**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, 2008**





**OR**





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





**Commission
      File Number: 001-32634**





**SMART
      ONLINE, INC.**


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








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





**4505
                Emperor Blvd., Ste. 320**
              **Durham,
                North Carolina**
            **27703****(Address
                of principal executive offices)**
            **(Zip
                Code)**





**(919)
      765-5000**


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





**2530
      Meridian Parkway, 2** **nd** **Floor, Durham, North Carolina 27713**


**(Former
      name, former address and former fiscal year, if changed since last
      report)**





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, a non-accelerated filer, or a smaller reporting company.
      See
      the definitions of “large accelerated filer,” “accelerated filer” and “smaller
      reporting company” in Rule 12b-2 of the Exchange Act.





Large accelerated filer
            o
            Accelerated filer
            oNon-accelerated filer
            o(Do not check if a smaller reporting company)
            Smaller reporting company
            x





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 10, 2008, there were approximately 18,408,723 shares of the
      registrant’s common stock, par value $0.001 per share,
      outstanding.





**SMART
      ONLINE, INC.**





**FORM
      10-Q**


For
      the
      Quarterly Period Ended September 30, 2008





**TABLE
      OF CONTENTS**





Page No.**PART
                I  – FINANCIAL INFORMATION**Item
                1.
            Financial
                StatementsConsolidated
                Balance Sheets as of September 30, 2008 (unaudited) and December
                31,
                2007
            3Consolidated
                Statements of Operations (unaudited) for the three and nine months
                ended
                September 30, 2008 and 2007
            4Consolidated
                Statements of Cash Flows (unaudited) for the nine months ended September
                30, 2008 and 2007
            5Notes
                to Consolidated Financial Statements (unaudited)
            6Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            18Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            30Item
                4.
            Controls
                and Procedures
            30Item
                4T.
            Controls
                and Procedures
            30**PART
                II  – OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            31Item
                1A.
            Risk
                Factors
            32Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            38Item
                5.
            Other
                Information
            38Item
                6.
            Exhibits
            40Signatures
            42


2


**PART
      I  – FINANCIAL INFORMATION**





**Item
      1.**   **Financial
      Statements**





**SMART
      ONLINE, INC.**


**CONSOLIDATED
      BALANCE SHEETS**


**September 30,**
                **2008**
                **(unaudited)**
              
              **December 31,**
                **2007****ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              30,751
              
              $
              3,473,959Accounts
                  receivable, net
              
              
              483,302
              
              
              815,102Contract
                  receivable, net
              
              
              160,000
              
              
              -Note
                  receivable
              
              
              60,000
              
              
              55,000Prepaid
                  expenses
              
              
              339,982
              
              
              90,886Deferred
                  financing costs
              
              
              -
              
              
              301,249Total
                  current assets
              
              
              1,074,035
              
              
              4,736,196Property
                  and equipment, net
              
              
              373,473
              
              
              174,619Capitalized
                  software, net
              
              
              120,191
              
              
              -Contract
                  receivable, net, non-current
              
              
              25,033
              
              
              -Note
                  receivable, non-current
              
              
              368,236
              
              
              225,000Prepaid
                  expenses, non-current
              
              
              295,201
              
              
              -Intangible
                  assets, net
              
              
              2,328,092
              
              
              2,882,055Goodwill
              
              
              2,696,642
              
              
              2,696,642Other
                  assets
              
              
              23,651
              
              
              60,311TOTAL
                  ASSETS
              
              $
              7,304,554
              
              $
              10,774,823**LIABILITIES
                  AND STOCKHOLDERS’ EQUITY (DEFICIT)**Current
                  liabilities:Accounts
                  payable
              
              $
              639,206
              
              $
              628,370Notes
                  payable
              
              
              1,606,981
              
              
              2,287,682Deferred
                  revenue
              
              
              164,459
              
              
              329,805Accrued
                  liabilities
              
              
              477,647
              
              
              603,338Total
                  current liabilities
              
              
              2,888,293
              
              
              3,849,195Long-term
                  liabilities:Notes
                  payable
              
              
              4,834,136
              
              
              3,313,903Deferred
                  revenue
              
              
              81,972
              
              
              247,312Total
                  long-term liabilities
              
              
              4,916,108
              
              
              3,561,215Total
                  liabilities
              
              
              7,804,401
              
              
              7,410,410Commitments
                  and contingenciesStockholders’
                  equity (deficit):Common
                  stock, $0.001 par value, 45,000,000 shares authorized, 18,410,389
                  and
                  18,159,768 shares issued and outstanding at September 30, 2008
                  and
                  December 31, 2007, respectively
              
