements.

Overview

     In 2001 we repositioned our products, moving away from the idea of the Internet as a stand-alone business category, and moving towards the idea of the Internet as an extremely efficient and flexible communication channel. We recognized that this technology can be utilized to greatly enhance the functionality of the software we licensed to our existing customer base, as well as expand into new areas where our technology can be used to connect advertising outlets with advertisers. During 2002, we began to execute our business plan and spent virtually the entire year on successfully enhancing and integrating our existing technology and new products into the existing and new customers. While some of our historical business has migrated to our new transaction based model, it continues to be used by hundreds of recruitment agencies and volume advertisers. During 2003 we continued customer requested enhancements to our existing applications and expect to monetize the rollouts to a greater extent in 2004 as more publications adapt the new robust applications available to them.

     In working with our customers, we recognized there was a great demand for our Web-based technology within the newspaper industry to run the online classified ad-taking abilities at our customer’s Web sites under a private label branded site concept. Therefore, we revised our business model to embrace these concepts, and we focused on the immediate needs of our customers. While doing this, we also made sure that our technology remained flexible to allow for changes as the needs of our customers change and as we develop product extensions and new lines of business based on our existing technology and expertise.

     We adopted our marketing and sales strategies to our new Web-based ad-taking ASP product, and began marketing the product in June 2001 and found that it was well received by our customers. During 2001, we implemented our Web-based classified ad-taking ASP product at 14 new metropolitan newspapers. Given the severe downturn in advertising revenue in 2001, we were told by many potential customers that implementing our ASP product will need to wait until their advertising revenue has returned to more normal levels. In 2002, despite a slow economy we contracted with an additional 16 newspapers to use our Web-based classified ad-taking ASP product.

     In 2003 we formalized our marketing effort behind our XML Gateway. (Application Programming Interface) With third parties and publishers alike looking to incorporate classified print advertising into their applications, the Gateway proved to be an easy way to accomplish it.

     Publishers are beginning to realize the revenue potential of offering print in combination with online advertising. Being able to accomplish it has been problematic due to old legacy systems that cannot accommodate this offering. Referred to as reverse publishing, it addresses the users who currently go online to buy an online ad for a reasonable up-charge they can include a print ad in their advertising package. The strength of a combination print and online ad assures the advertiser of maximum exposure. Publishers now receive classified advertising from a myriad of sources transmitted in a myriad of ways, each offering their own challenges to process in a

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quick and efficient way. The XML Gateway allows a newspaper to provide a common, single point of entry to whoever wants to send ads and easily drive them directly into their publishing systems.

     In 2003 we also saw the release of our new USER INTERFACE for Web-based ad-taking. This new interface accommodates a variety of customized up-sells for an advertiser. Including our bold headlines, borders, background shading, pictures and graphic attention getters. The user is able to create in real time an ad with a unique look and feel.

     As important as up sells are to newspapers for additional revenue, what is more important is the platform we have created that can expand to offer new and unique capabilities. The future of classifieds rest with the online side of the industry. While print classifieds are two-dimensional online classifieds will offer all that technology can provide. In the future we will be able to provide sound, text messaging, voice recognition, auction function and order fulfillment for items sold etc. All these capabilities will ultimately be provided by our ever-expanding suite of products. We will partner with these technologies or we will acquire to ensure our leadership role as the E-Commerce provider to the newspaper industry.

     In October of 2003 we acquired Edgil Associates, Inc. Edgil provides credit card processing to the newspaper industry. Key to their service is providing seamless integration of these transactions into billing systems and circulation systems alike. Historically operating in a license model we look forward to offering this service in a hosted environment with monthly fees and transaction fees in line with AdStar’s current model.

     Edgil’s customer account base offers fertile ground for cross selling opportunities for Web-based ad-taking.

     In addition to transitioning to a recurring revenue model and expanding our newspaper customers, we are now in a position to reduce our operating costs on a going forward basis. There can be no assurance that our new product offerings or the arrangement with Tribune Company will be successful in generating revenues sufficient to support our operating expenses.

