Index





**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


**_________________**





**FORM
      10-Q**


**_________________**


**(Mark
      One)**


**[X]    Quarterly
      report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934**





**For
      the quarterly period ended September 30, 2006**





**OR**





**[
       ]    Transition report pursuant to Section 13 of 15(d)
      of the Securities Exchange Act of 1934**





**Commission
      File Number: 333-119385**


**_________________**





**SMART
      ONLINE, INC.**


**(Exact
      name of registrant as specified in its charter)**


**_________________**





**Delaware**
            **95-4439334****(State
                of other jurisdiction of**
            **(I.R.S.
                Employer****incorporation
                or organization)**
            **Identification
                No.)**





**2530
                Meridian Parkway, 2nd Floor**
              **Durham,
                North Carolina**
            **27713****(Address
                of principal executive offices)**
            **(Zip
                Code)**








**(919)
      765-5000**


**(Registrant's
      telephone number, including area code)**


**_________________**





Indicate
      by check mark whether the Registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days: Yes  x   
No o





Indicate
      by check mark whether the Registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of accelerated
      filer and large accelerated filer in Rule 12b-2 of the Exchange Act.




(Check
                one):
            Large
                Accelerated Filer o
            Accelerated
                Filer o
            Non-accelerated
                Filerx





Indicate
      by check mark whether the Registrant is a shell company (as defined in rule
      12b-2 of the Exchange Act). Yes o     
No x





As
      of
      November 1, 2006, there were approximately 15,377,653 shares of the Registrant's
      Common Stock outstanding.














**Smart
      Online, Inc.**


**INDEX**





**Page
                No.****PART
                I. FINANCIAL
                INFORMATION****Item
                1.**
            **Financial
                Statements:**Consolidated
                Balance Sheets as of September 30, 2006
                (unaudited) and December 31, 2005
            3Consolidated
                Statements of Operations (unaudited) for the
                three months and nine months ended September 30, 2006 and
                2005
            4Consolidated
                Statements of Cash Flows (unaudited) for
                the three months and nine months ended September 30, 2006 and
                2005
            5Notes
                to Consolidated Financial Statements
                (unaudited)
            6**Item
                2.**
            **Management’s
                Discussion and Analysis of Financial Condition
                and Results of Operations**
            20**Item
                3.**
            **Quantitative
                and Qualitative Disclosures About Market
                Risk**
            36**Item
                4.**
            **Controls
                and Procedures**
            37**PART
                II. OTHER INFORMATION****Item
                1.**
            **Legal
                Proceedings**
            37**Item
                1A.**
            **Risk
                Factors**
            37**Item
                2.**
            **Unregistered
                Sales of Equity Securities and Use of
                Proceeds**
            47**Item
                6.**
            **Exhibits**
            48**Signatures**
            49





-2-





PARTI.
      FINANCIAL
      INFORMATION


**Item
        1.  FinancialStatements**





**SMARTONLINE,
      INC.**


**CONSOLIDATED
      BALANCE SHEETS**





**September
                30,****2006**
            
            **December
                31,****2005****Assets**
            
            (unaudited)CURRENT
                ASSETS:Cash
                and cash equivalents
            
            $
            680,787
            
            $
            1,434,966Restricted
                Cash
            
            
            332,653
            
            
            230,244Accounts
                receivable, net
            
            
            259,498
            
            
            504,979Prepaid
                expenses
            
            
            268,695
            
            
            370,225Assets
                Available for Sale
            
            
            -
            
            
            74,876Total
                current assets
            
            
            1,541,633
            
            
            2,615,290PROPERTY
                AND EQUIPMENT, net
            
            
            199,357
            
            
            216,969INTANGIBLE
                ASSETS, net
            
            
            6,498,483
            
            
            9,788,321OTHER
                ASSETS
            
            
            16,297
            
            
            40,400ASSETS
                AVAILABLE FOR SALE
            
            
            -
            
            
            1,897,099TOTAL
                ASSETS
            
            $
            8,255,770
            
            $
            14,558,079**Liabilities
                and Stockholders' Equity (Deficit)**CURRENT
                LIABILITIES:Accounts
                payable
            
            $
            1,109,172
            
            $
            855,904Accrued
                liabilities
            
            
            157,459
            
            
            48,674Accrued
                payroll
            
            
            -
            
            
            42,559Accrued
                Registration Rights Penalty
            
            
            475,815
            
            
            129,945Current
                Portion of Notes Payable
            
            
            2,823,159
            
            
            2,127,486Deferred
                revenue
            
            
            418,559
            
            
            687,222Liabilities
                Held for Sale
            
            
            -
            
            
            1,030,369Total
                current liabilities
            
            
            4,984,164
            
            
            4,922,159LONG-TERM
                LIABILITIES:Long-Term
                Portion of Notes Payable
            
            
            82,057
            
            
            2,243,652Unearned
                Revenue
            
            
            24,519
            
            
            78,771Liabilities
                Held for Sale
            
            
            -
            
            
            640,866Total
                long-term liabilities
            
            
            106,576
            
            
            2,963,289Total
                liabilities
            
            
            5,090,740
            
            
            7,885,448STOCKHOLDERS'
                EQUITY:Common
                stock, $.001 par value, 45,000,000 shares authorized at September
                30, 2006
                and December 31, 2005; 15,377,653 and 15,607,230 shares issued and
                outstanding at September 30, 2006 and December 31, 2005,
                respectively
            
            
            15,379
            
            
            15,607Additional
                paid-in capital
            
            
            59,002,387
            
            
            58,982,617Accumulated
                deficit
            
            
            (55,852,736
            )
            
            (52,325,593
            )Total
                stockholders' equity (deficit)
            
            
            3,165,030
            
            
            6,672,631TOTAL
                LIABILITIES AND STOCKHOLDERS' EQUITY
            
            $
            8,255,770
            
            $
            14,558,079


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








-3-





**SMARTONLINE,
      INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS(Unaudited)**





**Three
                Months Ended**
            
            **Nine
                Months Ended****September
                30, 2006**
            
            **September
                30, 2005**
            
            **September
                30, 2006**
            
            **September
                30, 2005**REVENUES:Subscription
                Fees
            
            $
            429,426
            
            $
            21,461
            
            $
            1,476,194
            
            $
            62,350Professional
                Services Fees
            
            
            242,177
            
            
            -
            
            
            1,051,200
            
            
            -Integration
                Fees
            
            
            6,250
            
            
            203,542
            
            
            182,660
            
            
            585,262Syndication
                Fees
            
            
            57,352
            
            
            103,602
            
            
            183,619
            
            
            299,244OEM
                Revenue
            
            
            9,000
            
            
            12,000
            
            
            27,000
            
            
            36,000Other
                Revenues
            
            
            5,001
            
            
            4,087
            
            
            27,312
            
            
            21,190Total
                Revenues
            
            
            749,206
            
            
            344,692
            
            
            2,947,985
            
            
            1,004,046COST
                OF REVENUES
            
            
            31,311
            
            
            25,800
            
            
            212,515
            
            
            79,438GROSS
                PROFIT
            
            
            717,895
            
            
            318,892
            
            
            2,735,470
            
            
            924,608OPERATING
                EXPENSES:General
                and Administrative
            
            
            1,208,044
            
            
            1,761,376
            
            
            4,844,464
            
            
            3,004,574Sales
                and Marketing
            
            
            135,027
            
            
            374,841
            
            
            666,940
            
            
            957,519Research
                and Development
            
            
            455,997
            
            
            371,137
            
            
            1,279,198
            
            
            872,767Total
                Operating Expenses
            
            
            1,799,068
            
            
            2,507,354
            
            
            6,790,602
            
            
            4,834,860LOSS
                FROM CONTINUINGOPERATIONS
            
            
            (1,081,173
            )
            
            (2,188,462
            )
            
            (4,055,132
            )
            
            (3,910,252
            )OTHER
                INCOME (EXPENSE):Interest
                Income (Expense), Net
            
            
            (51,746
            )
            
            7,606
            
            
            (190,802
            )
            
            17,801Takeback
                of Investor Relations Shares
            
            
            1,562,500
            
            
            -
            
            
            3,125,000
            
            
            -Write-off
                of Investment
            
            
            -
            
            
            -
            
            
            (25,000
            )
            
            -Gain
                on Debt Forgiveness
            
            
            -
            
            
            -
            
            
            144,351
            
            
            556,634Total
                Other Income
            
            
            1,510,754
            
            
            7,606
            
            
            3,053,549
            
            
            574,435NET
                INCOME (LOSS) FROM OPERATIONS
            
            
            429,581
            
            
            (2,180,856
            )
            
            (1,001,583
            )
            
            (3,335,817
            )DISCONTINUED
                OPERATIONSLoss
                      from Operations of Smart CRM(includes
                      Loss on Sale of $2,140,054)
            
            
            (2,329,429
            )
            
            -
            
            
            (2,525,563
            )
            
            -Income
                  Tax Effect
            
            
            -
            
            
            -
            
            
            -
            
            
            -Loss
                from Discontinued Operations
            
            
            (2,329,429
            )
            
            -
            
            
            (2,525,563
            )
            
            -NET
                LOSSNet
                Loss Attributed to Common Stockholders
            
            $
            (1,899,848
            )
            $
            (2,180,856
            )
            $
            (3,527,146
            )
            $
            (3,335,817
            )NET
                INCOME (LOSS) PER SHARE:Continuing
                OperationsBasic
            
            $
            0.03
            
            $
            (0.17
            )
            $
            (0.07
            )
            $
            (0.27
            )Fully
                Diluted
            
            $
            0.03
            
            $
            (0.17
            )
            $
            (0.07
            )
            $
            (0.27
            )Discontinued
                OperationsBasic
            
            $
            (0.15
            )
            $
            -
            
            $
            (0.17
            )
            $
            -Fully
                Diluted
            
            $
            (0.15
            )
            $
            -
            
            $
            (0.17
            )
            $
            -Net
                Loss Attributed to Common StockholdersBasic
            
            $
            (0.13
            )
            
            (0.17
            )
            
            (0.23
            )
            
            (0.27
            )Fully
                Diluted
            
            $
            (0.12
            )
            $
            (0.17
            )
            $
            (0.23
            )
            $
            (0.27
            )SHARES
                USED IN COMPUTING NET LOSS PER SHAREBasic
            
            
            15,127,510
            
            
            12,832,365
            
            
            15,077,583
            
            
            12,353,443Fully
                Diluted
            
            
            15,387,110
            
            
            12,832,365
            
            
            15,077,583
            
            
            12,353,443








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





-4-





**SMARTONLINE,
      INC.**


**STATEMENTS
      OF CASH** **FLOWS**


**(unaudited)**




**Nine
                Months Ended****September
                30, 2006**
            
            **September
                30, 2005**CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                loss from continuing operations
            
            $
            (1,001,583
            )
            $
            (3,335,817
            )Adjustments
                to reconcile net loss to net cashused
                in operating activities:Depreciation
                and amortization
            
            
            530,969
            
            
            39,237Takeback
                of IR Shares
            
            
            (3,125,000
            )
            
            -Stock
                Option Expense
            
            
            622,442
            
            
            -Registration
                Rights Penalties
            
            
            345,870
            
            
            -Common
                shares, warrants, or options issued in lieu of
                compensation
            
            
            -
            
            
            826,739Issuance
                of warrants
            
            
            -
            
            
            19,231Gain
                on debt forgiveness
            
            
            (144,351
            )
            
            (556,634
            )Writeoff
                of Investment
            
            
            25,000
            
            
            -Changes
                in assets and liabilities:Accounts
                receivable
            
            
            215,569
            
            
            (43,624
            )Prepaid
                expenses
            
            
            97,074
            
            
            (486,832
            )Other
                assets
            
            
            129
            
            
            44,888Deferred
                revenue
            
            
            (309,460
            )
            
            (359,967
            )Accounts
                payable
            
            
            379,431
            
            
            195,682Accrued
                payroll
            
            
            -
            
            
            72,009Accrued
                expenses
            
            
            102,402
            
            
            60,090Deferred
                compensation, notes payable, and interest
            
            
            -
            
            
            (1,091,814
            )Net
                cash provided by operating activities of discontinued
                operations
            
            
            212,199
            
            
            -Net
                cash used in operating activities
            
            
            (2,049,309
            )
            
            (4,616,812
            )CASH
                FLOWS FROM INVESTING ACTIVITIES:Purchases
                of furniture and equipment
            
            
            (7,362
            )
            
            (204,868
            )Redemption
                of marketable securities
            
            
            -
            
            
            395,000Net
                cash provided by investing activities of discontinued
                operations
            
            
            431,076
            
            
            -Net
                cash provided by (used in) investing activities
            
            
            423,714
            
            
            190,132CASH
                FLOWS FROM FINANCING ACTIVITIES:Advances
                to Smart CRM
            
            
            (744,918
            )
            
            -Advances
                from Smart CRM
            
            
            1,308,340
            
            
            -Principal
                Payments on Debt
            
            
            (1,460,333
            )
            
            -Restricted
                Cash
            
            
            (102,409
            )
            
            -Issuance
                of common stock
            
            
            2,522,100
            
            
            8,212,641Net
                cash provided by financing activities of discontinued
                operations
            
            
            (651,364
            )
            
            -Net
                cash provided by financing activities
            
            
            871,416
            
            
            8,212,641NET
                INCREASE IN CASHAND
                CASH EQUIVALENTS
            
            
            (754,179
            )
            
            3,785,961CASH
                AND CASH EQUIVALENTS,BEGINNING
                OF PERIOD
            
            
            1,427,489
            
            
            173,339CASH
                AND CASH EQUIVALENTS OF DISCONTINUED OPERATIONS,BEGINNING
                OF PERIOD
            
            
            7,477
            
            
            -LESS
                CASH AND CASH EQUIVALENTS OF DISCONTINUED OPERATIONS,END
                OF PERIOD
            
            
            -
            
            
            -CASH
                AND CASH EQUIVALENTS,END
                OF PERIOD
            
            $
            680,787
            
            $
            3,959,300Supplemental
                disclosures:Cash
                payment during the period for interest:
            
            $
            61,753
            
            $
            154,288Cash
                Payments for interest by discontinued operations
            
            
            41,875
            
            
            -Cash
                Payments for Taxes
            
            
            -
            
            
            -














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





-5-





**Smart
      Online, Inc.**


**Notesto
      Consolidated Financial Statements -
      Unaudited**







**1. 
      SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES**




***Description
      of Business -*** Smart Online, Inc. (“Smart Online” or the “Company”) was incorporated in the
      State of Delaware in 1993. Smart Online develops and markets Internet-delivered
      Software-as-a-Service (SaaS) software applications and data resources to start
      and run small businesses. The Company's subscribers access its products through
      the websites of the Company's private label syndication partners, including
      major companies and financial institutions, and the Company's main portal
      at  *www.SmartOnline.com* .





***Basis
      of Presentation*** -
      The accompanying consolidated balance sheet as of September 30, 2006 and the
      consolidated statements of operations for the three months and nine months
      ended September 30, 2006 and September 30, 2005, and the statements of cash
      flows for the nine months ended September 30, 2006 are unaudited. These
      unaudited consolidated financial statements should be read in conjunction with
      the audited consolidated financial statements and related notes, together with
      management's discussion and analysis of financial position and results of
      operations contained in the Company's Annual Report on Form 10-K for the year
      ended December 31, 2005 filed with the Securities and Exchange Commission
      (“SEC”) on July 11, 2006 (the “2005 Annual Report”).





The
      consolidated financial statements have been prepared in accordance with
      accounting principles generally accepted in the United States (“U.S. GAAP”). In
      the opinion of management, the unaudited consolidated financial statements
      contained in this Quarterly Report on Form 10-Q include all normal and recurring
      adjustments necessary for the fair presentation of the Company's consolidated
      statement of financial position as of September 30, 2006 and its consolidated
      results of operations for the three months and nine months ended September
      30, 2006 and September 30, 2005, and statements of cash flows for the nine
      months ended September 30, 2006. The results for the three months and nine
      months ended September 30, 2006 are not necessarily indicative of the results
      to
      be expected for the fiscal year ending December 31, 2006.




The
      consolidated financial statements have been prepared assuming that the Company
      will continue as a going concern.  As such, they do not include adjustments
      relating to the recoverability of recorded asset amounts and classification
      of
      recorded assets and liabilities.  The Company had accumulated losses of
      approximately $56 million at September 30, 2006 and will be required to make
      significant expenditures in connection with continuing research and development,
      sales and marketing, and general and administrative expenses. The Company's
      ability to continue its operations is dependent upon the raising of capital
      through equity or debt financing in order to meet its working
      needs.




These
      conditions raise substantial doubt about the Company's ability to continue
      as a
      going concern, and if substantial additional funding is not acquired or
      alternative sources developed, management will be required to curtail or cease
      its operations.




The
      Company may raise additional capital by the sale of its equity securities or
      other financing avenues.  Management believes that actions presently being
      taken to obtain additional financing will allow the Company to continue
      as a going concern.





***Significant
      Accounting Policies -*** In the opinion of management, the significant accounting policies used for
      the
      three-months and nine months ended September 30, 2006 are consistent with those
      used for the years ended December 31, 2005, 2004 and 2003. Accordingly, please
      refer to Smart Online's 2005 Annual Report for its significant accounting
      policies.




***Fiscal
      Year -*** Smart Online's fiscal year ends December 31. References to fiscal 2005, for
      example, refer to the fiscal year ending December 31, 2005.




***Use
      of Estimates -*** The preparation of financial statements in conformity with U.S. GAAP requires
      management to make estimates and assumptions in the Company's consolidated
      financial statements and notes thereto. Significant estimates and assumptions
      made by management include the determination of the provision for income taxes,
      the fair market value of stock awards issued and the period over which revenue
      is generated. Actual results could differ materially from those
      estimates.





-6-







***Software
      Development Costs*** -
      Smart Online has not capitalized any direct or allocated overhead associated
      with the development of software products prior to general release. Statement
      of
      Financial Accounting Standards (“SFAS”) No. 86, *Accounting for the Costs of Software to be Sold, Leased or Otherwise
      Marketed* ,
      requires capitalization of certain software development costs subsequent to
      the
      establishment of technological feasibility. Based on the Company's product
      development process, technological feasibility is established upon completion
      of
      a working model. Costs related to software development incurred between
      completion of the working model and the point at which the product is ready
      for
      general release have been insignificant.





***Impairment
      of Long Lived Assets*** -
      Long-lived assets and certain identifiable intangibles are reviewed for
      impairment whenever events or changes in circumstances indicate that the
      carrying amount of an asset may not be recoverable. Recoverability of assets
      to
      be held and used is measured by a comparison of the carrying amount of an asset
      to future net cash flows expected to be generated by the asset. If such assets
      are considered to be impaired, the impairment to be recognized is measured
      by
      the amount by which the carrying amount of the assets exceeds the fair value
      of
      the assets. Assets to be disposed of are reported at the lower of the carrying
      amount or fair value less costs to sell.





***Advertising
      Costs*** -
      Smart Online expenses all advertising costs as they are incurred. The amount
      charged to sales and marketing expense for advertising costs during the third
      quarters of 2006 and 2005 were $104 and $48,414, respectively. The amount
      charged to sales and marketing expense during the first nine months of 2006
      and
      2005 totaled $42,419 and $238,266, respectively. Advertising costs included
      $0
      and $46,251 of barter advertising expense for the three months ended September
      30, 2006 and September 30, 2005, respectively, and $37,913 and $227,501 for
      the
      nine-months ended September 30, 2006 and September 30, 2005,
      respectively.