              
              18,410
              
              
              18,160Additional
                  paid-in capital
              
              
              66,863,031
              
              
              66,202,179Accumulated
                  deficit
              
              
              (67,381,288
              )
              
              (62,855,926
              )Total
                  stockholders’ equity (deficit)
              
              
              (499,847
              )
              
              3,364,413TOTAL
                  LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
              
              $
              7,304,554
              
              $
              10,774,823





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


3


**SMART
      ONLINE, INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**(unaudited)**




**Three Months Ended**
            
            **Nine Months Ended****September 30,**
              **2008**
            
            **September 30,**
              **2007**
            
            **September 30,**
              **2008**
            
            **September 30,**
              **2007**REVENUES:Subscription
                fees
            
            $
            642,880
            
            $
            830,660
            
            $
            2,132,787
            
            $
            2,040,243Professional
                service fees
            
            
            620,826
            
            
            378,068
            
            
            2,129,710
            
            
            984,548License
                fees
            
            
            291,250
            
            
            200,000
            
            
            395,000
            
            
            480,000Other
                revenue
            
            
            31,412
            
            
            20,467
            
            
            77,387
            
            
            70,720Total
                revenues
            
            $
            1,586,368
            
            $
            $1,429,195
            
            $
            4,734,884
            
            $
            3,575,511COST
                OF REVENUES
            
            $
            223,569
            
            $
            168,035
            
            $
            636,430
            
            $
            355,942GROSS
                PROFIT
            
            $
            1,362,799
            
            $
            1,261,160
            
            $
            4,098,454
            
            $
            3,219,569OPERATING
                EXPENSES:General
                and administrative
            
            
            1,246,207
            
            
            1,398,170
            
            
            3,823,099
            
            
            3,567,385Sales
                and marketing
            
            
            709,906
            
            
            635,201
            
            
            2,137,375
            
            
            1,563,653Research
                and development
            
            
            941,067
            
            
            636,780
            
            
            2,547,439
            
            
            1,908,644Total
                operating expenses
            
            $
            2,897,180
            
            $
            2,670,151
            
            $
            8,507,913
            
            $
            7,039,682LOSS
                FROM OPERATIONS
            
            
            (1,534,381
            )
            
            (1,408,991
            )
            
            (4,409,459
            )
            
            (3,820,113
            )OTHER
                INCOME (EXPENSE):Interest
                expense, net
            
            
            (150,510
            )
            
            (139,124
            )
            
            (519,746
            )
            
            (400,910
            )Legal
                reserve and debt forgiveness, net
            
            
            -
            
            
            (39,477
            )
            
            -
            
            
            (34,877
            )Gain
                on legal settlements, net
            
            
            291,407
            
            
            -
            
            
            386,710
            
            
            -Other
                income
            
            
            1,064
            
            
            24,866
            
            
            17,133
            
            
            168,672Total
                other income (expense)
            
            $
            141,961
            
            $
            (153,735
            )
            $
            (115,903
            )
            $
            (267,115
            )NET
                LOSS
            
            $
            (1,392,420
            )
            
            (1,562,726
            )
            $
            (4,525,362
            )
            $
            (4,087,228
            )NET
                LOSS PER COMMON SHARE:Basic
                and fully diluted
            
            $
            (0.08
            )
            
            (0.09
            )
            
            (0.25
            )
            
            (0.24
            )WEIGHTED-AVERAGE
                NUMBER OF SHARES USED IN COMPUTING NET LOSS PER COMMON
                SHARE:Basic
                and fully diluted
            
            
            18,378,940
            
            
            17,292,639
            
            
            18,282,180
            
            
            17,002,827




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


4


**SMART
      ONLINE, INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(unaudited)**





**Nine Months**
              **Ended**
              **September 30,**
              **2008**
            
            **Nine Months**
              **Ended**
              **September 30,**
              **2007**CASH FLOWS FROM OPERATING ACTIVITIES:Net
                loss
            
            $
            (4,525,362
            )
            $
            (4,087,228
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            638,930
            
            
            631,267Amortization
                of deferred financing costs
            
            
            301,249
            
            
            320,083Provision
                for accounts and contract receivable allowances
            
            
            266,875
            
            
            -Stock-based
                compensation
            
            
            341,722
            
            
            574,343Registration
                rights penalty
            
            
            -
            
            
            (320,632
            )Gain
                on debt forgiveness
            
            
            -
            
            
            (215,123
            )Gain
                on disposal of assets
            
            
            (3,729
            )
            