     Prior to the development of our Web business, revenues had been generally sufficient to support our historic business. In developing our Web-based system we began to incur significant losses that could not be offset by the revenues generated by our historic business. These expenses caused us to incur significant losses from 1998 through 2003. Our future success is dependent upon our ability to substantially grow revenues and control costs to the point where we can fund the level of operations necessary to serve the anticipated customer base. To this end, our plans have included expanding the products and services offered to our customers by building on our proprietary software processes and unique position within the industry. We feel that there is significant opportunity to increase revenues by offering the Web software and services that we had initially developed for ourselves to print publications as an application service provider (“ASP”). In addition we have already taken steps to control or in some cases reduce cost on an ongoing basis.

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Results of Operations

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

	Three Months Ended
	March 31,
	2003			2004
ASP, net		54	%		38	%
Licensing and software		36	%		52	%
Customization and other		10	%		10	%
Net revenues		100	%		100	%
Cost of revenues		56	%		40	%
Gross Profit		44	%		60	%
General and administrative expense		49	%		42	%
Selling and marketing expense		27	%		31	%
Product development costs		43	%		36	%
Amortization		0	%		2	%
Loss from operations		(75	)%		(51	)%
Other income		0	%		0	%
Interest income (expense)		0	%		0	%
Loss before taxes		(75	)%		(51	)%
Provision for taxes		–			–
Net loss		(75	)%		(51	)%

Three Months Ended March 31, 2004 and 2003

Revenues

     Net revenues increased to $1,047,000 in 2004 from $593,000 in 2003, a net increase of $454,000 or 77%. The increase in net revenue for 2004 is primarily comprised of a net increase of $441,000 or 75% related to our wholly-owned subsidiary, Edgil Associates, Inc. (Edgil) which was acquired in October 2003. The remaining 2% net increase is primarily comprised of a $53,000 or 9% increase in ASP revenues, offset by a $12,000 or 2% decrease in Licensing and software and a $27,000 or 5% decrease in Customization and other revenues attributable to AdStar.

     The increase of $53,000 in ASP revenues is primarily attributable to the net addition 6 ASP customers included in the three months ended March 31, 2004 compared the to the three months ended March 31, 2003, accounting for approximately $25,000 with the remaining $27,000 increase coming from a quarter-over-quarter increase in transaction volumes from existing customers. Licensing and software decreased by $12,000 as a result of 3 customers who terminated the use of our outmoded licensed fax technology as the industry continues to move toward a web-based product, we now have only 2 such licenses remaining issued. The $27,000 decrease in Customization and other revenues is primarily due to timing of customer scheduling of installations, upgrades, and other custom work. We expect this amount to significantly increase over the remainder of 2004.

Cost of revenues

     Cost of revenue consists primarily of the costs to customize and install the AdStar software applications, configure end-user software, install Web-based ad-taking software, amortization of internally developed application modules, royalties, and co-location costs. Cost of revenues increased to $417,000 in the three months ended March 31, 2004 from $335,000 in comparable period in 2003, a net increase of $82,000 or 25%. The increase during 2004 is

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primarily comprised of a net increase of $119,000 or 36% attributable to Edgil offset by a $36,000 or 11% decrease attributable to AdStar. The $36,000 decrease is primarily due to a $36,000 reduction in direct labor as a direct result of the reduction of customization and other revenues.

General and administrative expense

     General and administrative expense consists primarily of the cost of executive, administrative, professional fees, accounting, and finance personnel. General and administrative expenses increased to $438,000 in the three months ended March 31, 2004 from $289,000 in comparable period in 2003, a net increase of $149,000 or 52%. The increase during 2004 is primarily comprised of a net increase of $122,000 or 42% attributable to Edgil and a $27,000 or 10% increase attributable to AdStar. The $27,000 increase is primarily related to $12,000 in temporary and permanent increases in financing wages and benefits and a $12,000 increase in legal fees primarily associated with post Edgil acquisition compensation plan research.

     Management believes that our existing executive and administrative personnel are sufficient to allow for continued organic growth without the need to add significant additional systems or personnel related costs for the near future. As we continue to grow and contemplate future acquisition candidates we may need to add additional support or mid-management level staffing.