***Net
      Income/Loss per Share -*** Basic loss per share is computed using the weighted-average number of common
      shares outstanding during the periods. Diluted loss per share is computed using
      the weighted-average number of common and dilutive common equivalent shares
      outstanding during the periods. Common equivalent shares consist of redeemable
      preferred stock, stock options and warrants that are computed using the treasury
      stock method.





***Stock-Based
      Compensation*** -
      Effective January 1, 2006, Smart Online adopted SFAS No. 123 (revised
      2004), *Share Based Payment* (“SFAS No. 123R”), using the modified-prospective-transition method. SFAS
      No. 123R revises SFAS No. 123, *Accounting for Stock-Based Compensation* (“SFAS No. 123”) and supersedes Accounting Principles Board Opinion
      No. 25, *Accounting for Stock Issued to Employees* (“APB No. 25”). SFAS No. 123R requires the cost of all share-based
      payments to employees, including grants of employee stock options, to be
      recognized in the financial statements based on their fair values at grant
      date,
      or the date of later modification, over the required service period. In
      addition, SFAS No. 123R requires unrecognized cost related to options
      vesting after the date of initial adoption to be recognized in the financial
      statements over the remaining requisite service period.





Under
      the modified-prospective-transition method, the amount of compensation cost
      recognized includes: (i) compensation cost for all share-based payments
      granted prior to, but not yet vested, as of January 1, 2006, based on the
      grant date fair value estimated in accordance with the original provisions
      of
      SFAS No. 123 and (ii) compensation cost for all share-based payments
      granted subsequent to January 1, 2006, based on the grant date fair value
      estimated in accordance with the provisions of SFAS No. 123R (See Note 8
      for details on option grants). Results for prior periods have not been
      restated.





As
      of September 30, 2006, the Company maintains the 2004 Equity Compensation Plan
      (the “2004 Plan”). The 2004 Plan provides for the grant of incentive stock
      options, non-statutory stock options, restricted stock awards, and other direct
      stock awards to employees (including officers) and directors of the Company
      as
      well as to certain consultants and advisors. The total number of shares of
      the
      Company's common stock reserved for issuance under the 2004 plan is 5,000,000
      shares, subject to adjustment in the event of stock split, stock dividend,
      recapitalization or similar capital change. (See Note 8 for details on option
      grants).





-7-








After
      adoption of SFAS No. 123R, the Company recognizes the stock based compensation
      of previously granted share-based options and new share based options under
      the
      straight-line method over the requisite service period. Total stock-based
      compensation expense recognized under SFAS No. 123R, was approximately
      $173,428 and $622,442 for the three months and nine months ended September
      30,
      2006, respectively. No share based compensation was capitalized in the
      consolidated financial statements.




The
      fair value of option grants under the 2004 Plan during the three and nine month
      periods ended September 30, 2006 and September 30, 2005 was estimated using
      the
      following weighted-average assumptions:





**Three
                Months Ended**
            
            **Nine
                Months Ended****September
                30,**
              **2006**
            
            **September
                30,**
              **2005**
            
            **September
                30,**
              **2006**
            
            **September
                30,**
              **2005**Dividend
                yield
            
            0.00%
            
            0%
            
            0.00%
            
            0.00%Expected
                volatility
            
            48.6%
            
            15.6%
            
            150%
            
            20.5%Risk
                free interest rate
            
            4.64%
            
            4.23%
            
            4.64%
            
            4.23%Expected
                lives (years)
            
            4.7
            
            9.7
            
            4.7
            
            9.5





For
      periods prior to January 1, 2006, Smart Online accounted for its stock-based
      compensation plans in accordance with the intrinsic value provisions of APB
      No.
      25. Stock options are generally granted at prices equal to the fair value of
      the
      Company's common stock on the grant dates. Accordingly, the Company did not
      record any compensation expense in the accompanying financial statements for
      the
      three months or nine months ended September 30, 2005 for its stock-based
      compensation plans. Had compensation expense been recognized consistent with
      the
      fair value provisions of SFAS No. 123R, the Company's net loss attributed to
      common stockholders and net loss attributed to common stockholders per share
      for
      the three and nine month periods ended September 30, 2005 would have been
      changed to the pro forma amounts indicated below:





**Three
                Months Ended September 30, 2005**
            
            **Nine
                Months Ended September 30, 2005**Net
                  loss attributed tocommon
                  stockholders:As
                reported
            
            $
            (2,180,856
            )
            $
            (3,335,817
            )Add:
                Compensation costrecorded
                at intrinsic value
            
            
            
            
            
            -Less:
                Compensation cost usingthe
                fair value method
            
            
            (204,099
            )
            
            (300,503
            )Pro
                forma
            
            $
            (2,384,955
            )
            $
            (3,636,320
            )







**Three
                Months Ended September 30, 2005**
            
            **Nine
                Months Ended September 30, 2005**Reported
                net loss attributed tocommon
                stockholders:Basic
                and diluted
            
            $
            (.17
            )
            $
            (.27
            )Pro
                forma net loss per share:Basic
                and diluted
            
            $
            (.19
            )
            $
            (.29
            )








-8-








***New
      Accounting Pronouncements -*** In
      September 2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Statement No. 157, *Fair
      Value Measurements* (“SFAS
      No. 157”). SFAS No. 157 defines fair value, establishes a framework for
      measuring fair value in U.S. GAAP, and expands disclosures about fair value
      measurements. SFAS No. 157 applies under other accounting pronouncements that
      require or permit fair value measurements pursuant to which the FASB has
      previously concluded that fair value is a relevant measurement attribute.
      Accordingly, SFAS No. 157 does not require any new fair value measurements.
      However, for some entities, the application of SFAS No. 157 will change current
      practices. SFAS No. 157 is effective for financial statements for fiscal years
      beginning after November 15, 2007. Earlier application is permitted provided
      that the reporting entity has not yet issued financial statements for that
      fiscal year. Management believes SFAS No. 157 will have no impact on the
      financial statements of the Company once adopted.





**2.
      PRESENTATION OF SUBSIDIARIES**





As
      more fully detailed in Smart Online's 2005 Annual Report, the Company completed
      two acquisitions in October 2005. On October 4, 2005, it purchased substantially
      all of the assets of Computility, Inc. (“Computility”). The Company operates
      this wholly-owned subsidiary as Smart CRM, Inc. (d/b/a Computility). On October
      18, 2005, Smart Online completed its purchase of all of the capital stock of
      iMart Incorporated (“iMart”). The Company operates this wholly-owned subsidiary
      as Smart Commerce, Inc. (d/b/a iMart) (“Smart Commerce”).





The
      financial statements for the three months and nine months ended September 30,
      2005 do not contain any accounts of these acquired companies as these were
      pre-acquisition periods. The consolidated financial statements for the three
      months and nine months ended September 30, 2006 contain full periods of
      operations of Smart Commerce and disclose the loss from discontinued operations
      of Smart CRM. Accordingly, the statements of operations for the periods
      presented in this Quarterly Report can only be compared by taking into account
      the acquisitions of iMart and Computility, and subsequent sale of the assets
      of
      Smart CRM.





**3.
      SALE OF SUBSTANTIALLY ALL THE ASSETS OF SMART CRM**





Upon
      our
      successful integration of the SFA/CRM application into the Company’s OneBiz SM platform, management deemed the remaining operations of Smart CRM, specifically
      consulting and network management, to be non-strategic to our ongoing operations
      and business model. On September 29, 2006, Smart Online, Smart CRM and Alliance
      Technologies, Inc. ("Alliance") executed and delivered an Asset Purchase
      Agreement pursuant to which Alliance acquired substantially all of the assets
      of
      Smart CRM. In accordance with SFAS No. 144, *Accounting
      for the Impairment and Disposal of Long-Lived Assets* ,
      the
      Company has reported the operating results for Smart CRM for the three-months
      and nine-months ended September 30, 2006 as discontinued operations and the
      assets and liabilities ultimately sold or disposed of on the balance sheet
      at
      September 30, 2006 and December 31, 2005 as available for sale.





The
      Smart
      CRM assets sold to Alliance included the traditional SFA/CRM application
      developed and sold by Smart CRM and its predecessor in interest, Computility,
      Inc. Smart Online retained all rights relating to the derivative SaaS
      application developed by Smart Online with Smart CRM and incorporated into
      its
      OneBiz SM platform. The other assets sold included substantially all of the fixed assets
      and computer hardware and software of Smart CRM, and certain identifiable
      intangible assets, including technology, customer bases, and common law
      trademarks relating to Computility. Further, Alliance agreed to hire
      substantially all of the employees of Smart CRM following the asset sale, with
      the exception of two key employees who remained with Smart Online.





In
      consideration for the transfer of these assets, Alliance paid Smart Online
      $600,000 in cash and assumed approximately $1.7 million in total liabilities
      related to Smart CRM, including all liabilities associated with the factoring
      activity of Smart CRM, for total compensation of approximately $2.3 million.
      In
      exchange, Alliance received assets valued at approximately $1.7 million,
      resulting in a gain on sale of $653,267. The goodwill associated with the
      disposed assets has been written down to zero resulting in an additional
      non-cash charge to “Other Income/Expense” in the amount of $2,793,321. The
      combined effect is a net loss on the sale of substantially all of the assets
      of
      Smart CRM totaling $2,140,054.





-9-











The
      major
      classes and carrying amounts of the assets and liabilities disposed of are
      as
      follows:





Classification
            
            
            
            Carrying
              Value
                at
              9/30/06**ASSETS**Accounts
                Receivable, net
            
            $
            82,290Fixed
                Assets, net
            
            
            400,624Identifiable
                Intangibles, net
            
            
            972,566Deferred
                Financing Costs
            
            
            224,443TOTAL
                ASSETS SOLD
            
            $
            1,679,923**LIABILITIES**Notes
                & Factor Debt Payable
            
            $
            1,610,478Customer
                Prepaid Services
            
            
            122,712TOTAL
                LIABILITIES ASSUMED BY BUYER
            
            $
            1,733,190CASH
                PAID BY BUYER
            
            $
            600,000TOTAL
                CONSIDERATION
            
            $
            2,333,190Gain
                on sale of Assets and Liabilities before Goodwill
                Write-down
            
            
            653,267Write-down
                of Goodwill related to Assets Sold
            
            
            (2,793,321
            )Net
                Loss on Sale of Assets
            
            $
            2,140,054





In
      addition, two key employees of Smart CRM entered into consulting and non-compete
      agreements with Alliance. Under these agreements, each key employee will provide
      certain consulting services to Alliance to assist with the transition of the
      purchased assets. Both key employees are prohibited from competing with Alliance
      with regard to the business associated with the assets purchased, but each
      is
      specifically allowed to continue his employment with Smart Online. In exchange,
      each key employee will receive a payment from Alliance of $50,000.





Smart
      Online and an entity controlled by the same key employees also entered into
      an
      agreement whereby this entity was paid $55,000 immediately
      following the closing of the asset sale described herein for assistance
      with identifying Alliance as an acquirer of the assets.





There
      is
      no relationship between Smart Online, Smart CRM and their affiliates, and
      Alliance and its affiliates.





**4.
      PRO FORMA RESULTS FROM OPERATIONS** **(unaudited)**





The
      following pro formas show the results of operations for the third quarter of
      2005 as if iMart had been acquired, and as if Computility had been sold, as
      of
      January 1, 2005.





Smart
                CRM
            
            Smart
                Commerce
            
            Smart
                Online
            
            Pro
                Forma (unaudited)Revenues
            
            $
            -
            
            $
            1,118,530
            
            $
            344,692
            
            $
            1,463,222Net
                Income (Loss)
            
            $
            -
            
            $
            515,908
            
            $
            (2,180,856
            )
            $
            (1,664,948
            )Basic
                and Diluted EPS
            
            
            -
            
            
            
            
            $
            (0.17
            )
            $
            (0.13
            )





The
      revenue and net loss for the discontinued operations of Smart CRM for the three
      months ended September 30, 2005, which have been excluded from the above pro
      formas, were $437,806 and ($128,865), respectively.





-10-








The
      following pro formas show the results of operations for the first nine months
      of
      2005 as if iMart had been acquired, and as if Computility had been sold, as
      of
      January 1, 2005.





Smart
                CRM
            
            Smart
                Commerce
            
            Smart
                Online
            
            Pro
                Forma (unaudited)Revenues
            
            $
            -
            
            $
            2,857,887,
            
            $
            1,004,046
            
            $
            3,861,933Net
                Income (Loss)
            
            $
            -
            
            $
            1,239,671
            
            $
            (3,335,817
            )
            $
            (2,096,146
            )Basic
                and Diluted EPS
            
            
            -
            
            
            
            
            $
            (0.27
            )
            $
            (0.17
            )





The
      revenue and net loss for the discontinued operations of Smart CRM for the nine
      months ended September 30, 2005, which have been excluded from the above pro
      formas, were $1,471,828 and ($127,854), respectively.





**5.  
      INDUSTRY SEGMENT INFORMATION**





SFAS
      No. 131, *Disclosures About Segments of an Enterprise and Related
      Information,* establishes standards for the way in which public companies disclose certain
      information about operating segments in their financial reports. Consistent
      with
      SFAS No. 131, the Company has defined two reportable segments, described
      below, based on factors such as geography, how it manages its operations and
      how
      the chief operating decision-maker views results.





The
      Smart Commerce segment's revenues are derived primarily from the development
      and
      distribution of multi-channel e-Commerce systems including domain name
      registration and e-mail solutions, e-Commerce solutions, website design and
      website hosting.





The
      Smart Online segment generates revenues from the development and distribution
      of
      internet-delivered SaaS small business applications through a variety of
      subscription, integration and syndication channels.





The
      Company includes costs such as corporate general and administrative expenses
      and
      share-based compensation expenses that are not allocated to specific segments
      in
      the Smart Online segment, which includes the parent or corporate
      segment.





No
      segment information is presented for the three months or nine months ended
      September 30, 2005 as these periods were pre-acquisition and Smart Online was
      operating in one segment.





The
      following table shows the Company's financial results by reportable segment
      for
      the three months ended September 30, 2006:





Smart
                Online
            
            Smart
                Commerce
            
            ConsolidatedREVENUES:Subscription
                Fees
            
            $
            14,717
            
            $
            414,709
            
            $
            429,426Professional
                Services Fees
            
            
            -
            
            
            242,177
            
            
            242,177Integration
                Fees
            
            
            6,250
            
            
            -
            
            
            6,250Syndication
                Fees
            
            
            57,352
            
            
            -
            
            
            57,352OEM
                Revenue
            
            
            9,000
            
            
            -
            
            
            9,000Other
                Revenues
            
            
            448
            
            
            4,553
            
            
            5,001Total
                Revenues
            
            
            87,767
            
            
            661,439
            
            
            749,206COST
                OF REVENUES
            
            
            16,879
            
            
            14,432
            
            
            31,311OPERATING
                EXPENSES
            
            
            1,338,773
            
            
            460,295
            
            
            1,799,068
                505OPERATING
                INCOME
            
            
            (1,267,885
            )
            
            186,712
            
            
            (1,081,173
            )OTHER
              INCOME
            
            
            1,510,708
            
            
            46
            
            
            1,510,754DISCONTINUED
                OPERATIONS
            
            
            (2,329,429
            )
            
            
            
            
            (2,329,429
            )NET
                INCOME/(LOSS) BEFORE INCOME TAXES
            
            $
            (2,086,606
            )
            $
            186,758
            
            $
            (1,899,848
            )TOTAL
                ASSETS
            
            $
            7,505,012
            
            $
            750,758
            
            $
            8,255,770








-11-








The
      following table shows the Company's financial results by reportable segment
      for
      the nine months ended September 30, 2006:




Smart
                Online
            
            Smart
                Commerce
            
            ConsolidatedREVENUES:Subscription
                Fees
            
            $
            54,453
            
            $
            1,421,741
            
            $
            1,476,194Professional
                Services Fees
            
            
            
            
            
            1,051,200
            
            
            1,051,200Integration
                Fees
            
            
            182,660
            
            
            -
            
            
            182,660Syndication
                Fees
            
            
            183,619
            
            
            -
            
            
            183,619OEM
                Revenue
            
            
            27,000
            
            
            -
            
            
            27,000Other
                Revenues
            
            
            1,261
            
            
            26,051
            
            
            27,312Total
                Revenues
            
            
            448,993
            
            
            2,498,992
            
            
            2,947,985COST
                OF REVENUES
            
            
            54,134
            
            
            158,381
            
            
            212,515OPERATING
                EXPENSES
            
            
            5,385,724
            
            
            1,404,878
            
            
            6,790,602OPERATING
                INCOME
            
            
            (4,990,865
            )
            
            935,733
            
            
            (4,055,132
            )OTHER
              INCOME (EXPENSE)
            
            
            3,078,050
            
            
            (24,501
            )
            
            3,053,549DISCONTINUED
                OPERATIONS
            
            
            (2,525,563
            )
            
            
            
            
            (2,525,563
            )NET
                INCOME/(LOSS) BEFORE INCOME TAXES
            
            $
            (4,438,378
            )
            $
            911,232
            
            $
            (3,527,146
            )TOTAL
                ASSETS
            
            $
            7,505,012
            
            $
            750,758
            
            $
            8,255,770





**6.**  **SEC
      MATTER AND INTERNAL INVESTIGATION**





On
      January 17, 2006, the SEC temporarily suspended the trading of the Company's
      securities. In its “Order of Suspension of Trading,” the SEC stated that the
      reason for the suspension was a lack of current and accurate information
      concerning Smart Online securities because of possible manipulative conduct
      occurring in the market for the its stock.  By its terms, that suspension
      ended on January 30, 2006 at 11:59 p.m. EST. As a result of the SEC's
      suspension, NASDAQ withdrew its acceptance of the Company's application to
      have
      its common stock traded on the NASDAQ Capital Market Simultaneously with the
      suspension, the SEC advised that it is conducting a non-public investigation.
      Smart Online has cooperated with the SEC, but it is unable to predict at this
      time whether the SEC will take any adverse action against it. In March 2006,
      Smart Online's Board of Directors authorized its Audit Committee to conduct
      an
      internal investigation of matters relating to the SEC suspension and
      investigation. The Audit Committee retained independent outside legal counsel
      to
      assist in conducting the investigation.





On
      July 7, 2006, the independent outside legal counsel conducting the internal
      investigation shared final findings with the Audit Committee, which were then
      shared with the full Board of Directors. The Audit Committee did not conclude
      that any of Smart Online's officers or directors engaged in fraudulent or
      criminal activity. However, it did conclude that the Company lacked an adequate
      control environment, and has taken action to address certain conduct of
      management that was revealed as a result of the investigation. A discussion
      of
      the significant deficiencies that were identified by the Audit Committee and
      related remediation efforts can be found in Item 9A of the Company's 2005 Annual
      Report.





-12-








**7** . **INTANGIBLE ASSETS**





Intangible
      assets consist primarily of intangibles acquired as part of the Computility
      and
      iMart acquisitions. In addition to these, Smart Online also has copyrights
      and
      trademarks related to certain products, names and logos used throughout its
      product lines. The assets acquired through the acquisitions include customer
      bases, technology, non-compete agreements, trade names, workforces in place,
      and
      goodwill. Trade names, work forces in place, and goodwill are not subject to
      amortization; and for the purpose of presentation, work forces in place are
      combined with goodwill.