            -Changes
                in assets and liabilities:Accounts
                receivable
            
            
            (120,108
            )
            
            (716,154
            )Notes
                receivable
            
            
            (148,236
            )
            
            (280,000
            )Prepaid
                expenses
            
            
            (544,297
            )
            
            (18,634
            )Other
                assets
            
            
            36,660
            
            
            (32,271
            )Deferred
                revenue
            
            
            (330,686
            )
            
            410,179Accounts
                payable
            
            
            10,836
            
            
            85,290Accrued
                and other expenses
            
            
            96,189
            
            
            329,643Net
                cash used in operating activities
            
            $
            (3,979,957
            )
            $
            (3,319,237
            )CASH
                FLOWS FROM INVESTING ACTIVITIES:Purchases
                of furniture and equipment
            
            
            (293,656
            )
            
            (86,549
            )Purchase
                of trade name
            
            
            -
            
            
            (2,033
            )Proceeds
                from sale of furniture and equipment
            
            
            13,564
            
            
            -Capitalized
                software
            
            
            (120,191
            )
            
            -Net
                cash used in investing activities
            
            $
            (400,283
            )
            $
            (88,582
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Repayments
                on notes payable
            
            
            (5,022,392
            )
            
            (1,784,272
            )Debt
                borrowings
            
            
            5,861,924
            
            
            1,472,850Issuance
                of common stock
            
            
            97,500
            
            
            5,748,607Expenses
                related to Form S-1 filing
            
            
            -
            
            
            (128,244
            )Net
                cash provided by (used in) financing activities
            
            $
            937,032
            
            $
            5,308,941NET
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            $
            (3,443,208
            )
            $
            1,901,122CASH
                AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            3,473,959
            
            
            326,905CASH
                AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            30,751
            
            $
            2,228,027Supplemental
                disclosures of cash flow information:Cash
                paid during the period for:Interest
            
            $
            243,168
            
            $
            247,400Taxes
            
            $
            38,905
            
            $
            -Supplemental
                schedule of non-cash financing activities:Conversion
                of debt to equity
            
            $
            228,546
            
            $
            -Shares
                issued in settlement of registration rights penalties
            
            $
            -
            
            $
            144,351





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


5


**SMART
      ONLINE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(unaudited)**





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





***Description
      of Business*** -
      Smart
      Online, Inc. (the “Company”) was incorporated in the State of Delaware in 1993.
      The Company develops
      and markets software products and services targeted to small businesses that
      are
      delivered via a Software-as-a-Service (“SaaS”) model. The Company sells its SaaS
      products and services primarily through private-label marketing partners. In
      addition, the Company provides website consulting services, primarily in the
      e-commerce retail industry. The Company maintains a website for potential
      partners containing certain corporate information located at
      www.smartonline.com.





***Basis
      of Presentation*** -
      The
      financial statements as of and for the three and nine months ended September
      30,
      2008 and 2007 included in this Quarterly Report on Form 10-Q are unaudited.
      The
      balance sheet as of December 31, 2007 is obtained from the audited financial
      statements as of that date. The accompanying statements should be read in
      conjunction with the audited financial statements and related notes, together
      with management’s discussion and analysis of financial condition and results of
      operations, contained in the Company’s Annual Report on Form 10-K for the year
      ended December 31, 2007 filed with the Securities and Exchange Commission (the
      “SEC”) on March 25, 2008 (the “2007 Annual Report”).





The
      financial statements have been prepared in accordance with accounting principles
      generally accepted in the United States (“U.S. GAAP”). In the opinion of the
      Company’s management, the unaudited statements in this Quarterly Report on Form
      10-Q include all normal and recurring adjustments necessary for the fair
      presentation of the Company’s statement of financial position as of September
      30, 2008, and its results of operations and cash flows for the three and nine
      months ended September 30, 2008 and 2007. The results for the three and nine
      months ended September 30, 2008 are not necessarily indicative of the results
      to
      be expected for the fiscal year ending December 31, 2008.




***Significant
      Accounting Policies*** -
      In the
      opinion of the Company’s management, the significant accounting policies used
      for the three and nine months ended September 30, 2008 are consistent with
      those
      used for the years ended December 31, 2007 and 2006. Accordingly, please refer
      to the 2007 Annual Report for the Company’s significant accounting
      policies.