Selling and marketing expense

     Selling and marketing expense consists primarily of direct charges for advertising, sales promotion, marketing, and trade shows, as well as the cost for business development. Selling increased to $328,000 in 2004 from $161,000 in 2003, a net increase of $167,000 or 104%. The increase during 2004 is primarily comprised of a net increase of $82,000 or 51% attributable to Edgil and an $84,000 or 54% increase attributable to AdStar.

     The $84,000 increase is comprised of a $56,000 net increase in salary, moving and related expenses, primarily related to the hiring of a senior vice president of sales, a $10,000 commission expense related to a newly created commission plan, a $44,000 increase in travel and trade shows as anticipated with the increased focus on selling and marketing our products, offset by a $25,000 reduction in outside consulting fees.

     In 2004 we expect an increase in selling and marketing expenses as compared to the related periods of 2003 as we continue the development and implementation of our strategic marketing plan and continue to build upon our existing relationships with Tribune Company, Knight-Ridder, Inc., CareerBuilder, L.L.C., Manheim Interactive, Inc. and other potential strategic partners.

Product maintenance and development costs

     Product maintenance and development expenses consist of expenses to identify functional requirements, to plan, identify and conceptually design the required technical infrastructure, and to perform Web-site maintenance and other general routine fixes. The costs consist primarily of personnel related expenses for technical and design functions including outside consultants. Product maintenance and development expense increased to $376,000 in 2004 from $253,000 in 2003, a net increase of $123,000 or 49%. The increase during 2004 is primarily comprised of a net increase of $121,000 or 48% attributable to Edgil while AdStar remained essentially flat with a net $2,000 or 1% increase.

     From mid April through September 30, 2003 we had a net reduction of 7 full time equivalent technical staff. In addition, during December 2003 we identified an additional 4

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technical staffing positions that were eliminated on January 5, 2004. We believe this lowered level of technical staffing will be sufficient for the near future. Conversely, we may need to increase technical staffing in the short term if we obtain additional customers more quickly than currently expected or an unexpected increase in customer demand for customization projects. However, an increase in customer demand requiring an increase in technical staffing costs are generally offset by increased revenues for such services.

Liquidity and Capital Resources

     Prior to 1999 we financed our business primarily from cash generated by operations. Subsequently, we have financed our business through a combination of cash generated from operations and debt and equity financings. For the years ending December 31, 2003 and 2002, we raised net proceeds of $2,622,000 and $3,831,000, respectively, in equity and debt financings, including the acquisition of Edgil in October 2003. In April 2004 we raised an additional $1,500,000 from a convertible debt financing to fund operations and enhance and expand the product line we provide our customers.

     As of March 31, 2004, we had cash and cash equivalents of approximately $1,883,000 compared to $2,092,000, as of December 31, 2003 a combined net decrease of $209,000. The net decrease in cash and cash equivalents was a result of $32,000 in net cash used in operating activities, $254,000 in net cash used in investing activities, offset by net proceeds of $76,000 provided by financing activities.

     Net cash used in operations during the three months ended March 31, 2004 was approximately $32,000. Net cash used in operating activities was primarily the result of a net loss of $542,000 less non-cash charges of $208,000 in Depreciation and amortization, a $370,000 increase in Due to publications, a $133,000 increase in Deferred revenue and customer deposits, offset by a $190,000 decrease in Accounts payable and accrued expenses. The increase in Due to publications is a by-product of the seasonal nature of the classified industry whereby a greater volume of newspaper ads are placed in the first three quarters of the calendar year with a material drop-off in the fourth quarter.

     Net cash used in investing activities during the three months ended March 31, 2004 was approximately $254,000. Net cash used in investing activities was primarily comprised of $158,000 in ongoing enhancements to our proprietary software as well as an additional $85,000 increase in the cost of the acquisition of Edgil. The software enhancements primarily relate to the conversion of Edgil’s EdgeCapture payment processing software from a stand-alone server based application to a web-based application available to all AdStar and Edgil customers, as well as new customers, while the addition to the cost of Edgil is primarily related to additional legal and accounting fees required to satisfy NASDAQ technical requirements.