**Asset
                Category**
            **Value
                Assigned**
            **Residual**
              **Value**
            **Weighted**
              **Avg
                Useful**
              **Life**
            **Accumulated**
              **Amortization**
              **At
                9/30/06**
            **Carrying**
              **Value**
              **At
                9/30/06**Customer
                Base
            $  
                 1,944,347
            $0
            6.2
            $
                321,624
            $    
                1,622,723Technology
            $  
                    501,264
            $0
            3
            $
                160,126
            $   
                    341,138Non-Compete
            $      
                891,785
            $0
            3.9
            $
                222,094
            $     
                  669,691Copyright
                & Trademark
            $        
                50,339
            $0
            10
            $  
                37,550
            $  
                       12,789Trade
                Name *
            $   
                1,155,500
            n/a
            n/a
            n/a
            $ 
                   1,155,500Work
                Force &
              Goodwill
                *
            $     2,696,642
            n/a
            n/a
            n/a
            $  
                  2,696,642**TOTALS**
            **$  
                7,239,877**
            
            
            **$
                741,394**
            **$  
                6,498,483**





*
      Trade Name and Work Force & Goodwill are not subject to amortization and are
      deemed to have an indefinite life in accordance with SFAS No.142, *Goodwill and Other Intangible Assets.*




The
      above
      table has been adjusted to reflect the sale of substantially all of the assets
      of Smart CRM. The following assets and related accumulated amortization, if
      applicable, were removed:





**Asset
                Category**
            
            **ValueAssigned**
            
            **Accumulated
                Amortization**
            
            **CarryingValue**Customer
                Base
            
            $
            560,642
            
            $
            112,128
            
            $
            448,514Technology
            
            
            748,578
            
            
            249,526
            
            
            499,052Trade
                Name
            
            
            25,000
            
            
            -
            
            
            25,000Goodwill
            
            
            2,793,321
            
            
            -
            
            
            2,793,321TOTALS
            
            $
            4,127,541
            
            $
            361,654
            
            $
            3,765,887





Goodwill
      was calculated as the difference between the purchase price and the value of
      the
      identifiable tangible and intangible assets acquired. Trademarks and copyrights
      were capitalized using the costs of all legal and application fees
      incurred.





As
      adjusted for the sale of substantially all of Smart CRM’s assets, for the three
      months ended September 30, 2006 and September 30, 2005, the aggregate
      amortization expense on the above intangibles was $274,778 and $1,079,
      respectively. As adjusted for the sale of substantially all of Smart CRM’s
      assets , for the nine months ended September 30, 2006 and September 30, 2005,
      the aggregate amortization expense on the above intangibles was $812,586 and
      $3,237, respectively.





**8.**  **STOCKHOLDERS'
      EQUITY**




***Common
      Stock and Warrants***




On
      July 6, 2006, the Company sold 100,000 shares of our common stock to the
      Blueline Fund (“Blueline”), an existing investor for a price of $2.50 per share
      resulting in gross proceeds of $250,000. The Company incurred immaterial
      issuance costs related to this stock sale.





In
      August 2006, the Company sold an aggregate of 100,000 shares of its common
      stock
      to Blueline and Phillippe Pouponnot, for a price of $2.50 per share, resulting
      in gross proceeds of $250,000. The Company incurred immaterial issuance costs
      related to these stock sales.





On
      August 30, 2006, Smart Online entered into a “Settlement Agreement” with Berkley
      Financial Services, Ltd. (“Berkley”) with respect to a ”Consulting Agreement,”
dated October 26, 2005. Under the Consulting Agreement, Berkley was to receive
      625,000 shares of Smart Online's common stock (the “Shares”) and a cash payment
      of $250,000 (the “Cash Fee”) for investor relations consulting services. The
      Company paid the entire Cash Fee, and the Shares were issued to Berkley, but
      were never delivered. Under the Settlement Agreement, Berkley agreed, in part,
      to release its claim to the Shares, but retained the Cash Fee as consideration
      for services performed under the Consulting Agreement and for entering into
      the
      Settlement Agreement. Smart Online recorded a gain of $1,562,500 during the
      third quarter of 2006 related to this settlement. The terms of this Settlement
      Agreement are more fully set forth in the Company's Current Report on Form
      8-K
      filed on August 30, 2006, and that form is hereby incorporated by reference
      herein.





-13-








***Stock
      Option Plans***




The
      Company maintains three equity compensation plans, only one of which (the Smart
      Online, Inc. 2004 Equity Compensation Plan) is currently active.





The
      following is a summary of the status of these plans and stock option
      activity:





**Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**BALANCE,
                June 30, 2005
            
            
            2,580,600
            
            $
            5.58Forfeited
            
            
            (152,500
            )
            $
            8.50Granted
            
            
            0
            
            $
            0BALANCE,
                September 30, 2006
            
            
            2,428,100
            
            $
            5.39





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





**Currently
                Exercisable****Exercise**
              **Price**
            **Number
                of**
              **Shares**
              **Outstanding**
            **Average**
              **Remaining**
              **Contractual
                Life**
              **(Years)**
            **Number
                of**
              **Shares**
            **Weighted**
              **Average**
              **Exercise**
              **Price**From
                $1.30 to $1.43
            595,000
            2.3
            595,000
            $
                1.41From
                $2.50 to $3.50
            512,500
            8.0
            314,165
            $
                3.49$5.00
            252,400
            4.6
            110,400
            $
                5.00$7.00
            155,000
            9.0
            53,000
            $
                7.00From
                $8.20 to $8.61
            510,500
            8.8
            88,900
            $
                8.61From
                $9.00 to $9.82
            402,700
            4.4
            110,240
            $
                9.82





***Dividends***





Smart
      Online has not paid any cash dividends through September 30, 2006.











-14-





**9.**  **MAJOR
      CUSTOMERS AND CONCENTRATION OF CREDIT RISK**





Smart
      Online derives a significant portion of its revenues from certain customer
      relationships. The following is a summary of customers that represent greater
      than ten percent of the Company's total revenues from continuing
      operations:





3
                Months Ended September 30, 2006Revenues
            
            %
                of Total
              RevenuesCustomer
                E
            
            
            Professional
                Services
            
            
            185,935
            
            
            25
            %Customer
                F
            
            
            Subscription
            
            
            352,553
            
            
            47
            %Others
            
            
            Various
            
            
            210,718
            
            
            28
            %Total
            
            
            
            
            $
            749,206
            
            
            100
            %




3
                Months Ended September 30, 2005Revenues
            
            %
                of Total
              RevenuesCustomer
                A
            
            
            Integration
            
            
            85,000
            
            
            25
            %Customer
                B
            
            
            Integration
            
            
            50,000
            
            
            15
            %Customer
                C
            
            
            Syndication/Barter
            
            
            46,250
            
            
            13
            %Others
            
            
            Various
            
            
            163,442
            
            
            47
            %Total
            
            
            
            
            $
            344,692
            
            
            100
            %





9
                Months Ended September 30, 2006Revenues
            
            %
                of Total
              RevenuesCustomer
                E
            
            
            Professional
                Services
            
            $
            848,217
            
            
            29
            %Customer
                F
            
            
            Subscription
            
            
            1,365,826
            
            
            46
            %Others
            
            
            Various
            
            
            733,942
            
            
            25
            %Total
            
            
            
            
            $
            2,947,985
            
            
            100
            %




9
                Months Ended September 30, 2005Revenues
            
            %
                of Total
              RevenuesCustomer
                A
            
            
            Integration
            
            
            136,183
            
            
            14
            %Customer
                B
            
            
            Integration
            
            
            125,000
            
            
            12
            %Customer
                C
            
            
            Syndication/Barter
            
            
            127,188
            
            
            13
            %Customer
                D
            
            
            Integration/Barter
            
            
            123,750
            
            
            12
            %Others
            
            
            Various
            
            
            491,925
            
            
            49
            %Total
            
            
            
            
            $
            1,004,046
            
            
            100
            %





The
      Company had three customers that accounted for 50%, 29% and 11% of net
      receivables at September 30, 2006. The customer that accounted for approximately
      $75,000, or 29%, of net receivables at September 30, 2006 underwent a
      restructuring in the first quarter of 2006. This restructuring has resulted
      in a
      decrease in revenue of approximately 30% from this customer for June through
      September of 2006. However, future revenues from this customer may vary
      significantly, and the Company can offer no assurances that future revenues
      from this customer will not decrease materially. The Company had three customers
      that accounted for 25%, 22% and 10% of receivables at December 31,
      2005.








-15-





**10.**  **COMMITMENTS
      AND CONTINGENCIES**





On
      August 30, 2002, the Company entered into a reseller agreement with Smart IL
      Ltd., formerly known as Smart Revenue Europe Ltd. (“SIL”), an Israel based
      software company that specialized in secured instant messaging products, whereby
      SIL paid it $200,000 for nonexclusive rights to distribute Smart Online products
      in certain foreign territories in exchange for Smart Online's marketing support
      and a twenty percent (20%) commission from the gross sales generated by SIL.
      Under the terms of this agreement, the Company is to collect the revenue, if
      any, from SIL's customers and then make the required payments to SIL. On May
      1,
      2003, this reseller agreement was terminated. However, under the terms of that
      termination agreement, certain payment obligations to SIL survive termination
      with regard to a limited number of prospective business candidates. Under the
      integration agreement with SIL, dated April 2003, the Company would be required
      to issue Doron Roethler 80,000 shares of its common stock if the Company
      integrates certain third party products into the Company's own, and, pursuant
      to
      a revenue sharing arrangement, it may be required to pay SIL a portion of its
      revenue from the sales of SIL's products and services.





During
      August 2005, Smart Online acquired rights to an accounting software engine
      from
      a software development company and co-developed its accounting software
      application with that developer. The Company has exclusive rights to the
      accounting application, and non-exclusive rights to the software engine included
      in the application. In connection with this agreement, the Company agreed to
      pay
      the developer up to $512,500 and issue up to $287,500 worth of its common stock
      based upon the developer attaining certain milestones. As of June 30, 2006
      the
      developer had earned and been paid $255,000 ($225,000 in cash and $30,000 of
      Smart Online common stock). Although this product was integrated into the
      OneBiz SM application suite in December 2005, the Company did not accept the software
      application as completed under this agreement because, in management's judgment
      and based on feedback received from both customers and an accounting consultant,
      certain modifications and features were needed to improve the usability of
      the
      accounting application. As a result, Smart Online is continuing to work with
      the
      software development company to complete and improve the accounting application.
      Smart Online has deposited $37,500 into escrow, which was originally to be
      released to the software development company upon acceptance of the accounting
      application, with the remaining money and stock to be partially payable at
      acceptance, up to 100 days after acceptance and up to 190 days after
      acceptance.





The
      Company entered into a letter agreement, effective June 29, 2006, with its
      former independent certified public accountants, BDO Seidman, LLP ("BDO").
      Under
      the terms of the letter agreement, Smart Online agreed to pay BDO a total of
      $120,000 in twelve (12) equal monthly installments beginning June 30, 2006.
      These payments are being made in settlement of $246,855 that BDO claims is
      owed
      by Smart Online in connection with audit services performed by BDO under a
      letter agreement between BDO and Smart Online, dated May 27, 2004. As a result
      of this agreement, Smart Online recorded a gain of $96,855 during June
      2006.








**11.**  **SUBSEQUENT
      EVENTS**





On
      October 2, 2006, the Company entered into amendments to certain registration
      rights agreements with certain existing investors. The registration rights
      agreements were entered into in connection with certain private placements
      that
      took place during 2005 and 2006. Under the original registration rights
      agreements, the investors have been accruing a late registration penalty based
      on a formula using the time between the target registration date, which has
      passed, and the actual registration date, which has not yet
      occurred.





Under
      the terms of the amendments, these existing investors will receive a
      predetermined payment as Smart Online has not registered the subject shares.
      At
      Smart Online's sole discretion, this amount may be paid in shares of Smart
      Online common stock instead of cash. The number of such shares is determined
      by
      dividing the penalty amount by the purchase price of the shares under the
      applicable subscription agreement.





-16-








Smart
      Online is unable to predict at this time when the actual registration date
      will
      be relating to these registration rights agreements. As of September 30, 2006,
      the aggregate penalty amount due under the prior registration rights agreement
      would have been $129,226 to those investors who amended their registration
      rights agreement on October 2, 2006. If Smart Online had not settled the
      registration penalties with these existing investors, the aggregate penalty
      amount would have continued to accrue penalties until a registration agreement
      was filed by Smart Online. Smart Online settled for an aggregate amount of
      $93,728 with these investors. Following the execution of these agreements,
      no
      further penalties will accrue for those existing stockholders that entered
      into
      the amendment. For each existing stockholder that enters into the amendment,
      the
      penalty amount will be less than it would have been were the amendment not
      executed.





Approximately
      three and a half years ago, the Company petitioned (as is required under French
      law) a court in France to allow us to liquidate Smart Online S.A., a French
      subsidiary of Smart Online. As a result, we paid $113,056.83 to Smart Online
      S.A. in settlement of all claims against us. Michael Nouri, the Company’s
      President and CEO and the former President and CEO of Smart Online S.A., was
      subsequently sued personally as the legal representative of Smart Online S.A.
      The Liquidateur for Smart Online, S.A. has agreed to a proposal for settlement
      offered by Mr. Nouri in the amount of $15,000 Euros (US $19,200 based on an
      exchange rate of approximately US $1.28 per Euro). On October 19, 2006, the
      court officially recorded the withdrawal of the claims asserted by the
      Liquidateur. The Company’s Board of Directors has authorized it to indemnify Mr.
      Nouri for the amount of any settlement and all legal costs and fees and other
      expenses associated with the defense of Mr. Nouri in relation to this matter,
      because Mr. Nouri was acting on the Company’s behalf in the liquidation of its
      French subsidiary.





As
      described above under Note 10, the Company entered into an agreement for the
      co-development of its accounting application with a software development
      company. The Company and the software development company are continuing to
      work
      on the modifications and features necessary to address the feedback received
      from both customers and an accounting consultant. The payment schedule described
      above was recently amended so that the $37,500 from escrow would be released not
      upon acceptance of the accounting application, but in good faith as a
      consequence of the continued work by the software development company on this
      project. The remaining money would still be partially paid at acceptance, up
      to
      100 days after acceptance and up to 190 days after acceptance.




On
      November 9, 2006, Smart Commerce entered into a loan agreement with Fifth Third
      Bank of Southfield, Michigan. Under the terms of this agreement, Smart Commerce
      borrowed $1.8 million to be paid back in twenty-four (24) monthly installments
      of $75,000 plus interest beginning in December, 2006. The interest rate is
      prime
      plus 1.5% as periodically determined by Fifth Third Bank.  Currently and at
      closing, the prime rate was 8.25%.  The loan is secured by all of the
      assets of Smart Commerce, including a security account of $250,000 with Fifth
      Third and all of Smart Commerce’s intellectual property. The loan is guaranteed
      by the Company and such guaranty is secured by all the common stock of Smart
      Commerce. Under the terms of the loan agreement, Smart Commerce is to establish
      a lock box account with Fifth Third, but has the right to use the amounts
      deposited therein for any purpose not inconsistent with the loan agreement
      and
      related documents so long as no event of default exists and is continuing.
      Further, the amount in the security account will be released in three (3)
      installments of approximately $83,000 if on June 30, 2007, December 31, 2007,
      and June 30, 2008 Smart Commerce meets certain revenue goals.





On
      November 8, 2006, the Company entered into an amendment to the “Lock Box
      Agreement,” dated October 17, 2005, such amendment by and between Smart Online,
      Smart Commerce, and certain former shareholders of iMart Incorporated (the
      “Sellers”). Under the terms of the original agreement, cash collected by Smart
      Commerce was deposited into a lockbox account and restricted so that cash could
      only be used for the following puroses, in the order of priority
      presented:  (1) to fund the operating expenses of Smart Commerce, (2) to
      fund purchase price installment payments, and (3) to fund non-compete
      installment payments.  Only after all these funding requirements were met
      was the Company permitted to use excess cash for general operating
      purposes.  Under the terms of this Amendment, Smart Online is to pay the
      Sellers $1,329,518
      upon the deposit of a certain amount into the lock box account, approximately
      $700,000 on January 1, 2007, and approximately $300,000 on or before February
      4,
      2007. The payments are made in satisfaction of certain installment and
      noncompetition payments owed the Sellers under the “Stock Purchase
      Agreement,”
      dated October 17, 2005, by and between the same parties and as described in
      further detail elsewhere in this document. In exchange, the Sellers released
      their security interest in the proceeds of Smart Commerce, agreed to allow
      funds
      in the Sellers’ lock box account to be swept into an account with Fifth Third,
      and agreed to the future closure of the Sellers’ lock box account in connection
      with the establishment of a lock box account with Fifth Third.





-17-











On
      November 14, 2006, Smart Online entered into a revolving credit arrangement
      with
      Wachovia Bank, NA (“Wachovia”). The line of credit advanced by Wachovia is $1.3
      million, and can be used for general working capital. Any advances made on
      the line of credit must be paid off no later than August 1, 2007, with monthly
      payments of accrued interest only commencing on December 1, 2006 on any
      outstanding balance. The interest shall accrue on the unpaid principal
      balance at  LIBOR Market Index Rate plus 0.9%.  The line of
      credit is secured by Smart Online’s deposit
      account
      at Wachovia and an irrevocable standby letter of credit in the amount of
      $1,300,000 issued by HSBC Private Bank (Suisse) S.A. with Atlas Capital, S.A.,
      a
      current stockholder of Smart Online, as account party.  Atlas and the
      Company have separately agreed that in the event of a default by Smart Online
      in
      the repayment of the line of credit that results in the letter of credit being
      drawn, Smart Online shall reimburse Atlas any sums that Atlas is
      required to pay under such letter of credit. At the sole discretion of
      Smart Online, these payments may be made in cash or by issuing shares of the
      Company’s Common Stock at a set per share price of $2.50.

















-18-





**Item
      2.** **MANAGEMENT’SDISCUSSION
      AND ANALYSIS OF FINANCIAL CONDITION AND
      RESULTS OF OPERATIONS**





*The
      following discussion in Management's Discussion and Analysis of Financial
      Condition as Results of Operations and elsewhere in this report contains
      forward-looking statements within the meaning of Section 27A of the Securities
      Act of 1933 and Section 12E of the Securities Exchange Act of 1934 (the
“Exchange Act”). Forward-looking statements consist of, among other things,
      trend analyses, statements regarding future events, future financial
      performance, our plan to build our business and the related expenses, our
      anticipated growth, trends in our business, the effect of foreign currency
      exchange rate and interest rate fluctuations on our business, the potential
      impact of current litigation or any future litigation, the potential
      availability of tax assets in the future and related matters, and the
      sufficiency of our capital resources, all of which are based on current
      expectations, estimates, and forecasts, and the beliefs and assumptions of
      our
      management. Words such as “expects,” “anticipates,” “projects,” “intends,”
“plans,” “estimates,” variations of such words, and similar expressions are also
      intended to identify such forward-looking statements. These forward-looking
      statements are subject to risks, uncertainties and assumptions that are
      difficult to predict. Therefore, actual results may differ materially and
      adversely from those expressed in any forward-looking statements. Readers are
      directed to risks and uncertainties identified below, under “Risk Factors” and
      elsewhere in this report, for factors that may cause actual results to be
      different than those expressed in these forward-looking statements. Except
      as
      required by law, we undertake no obligation to revise or update publicly any
      forward-looking statements for any reason.*





**Overview**








We
      develop and market Internet-delivered Software-as-a-Service (“SaaS”) on-demand
      software applications and data resources for small businesses. We reach small
      businesses through syndication arrangements with other companies that
      private-label our software applications through their corporate websites, and
      through our own website, www.smartonline.com. Our syndication relationships
      provide a cost and time efficient way to market our products and services to
      the
      small business sector.