***Reclassifications*** -
      Certain
      prior year and comparative period amounts have been reclassified to conform
      to
      current year presentation. These reclassifications had no effect on previously
      reported net income or stockholders’ equity.





***Principles
      of Consolidation*** *-* The
      accompanying consolidated financial statements include the accounts of the
      Company and its wholly-owned subsidiaries, Smart CRM, Inc. (“Smart CRM”) and
      Smart Commerce, Inc. (“Smart Commerce”). All significant intercompany accounts
      and transactions have been eliminated. Subsidiary accounts are included only
      from the date of acquisition forward.





***Revenue
      Recognition*** -
      The
      Company derives revenue primarily from subscription fees charged to customers
      accessing its SaaS applications; the perpetual or term licensing of software
      platforms or applications; and professional services, consisting of consulting,
      development, hosting, and maintenance services. These arrangements may include
      delivery in multiple-element arrangements if the customer purchases a
      combination of products and/or services. Because the Company licenses, sells,
      leases, or otherwise markets computer software, it uses the residual method
      pursuant to American Institute of Certified Public Accountants (“AICPA”)
      Statement of Position 97-2, *Software Revenue Recognition* (“SOP
      97-2”), as amended. This method allows the Company to recognize revenue for a
      delivered element when such element has vendor specific objective evidence
      (“VSOE”) of the fair value of the delivered element. If VSOE cannot be
      determined or maintained for an element, it could impact revenues as all or
      a
      portion of the revenue from the multiple-element arrangement may need to be
      deferred.





If
      multiple-element arrangements involve significant development, modification,
      or
      customization or if it is determined that certain elements are essential to
      the
      functionality of other elements within the arrangement, revenue is deferred
      until all elements necessary to the functionality are provided by the Company
      to
      a customer. The determination of whether the arrangement involves significant
      development, modification, or customization could be complex and require the
      use
      of judgment by management.


6


Under
      SOP
      97-2, provided the arrangement does not require significant development,
      modification, or customization, revenue is recognized when all of the following
      criteria have been met:





1.  persuasive
      evidence of an arrangement exists





2.  delivery
      has occurred





3.  the
      fee
      is fixed or determinable





4.  collectibility
      is probable





If
      at the
      inception of an arrangement the fee is not fixed or determinable, revenue is
      deferred until the arrangement fee becomes due and payable. If collectibility
      is
      deemed not probable, revenue is deferred until payment is received or collection
      becomes probable, whichever is earlier. The determination of whether fees are
      collectible requires judgment of management, and the amount and timing of
      revenue recognition may change if different assessments are made.





Under
      the
      provisions of Emerging Issues Task Force Issue No. 00-21, *Revenue
      Arrangements with Multiple Deliverables* ,
      consulting, website design fees, and application development services are accounted for separately from the license of associated
      software platforms when these services have value to the customer and there
      is
      objective and reliable evidence of fair value of each deliverable. When
      accounted for separately, revenues are recognized as the services are rendered
      for time and material contracts, and when milestones are achieved and accepted
      by the customer for fixed-price or long-term contracts. The majority of the
      Company’s consulting service contracts are on a time and material basis and are
      typically billed monthly based upon standard professional service
      rates.





Application
      development services are typically fixed price and of a longer term. As such,
      they are accounted for as long-term construction contracts that require revenue
      recognition to be based on estimates involving total costs to complete and
      the
      stage of completion. The assumptions and estimates made to determine the total
      costs and stage of completion may affect the timing of revenue recognition,
      with
      changes in estimates of progress to completion and costs to complete accounted
      for as cumulative catch-up adjustments. If the criteria for revenue recognition
      on construction-type contracts are not met, the associated costs of such
      projects are capitalized and included in costs in excess of billings on the
      balance sheet until such time that revenue recognition is
      permitted.





Subscription
      fees primarily consist of sales of subscriptions through private-label marketing
      partners to end users. We typically have a revenue share arrangement with these
      private-label marketing partners in order to encourage them to market our
      products and services to their customers. Subscriptions are generally payable
      on
      a monthly basis and are typically paid via credit card of the individual end
      user or the aggregating entity. Any payments received in advance of the
      subscription period are accrued as deferred revenue and amortized over the
      subscription period.





Because
      our customers generally do not have the contractual right to take possession
      of
      the software we license or market at any time, we recognize revenue on hosting
      and maintenance fees as the services are provided in accordance with Emerging
      Issues Task Force Issue No. 00-3, *Application
      of AICPA Statement of Position 97-2 to Arrangements That Include the Right
      to
      Use Software Stored on Another Entity’s Hardware* .