     Net cash provided by financing activities during the three months ended March 31, 2004 was approximately $75,000, which primarily consisted of $84,000 in net proceeds from the exercise of employee options vendor warrants, offset by $9,000 in Principal repayments on capital leases.

     At March 31, 2004, we have an accumulated deficit of $14,703,000. We have incurred significant recurring net losses for the years ended December 2002, 2003 and the three months ended March 31, 2004 of $2,160,000 and $2,842,000 and $542,000. Our 2002 and 2003 and first quarter 2004 net losses were principally attributable to our shift in focus from an on-line business to an ASP business. We expect to continue to incur losses until we are able to increase revenues significantly from fees based on the number of purchases transacted through our ASP product. We believe cash on hand of $1,883,000 at March 31, 2004, the $1,500,000 in proceeds from a convertible debt financing we closed in April 2004, the positive cash flows we are currently generating from our acquisition of Edgil, our reduction in personnel at the beginning of January

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2004 and expected increase in revenues from our continued success in growing our ASP business will generate sufficient capital to meet our cash needs through the next twelve months. In addition we believe the $1,500,000 in convertible debt financing in April 2004 will further enhance our ability to grow organically and position us to take advantage of additional strategic acquisitions and revenue sharing arrangements should they present themselves. In May 2004, $225,000 of the debt was converted into equity which is expected to have a positive impact our cash flow in the third quarter of 2004.

     We are optimistic that our growing ASP business will continue to be accepted in the marketplace. However, our ability to sell ASP business products and service offerings during the current year may be hampered by the current unstable climate in the advertising market, the geo-political climate, including the war in Iraq, and state of the economy in general. These factors, coupled with the unproven ability of our newly acquired subsidiary, Edgil, to continue to generate positive cash flow, possible competition from other vendors, the extended selling cycle in our industry, and customer delays in customization and implementations, could delay our ability to increase revenue to a level sufficient to cover our expenses.

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

Critical Accounting Policies and Estimates

     The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements require that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure. On an on-going basis, we re-evaluate our estimates, including those relating to revenue recognition, uncollectible accounts receivable, intangible assets and contingent expenses and revise reported amounts prospectively. We base our estimates on historical experiences, combined with anticipated activity and various other assumptions that we believe to be reasonable under the circumstances. When combined, this body of knowledge forms the basis for making judgments about the carrying value of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.

     Financial Reporting Release No. 60, which was recently issued by the Securities and Exchange Commission, requires all companies to include a discussion of critical accounting policies or methods used in preparation of financial statements. The following is a brief discussion of our most critical accounting policies, including those methods affected by our more complex judgments and estimates.

Revenue Recognition

We derive revenue from several products and services as follows:

ASP revenue – We receive revenue by providing an application service provider (“ASP”) product that allows customers to use our software applications on a “shared system” over the Internet. This technology is a publisher-specific ad-taking Web site service that

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offers visitors to a newspaper’s Web page the opportunity to buy classified ads, for both the print and/or on-line editions of the newspaper, in real-time, on a 24/7 basis. We receive monthly fees for hosting the transactions and providing customer support, and recognize the fees ratably over the contract period.

Web site revenue – The Company receives revenue from fees charged to customers who transact business on the Advertise123.com Web site. This site permits the general public to plan, schedule, compose and purchase advertising from many print and on-line publishers. Under the guidance provided by the Securities Exchange Commission Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition” and the Emerging Issues Task Force (“EITF”) Abstract No. 99-19 “Reporting Revenue Gross as a Principal versus Net as an Agent” (“EITF 99-19”), we are, in substance, acting as an agent for the publishers and therefore recognizes as revenue only the net fees realized on the transactions. We recognize revenue on a per-transaction basis when the ad is placed through their system and collection from the customer is probable.