Except
      as noted below, all financial information for periods prior to our acquisition
      of Computility, Inc. (“Computility”) and iMart Incorporated (“iMart”) contained
      in this section refer to the financial performance of Smart Online, Inc. (“Smart
      Online”) only, and does not include the financial performance of either
      Computility or iMart before the acquisitions occurred in October 2005.





Unless
      otherwise specified, all amounts and discussions below pertain to the results
      of
      continuing operations only. The amounts of the discontinued segment, Smart
      CRM,
      Inc. (d/b/a Computility (“Smart CRM”),
      are not
      included in the figures and discussions below unless specifically
      mentioned.





**Sources
      of Revenue**





We
      currently derive revenues from continuing operations from the following
      sources:




·
            *Subscription
                Fees*- Subscription fees are monthly fees charged to customers for access
                to
                our suite of applications, including those applications acquired
                in or
                developed as a result of the iMart and Computility acquisitions.
                These are
                comprised of sales of subscriptions directly to end-users, or to
                others
                for distribution to end-users; hosting and maintenance fees; and
                e-Commerce website design fees. Subscription sales are made either
                on a
                subscription or on a “for fee” basis. End-user subscriptions, which
                include access to most of our offerings, are payable in advance on
                a
                monthly basis and are targeted at small companies. We continue to
                work to
                on leveraging existing and new syndication partners and believe we
                will
                need to continue to invest more time and money on marketing and sales
                efforts before significant revenue is generated. We currently have
                in
                place a policy where we provide new users a limited free use period
                of up
                to 14-days, after which we terminate access for users who fail to
                become
                paid subscribers. Our agreements with our syndication partners call
                for us
                to share subscription fees generated on each respective syndication
                website with the partner. We began to offer our suite of
                OneBizSMsoftware applications on November 4, 2005 on our own website, and
                we have
                migrated the syndication site of two of our partners to
                OneBizSM. We are continuing to work with our other partners in order to determine
                which applications and services our partners want migrated to their
                syndication websites. In May 2006, we released a simplified version
                of our
                SFA/CRM application as part of the subscription to our suite of
                applications available on our core website. We have determined that
                any
                integration of parts of our new e-Commerce software applications
                into our
                application suite will be performed when a demand for such integration
                arises. Until then, these applications will be offered only on a
                subscription basis through Smart Commerce, Inc. (d/b/a iMart) (“Smart
                Commerce”). These and other “for fee” services allow customers to purchase
                one-time use of a specific software or content service.








-19-








Subscription
      fees through our syndication partners remain the primary focus of our revenue
      growth strategy. Additional time is required to leverage these relationships.
      The total number of subscribers to our services both through our main portal
      and
      the websites of our syndication partners has decreased from the number of
      subscribers we had in January 2006. Subscription fees represented $429,426
      or
      57% of our total revenues for the third quarter of 2006, as compared to $21,461
      or 7% of our total revenues for the third quarter of 2005. Subscription fees
      represented $1,476,194 or 50% of our total revenues for the first nine months
      of
      2006, as compared to $62,350 or 6% of our total revenues for the first nine
      months of 2005. We had one customer that accounted for approximately $352,553
      or
      47% of total revenues from continuing operations during the third quarter 2006.
      In the first quarter of 2006, we learned that this customer underwent a
      restructuring. This restructuring has resulted in a decrease of revenue of
      approximately 30% from this customer through September of 2006. However, future
      revenues from this customer may vary significantly, and we can offer no
      assurances that future revenues from this customer will not decrease
      materially.





·
            *Professional
                Services Fees*- Professional services fees are fees charged to customers for consulting
                services and services rendered and charged for on an hourly or contractual
                basis. Professional services fees are currently generated exclusively
                by
                Smart Commerce through services such as website design and IT consulting
                services. Professional services fees represented $242,177 or 32%
                of our
                total revenues for the third quarter of 2006, as compared to $0 for
                the
                third quarter of 2005. Professional services fees represented $1,051,200
                or 36% of our total revenues for the first nine months of 2006, as
                compared to $0 for the first nine months of
                2005.





·
            *Integration
                Fees*- Integration fees are fees charged to partners to integrate their
                products into our syndication platform. Integrating third-party content
                and products has been a key component of our strategy to continuously
                expand and enhance the platform offered to syndication partners and
                our
                own customer base. Integration fees represented $6,250 or 1% of our
                total
                revenues for the third quarter of 2006, as compared to $203,542 or
                59% of
                our total revenues for the third quarter of 2005. Integration fees
                represented $182,660 or 6% of our total revenues for the first nine
                months
                of 2006, as compared to $585,262 or 58% of our total revenues for
                the
                first nine months of 2005. Unless we sign new agreements with partners
                for
                integration services, these fees will be reduced although we will
                continue
                to recognize deferred revenue from our current integration
                partners.








-20-








·
            *Syndication
                Fees*- Syndication fees consist of (a) fees charged to syndication
                partners to create a customized private-label site and (b) barter
                revenue
                derived from syndication agreements with media
                companies.





Our
      syndication agreements also provide that we receive a percentage of the revenue
      generated by our partners from their websites, which are classified as
      subscription fees. We receive revenue from one of these revenue sharing
      agreements. These agreements also include bartering arrangements for advertising
      and joint marketing programs to take advantage of discounted advertising rates
      and to provide an opportunity for revenue sharing. While we intend to derive
      a
      majority of our syndication fees from traditional non-barter transactions,
      we
      will evaluate barter transactions on a case-by-case basis.





Syndication
      fees represented $57,352 or 8% of our total revenues for the third quarter
      of
      2006, as compared to $103,602 or 30% of our total revenues for the third quarter
      of 2005. Syndication fees represented $183,619 or 6% of our total revenues
      for
      the first nine months of 2006, as compared to $299,244 or 30% of our total
      revenues for the first nine months of 2005. As our focus shifts to increasing
      our subscription fees, we anticipate continued decreases in syndication
      fees.





-21-








·
            *OEM
                Revenue*- OEM revenue consists of royalties paid for a license to distribute
                some
                of our software products. OEM revenue is recorded based on the greater
                of
                actual sales or contractual minimum guaranteed royalty payments.
                We record
                the minimum guaranteed royalties monthly and receive payment of the
                royalties on a quarterly basis, thirty days in arrears. To the extent
                actual royalties exceed the minimum guaranteed royalties, the excess
                is
                recorded in the quarter we receive notification of such additional
                royalties.





OEM
      revenue represented $9,000 or 1% of our total revenues for the third quarter
      of
      2006, as compared to $12,000 or 3% of our total revenues for the third quarter
      of 2005. OEM revenue represented $27,000 or 1% of our total revenues for the
      first nine months of 2006, as compared to $36,000 or 4% of our total revenues
      for the first nine months of 2005.





·
            *Other
                Revenues*-
                Other revenues consist primarily of sales of shrinkwrapped products
                and
                other immaterial revenues that do not fall into any other
                category.





Both
      syndication and integration fees are recognized on a monthly basis over the
      life
      of the contract, although a significant portion of integration fees is received
      upfront. Our contracts are typically non-cancelable, though customers usually
      have the right to terminate their contracts for cause if we fail to perform.
      We
      generally invoice our paying customers in annual or monthly installments, and
      typical payment terms provide that our customers pay us within 30 days of
      invoice. Amounts that have been invoiced are recorded as accounts
      receivable and in deferred revenue or revenue, depending on whether applicable
      revenue recognition criteria have been met. In general, we collect our billings
      in advance of the service period. Online marketing, which consists of marketing
      services provided to our integration and syndication partners, in the past
      generated additional revenue. In addition, certain users have requested that
      we
      implement online marketing initiatives for them, such as promoting their
      products through Google or Overture Services. Online marketing has not been
      a
      material source of past revenue. We intend to seek an increase in the level
      of
      online marketing services in the future, but have not initiated any efforts
      to
      do so as we focus on other aspects of our business plan. We have not signed
      a
      new significant strategic partner relationship for the applications we sell
      via
      our OneBiz SM platform since the beginning of the second quarter of 2005. We plan to enter
      into new integration and syndication agreements that are advantageous to
      improving our business and increasing our subscription fees.





Additionally,
      we receive a portion of third-party sales of products and services by our
      integration partners through revenue sharing arrangements, which involve a
      split
      of realized revenues. Hosting and maintenance fees are charged for supporting
      and maintaining the private-label portal and providing customer and technical
      support directly to our syndication partners' users and are recognized on a
      monthly basis. E-Commerce website design fees, which are charged for building
      and maintaining corporate websites or to add the capability for e-Commerce
      transactions, are recognized over the life of the project. Domain name
      registration fees are recognized over the term of the registration
      period.





For
      additional information, please refer to the “Revenues” section of the “Overview
      of Results of Operations for the Quarters Ended September 30, 2006 and September
      30, 2005,” below.





**Cost
      of Revenues**





Cost
      of revenues is comprised primarily of salaries associated with maintaining
      and
      supporting integration and syndication partners and the cost of an external
      hosting facility associated with maintaining and supporting integration and
      syndication partners. Additionally, during 2005, a portion of cost of revenues
      included third-party fees. Historically, we do not capitalize any costs
      associated with the development of our products and platform. Statement of
      Financial Accounting Standards (“SFAS”) No. 86, *Accounting for the Costs of Software to be Sold, Leased or Otherwise
      Marketed* ,
      requires capitalization of certain software development costs subsequent to
      the
      establishment of technological feasibility. Based on our product development
      process, technological feasibility is established upon completion of a working
      model. Costs related to software development incurred between completion of
      the
      working model and the point at which the product is ready for general release
      have been insignificant.





-22-








**Operating
      Expenses**





Our
      operating expenses include expenses for research and development, sales and
      marketing, and general and administrative costs.





*Research
      and Development* .
      Research and development expenses consist primarily of salaries for our
      development team. We have historically focused our research and development
      activities on increasing the functionality and enhancing the ease of use of
      our
      on-demand application service. For example, we are continuing to resolve issues
      with our accounting application and enhancing and improving the usability of
      our
      other applications, while adding functionality to our OneBiz SM suite of applications. Because of our multi-tenant architecture, we are
      able to provide all customers with a service based on a single version of our
      application. As a result, we do not have to maintain multiple versions, which
      enables us to have relatively low research and development expenses as compared
      to traditional enterprise software business models. We expect that in the
      future, research and development expenses will increase in absolute dollars
      as
      we upgrade and extend our service offerings and develop new technologies. 
In 2006, we integrated a simplified version of the SFA/CRM application we
      acquired from a recent acquisition into our application suite; may integrate
      the
      e-Commerce applications we acquired in our other recent acquisition if a demand
      for such integration arises; and in August, we hired additional development
      personnel.





*Sales
      and Marketing* .
      Sales and marketing expenses consist primarily of salaries for sales and
      marketing staff. We expect these expenditures to increase significantly in
      the
      future, assuming we are successful in entering new financing agreements, as
      we
      launch and begin marketing our latest version of the applications. Following
      the sale of substantially all the assets of a subsidiary, we are also evaluating
      whether we will move our sales team from our headquarters in North Carolina
      to
      Iowa. We
      have embarked on an effort to target larger companies which have small business
      customer bases. The strategy is to implement private label syndication platforms
      for these companies in order to gain access to their small business customer
      bases. We expect to create certain types of these arrangements in the future
      with companies who offer the ability to reach small business customers. Such
      arrangements may assist in off-setting our outlay of cash for print and online
      advertising and marketing while providing reduced advertising
      prices.





Generally,
      we expect we will have to increase sales and marketing expenses before we can
      substantially increase our revenue from sales of subscriptions. We plan to
      increase penetration within our existing private-label customer base, expand
      our
      domestic selling and marketing activities, build brand awareness and participate
      in additional marketing programs. We have not been able to do so because we
      have
      not had sufficient capital in order to implement our plans. If we are able
      to
      enter additional financing arrangements, we expect that in the future, marketing
      and sales expenses will increase in absolute dollars. However, we anticipate
      that entering such arrangements will be difficult, and we can offer no
      assurances that we will be successful in our efforts to do so.





*General
      and Administrative* .
      General and administrative expenses consist primarily of salaries and related
      expenses for executives, finance and accounting, human resources, professional
      fees, and other corporate expenses, including facilities costs. We expect that
      in the future, general and administrative expenses will increase as we add
      administrative and finance personnel and incur additional professional fees
      and
      insurance costs related to the growth of our business and to our operations
      as a
      public company. Non-recurring general and administrative expenses may also
      be
      significant as a result of legal fees related to the SEC's suspension of trading
      of our securities and the continuing SEC matter. We expect to incur increased
      and significant costs in upcoming periods related to our compliance with Section
      404 of the Sarbanes-Oxley Act of 2002, and the implementation of changes made
      in
      our internal controls and procedures as detailed in Item 9A of our Annual Report
      on Form 10-K for the year ended December 31, 2005, filed with the Securities
      and
      Exchange Commission (the “SEC”) on July 11, 2006 (the “2005 Annual
      Report”).





-23-








As
      of January 1, 2006, our operating expenses include stock-based expenses related
      to options and warrants issued to employees and non-employees. These charges
      have been significant and are reflected in our historical financial results
      for
      the first and second quarters of 2006. Effective January 1, 2006, we adopted
      SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS No. 123R”), using the modified-prospective-transition method. We will
      continue to use the Black-Scholes-Merton fair value pricing method that we
      previously used for our pro forma disclosures prior to January 1, 2006. For
      periods prior to January 1, 2006, we accounted for our stock-based compensation
      plans in accordance with the intrinsic value provisions of Accounting Principles
      Board Opinion No. 25, *Accounting for Stock Issued to Employees* (“APB No. 25”). Under APB No. 25, we were not required to record compensation
      expense for options granted with exercise prices equal to the fair market value
      of our common stock on the date of the grant. Accordingly, we did not record
      any
      compensation expense in the accompanying financial statements for the three
      months or nine months ended September 30, 2005 for our stock-based compensation
      plans.





**Factoring
      Agreements**





During
      the first nine months of 2006 through Smart CRM, we entered into multiple
      factoring agreements. These factoring arrangements resulted in gross aggregate
      proceeds of approximately $798,792 to Smart CRM. Although Smart Online was
      able
      to utilize all of these proceeds for our operations, the corresponding liability
      was assumed by the purchasor of the assets of Smart CRM. (see Note 3 to the
      Financial Statements, “Sale of Substantially All the Assets of Smart CRM,” for
      further discussion).  This cash resource is no longer available following
      the sale of substantially all of the assets of Smart CRM.





**Critical
      Accounting Policies and Estimates**





Our
      discussion and analysis of financial condition and results of operations are
      based upon our consolidated financial statements, which have been prepared
      in
      accordance with accounting principles generally accepted in the United States.
      The preparation of these financial statements requires us to make estimates
      and
      judgments that affect the reported amounts of assets, liabilities, revenues
      and
      expenses, and related disclosures of contingent assets and liabilities.
“Critical accounting policies and estimates” are defined as those most important
      to the financial statement presentation and that require the most difficult,
      subjective, or complex judgments. We base our estimates on historical experience
      and on various other factors that we believe to be reasonable under the
      circumstances, the results of which form the basis for making judgments about
      the carrying value of assets and liabilities that are not readily apparent
      from
      other sources. Under different assumptions and/or conditions, actual results
      of
      operations may materially differ. We periodically re-evaluate our critical
      accounting policies and estimates, including those related to revenue
      recognition, provision for doubtful accounts and sales returns, expected lives
      of customer relationships, useful lives of intangible assets and property and
      equipment, provision for income taxes, valuation of deferred tax assets and
      liabilities, and contingencies and litigation reserves. Management has
      consistently applied the same critical accounting policies and estimates which
      are fully described in our 2005 Annual Report, which is hereby incorporated
      by
      reference.





**Overview
      of Results of Operations for the Quarters Ended September 30, 2006 and September
      30, 2005**





The
      following table shows our consolidated statements of operations data expressed
      as a percentage of revenues from our continuing operations for the periods
      indicated:









-24-








**Three
                Months**
              **Ended**
              **September
                30,2006**
            
            **Three
                Months**
              **Ended**
              **September
                30,2005**REVENUES:Subscription
                Fees
            
            
            57
            %
            
            7
            %Professional
                Services Fees
            
            
            32
            %
            
            0
            %Integration
                Fees
            
            
            1
            %
            
            59
            %Syndication
                Fees
            
            
            8
            %
            
            30
            %OEM
                Revenue
            
            
            1
            %
            
            3
            %Other
                Revenues
            
            
            1
            %
            
            1
            %Total
                Revenues
            
            
            100
            %
            
            100
            %COST
                OF REVENUES
            
            
            4
            %
            
            7
            %GROSS
                PROFIT
            
            
            96
            %
            
            93
            %OPERATING
                EXPENSES:General
                and Administrative
            
            
            161
            %
            
            511
            %Sales
                and Marketing
            
            
            18
            %
            
            109
            %Research
                and Development
            
            
            61
            %
            
            108
            %Total
                Operating Expenses
            
            
            240
            %
            
            728
            %LOSS
                FROM CONTINUING OPERATIONS
            
            
            (144
            %)
            
            (635
            %)OTHER
                INCOME (EXPENSE):Interest
                Income (Expense), Net
            
            
            (7
            %)
            
            2
            %Takeback
                of Investor Relations Shares
            
            
            209
            %
            
            0
            %Total
                Other Income (Expense)
            
            
            202
            %
            
            2
            %





**Revenues**





Total
      revenues were $749,206 for the third quarter of 2006 compared to $344,692 for
      the third quarter of 2005, representing an increase of $404,514 or 117%. This
      increase is primarily attributable to revenue from our newly acquired
      subsidiary, Smart Commerce, in the amount of $661,439. The revenue generated
      by
      this subsidiary is generally composed of subscription fees and professional
      services fees related to domain name subscriptions. There was no comparable
      revenue generated by this subsidiary for the third quarter of 2005 as that
      was a pre-acquisition period. This increase was partially offset by the
      decreases in integration fees of $197,292 and syndication fees of $46,250 fees
      discussed below. An underlying factor in Smart Online’s decrease in
      revenues was our inability to increase revenue through the signing of new
      contracts. Through almost the entire third quarter, we have been distracted
      by
      and focused on the SEC matter and the internal investigation and matters related
      thereto. Also, potential new customers have been delaying contract negotiations
      until they can be more assured of our ability to continue operations. In the
      period immediately following the end of the third quarter of 2006, we have
      been
      able to make progress in redirecting our focus to sales and revenue. However,
      we
      can offer no assurance that the redirection of our focus will result
      in substantial new business relationships.








-25-





Subscription
      fees increased to $429,426 for the third quarter of 2006 from $21,461 for the
      third quarter of 2005. This increase was primarily due to $414,709 in
      subscription fees from Smart Commerce. This increase was offset by a decrease
      of
      $6,744 in subscription fees for Smart Online.





Professional
      services fees increased to $242,177 for the third quarter of 2006 from $0 for
      the third quarter of 2005. This increase was due to $242,177 of professional
      services fees generated by Smart Commerce.





Integration
      fees decreased 97% to $6,250 for the third quarter of 2006 as compared to
      $203,542 for the same period in 2005. This decrease is primarily due to the
      reduction of the number of active integration partners with deferred revenue
      to
      one (1) in the third quarter of 2006 from six (6) in the third quarter of 2005.
      The 2006 and 2005 periods also included $0 and $5,000 of revenue derived from
      barter transactions, respectively. As integration fees are recognized over
      the
      terms of the agreements, revenue recognition is based upon the terms and timing
      of the agreements and does not reflect actual cash flow.





Syndication
      fees decreased 45% to $57,352 for the third quarter of 2006 as compared to
      $103,602 for the same period in 2005. This decrease was primarily due to the
      reduction of the number of active syndication partners with deferred revenue
      to
      two (2) in the third quarter of 2006 from three (3) in the third quarter of
      2005. The 2006 and 2005 periods included $26,727, and $72,977 of revenue derived
      from barter transactions, respectively. Similarly, as syndication fees are
      recognized over the terms of the agreements, revenue recognition is based upon
      the terms and timing of the agreements and does not reflect actual cash flow.
      Although we are actively marketing our services to syndication partners, we
      have
      not been successful in securing agreements due to the distraction of the SEC
      matter and potential partners’ concerns about our financial
      condition.





Other
      revenues increased 22% to $5,001 for the third quarter of 2006 from $4,087
      for
      the third quarter of 2005. This increase is primarily due to the other revenue
      source in the amount of $4,553 for Smart Commerce. This increase was offset
      be a decrease in other revenues in the amount of $3,639 for Smart
      Online.





**Cost
      of Revenues**





Cost
      of Revenues increased $5,511 or 21% to $31,311 in the third quarter of 2006,
      up
      from $25,800 in the third quarter 2005, primarily as a result of the inclusion
      of the cost of revenues of our subsidiary Smart Commerce in the amount of
      $14,432 for the three months ended September 30, 2006. This increase was offset
      by a decrease in the cost of revenues for Smart Online in the amount of $8,921,
      which was the result of a reduction in personnel.





Cost
      of Revenues as a percentage of revenues decreased to 4% for the three months
      ended September 30, 2006 from 7% for the three months ended September 30, 2005.
      This is primarily as a result of (1) the decrease in personnel included in
      the Smart Online cost of revenues, and (2) the inclusion of Smart Commerce,
      whose cost of revenues as a percentage of revenue for the three months ended
      September 30, 2006 was 2%.





For
      the same reasons, gross margin for the three months ended September 30, 2006
      increased to 96% as compared to 93% for the three months ended September 30,
      2005.





**Operating
      Expenses**





Operating
      expenses decreased to $1,799,068, or 28%, for the third quarter of 2006 from
      $2,507,354 during the third quarter of 2005. The principal factors resulting
      in
      the decrease in operating expense in the third quarter of 2006 were (1) that
      no
      investor relations consultants were engaged in this period, (2) there was no
      option expense recorded for services rendered by consultants, (3) accounting
      expenses decreased with the addition of a full time CFO resulting in less
      reliance on third party firms for accounting services, (4) a decrease in
      advertising and marketing services, and (5) a decrease in sales and
      corresponding commissions. These decreases were offset by an increase in
      operating expenses associated with the inclusion of Smart Commerce, which was
      not acquired until the fourth quarter of 2005. The following table sets forth
      the three primary components of our operating expenses for the third quarters
      of
      2006 and 2005, respectively:





**For
                the three months**
              **ended
                September 30,****2006**
            
            **2005****Operating
                Expenses**General
                and Administrative
            
            $
            1,208,044
            
            $
            1,761,376Sales
                and Marketing
            
            
            135,027
            
            
            374,841Research
                and Development
            
            
            455,997
            
            
            371,137**Total
                Operating Expenses**
            
            $
            1,799,068
            
            $
            2,507,354








-26-








*General
      and Administrative.* General and administrative expenses decreased by $553,332, or 31% to $1,208,044
      for the third quarter of 2006 from $1,761,376 in the same quarter of 2005.
      This
      decrease was primarily due a reduction of approximately $476,000 in consultant
      costs, such as investor relation firms; a decrease of approximately $78,000
      in
      accounting fees with the hiring of a full time CFO; and a reduction of
      approximately $538,000 in expenses associated with options rendered for services
      by consultants. This decrease in general and administrative services is offset
      by a $171,540 increase associated with the inclusion of our subsidiary, Smart
      Commerce, which was not acquired until the fourth quarter of 2005, and $58,607
      in certain legal expenses in connection with the SEC matter.





We
      are still in dispute with our insurance carrier regarding its refusal to cover
      certain legal expenses related to the SEC matter. We contend that these legal
      expenses should be reimbursed by our insurance carrier. Because the outcome
      of
      this dispute remains unclear, we have expensed all legal costs incurred and
      we
      will account for any insurance reimbursement, should there be any, in the period
      such amounts are reimbursed. Our insurance carrier has made payments totaling
      approximately $730,000 to date **.**





*Sales
      and Marketing.* Sales and marketing expenses decreased to $135,027 in the third quarter of
      2006
      from $374,841 in the third quarter 2005, a decrease of $239,814 or 64%. This
      decrease is primarily due to a reduction in Smart Online's sales and marketing
      staff and related commission expense; a reduction in the costs associated with
      press releases; a reduction in the use of temporary staffing agencies for
      customer service support; and a reduction in the number of consulting contracts
      which, in total, amounted to a reduction of approximately $325,000. This
      reduction was offset by $85,132 of third quarter sales and marketing expense
      of
      Smart Commerce.





Generally,
      we expect we will have to increase marketing and sales expenses before we can
      substantially increase our subscription fees. Assuming we are successful in
      raising additional financing, we plan to invest in marketing and sales by
      increasing the number of sales personnel, seeking additional syndication
      partners with small business customer bases, increasing penetration within
      our
      existing customer base, expanding our domestic selling and marketing activities,
      building brand awareness and participating in additional marketing programs.
      However, we have not been able to raise sufficient financing to implement this
      strategy to date, and there can be no assurances that we will be able to do
      so
      in the future.





*Research
      and Development.* Research and development expense increased to $455,997 in the third quarter
      of
      2006 from $371,137 in the third quarter of 2005, an increase of $84,860 or
      23%.
      This increase is primarily due to the inclusion of the research and development
      expense in the amount of $204,623 for Smart Commerce. The increase was offset
      by
      a decrease in Smart Online’s research and development expense in the amount of
      $119,763, as wages and bonuses in the third quarter of 2006 were reduced from
      the third quarter 2005. We have hired additional development personnel and
      expect research and development expenses to increase during the fourth quarter
      of 2006.





**Discontinued
      Operations**





In
      accordance with SFAS No. 144, *Accounting
      for the Impairment or Disposal of Long-Lived Assets* ,
      we
      reported our Smart CRM segment as a discontinued operation in the consolidated
      financial statements because of the sale of substantially all of the assets
      and
      liabilities of Smart CRM effective September, 29, 2006. The net loss from the
      discontinued operations for the third quarter of 2006 was $2,329,429. The major
      components of this loss were a loss from Smart CRM’s operations of $147,160 and
      a loss on sale of assets of $2,140,054. The loss on sale of assets was composed
      of a gain on the sale of the assets of $653,267 and a write-down in goodwill
      of
      $2,793,321. There were no corresponding amounts for the third quarter of
      2005.








-27-





**Other
      Income (Expense)**





The
      following table sets forth the principal components of other income (expense)
      for the third quarter of 2006 and 2005, respectively:





**For
                the three months**
              **ended
                September 30****2006**
            
            **2005****Other
                Income (Expense)**Interest
                Income (Expense), Net
            
            $
            (51,746
            )
            $
            7,606Takeback
                of Investor Relations Shares
            
            
            1,562,500
            
            
            -**Total
                Other Income (Expense)**
            
            $
            1,510,754
            
            $
            7,606





We
      incurred net interest expense of $51,746 during the third quarter of 2006 and
      $7,606 of net interest income during the third quarter of 2005. Interest expense
      increased as a direct result of the notes payables related to the iMart and
      Computility acquisitions, including notes related to non-compete agreements.


We
      recorded other income in the amount of $1,562,500 related to taking back 625,000
      shares of our common stock resulting from the August 30, 2006 cancellation
      of an
      investor relations contract. Shares were taken back at the fair market value
      on
      the date of the contract cancellation which was $2.50 per share based on our
      recent private placement of shares.





**Net
      Loss**





Net
      loss for the three months ended September 30, 2006 decreased to $1,899,848
      from
      $2,180,856 for the three months ended September 30, 2005. The reasons for this
      decrease in net loss are set forth more fully above, but primarily consist
      of
      (1) increased revenues as a result of the addition of revenues from Smart
      Commerce, (2) the takeback of the investor relations shares, and (3) reduced
      General & Administrative and Sales & Marketing expenses. These decreases
      are partially offset by the increases in expenses resulting primarily from
      (1)
      the inclusion of the operating expenses of our subsidiary, (2) an increase
      in
      legal and professional fees included in General & Administrative expenses,
      (3) the inclusion of compensation expense related to options, (4) the inclusion
      of amortization expense related to the intangible assets we acquired and (5)
      the
      net loss on sale of the assets of Smart CRM.








-28-





**Overview
      of Results of Operations for the Nine Months Ended September 30, 2006 and
      September 30, 2005**





The
      following table shows our consolidated statements of operations data expressed
      as a percentage of revenue from continuing operations for the periods
      indicated:




**Nine
                Months**
              **Ended**
              **September
                30,2006**
            
            **Nine
                Months**
              **Ended**
              **September
                30,2005**REVENUES:Subscription
                Fees
            
            
            50
            %
            
            6
            %Professional
                Services Fees
            
            
            36
            %
            
            0
            %Integration
                Fees
            
            
            6
            %
            
            58
            %Syndication
                Fees
            
            
            6
            %
            
            30
            %OEM
                Revenue
            
            
            1
            %
            
            4
            %Other
                Revenues
            
            
            1
            %
            
            2
            %Total
                Revenues
            
            
            100
            %
            
            100
            %COST
                OF REVENUES
            
            
            7
            %
            
            8
            %GROSS
                PROFIT
            
            
            93
            %
            
            92
            %OPERATING
                EXPENSES:General
                and Administrative
            
            
            164
            %
            
            299
            %Sales
                and Marketing
            
            
            23
            %
            
            95
            %Research
                and Development
            
            
            43
            %
            
            87
            %Total
                Operating Expenses
            
            
            230
            %
            
            481
            %LOSS
                FROM CONTINUING OPERATIONS
            
            
            (137
            %)
            
            (389
            %)OTHER
                INCOME (EXPENSE):Interest
                Income (Expense), Net
            
            
            (7
            %)
            
            2
            %Takeback
                of Investor Relations Shares
            
            
            106
            %
            
            0
            %Write-off
                of Investment
            
            
            (1
            %)
            
            0
            %Gain
                on Debt Forgiveness
            
            
            5
            %
            
            55
            %Total
                Other Income (Expense)
            
            
            103
            %
            
            57
            %





**Revenues**





Total
      revenues were $2,947,985 for the first nine months of 2006 compared to
      $1,004,046 for the first nine months of 2005 representing an increase of
      $1,943,939 or 194%. This increase is primarily attributable to revenue in the
      amount of $2,498,992 from Smart Commerce. The revenue generated by this
      subsidiary is generally composed of subscription fees and professional services
      fees related to domain name subscriptions. There was no comparable revenue
      generated by this subsidiary for the first nine months of 2005 as that was
      a
      pre-acquisition period. The additional revenues Smart Commerce were offset
      by
      decreases of $402,602 and $115,625 in integration and syndication fees,
      respectively, as discussed more fully below. An underlying factor in the
      decrease in our revenues as well as our inability to increase revenue through
      the signing of new contracts during the nine months ended September 30, 2006
      has
      been the distraction of and our focus on the SEC matter, the internal
      investigation, and issues related thereto.  Also, potential new customers
      have been delaying contract negotiations until they can be more assured of
      our
      ability to continue operations. In the period immediately following the end
      of
      the third quarter of 2006, we have been able to make progress in redirecting
      our
      focus to sales and revenue and it appears that some of these potential
      customers may be willing to reinitiate discussions. However, we can offer no
      assurance that these potential customers will ultimately enter into business
      relationships with us.





-29-








Subscription
      fees increased to $1,476,194 for the first nine months of 2006 from $62,350
      for
      the first nine months of 2005. This increase was primarily due to $1,421,741
      in
      subscription fees from Smart Commerce. This increase was offset by a decrease
      of
      $7,897 in subscription fees for Smart Online.





Professional
      services fees increased to $1,051,200 for the first nine months of 2006 from
      $0
      for the first nine months of 2005. This increase was primarily due to $1,051,200
      of professional services fees generated by Smart Commerce, of which $450,000
      was
      a one time payment by a customer of a subsidiary for a perpetual license.





Integration
      fees decreased 69% to $182,660 for the first nine months of 2006 as compared
      to
      $585,262 for the same period in 2005. This decrease is primarily due to the
      reduction of the number of active integration partners with deferred revenue
      to
      five (5) in the first nine months of 2006 from eight (8) in the first nine
      months of 2005. The 2006 and 2005 periods also included $6,667 and $138,750
      of
      revenue derived from barter transactions, respectively. As integration fees
      are
      recognized over the terms of the agreements, revenue recognition is based on
      the
      terms and timing of the agreements and does not reflect actual cash
      flow.





Syndication
      fees decreased 39% to $183,619 for the first nine months of 2006 as compared
      to
      $299,244 for the same period in 2005. This decrease was primarily due to the
      reduction of the number of active syndication partners with deferred revenue
      to
      two (2) in the first nine months of 2006 from three (3) in the first nine months
      of 2005. The 2006 and 2005 periods included $91,744 and 207,369 of revenue
      derived from barter transactions, respectively. Similarly, as syndication fees
      are recognized over the terms of the agreements, revenue recognition is based
      on
      the terms and timing of the agreements and does not reflect actual cash
      flow.





Other
      revenues increased 29% to $27,312 for the first nine months of 2006 from $21,190
      for the first nine months of 2005. This increase is primarily due to the other
      revenue source of Smart Commerce in the amount of $26,051. This increase is
      offset by a decrease in the other revenues for Smart Online in the amount of
      $19,928.





**Cost
      of Revenues**





Cost
      of revenues increased $133,077, or 168% to $212,515 in the first nine months
      of
      2006, up from $79,438 in the first nine months of 2005. This increase was
      primarily a result of the inclusion of the cost of revenues of Smart Commerce
      in
      the amount of $158,380 for the nine months ended September 30, 2006. This amount
      is offset by a decrease in the cost of revenues for Smart Online in the amount
      of $25,304, which was the result of reductions in personnel.





Cost
      of Revenues as a percentage of revenues decreased to 7% for the nine months
      ended September 30, 2006 from 8% for the nine months ended September 30, 2005.
      This decrease is due primarily to the reduction in personnel as well as the
      inclusion of Smart Commerce whose cost of revenues as a percentage of its total
      revenues for the nine months ended September 30  ,
      2006 was 6.3%.





For
      the same reasons, gross margin for the nine months ended September 30, 2006
      increased to 93% as compared to 92% for the nine months ended September 30,
      2005.





**Operating
      Expenses**





Operating
      expenses increased to $6,790,602 for the first nine months of 2006 from
      $4,834,860 during the first nine months of 2005. The principal factors resulting
      in the increase in operating expense were (1) the inclusion of the operating
      expenses of Smart Commerce, which was not acquired until the fourth quarter
      of
      2005 (2) an increase in legal and professional fees included in general and
      administrative expenses related to both the increased expense of being a public
      company, and the increased legal fees related to the SEC matter and our own
      internal investigation, (3) consulting fees and additional staff in sales and
      marketing, (4) additional programming, database management, quality assurance,
      and project management resources in the development function to support the
      on-going development of the OneBiz SM product, (5) the inclusion of compensation expense related to options which
      are
      now accounted for under SFAS No. 123R, and (6) the inclusion of amortization
      expense related to the intangible assets acquired as part of the iMart
      acquisition. The following table sets forth the three primary components of
      our
      operating expenses for the nine months ended September 30, 2006 and September
      30, 2005, respectively:





-30-








**For
                the nine months ended September 30****2006**
            
            **2005****Operating
                Expenses**General
                and Administrative
            
            $
            4,844,464
            
            $
            3,004,574Sales
                and Marketing
            
            
            666,940
            
            
            957,519Research
                and Development
            
            
            1,279,198
            
            
            872,767**Total
                Operating Expenses**
            
            $
            6,790,602
            
            $
            4,834,860





*General
      and Administrative.* General and administrative expenses increased by $1,839,890, or 61% to
      $4,844,464 for the first nine months of 2006 from $3,004,574 in the same period
      of 2005. This increase was primarily due to approximately $527,000 of additional
      amortization expense related to the intangible assets acquired from iMart;
      approximately $537,000 of other general and administrative expenses from Smart
      Commerce; approximately $836,000 of additional legal expenses related to the
      SEC
      matter and our own internal investigation; approximately $280,000 of additional
      wages related to additional administrative personnel; approximately $622,000
      of
      additional compensation expense related to stock options as accounted for under
      the newly adopted SFAS No. 123R; increase of approximately $63,000 of bad debt
      expense; approximately $23,000 of additional insurance expense related to the
      creation of our in-house legal department; approximately $25,000 for an
      independent appraisal of intangible assets acquired from Computility and iMart
      that was performed in the first quarter of 2006; and approximately $51,000
      for
      market research on our securities. ****





We
      are still in dispute with our insurance carrier regarding its refusal to cover
      certain legal expenses related to the SEC matter. We contend that these legal
      expenses should be reimbursed by our insurance carrier. Because the outcome
      of
      this dispute is unclear, we have expensed all legal costs incurred and we will
      account for any insurance reimbursement, should there be any, in the period
      such
      amounts are reimbursed. Our insurance carrier has made payments of approximately
      $730,000 to date.





*Sales
      and Marketing.* Sales and marketing expenses decreased to $666,940 in the first nine months
      of
      2006 from $957,519 in the first nine months of 2005, a decrease of $290,579
      or
      30%. This decrease is primarily due to a reduction in Smart Online's barter
      advertising expense of approximately $190,000; a reduction in sales and
      marketing wages by approximately $130,000 with a decrease in associated
      commissions by approximately $34,000; a reduction of recruiting expenses by
      approximately $50,000; a reduction of marketing services by approximately
      $73,000; and a reduction of consultants engaged by approximately $178,000.
      This
      decrease is offset by the addition of $361,676 sales and marketing expense
      from
      Smart Commerce.





Generally,
      we expect we will have to increase marketing and sales expenses before we can
      substantially increase our subscription fees. Assuming we are successful in
      raising additional financing, we plan to invest in marketing and sales by
      increasing the number of sales personnel, seeking additional syndication
      partners with small business customer bases, increasing penetration within
      our
      existing customer base, expanding our domestic selling and marketing activities,
      building brand awareness and participating in additional marketing
      programs.





*Research
      and Development.* Research and development expenses increased to $1,279,198 in the first nine
      months of 2006 from $872,767 in the first nine months of 2005, an increase
      of
      $406,431, or 47%. This increase is primarily due to the inclusion of the
      research and development expenses of Smart Commerce in the amount of $506,366. **** This
      increase is offset by a decrease in the amount of Smart Online’s research and
      development expense by $101,171, which was the result of reductions in
      personnel. We hired additional development personnel and expect research and
      development expenses to increase during the fourth quarter of 2006.








-31-





**Discontinued
      Operations**





In
      accordance with SFAS No. 144, *Accounting
      for the Impairment or Disposal of Long-Lived Assets* ,
      we
      reported our Smart CRM segment as a discontinued operation in the consolidated
      financial statements because of the sale of substantially all of the assets
      and
      liabilities of Smart CRM effective September, 29, 2006. The net loss from the
      discontinued operations for the nine months ended September 30, 2006 was
      $2,525,563. The major components of this loss were a loss from operations of
      $251,589 and a loss on sale of assets of $2,140,054. The loss on sale of assets
      was composed of a gain on the sale of the assets of $653,267 and a write-down
      in
      goodwill of $2,793,321. There were no corresponding amounts for nine months
      ended September 30, 2005.