Licensing and Software; Customization and other revenues — We generate revenue from technology service contracts that generally contain multiple elements such as software customization services, monthly fees and post-contract customer support (PCS). Revenue from these arrangements is recognized in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition”, and SOP 98-9, “Software Revenue Recognition with Respect to Certain Transactions”. Accordingly, revenue is allocated to each element within the contract based on the relative fair values of those elements using vendor specific objective evidence. Revenue from monthly fees and PCS under software maintenance arrangements is based upon renewal rates and is recognized ratably over the term of the arrangement. Revenue from software customization services is recognized as the services are performed, using a percentage of completion methodology based on labor hours. We also provide customization services at the customers’ request and recognizes revenue as the services are performed, using a percentage of completion methodology based on labor hours.

Deferred revenue consists primarily of deferred revenues from long-term License and Software contracts, PCS maintenance arrangements prepaid annually and customization and other revenues billed and paid in advance. Revenues from upfront license fees, monthly fees and PCS under software maintenance arrangements is based upon renewal rates and is recognized ratably over the term of the arrangement, licenses and maintenance generally range from month–to-month up to 10 years on historical AdStar and 25 years and 3 to 5 years on historical Edgil, respectively. Deferred revenue on the 25-year license arrangements are $106,000, PCS contracts paid in advance and prepaid customer deposits are $80,000 for year ended December 31, 2003. Revenue from software customization services is recognized upon the completion of services. As part of the integration of Edgil into AdStar’s business model we are currently offering new Edgil contracts on terms and conditions similar to AdStar, generally one year or less in duration.

Areas requiring management’s judgment includes revenue recognition and cost estimation on the fixed fee software customization element of the contracts. Revenue is recognized on these contracts using a percentage-of-completion methodology, based upon labor input measures and an estimate of time to completion. Monthly, technical management reviews the estimate of labor hours required to complete the customization and the effect of any change in estimate is reflected in the period in which the change is first known. Such changes in estimates have not been material to our results of operation. The corresponding cost of revenue charge is derived based upon the same labor input measurements and our existing cost structure. If we do not accurately estimate the

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resources required under the contract or the scope of the work to be performed, or if we do not manage our projects properly within the prescribed timeframe, future margins may be significantly and adversely affected. If increases in projected costs-to-complete are sufficient to create a loss contract, the entire estimated loss is charged to operations in the period the loss first becomes known. The complexity of the estimation process and uncertainties inherent in software customization activities may affect the percentages derived under the percentage-of-completion accounting method, which in turn may affect the amounts reported in the financial statements.

Software Development Costs

Costs to establish the technological feasibility of software applications developed by us are charged to expense as incurred. Certain costs incurred subsequent to achieving technological feasibility are capitalized. Accordingly, we capitalize a portion of the internal labor costs and external consulting costs associated with essential Web site development and enhancement activities. Costs associated with conceptual design and feasibility assessments as well as maintenance and routine changes are expensed as incurred. Capitalized costs are amortized based on current or future revenue for each product with an annual minimum equal to the straight-line basis over the estimated economic lives of the applications, not to exceed 5 years. During the three months ended March 31, 2004 we capitalized $158,000 and amortized $159,000 in capitalized software costs and expensed $376,000 in software development and maintenance costs.

Warranties and Product liability

We warrant that our products conform to their respective functional specifications. Our customized software products, ASP application products and Software License Agreements are warranted to perform as designed. Such warranties are extended throughout the term of extended service agreements that clients enter into with us. Direct costs associated with the initial period of service have been insignificant and are generally covered by upfront fees.

We currently carry product liability insurance. We believe the amount of insurance is adequate to cover its risks. To further mitigate its risks, ours standard service agreement expressly limits its liabilities and warranties of its products and services in accordance with accepted provisions of the Uniform Commercial code as adopted in most states.

Allowance for doubtful accounts

We maintain an allowance for doubtful accounts using estimates that we make based on factors we believe appropriate such as the composition of the accounts receivable aging, historical bad debts, changes in payment patterns, customer creditworthiness and current economic trends. If we used different assumptions, or if the financial condition of the customers were to deteriorate, resulting in an impairment of their ability to make payments, additional provisions for doubtful accounts would be required and would increase our bad debt expense.