**Other
      Income (Expense)**





The
      following table sets forth the principal components of other income (expense)
      for the nine months ended September 30, 2006 and September 30, 2005,
      respectively:





**2006**
            
            **2005****Other
                Income (Expense)**Interest
                Income (Expense), Net
            
            $
            (190,802
            )
            $
            17,801Takeback
                of Investor Relations Shares
            
            
            3,125,000
            
            
            -Write-off
                of Investment
            
            
            (25,000
            )
            
            -Gain
                from Debt Forgiveness
            
            
            144,351
            
            
            556,634**Total
                Other Income (Expense)**
            
            $
            3,053,549
            
            $
            574,435





We
      incurred net interest expense of $190,802 during the first nine months of 2006
      and net interest income of $17,801 during the first nine months 2005. Interest
      expense increased as a direct result of the notes payables related to the iMart
      and Computility acquisitions, including notes related to non-compete agreements.
      The 2005 interest income totaling $17,801 was primarily from interest earned
      on
      money market account deposits.





We
      recorded other income in the amount of $3,125,000 related to taking back a
      total
      of 1,250,000 shares of our common stock resulting from the May 31 and August
      30,
      2006 cancellation of two investor relations contracts. Shares were taken back
      at
      the fair market value on the date of the contract cancellation, which was $2.50
      per share on each date, based on our recent private placement of
      shares.





One
      of the assets purchased as part of the iMart acquisition was a $25,000
      investment in a privately held company that was a customer of iMart's.
      Management determined that it is likely that such investment became worthless
      in
      the first quarter of 2006, so the entire $25,000 investment has been written
      off. We also reserved for all of the accounts receivable due from that customer
      of approximately $63,000.





We
      realized gains of $144,351 and $556,634 during the first nine months of 2006
      and
      2005, respectively, from negotiated and contractual releases of outstanding
      liabilities. The 2006 gains were the aggregate results of negotiated settlements
      with our former auditors. The 2005 gain resulted from a settlement of Internal
      Revenue Service claims for penalty and interest.





**Net
      Loss**





Net
      loss for the nine months ended September 30, 2006 increased to $3,527,146 from
      $3,335,817 for the nine months ended September 30, 2005. The reasons for this
      increase in net loss are set forth more fully above, but primarily consist
      of
      (1) the inclusion of the operating expenses of Smart Commerce, including the
      research and development costs associated with that segment, (2) an increase
      in
      legal and professional fees included in General & Administrative expenses,
      (3) the inclusion of compensation expense related to options, (4) the inclusion
      of amortization expense related to the intangible assets we acquired, (5) the
      net loss on sale of the assets of Smart CRM (including the impairment of
      goodwill), (6) increased interest expense, and (7) a decrease in income from
      debt forgiveness. These increases in expenses were partially offset by (1)
      increased revenues as a result of the addition of revenues from Smart Commerce,
      (2) the takeback of the investor relations shares, and (3) decreased Sales
&
Marketing expense.








-32-





**Provision
      for Income Taxes**





We
      have not recorded a provision for income tax expense because we have been
      generating net losses. Furthermore, we have not recorded an income tax benefit
      for the three months or nine months ended September 30, 2006 or fiscal 2005
      primarily due to continued substantial uncertainty regarding our ability to
      realize our deferred tax assets. Based upon available objective evidence, there
      has been sufficient uncertainty regarding the ability to realize our deferred
      tax assets, which warrants a full valuation allowance in our financial
      statements. We have approximately $35,000,000 in net operating loss
      carryforwards, which may be utilized to offset future taxable
      income.





**Liquidity
      and Capital Resources**





At
      September 30, 2006, our principal sources of liquidity were unrestricted cash
      and cash equivalents totaling $680,787 and accounts receivable of $259,498.
      As
      of November 11, our principal sources of liquidity were unrestricted cash and
      cash equivalents totaling approximately $220,000 and accounts receivable of
      approximately $191,000. We have a bank line of credit with Wachovia Bank, NA,
      in
      the amount of $1.3 million. (For a more complete description of our line of
      credit, please see Note 11 to the Financial Statements, “Subsequent
      Events.”)





At
      September 30, 2006, we had working capital deficit of approximately $3.4
      million. Taking into account our line of credit, our working capital is not
      sufficient to fund our operations beyond April 2007, unless we
      substantially increase our revenue, limit expenses or raise substantial
      additional financing.





Our
      primary source of liquidity during 2005 and the first nine months of 2006 was
      from sales of our securities. During 2005, we generated net cash from financing
      activities, including the sales of common stock, of approximately $7.7 million.
      During the same period we consumed approximately $6.4 million of cash in
      operations. During the first nine months of 2006, we raised an additional $2.5
      million of proceeds through the sale of additional shares of common stock,
      and
      approximately $22,000 on the exercise of warrants. In addition, we raised
      approximately $799,000 through the factoring of receivables of Smart CRM. This
      cash resource is no longer available to us following the sale of the assets
      of
      Smart CRM.





As
      a result of the 2006 cash infusions from stock sales, factoring arrangements,
      settlement of various claims and lawsuits, and based upon current cash-on-hand,
      our line of credit, and contracts signed to date, our management believes we
      have sufficient working capital to fund operations through April 2007.
      Management is actively evaluating additional financing options for 2006 and
      beyond, including investment from existing and new shareholders, signing
      additional syndication partners, signing additional integration partners, and
      continuing to grow our base of subscription customers.





**Deferred
      Revenue.** At September 30, 2006, we had deferred revenue totaling $418,559, net of
      offsetting amounts receivable. Deferred revenue represents amounts collected
      in
      advance of the revenue being recognized. Based upon current conditions, we
      expect that 100% of this amount will be recognized in the short
      term.





**Going
      Concern.** Our auditors have issued an explanatory paragraph in their report included
      in
      our 2005 Annual Report, in which they express substantial doubt as to our
      ability to continue as a going concern. The financial statements do not include
      any adjustments relating to the recoverability and classification of recorded
      asset amounts or the amounts or classification of liabilities that might be
      necessary should we be unable to continue as a going concern. Our continuation
      as a going concern is dependent upon our ability to generate sufficient cash
      flows to meet our obligations on a timely basis, to obtain additional financing
      as may be required, and ultimately to attain profitable operations and positive
      cash flows. As discussed above, management has plans which it believes will
      enable us to raise additional financing and generate greater cash flows from
      operations. However, there can be no assurance that these efforts will be
      successful. If our efforts are unsuccessful, we may have to cease operations
      and
      liquidate our business.





**Fiscal
      2006 and 2007 Outlook.** We believe our capital requirements in 2006 and beyond will be greater than
      in
      past years as we continue to update, enhance and add functionality to our
      OneBiz SM platform, including the addition of development personnel; add sales and
      marketing personnel in implementing our syndication partner strategy; continue
      to integrate the e-Commerce business we acquired in October 2005; and incur
      expenses associated with becoming a public company and complying with the
      Sarbanes-Oxley Act of 2002. As such, our historical cash flows may not be
      indicative of future cash flows.





-33-











We
      currently are evaluating various equity and debt financing options to assist
      with our plans to invest in marketing
      and sales and for other operating expenses. Our future capital requirements
      will
      depend on many factors, including our rate of revenue growth, the expansion
      of
      our marketing and sales activities, the timing and extent of spending to support
      product development efforts and expansion into new territories, the timing
      of
      introductions of new services and enhancements to existing services, and the
      market acceptance of our services.





Although
      we have signed no new contracts during 2006, if we are successful in signing
      new
      contracts during the remainder of 2006, we anticipate our receivables and
      collections from integration, syndication, and end-user licensing opportunities
      to increase starting the first quarter of 2007.





Until
      the fourth quarter of 2005, we allowed most of our web-based products to be
      used
      without charge for extended time periods. This gained us users, but limited
      our
      revenue. In the fourth quarter of 2005, we limited our free use policy to a
      free
      use period of up to 14-days, after which we terminate access for users who
      fail
      to become paid subscribers. However, there can be no assurance that we will
      be
      successful in attracting new customers or that customers will pay for our
      products. The total number of subscribers to our services both through our
      main
      portal and the websites of our syndication partners has decreased from the
      number of subscribers we had in January 2006. However, our strategy is to obtain
      additional subscribers through the private label websites of current and
      potential syndication partners. If we are unable to materially increase the
      number of subscribers to our services through leveraging existing partners
      or
      entering into contract with new partners, our business may be substantially
      harmed.





Smart
      Online's receivables are from major companies or banking institutes
      (approximately $19,606 of accounts receivable as of September 30, 2006),
      while the receivables of Smart Commerce is primarily from individual small
      businesses and end users, (approximately $234,134 of accounts
      receivable as of September 30, 2006). Management has evaluated the need for
      an allowance for doubtful accounts and determined that an allowance for doubtful
      accounts of approximately $68,000 is adequate as of September 30, 2006. There
      was no allowance for doubtful accounts as of December 31, 2005.





Following
      the sale of substantially all the assets of a subsidiary, we are evaluating
      whether we will move our sales team from our headquarters in North Carolina
      to
      Iowa. From time to time, we evaluate strategic opportunities, potential
      investments in complementary businesses and divestitures of assets outside
      our
      evolving business strategy. We anticipate continuing to make such evaluations
      during the remainder of fiscal year 2006 and into fiscal 2007.





**Recent
      Developments.**





On
      January 17, 2006, the SEC temporarily suspended the trading of our securities.
      In its “Order of Suspension of Trading,” the SEC stated that the reason for the
      suspension was a lack of current and accurate information concerning our
      securities because of possible manipulative conduct occurring in the market
      for
      our stock. By its terms, that suspension ended on January 30, 2006 at 11:59
      p.m.
      EST. As a result of the SEC's suspension, NASDAQ withdrew its acceptance of
      our
      application to have our common stock traded on the NASDAQ Capital Market.
      Simultaneously with the suspension, the SEC advised us that it is conducting
      a
      non-public investigation. While we continue to cooperate with the SEC, we are
      unable to predict at this time whether the SEC will take any adverse action
      against us. In March 2006, our Board of Directors authorized its Audit Committee
      to conduct an internal investigation of matters relating to the SEC suspension
      and investigation. The Audit Committee retained independent outside legal
      counsel to assist in conducting the investigation. On July 7, 2006, the
      independent outside legal counsel shared its final findings with the Audit
      Committee, which were then shared with the full Board of Directors. The Audit
      Committee did not conclude that any of our officers or directors have engaged
      in
      fraudulent or criminal activity. However, it did conclude that we lacked an
      adequate control environment, and has taken action to address certain conduct
      of
      management that was revealed as a result of the investigation. The Audit
      Committee concluded that the control deficiencies primarily resulted from our
      transition from a private company to a publicly reporting company and
      insufficient preparation for, focus on and experience with compliance
      requirements for a publicly reporting company. As one of the results of these
      findings, Mr. Jeffrey LeRose was appointed to the position of non-executive
      Chairman of the Board of Directors to separate the leadership of the Board
      of
      Directors from the management of the Company, which is a recommended best
      practice for solid corporate governance. Mr. Nouri has stepped down as Chairman
      of the Board of Directors, but will continue to serve as our President, Chief
      Executive Officer and as a member of the Board of Directors. A discussion of
      the
      significant deficiencies that were identified by the Audit Committee and related
      remediation efforts can be found in Item 9A of our 2005 Form 10-K.





-34-








On
      July 6, 2006, we sold 100,000 shares of our common stock to the Blueline Fund
      (“Blueline”), an existing investor, for a price of $2.50 per share resulting in
      gross proceeds of $250,000. We incurred immaterial issuance costs related to
      this stock sale.





On
      August 17 and 21, 2006, we sold as aggregate of 100,000 shares of our common
      stock to Blueline and Phillippe Pouponnot, for a price of $2.50 per share
      resulting in gross aggregate proceeds of $250,000. We incurred immaterial
      issuance costs related to this stock sale.





The
      Company entered into an agreement for the co-development of its accounting
      application with a software development company. The Company and the software
      development company are continuing to work on the modifications and features
      necessary to address the feedback received from both customers and an accounting
      consultant. The payment schedule described above was recently amended so that
      the $37,500 from escrow would be released not upon acceptance of the accounting
      application ,
      but in good faith as a consequence of the continued work by the software
      development company on this project. The remaining money would still be
      partially paid at acceptance, up to 100 days after acceptance and up to 190
      days
      after acceptance.





On
      November 9, 2006, Smart Commerce entered into a loan agreement with Fifth Third
      Bank of Southfield, Michigan. Under the terms of this agreement, Smart Commerce
      borrowed $1.8 million to be paid back in twenty-four (24) monthly installments
      of $75,000 plus interest beginning in December, 2006. The interest rate is
      prime
      plus 1.5% as periodically determined by Fifth Third Bank.  Currently and at
      closing, the prime rate was 8.25%.  The loan is secured by all of the
      assets of Smart Commerce, including a security account of $250,000 with Fifth
      Third and all of Smart Commerce’s intellectual property. The loan is guaranteed
      by the Company and such guaranty is secured by all the common stock of Smart
      Commerce. Under the terms of the loan agreement, Smart Commerce is to establish
      a lock box account with Fifth Third, but has the right to use the amounts
      deposited therein for any purpose not inconsistent with the loan agreement
      and
      related documents so long as no event of default exists and is continuing.
      Further, the amount in the security account will be released in three (3)
      installments of approximately $83,000 if Smart Commerce meets certain revenue
      goals on June 30, 2007, December 31, 2007, and June 30, 2008.





On
      November 8, 2006, the Company entered into an amendment to the “Lock Box
      Agreement,” dated October 17, 2005, such amendment by and between Smart Online,
      Smart Commerce, and certain former shareholders of iMart Incorporated (the
      “Sellers”). Under the terms of this Amendment, Smart Online is to pay the
      Sellers $1,329,518
      upon the deposit of a certain amount into the lock box account, approximately
      $700,000 on January 1, 2007, and approximately $300,000 on or before February
      4,
      2007. The payments are made in satisfaction of certain installment and
      noncompetition payments owed the Sellers under the “Stock Purchase Agreement,
      dated October 17, 2005, by and between the same parties and as described in
      further detail elsewhere in this document. In exchange, the Sellers released
      their security interest in the proceeds of Smart Commerce, agreed to allow
      funds
      in the Sellers’ lock box account to be swept into an account with Fifth Third,
      and agreed to the future closure of the Sellers’ lock box account in connection
      with the establishment of a lock box account with Fifth Third.




[Add
      paragraph describing Wachovia line of credit when
      finalized in Note 11.]





**Item
      3.**  **QUANTITATIVEAND
      QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**




***Foreign
      currency exchange risk***





For
      the nine months ended September 30, 2006 and 2005, all of our contracts and
      transactions were U.S. dollar denominated. As a result our results of operations
      and cash flows are not subject to fluctuations due to changes in foreign
      currency exchange rates.





***Interest
      rate sensitivity***





We
      had unrestricted cash and cash equivalents totaling $1,434,966, $173,339, and
      $101,486 at December 31, 2005, 2004, and 2003, respectively. At September 30,
      2006, our unrestricted cash was $680,787. These amounts were invested primarily
      in demand deposit accounts and money market funds. The unrestricted cash and
      cash equivalents are held for working capital purposes. We do not enter into
      investments for trading or speculative purposes. Due to the short-term nature
      of
      these investments, we believe that we do not have any material exposure to
      changes in the fair value of our investment portfolio as a result of changes
      in
      interest rates. Declines in interest rates, however, will reduce future
      investment income.





-35-











In
      addition, changes in interest rates will have a negligible effect on
      management’s decisions with regard to our financing activities, including
      factoring receivables, financing existing debt, funding future acquisitions,
      or
      obtaining additional working capital.




**Item
      4.** **** **CONTROLSAND
      PROCEDURES**





**Evaluation
      of Disclosure Controls and Procedures**




As
      required by paragraph (b) of Rule 13a-15 under the Exchange Act, an evaluation
      was carried out under the supervision and with the participation of our
      management, including our Chief Executive Officer and Chief Financial Officer,
      of the effectiveness of our disclosure controls and procedures (as defined
      in
      Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period
      covered by this Quarterly Report. As defined in Rule 13a-15(e) and 15d-15(e)
      under the Exchange Act, the term disclosure controls and procedures means
      controls and other procedures of an issuer that are designed to ensure that
      information required to be disclosed by the issuer in the reports that it files
      or submits under the Exchange Act is recorded, processed, summarized and
      reported, within the time periods specified in the SEC’s rules and forms.
      Disclosure controls and procedures include, without limitation, controls and
      procedures designed to ensure that information required to be disclosed by
      an
      issuer in the reports that it files or submits under the Exchange Act is
      accumulated and communicated to the issuer's management, including its principal
      executive and principal financial officers, or persons performing similar
      functions, as appropriate to allow timely decisions regarding required
      disclosure.





Based
      on
      their evaluation, our Chief Executive Officer and Chief Financial Officer
      concluded that, as of the end of the period covered by this Quarterly Report,
      our disclosure controls and procedures were not effective because of the
      significant deficiencies that we are in the process of remediating. These
      significant deficiencies and the related changes to our controls were described
      under Item 9A of Part II of our 2005 Annual Report .





**Changes
      to Internal Control Over Financial Reporting**




In
        August
        2006, we advanced our CEO $17,300 against his September and October salaries.
        The advancement of monies was done to facilitate repayments of a personal
        loan
        the CEO had been directed to repay by our Board of Directors. However, because
        our CEO had use of these funds before they were due, the advancement could
        be
        considered as a loan that is not permissible under Section 402 of the
        Sarbanes-Oxley Act of 2002. Section 402 prohibits a Company from extending
        or
        maintaining credit, either directly or indirectly, in the form of personal
        loans
        to or for any director or executive officer. The Company has initiated a
        stringent policy that will prohibit the advancement of monies against any
        compensation due an officer or director. Company will also implement accounting
        controls that will monitor payroll transactions in order to prevent any similar
        advancements from being made in the future. The Company already has in place,
        and will reiterate the policy of a strict prohibition against any loan made
        to a
        director or executive officer that is not solely for a clear business purpose
        in
        the ordinary course of the Company's business.


Except
      for the changes in our internal control over financial reporting that were
      implemented after December 31, 2005 and that are described in Item 9A of Part
      II
      of our 2005 Annual Report, there have been no changes
      in our internal control over financial reporting that occurred during the third
      quarter of fiscal 2006 that have materially affected, or are reasonably likely
      to materially affect, our internal control over financial
      reporting.





**PART
      II.  OTHERINFORMATION**





**Item.
      1.** **** **LEGALPROCEEDINGS**





During
      the nine months ended September 30, 2006, there were no material developments
      in
      the legal proceedings previously reported in our 2005 Annual Report. Please
      refer to Part I, Item 3 of our 2005 Annual Report for additional
      information.


**Item
      1A. RISKFACTORS**





**Risk
      Factors**




An
      investment in us involves significant risks. You should read the risks described
      below very carefully before deciding whether to invest in us. The following
      is a
      description of what we consider our primary challenges and risks.







-36-





We
      operate in a dynamic and rapidly changing business environment that involves
      substantial risk and uncertainty and these risks may change over time. The
      following discussion addresses some of the risks and uncertainties that could
      cause, or contribute to causing, actual results to differ materially from
      expectations. In evaluating our business, readers should pay particular
      attention to the descriptions of risks and uncertainties described below and
      in
      other sections of this document and our other filings with the SEC, particularly
      Part I, “Item 1A. Risk Factors” in our 2005 Annual Report. These risks and
      uncertainties are not the only ones we face. Additional risks and uncertainties
      not presently known to us, that we currently deem immaterial or that are similar
      to those faced by other companies in our industry or business in general may
      also affect our business. If any of the risks described below actually occurs,
      our business, financial condition or results of future operations could be
      materially and adversely affected.




**We
      have organized these factors into the following
      categories:**




·
            Our
                Financial Condition





·
            Our
                Products and Operations





·
            Our
                Market, Customers and Partners





·
            Our
                Officers, Directors, Employees and
                Shareholders





·
            Regulatory
                Matters that Affect Our Business





·
            Matters
                Related to the Market For Our
                Securities





**Risks
      Associated with Our Financial Condition**





**(1)
      We Have Had Recurring Losses From Operations Since Inception, and Have
      Deficiencies in Working Capital and Equity Capital. If We Do Not Rectify These
      Deficiencies, We May Have to Cease Operations and Liquidate Our Business.
      Because We Have Only Nominal Tangible Assets, You May Lose Your Entire
      Investment.**




Through
      September 30, 2006, we have lost an aggregate of approximately $56 million
      since
      inception on August 10, 1993. During the quarters ended September 30, 2006
      and
      September 30, 2005, we incurred a net loss of approximately $1.9 million and
      $2.2 million, respectively. During the nine months ended September 30, 2006
      and
      September 30, 2005, we incurred a net loss of approximately $3.5 million and
      $3.3 million, respectively. Losses do not include the pre-acquisition losses,
      or
      profit, of the two companies we acquired during the fourth quarter of 2005.
      At
      September 30, 2006, we had a $3.4 million working capital deficit. Our working
      capital, including our line of credit, is not sufficient to fund our operations
      beyond April 2007, unless we substantially increase our revenue, limit
      expenses or raise substantial additional financing. Because we have only nominal
      tangible assets, you may lose your entire investment.




**(2)
      Our Independent Registered Public Accountants Indicate That They Have
      Substantial Doubts That We Can Continue as a Going Concern. Our Independent
      Registered Public Accountants' Opinion May Negatively Affect Our Ability to
      Raise Additional Funds, Among Other Things. If We Fail to Raise Sufficient
      Capital, We Will Not Be Able to Implement Our Business Plan, We May Have To
      Liquidate Our Business, and You May Lose Your Investment.**




Sherb
      & Co., LLP, our independent registered public accountants, has expressed
      substantial doubt, in their report included with our 2005 Annual Report about
      our ability to continue as a going concern given our recurring losses from
      operations and deficiencies in working capital and equity, which are described
      in the first risk factor above. This opinion could materially limit our ability
      to raise additional funds by issuing new debt or equity securities or otherwise.
      If we fail to raise sufficient financing, we will not be able to implement
      our
      business plan, we may have to liquidate our business and you may lose your
      investment. You should consider our independent registered public accountants'
      comments when determining if an investment in us is suitable.







-37-





**(3)
      We Will Require Additional Financing To Fund Our Operations Or Growth. If
      Financing Is Not Available, We May Have to Liquidate Our Business and You May
      Lose Your Investment.**




Including
      our cash and our line of credit, we lack sufficient amounts to fund operations
      past April 2007. We will be required to seek additional equity and/or debt
      financing to fund our operations through the remainder of 2007. Factors such
      as
      the suspension of trading of shares of our common stock by the SEC and the
      resulting drop in share price, trading volume and liquidity; the commercial
      success of our existing services and products; the timing and success of any
      new
      services and products; the progress of our research and development efforts;
      our
      results of operations; the status of competitive services and products; and
      the
      timing and success of potential strategic alliances or potential opportunities
      to acquire technologies or assets may require us to seek additional funding
      sooner than we expect. We cannot assure you that such funding will be available.
      If sufficient financing is not raised, our ability to achieve or sustain
      positive cash flows, maintain current operations, fund any potential growth,
      take advantage of unanticipated opportunities, develop or enhance services
      or
      products, or otherwise respond to competitive pressures would be significantly
      limited. If we fail to raise sufficient financing, we will not be able to
      implement our business plan, we may have to liquidate our business and you
      may
      lose your investment. Certain restrictions on resale of over nine million shares
      of our common stock terminated on October 1, 2005; and additional restrictions
      on these shares expired in September or October 2006 . The lapse of these
      restrictions and any increased volume of sales resulting therefrom may adversely
      affect the market value of our Common Stock and may make it more difficult
      for
      us to raise additional financing.




In
      addition, on January 17, 2006, the SEC temporarily suspended trading in our
      securities. As a result, NASDAQ withdrew its acceptance of our application
      to be
      traded on the NASDAQ Capital Market. Following that suspension, the SEC alerted
      brokers and dealers that, pursuant to Rule 15c2-11 promulgated under the
      Securities Exchange Act of 1934, brokers and dealers are prohibited from
      directly or indirectly offering quotations in our common stock unless such
      broker or dealer has strictly complied with Rule 15c2-11. On September 11,
      2006,
      our common stock returned to trading on the Over the Counter - Bulletin Board
      (“OTC-BB”). However, there can be no assurance that the SEC will not take any
      additional or further action against us, and this uncertainty may also make
      it
      more difficult for us to raise financing.




**(4)
      If We Are Able to Raise Additional Financing, But Are Not Able to Obtain Terms
      That Are Favorable to Us, Existing Stockholders and New Investors May Suffer
      Dilution of Their Ownership Interests in Our Company or Otherwise Lose Value
      In
      Our Securities.**




If
      we raise additional funds through the issuance of equity securities or debt
      convertible into equity securities, the percentage of stock ownership by our
      existing stockholders would be reduced. In addition, such securities could
      have
      rights preferences and privileges senior to those of our current stockholders,
      which could substantially decrease the value of our securities owned by them.
      For example, from March through August 2006, we sold an aggregate of 1,000,000
      shares of common stock to investors for a price of $2.50 per share for total
      aggregate proceeds of $2.50 million. Because of the share price, we had to
      sell
      a significant number of shares to raise the necessary amount of
      capital.





**(5)
      In the Future, We May Enter Into Certain Debt Financing Transactions With Third
      Parties That Could Adversely affect our Financial Health..**





We
      are evaluating various equity and debt financing options and in the future
      may
      incur indebtedness that could adversely affect our financial health. For
      example, it could:




·
            
            increase
                our vulnerability to general adverse economic and industry
                conditions;




·
            
            require
                us to dedicate a substantial portion of our cash flow from operations
                to
                payments on our debt, thereby reducing the availability of our cash
                flow
                to fund working capital, capital expenditures and other general corporate
                purposes;







-38-








·
            
            limit
                our flexibility in planning for, or reacting to, changes in our business
                and the industry in which we
                operate;





·
            
            result
                in the loss of a significant amount of our assets or the assets of
                our
                subsidiary if we are unable to meet the obligations of these
                arrangements;




·
            
            place
                us at a competitive disadvantage compared to our competitors that
                have
                less indebtedness or better access to capital by, for example, limiting
                our ability to enter into new markets;
                and




·
            
            limit
                our ability to borrow additional funds in the
                future.




**Risks
      Associated with Our Products and Operations**




**(6)
      Our Business Is Dependent Upon the Development and Market Acceptance of Our
      Applications, Including the Acceptance of Using Some of Our Applications to
      Conduct Business. Our Business Models and Operating Plans Have Changed As A
      Result of Forces Beyond Our Control. Consequently, We Have Not Yet Demonstrated
      That We Have a Successful Business Model or Operating
      Plan.**




We continually
      revise our business models and operating plans as a result of changes in our
      market, the expectations of customers and the behavior of
      competitors .
      Today, we anticipate that our future financial performance and revenue growth
      will depend, in large part, upon our Internet-based SaaS business model and
      the
      results of our sales efforts to reach agreements with syndication partners
      with
      small business customer bases, but these business models may again become
      ineffective due to forces beyond our control that we do not currently
      anticipate. Despite our sales efforts, the number of small business subscribers
      to our main portal has declined since January 2006 and no syndication partners
      have entered into agreements with us. Consequently, we have not yet demonstrated
      that we have a successful business model or operating plan. Our evolving
      business model makes our business operations and prospects difficult to
      evaluate. There
      can
      be no assurance that our revised business model will allow us to capture
      significant future market potential. Investors
      in our securities should consider all the risks and uncertainties that are
      commonly encountered by companies in this stage of operations under our current
      business model, particularly companies, such as ours, that are in emerging
      and
      rapidly evolving markets.





Our
      future financial performance and revenue growth will depend in part, upon the
      successful development, integration, introduction, and customer acceptance
      of
      our software applications. Thereafter, other new products either developed
      or
      acquired and enhanced versions of our existing applications will be critically
      important to our business. Our business could be harmed if we fail to timely
      deliver enhancements to our current and future solutions that our customers
      desire. We
      also
      must continually modify and enhance our services and products to keep pace
      with
      market demands regarding hardware and software platforms, database technology,
      information security, and electronic commerce technical standards. There
      can be no assurance that we will be able to successfully develop new services
      or
      products, or to introduce in a timely manner and gain acceptance of our new
      services or products in the marketplace.




Our
      business could be harmed if we fail to achieve the improved performance that
      customers want with respect to our current and future offerings. We cannot
      assure you that our products will achieve widespread market penetration or
      that
      we will derive significant revenues from the sale of our
      applications.





Certain
      of our services involve the storage and transmission of customers' proprietary
      information (such
      as
      credit card, employee, purchasing, supplier, and other financial and accounting
      data). If
      customers determine that our services do not provide adequate security for
      the
      dissemination of information over the Internet or corporate extranets, or are
      otherwise inadequate for Internet or extranet use or if, for any other reason,
      customers fail to accept our products for use, our business will be harmed.
      Our
      failure to prevent security breaches, or well-publicized security breaches
      affecting the Internet in general, could significantly harm our business,
      operating results, and financial condition.







-39-





**(7)
      We May Consider Strategic Divestiture, Acquisition or Investment Opportunities
      in the Future. We Face Risks Associated with Any Such
      Opportunity.**




From
      time
      to time we evaluate strategic opportunities available to us for product,
      technology or business acquisitions, investments and divestitures. In
      the future, we may divest ourselves of products or technologies that are not
      within our continually evolving business strategy or acquire other products
      or
      technologies. We may not realize the anticipated benefits of any such current
      or
      future opportunity to the extent that we anticipate, or at all. We may have
      to
      issue debt or equity securities to pay for future acquisitions or investments,
      the issuance of which could be dilutive to our existing stockholders. If any
      opportunity is not perceived as improving our earnings per share, our stock
      price may decline. In addition, we may incur non-cash amortization charges
      from
      acquisitions, which could harm our operating results. Any completed acquisitions
      or divestitures would also require significant integration or separation
      efforts, diverting our attention from our business operations and strategy.
      Our
      limited acquisition experience is from 2005, and therefore our ability as an
      organization to integrate any acquired companies into our business is unproven.
      Acquisitions and investments involve numerous risks, including:




·
            difficulties
                in integrating operations, technologies, services and
                personnel;





·
            diversion
                of financial and managerial resources from existing
                operations;





·
            reduction
                of available cash;





·
            risk
                of entering new markets;





·
            potential
                write-offs of acquired assets;





·
            potential
                loss of key employees;





·
            inability
                to generate sufficient revenue to offset acquisition or investment
                costs;
                and





·
            delays
                in customer purchases due to
                uncertainty.




If
      we fail to properly evaluate and execute acquisitions, divestitures or
      investments, our business and prospects may be seriously harmed.




**(8)
      Our Agreements in the Acquisition of iMart Incorporated Contain Installment
      Payments, Lock Box, License, Noncompetition and Control Provisions That Could
      Have A Material Adverse Effect on Us.**




When
      we purchased iMart in October 2005, we committed to make installment payments
      of
      approximately $3,462,000 and non-competition payments to two key employees
      of
      $780,000. The cash flow we received from the business we purchased from iMart
      has been insufficient to cover the any of the installment payments we have
      been
      required to make to iMart's shareholders. We had to fund 83% of the January
      2006
      installment from our working capital, 6% in April 2006, 31% in July 2006, and
      9%
      in October 2006. If the acquired business continues to not generate sufficient
      cash flow, our working capital could be substantially depleted. We recently
      amended the lock box agreement, terminating the iMart shareholders’ security
      interest in the amounts in lock box, and agreed to pay the installment payments
      and noncompetition payments in three non-equal installments by February 4,
      2007.
      If we default in any payments, key employees of Smart Commerce will have a
      nonexclusive license to certain software of Smart Commerce, their
      non-competition restrictions will terminate and their non-solicitation and
      nondisclosure contracts will be limited in scope. In addition, a key employee
      of
      Smart Commerce has received contractual rights to operate our e-Commerce
      subsidiary within agreed upon financial parameters. All of these provisions
      are
      interrelated and pose certain risks for us.







-40-








Most
      of the consideration being paid to the key employees, who were shareholders
      of
      iMart and are now employees of Smart Commerce, is in cash in installments over
      a
      three-month period, and the value of our shares owned by the key employees
      is
      substantially less than the cash payments required to be made to the key
      employees. Due to several of the acquisition contract provisions, conflict
      of
      interest situations may arise between the key employee's personal interests
      and
      the interests of our shareholders as the key employee exercises the contractual
      authority granted to him in the acquisition agreements. The acquisition
      agreements address conflict of interest situations and provide that until all
      the acquisition purchase price installment payments are made, the key employee
      will determine what is in the best interest of Smart Commerce, Smart Online
      and
      the selling shareholders of iMart, but he must identify any conflicts of
      interest to Smart Commerce's Chief Executive Officer, in which case Smart
      Commerce's Chief Executive Officer (who is currently also our Chief Executive
      Officer ) can make the decision with respect to which a conflict of interest
      exists, except that if the decision would cause Smart Commerce's EBITDA to
      be
      substantially below $1,452,795, then Smart Commerce's Chief Executive Officer
      can make the decision only if either the amount in the lock box account is
      at
      least $500,000 or we provide an irrevocable letter of credit or cash for payment
      of the remaining acquisition purchase price installment obligations. We would
      not have to provide the letter of credit or cash, if the decision relates to
      compliance with applicable laws, rules or regulations applicable to Smart
      Commerce.





We
      also entered into a loan agreement with a third party bank in order to finance
      a
      portion of the payments to the iMart shareholders. Under
      the
      terms of this agreement, Smart Commerce borrowed $1.8 million to be paid back
      in
      twenty-four (24) monthly installments of $75,000 plus interest.  The
      interest rate is prime plus 1.5% as periodically determined by Fifth third
      Bank.  Currently and at closing, the prime rate was 8.25%. The loan is
      secured by all of the assets of Smart Commerce, including a security account
      of
      $250,000 and all of Smart Commerce’s intellectual property. The loan is
      guaranteed by the Company and such guaranty is secured by all the common stock
      of Smart Commerce. If an event of default occurs and remains uncured, then
      the
      lender could foreclose on the assets securing the loan. If that were to occur,
      it would have a substantial adverse effect on our business.








Without
      agreement by the authorized people to release funds from the lock box account,
      we will be required to find other resources to pay the operating expenses of
      Smart Commerce, which we expect will exceed the $146,000 of monthly expenses
      targeted to be paid from the lock box account. Consequently, we the iMart
      acquisition has had a negative impact on our cash resources, and we expect
      the
      acquisition to have a similar negative impact at least until all payments under
      the revised lock box agreement are made. If the authorized signatories fail
      to
      reach agreement, the lock box revenue will be frozen and Smart Commerce and
      Smart Online may be unable to pay their obligations, which could substantially
      harm their businesses.




These
      provisions of the iMart acquisition agreements described above may have a
      material adverse effect on us and present many risks for us and our investors.
      Financial parameters contained in the agreements may impair our ability to
      integrate the e-Commerce business we acquired into our overall business
      strategy. Contractual decision-making ability granted to the key employee may
      lead to disputes with officers and directors of Smart Online that interfere
      with
      operation of the business. Since the key employee established the relationships
      with substantially all of Smart Commerce’s customers and we do not have
      long-term contracts with these customers, our ability to retain the customers
      we
      acquired may be at substantial risk if the key employee's non-competition and
      non-solicitation restrictions are terminated and he obtains the license to
      the
      e-Commerce products we acquired from iMart. Potential acquirors may decide
      not
      to purchase us because of these provisions or may substantially lower their
      offering price, in which case we may seek to renegotiate with the key employee.
      The substantial acquisition price installments payments and non-competition
      payments required to be paid may drain our financial resources or we may fail
      to
      make such payments, which may trigger the termination of non-competition
      provisions and the grant of a license that would enable the key employee to
      compete with us. Similarly, making the payments on the loan used to finance
      part
      of these payments may drain our financial resources or cause other material
      harm
      to our business if the lender forecloses on the secured assets. Also, investors
      may fear that conflicts of interest may cause the key employee to make decisions
      that are not in the interest of our shareholders.







-41-





**(9)
      We Rely on Third-Party Software That May Be Difficult To Repair Should Errors
      or
      Failures Occur. Such an Error or Failure, or the Process Undertaken by Us to
      Correct Such an Error or Failure, Could Disrupt Our Services and Harm Our
      Business.**




We
      rely on software licensed from third parties in order to offer our services.
      We
      use key systems software from commercial vendors. The software we use may not
      continue to be available on commercially reasonable terms, or at all, or
      upgrades may not be available when we need them. We currently do not have
      support contracts or upgrade subscriptions with some of our key vendors. We
      are
      not currently aware of any immediate issues, but any loss of the right to use
      any of this software could result in delays in the provisioning of our services
      until equivalent technology is either developed by us, or, if available, is
      identified, obtained and integrated, which could harm our business. Any errors
      or defects in, or unavailability of, third-party software could result in errors
      or a failure of our services, which could harm our business.





We
      also use key systems software from leading open source communities that are
      free
      and available in the public domain. Our products will use additional public
      domain software, if needed for successful implementation and deployment. We
      currently do not have support contracts for the open source software that we
      use. We rely on our own research and development personnel and the open source
      community to discover and fix any errors and bugs that may exist in the software
      we use. As a result, if there are errors in such software of which we are
      unaware or are unable to repair in a timely manner, there could be a disruption
      in our services if certain critical defects are discovered in the software
      at a
      future date.







**Risks
      Associated with Our Markets, Customers and Partners**





**(10)
      There are Risks Associated with International Operations, Which May Become
      a
      Bigger Part of Our Business in the Future.**




We
      currently do not currently generate substantial revenue from international
      operations. Currently, we are exploring the possibility of expanding into
      international markets. If we do so, our international operations will be subject
      to risks associated with operating abroad. These international operations are
      subject to a number of difficulties and special costs, including:




·
            costs
                of customization and localization of products for foreign
                countries;





·
            laws
                and business practices favoring local
                competitors;





·
            uncertain
                regulation of electronic commerce;





·
            compliance
                with multiple, conflicting, and changing governmental laws and
                regulations;





·
            longer
                sales cycles; greater difficulty in collecting accounts
                receivable;





·
            import
                and export restrictions and
                tariffs;





·
            potentially
                weaker protection for our intellectual property than in the United
                States,
                and practical difficulties in enforcing such rights
                abroad;





·
            difficulties
                staffing and managing foreign
                operations;





·
            multiple
                conflicting tax laws and regulations;
                and





·
            political
                and economic instability.





Our
      international operations will also face foreign currency-related risks. To
      date,
      most of our revenues have been denominated in United States Dollars, but an
      increasing portion of our revenues may be denominated in foreign currencies.
      We
      do not engage in foreign exchange hedging activities, and therefore our
      international revenues and expenses may be subject to the risks of foreign
      currency fluctuations.