Contractual Obligations, Commitments and Contingencies

We have contractual obligations and commitments primarily with regards to employment agreements for 3 of our executives, certain non-cancelable operating lease obligations for office space and equipment, and capital lease obligations for computer equipment and office furniture.

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The following table aggregates our expected contractual obligations and commitments subsequent to March 31, 2004:

	Payments due by Period
							Beyond
Contractual obligations	2005		2006		2007		2008		Total
Employment agreements (1)	$	569,375	$	372,400	$	159,600	$	—	$	1,101,375
Capital Lease commitments		37,615		10,460		—		—		48,075
Operating lease commitments (2)		414,524		111,919		37,113		—		563,556
Loans from stockholders		21,000		21,000		21,000		—		63,000
	$	1,042,514	$	515,779	$	217,713	$	–	$	1,776,006

(1)	Includes employment agreements entered into pursuant to the Merger agreement whereby the two stockholders of Edgil entered into employment agreements, each receives a monthly salary of $7,000 for six months commencing October 21, 2003.
(2)	Excludes sublet office agreement of $2,400 and $11,000 per month through April and May 2005 respectively.

Item 3. Controls And Procedures

     Evaluation of Disclosure Controls and Procedures. The Company’s management, with the participation of the chief executive officer and the chief financial officer, carried out an evaluation of the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (the “Exchange Act”) Rules 13a-15(e) and 15-d-15(e)) as of the end of the period covered by this 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, the Company’s disclosure controls and procedures are effective, providing them with material information relating to the Company as required to be disclosed in the reports the Company files or submits under the Exchange Act on a timely basis.

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

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 three month period ended March 31, 2004, 8,226 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 $17,175. The vendors have taken the shares for investment.

     On April 12, 2004, we closed on a $1.5 million private placement of a 3-year secured convertible note (the “Note”) and 7-year warrants to purchase 200,000 shares (the “Warrants”) of

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our common stock (the “Common Stock”) with Laurus Master Fund, Ltd., a New York City based institutional fund and an accredited investor (“Laurus Master Fund”).

     The Note bears interest at the prime rate minus one percentage point and is convertible into Common Stock at an initial fixed conversion price of $2.25 per share (the “Fixed Conversion Price”), 105% of the average closing price of the Common Stock (“Average Closing Price”) during the 22 trading days preceding the closing date. The Note has limited anti-dilution protection for capital changes and, on a weighted average basis, for issuance of Common Stock below the Fixed Conversion Price, excluding shares issued in mergers, acquisition or strategic relationships, shares underlying compensatory options, shares issued on conversion or exercise of outstanding securities and other exceptions.

     The shares underlying the Note are covered by an effective registration statement and subject to certain limitations based on market volume for the Common Stock and Laurus Master Fund’s aggregate holdings, Laurus Master Fund is required to convert all monthly installments of principal and interest into Common Stock if the Average Closing Price is more than 10 percent above the Fixed Conversion Price. Additionally, we may redeem the Note by paying 125 percent of the then outstanding principal balance plus accrued interest. The Note is secured by a first lien on all of our assets.

     Of the Warrants, 120,000 are exercisable at $2.58 and 80,000 are exercisable at $2.80 (120% and 130% of the Average Closing Price during the 22 trading days preceding the closing).

     Pursuant to the terms of the Note and the Warrants, Laurus Master Fund may not receive shares of Common Stock on conversion of the Note or exercise of the Warrants to the extent such conversion or exercise would result in Laurus Master Fund beneficially owning in excess of 4.99% of the issued and outstanding shares of Common Stock.

     The net proceeds from the financing will be added to our working capital. We believe that with this added working capital we can more quickly achieve the goals of our business plan and accelerate our strategic acquisition program.

Item 6. Exhibits and Reports on Form 8-K

a. 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.

b. Reports on Form 8-K:

     We filed a current report on form 8-K, on January 5, 2004 with respect to Item 2 and on April 16, 2004 with respect to Item 5.

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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 May 14, 2004	/s/ Leslie Bernhard
	President & CEO
Date May 14, 2004	/s/ Anthony J. Fidaleo
	Chief Financial Officer
	(Principal Financial Officer)

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