-42-










We
      must also customize our services and products for international markets. This
      process is much more complex than merely translating languages. For example,
      our
      ability to expand into international markets will depend on our ability to
      develop and support services and products that incorporate the tax laws,
      accounting practices, and currencies of applicable countries. Since a large
      part
      of our value proposition to customers is that our products have been developed
      with the peculiar needs of small businesses in mind, any variation in business
      practice from one country to another may substantially decrease the value of
      our
      products in that country unless we identify the important differences and
      customize our product to address the differences.




Our
      international operations also increase our exposure to international laws and
      regulations. If we cannot comply with foreign laws and regulations, which are
      often complex and subject to variation and unexpected changes, we could incur
      unexpected costs and potential litigation. For example, the governments of
      foreign countries might attempt to regulate our services and products or levy
      sales or other taxes relating to our activities. In addition, foreign countries
      may impose tariffs, duties, price controls or other restrictions on foreign
      currencies or trade barriers, any of which could make it more difficult for
      us
      to conduct our business in international markets.




We
      intend to expand our international sales and marketing activities and enter
      into
      relationships with additional international distribution partners. We are in
      the
      early stages of developing our indirect distribution channels in markets outside
      the United States. We may not be able to attract and retain distribution
      partners that will be able to market our products effectively.





**(11)
      We Do Not Have an Adequate History With Our Subscription Model to Predict the
      Rate of Customer Subscription Renewals and the Impact These Renewals Will Have
      on Our Revenue or Operating Results.**




We
      derive subscription fees primarily from our stand-alone e-Commerce application.
      At the end of 2005, we began to generate a small amount of revenue from
      subscriptions to our main portal. Our small business customers do not sign
      long-term contracts. Our customers have no obligation to renew their
      subscriptions for our services after the expiration of their initial
      subscription period and in fact, customers have often elected not to do so.
      In
      addition, our customers may renew for a lower-priced edition of our services
      or
      for fewer users. Many of our customers utilize our services without charge.
      We
      have limited historical data with respect to rates of customer subscription
      renewals for paying customers since the launch of and migration of one of our
      syndication partners our OneBiz SM platform, so we cannot accurately predict customer renewal rates. Our customers'
      renewal rates may decline or fluctuate as a result of a number of factors,
      including when we begin charging for our services, their dissatisfaction with
      our services and their ability to continue their operations and spending levels.
      The number of current subscribers to our main portal is less than the number
      of
      subscribers in mid-January 2006. If our customers do not renew their
      subscriptions for our services, or we are not able to increase the number of
      subscribers, our revenue may decline and our business will suffer.




**(12)
      We Depend on Corporate Partners to Market Our Products Through Their Web Sites
      and OEM or Integration Relationships Under Relatively Short-Term Agreements.
      Termination of These Agreements Could Cause a Substantial Decline in Our Revenue
      and a Substantial Increase in Customer Acquisition Costs.**




Approximately
      13% of total revenues during the first half of 2006, approximately 46% of total
      revenues during 2005, and approximately 93% of total revenues during 2004 were
      derived from syndication, integration and OEM agreements with short terms. Under
      these agreements, we both derive revenue and utilize the resources of our
      partners to reduce our customer acquisition costs. We anticipate that revenue
      from syndication, integration and OEM fees will not be a significant part of
      our
      business going forward. However, termination or non-renewal of any current
      agreements could cause a decline in our revenues and a substantial increase
      in
      customer acquisition costs.





-43-







We
      also depend on our syndication and integration partners, OEM relationships
      and
      referral relationships to offer products and services to a larger customer
      base
      than we can reach through direct sales, or other marketing efforts. We have
      not
      signed a new significant strategic partner relationship for the applications
      we
      sell via our OneBiz SM platform since the beginning of the second quarter of 2005. Our success depends
      in part on the ultimate success of our syndication and integration partners,
      OEM
      relationships and referral partners and their ability to market our products
      and
      services successfully. Our partners are not obligated to provide potential
      customers to us. In addition, some of these third parties have entered, and
      may
      continue to enter into, strategic relationships with our competitors. Further,
      many of our strategic partners have multiple strategic relationships, and they
      may not regard us as significant for their businesses. Our strategic partners
      may terminate their respective relationships with us, pursue other partnerships
      or relationships, or attempt to develop or acquire products or services that
      compete with our products or services. Our strategic partners also may interfere
      with our ability to enter into other desirable strategic relationships. If
      we
      are unable to maintain our existing strategic relationships or enter into
      additional strategic relationships, we will have to devote substantially more
      resources to the distribution, sales, and marketing of our products and
      services.




**(13)
      We Depend on Subscription Fees; Our Future Growth is Substantially Dependent
      on
      Customer Demand for Our Subscription Services Delivery Models. Failure to
      Increase This Revenue Could Harm Our Business.**




Subscription
      fees represented approximately 50% of our total revenues for the first nine
      months of 2006, 7.7% of our total revenues for 2005, and 6.2% of our total
      revenues for 2004. With the launch of our new applications and the acquisition
      of iMart, subscription fees represent a significant percentage of our total
      revenues and our future financial performance and revenue growth depends, in
      large part, upon the growth in customer demand for our outsourced services
      delivery models. As such, we have invested significantly in infrastructure,
      operations, and strategic relationships to support these models, which represent
      a significant departure from the delivery strategies that other software vendors
      and we have traditionally employed. To maintain positive margins for our small
      business services, our revenues will need to continue to grow more rapidly
      than
      the cost of such revenues. There can be no assurance that we will be able to
      maintain positive gross margins in our subscription services delivery models
      in
      future periods. If our subscription services business does not grow
      sufficiently, we could fail to meet expectations for our results of operations,
      which could harm our business.




Any
      delays in implementation may prevent us from recognizing subscription revenue
      for periods of time; even when we have already incurred costs relating to the
      implementation of our subscription services. Additionally, customers can cancel
      our subscription services contracts at any time and, as a result, we may
      recognize substantially less revenue than we expect. If large numbers of
      customers cancel or otherwise seek to terminate subscription agreements more
      quickly than we expect, our operating results could be substantially harmed.
      To
      become successful, we must cause subscribers who do not pay fees to begin paying
      fees and increase the length of time subscribers pay subscription
      fees.




**Risks
      Associated with Our Officers, Directors, Employees and
      Stockholders**




**(14)
      Our Executive Management Team Is Critical to the Execution of Our Business
      Plan
      and the Loss of Their Services Could Severely Impact Negatively on Our Business;
      We Need to Attract Independent Members to Join Our Board of
      Directors.**




Our
      success depends significantly on the continued services of our management
      personnel, including Michael Nouri, who is President and Chief Executive
      Officer, and Henry Nouri, our Executive Vice President. Losing any one of our
      officers could seriously harm our business. Competition for executives is
      intense. If we had to replace any of our officers, we would not be able to
      replace the significant amount of knowledge that they have about our operations.
      All of our executive team work at the same location, which could make us
      vulnerable to loss of our entire management team in the event of a natural
      or
      other disaster. We do not maintain key man insurance policies on
      anyone.





-44-








In
      addition, in March 2006, our Board of Directors authorized its Audit Committee
      to conduct an internal investigation of matters relating to the SEC suspension
      and investigation. Final findings of the independent outside legal counsel
      were
      shared with the full Board of Directors on July 7, 2006. As one result of these
      findings, Mr. Jeffrey LeRose was appointed to the position of non-executive
      Chairman of the Board of Directors. Mr. Nouri stepped down as Chairman of the
      Board of Directors, but will continue to serve as our President, Chief Executive
      Officer and as a member of the Board of Directors. This internal investigation
      placed considerable time demands upon our independent directors. After the
      end
      our fiscal year, two of our directors resigned because of the time commitments
      required to adequately perform their duties as a directors. As of November
      1,
      2006, we had three directors, only one of whom is independent. Therefore, we
      are
      continuing our search for additional independent directors with public company
      experience and financial expertise to add to our Board of Directors. However,
      given the unresolved status of the SEC matter, there can be no guarantee that
      we
      will be able to attract independent directors to join the Board of
      Directors.





The
      SEC matter may result in the loss of services of one or more of our officers
      or
      directors, and it and the Audit Committee investigation have resulted in changes
      to our internal controls and procedures as set forth in Item 9A of our 2005
      Annual Report. Any such change may have a material adverse impact on our
      business.




**(15)
      Officers, Directors and Principal Stockholders Control Us. This Might Lead
      Them
      to Make Decisions That Do Not Benefit the Interests of Minority
      Stockholders.**




Our
      officers, directors and principal stockholders beneficially own or control
      a
      significant portion of our outstanding stock. As a result, these persons, acting
      together, will have the ability to control substantially all matters submitted
      to our stockholders for approval (including the election and removal of
      directors and any merger, consolidation or sale of all or substantially all
      of
      our assets) and to control our management and affairs. Accordingly, this
      concentration of ownership may have the effect of delaying, deferring or
      preventing a change in control of us, impeding a merger, consolidation, takeover
      or other business combination involving us or discouraging a potential acquiror
      from making a tender offer or otherwise attempting to obtain control of us,
      which in turn could materially and adversely affect the market price of our
      common stock.




**Regulatory
      Risks**




**(16)
      Compliance With New Regulations Governing Public Company Corporate Governance
      and Reporting Is Uncertain and Expensive.**




As
      a public company, we have incurred and will incur significant legal, accounting
      and other expenses that we did not incur as a private company. We will incur
      costs associated with our public company reporting requirements. We also
      anticipate that we will incur costs associated with recently adopted corporate
      governance requirements, including requirements under the Sarbanes-Oxley Act
      of
      2002, the changes in our internal controls and procedures, as well as new rules
      implemented by the SEC and the NASD. We expect these rules and regulations
      to
      increase our legal and financial compliance costs and to make some activities
      more time consuming and costly. Any unanticipated difficulties in preparing
      for
      and implementing these reforms could result in material delays in complying
      with
      these new laws and regulations or significantly increase our costs. Our ability
      to fully comply with these new laws and regulations is also uncertain. Our
      failure to timely prepare for and implement the reforms required by these new
      laws and regulations could significantly harm our business, operating results,
      and financial condition. We also expect these new rules and regulations may
      make
      it more difficult and more expensive for us to obtain director and officer
      liability insurance and we may be required to accept reduced policy limits
      and
      coverage or incur substantially higher costs to obtain the same or similar
      coverage. As a result, it may be more difficult for us to attract and retain
      qualified individuals to serve on our Board of Directors or as executive
      officers. We are currently evaluating and monitoring developments with respect
      to these new rules. We have also incurred, and may continue to incur,
      substantial additional professional fees and expenses associated with the SEC's
      suspension of trading of our securities in January 2006, and with the internal
      investigation authorized by our Board of Directors in March 2006. Although
      our
      insurance carrier has paid a portion of these fees, not all such fees and
      expenses will be covered by our insurance.





-45-








By
      the
      end of fiscal 2007, we are required to comply with the Sarbanes-Oxley Act of
      2002 requirements involving the assessment of our internal control over
      financial reporting and our independent accountants’ audit of that assessment.
      In March 2006, we retained a new Chief Financial Officer.  His
      review of our internal control over financial reporting to date and the final
      findings of our Audit Committee investigation have identified several
      deficiencies in our internal control over financial reporting. While we have
      made some progress on this remediation effort, we continue to work on addressing
      all the issues raised in these findings. Although we believe our on-going review
      and testing of our internal control over financial reporting will enable us
      to
      be compliant with these requirements, we have identified some deficiencies
      and
      may identify others
      that we may not be able to remediate and test by the end of fiscal 2007. If
      we
      cannot assess our internal controls over financial reporting as effective,
      or
      our external auditors are unable to provide an unqualified attestation report
      on
      such assessment, our stock price could decline.





**(17)
      The SEC Suspension of Trading of Our Securities Has Damaged Our Business, and
      It
      Could Damage Our Business in the Future.**





The
      suspension of trading by the SEC has already harmed our business in many ways,
      and may cause further harm in the future. In part, we have experienced a
      decreased ability to raise financing due to the lack of liquidity of our stock
      and to questions raised by the SEC's action. Our decreased ability to raise
      financing has already prevented us from making the investments we need to make
      in sales and marketing and may in the future cause us to reduce research and
      development. Legal and other fees related to the SEC's action also reduce our
      cash flow. Reduced cash flow jeopardizes our ability to make the installment
      payments required by the agreements to acquire iMart. The time spent by our
      management team and directors dealing with issues related to the SEC action
      also
      detracts from the time they spend on our operations. Since the commencement
      of
      the SEC action and the related Audit Committee investigation, two of our
      independent Board members have resigned due to the time commitments required
      to
      adequately perform their Board duties. One of these Board members was our Audit
      Committee's chairman and our Audit Committee financial expert. We are currently
      conducting a search for additional independent directors, but there can be
      no
      assurance that we will attract new independent directors. Finally, an important
      part of our business plan is to enter into private label syndication agreements
      with large companies. The SEC's action and related matters has caused us to
      be a
      less attractive partner for large companies and has caused us to lose important
      opportunities. The SEC's action and related matters may cause other problems
      in
      our operations.





**Item
      2.** **** **UNREGISTEREDSALES
      OF EQUITY SECURITIES AND USE OF
      PROCEEDS**





On
      July 6, 2006, we sold 100,000 shares of our common stock to the Blueline Fund
      (“Blueline”), an existing stockholder, for a price of $2.50 per share resulting
      in gross proceeds of $250,000. We incurred immaterial issuance costs related
      to
      this stock sale.





The
      shares were issued directly by us pursuant to an offering and sale exemption
      from registration under the Securities Act of 1933, as amended, pursuant to
      Section 4(2) of the Act and Rule 506 of Regulation D promulgated thereunder,
      as
      the sale was not a transaction involving a public offering. We gave Blueline
      the
      opportunity to ask questions and receive answers concerning the terms and
      conditions of the transaction and to obtain any additional information which
      we
      possessed or could obtain without unreasonable effort or expense that is
      necessary to verify the information furnished. We advised Blueline of
      limitations on resale, and neither we nor any person acting on our behalf sold
      the securities by any means of general solicitation or general
      advertising.





In
      August 2006, we sold an aggregate of 100,000 shares of our common stock to
      Blueline and Philippe Pouponnot, for a price of $2.50 per share, resulting
      in
      gross proceeds of $250,000. The Company incurred immaterial issuance costs
      related to these stock sales.





The
      shares were issued directly by us pursuant to an offering and sale exemption
      from registration under the Securities Act of 1933, as amended, pursuant to
      Section 4(2) of the Act and Rule 506 of Regulation D promulgated thereunder,
      as
      the sale was not a transaction involving a public offering. We gave Blueline
      the
      opportunity to ask questions and receive answers concerning the terms and
      conditions of the transaction and to obtain any additional information which
      we
      possessed or could obtain without unreasonable effort or expense that is
      necessary to verify the information furnished. We advised Blueline of
      limitations on resale, and neither we nor any person acting on our behalf sold
      the securities by any means of general solicitation or general
      advertising.





-46-











For
      a
      more complete description of these sales, please see our Current Reports on
      Form
      8-K, filed on July 11 and August 22, 2006, which are hereby incorporated by
      reference herein.





**Item
      6.** **** **EXHIBITS**




The
      following exhibits have been or are being filed herewith and are numbered in
      accordance with Item 601 of Regulation S-K:





Exhibit
                No.
            Description2.1
            Asset
                Purchase Agreement, dated September 30, 2006, by and between Alliance
                Technologies, Inc., Smart CRM, Inc., and Smart Online,
                Inc.10.1
            Form
                of Subscription Agreement, Subscriber Rights Agreement, and Dribble
                Out
                Agreement, dated July 6, 2006, by and between Smart Online, Inc.
                and Atlas
                Capital, S.A. (incorporated herein by reference to Exhibit 10.36
                to our
                Annual Report on Form 10-K, as filed with the SEC on July 11,
                2006)10.2
            Form
                of Subscription Agreement, Subscriber Rights Agreement, and Dribble
                Out
                Agreement, dated August 17 and 21, 2006, by and between Smart Online,
                Inc.
                and certain investors10.3
            Smart
                Online, Inc. Revised Board Compensation Policy, effective August
                1,
                2006.31.1
            Certification
                of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as Adopted
                Pursuant to Section 302 of the Sarbanes-Oxley Act of
                200231.2
            Certification
                of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as Adopted
                Pursuant to Section 302 of the Sarbanes-Oxley Act of
                200232.1
            Certification
                of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
                Adopted
                Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit
                is
                being furnished pursuant to Section 905 of the Sarbanes-Oxley Act
                of 2002
                and shall not, except to the extent required by that Act, be deemed
                to be
                incorporated by reference into any document or filed herewith for
                the
                purposes of liability under the Securities Exchange Act of 1934,
                as
                amended, or the Securities Act of 1933, as amended, as the case may
                be.32.2
            Certification
                of Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350,
                as
                Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                This
                exhibit is being furnished pursuant to Section 905 of the Sarbanes-Oxley
                Act of 2002 and shall not, except to the extent required by that
                Act, be
                deemed to be incorporated by reference into any document or filed
                herewith
                for the purposes of liability under the Securities Exchange Act of
                1934,
                as amended, or the Securities Act of 1933, as amended, as the case
                may
                be.








-47-





**SIGNATURES**





Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.





Dated:
      November 14, 2006








**Smart
                Online, Inc.**/s/ Michael
                Nouri**Michael Nouri****Principal Executive Officer****Smart
                Online, Inc.**/s/ Nicholas
                Sinigaglia**Nicholas Sinigaglia****Principal Financial Officer and****Principal Accounting Officer**























-48-





**SMART
      ONLINE, INC.**


**EXHIBIT
      INDEX**








Exhibit
                No.
            Description2.1
            Asset
                Purchase Agreement, dated September 30, 2006, by and between Alliance
                Technologies, Inc., Smart CRM, Inc., and Smart Online,
                Inc.10.1
            Form
                of Subscription Agreement, Subscriber Rights Agreement, and Dribble
                Out
                Agreement, dated July 6, 2006, by and between Smart Online, Inc.
                and Atlas
                Capital, S.A. (incorporated herein by reference to Exhibit 10.36
                to our
                Annual Report on Form 10-K, as filed with the SEC on July 11,
                2006)10.2
            Form
                of Subscription Agreement, Subscriber Rights Agreement, and Dribble
                Out
                Agreement, dated August 17 and 21, 2006, by and between Smart Online,
                Inc.
                and certain investors10.3
            Smart
                Online, Inc. Revised Board Compensation Policy, effective August
                1,
                2006.31.1
            Certification
                of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as Adopted
                Pursuant to Section 302 of the Sarbanes-Oxley Act of
                200231.2
            Certification
                of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as Adopted
                Pursuant to Section 302 of the Sarbanes-Oxley Act of
                200232.1
            Certification
                of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
                Adopted
                Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit
                is
                being furnished pursuant to Section 905 of the Sarbanes-Oxley Act
                of 2002
                and shall not, except to the extent required by that Act, be deemed
                to be
                incorporated by reference into any document or filed herewith for
                the
                purposes of liability under the Securities Exchange Act of 1934,
                as
                amended, or the Securities Act of 1933, as amended, as the case may
                be.32.2
            Certification
                of Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350,
                as
                Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                This
                exhibit is being furnished pursuant to Section 905 of the Sarbanes-Oxley
                Act of 2002 and shall not, except to the extent required by that
                Act, be
                deemed to be incorporated by reference into any document or filed
                herewith
                for the purposes of liability under the Securities Exchange Act of
                1934,
                as amended, or the Securities Act of 1933, as amended, as the case
                may
                be.












50