***Fiscal
      Year*** -
      The
      Company’s fiscal year ends December 31. References to fiscal 2007, for example,
      refer to the fiscal year ending December 31, 2007.




***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 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.





***Software
      Development Costs*** -
      Statement of Financial Accounting Standards (“SFAS”) No. 86, *Accounting
      for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed* (“SFAS
      No. 86”), requires capitalization of certain software development costs
      subsequent to the establishment of technological feasibility, with costs
      incurred prior to this time expensed as research and development. Technological
      feasibility is established when all planning, designing, coding, and testing
      activities that are necessary to establish that the product can be produced
      to
      meet its design specifications have been completed. Historically, the Company
      had not developed detailed design plans for its SaaS applications, and the
      costs
      incurred between the completion of a working model of these applications and
      the
      point at which the products were ready for general release had been
      insignificant. These factors, combined with the historically low revenue
      generated by the sale of the applications that do not support the net realizable
      value of any capitalized costs, resulted in the continued expensing of
      underlying costs as research and development.


7


Beginning
      in May 2008, the Company determined that it was strategically desirable to
      develop an industry standard platform and enhance the current SaaS applications.
      A detailed design plan indicated that the product was technologically feasible,
      and in July 2008, development commenced. All related costs from that point
      in
      time are being capitalized in accordance with SFAS No. 86.





***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 comparing 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 as the
      amount by which the carrying amount of the assets exceeds the fair value of
      the
      assets. Assets to be disposed are reported at the lower of the carrying amount
      or fair value less costs to sell.





***Advertising
      Costs*** - The
      Company expenses all advertising costs as they are incurred. The amounts charged
      to sales and marketing expense during the third quarter of 2008 and 2007 were
      $7,795 and $11,133, respectively. During the first nine months of 2008 and
      2007,
      these amounts were $20,205 and $26,802, respectively.





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





***Stock-Based
      Compensation*** ** - ** The
      Company adopted SFAS No. 123 (revised 2004), *Share-Based
      Payment* (“SFAS
      No. 123R”), which requires companies to expense the value of employee stock
      options, restricted stock, and similar awards and applies to all such securities
      outstanding and vested.





In
      computing the impact of stock-based compensation expense, the fair value of
      each
      award is estimated on the date of grant based on the Black-Scholes
      option-pricing model utilizing certain assumptions for a risk-free interest
      rate, volatility, and expected remaining lives of the awards. The assumptions
      used in calculating the fair value of share-based payment awards represent
      management’s best estimates, but these estimates involve inherent uncertainties
      and the application of management’s judgment. As a result, if factors change and
      the Company uses different assumptions, the Company’s stock-based compensation
      expense could be materially different in the future. In addition, the Company
      is
      required to estimate the expected forfeiture rate and only recognize expense
      for
      those shares expected to vest. In estimating the Company’s forfeiture rate, the
      Company analyzed its historical forfeiture rate, the remaining lives of unvested
      options, and the amount of vested options as a percentage of total options
      outstanding. If the Company’s actual forfeiture rate is materially different
      from its estimate, or if the Company reevaluates the forfeiture rate in the
      future, the stock-based compensation expense could be significantly different
      from what the Company has recorded in the current period.





The
      following is a summary of the Company’s stock-based compensation expense for the
      periods indicated:


8





**Three
                Months Ended**
            
            **Nine
                Months Ended****September 30,**
              **2008**
            
            **September 30,**
              **2007**
            
            **September 30,**
              **2008**
            
            **September 30,**
              **2007**Compensation
                expense included in G&A expense related to stock
                options
            
            $
            30,995
            
            $
            146,860
            
            $
            106,199
            
            $
            458,328Compensation
                expense included in G&A expense related to restricted stock
                awards
            
            
            50,583
            
            
            47,466
            
            
            235,523
            
            
            116,016Total
                SFAS No. 123R expense
            
            $
            81,578
            
            $
            194,326
            
            $
            341,722
            
            $
            574,344





The
      fair
      value of option grants under the Company’s equity compensation plan and other
      stock option issuances during the three months and nine months ended September
      30, 2008 and 2007 were estimated using the Black-Scholes option-pricing model
      with the following weighted-average assumptions:


**Three Months Ended**
              
              **Nine Months Ended****September 30,**
                **2008**
              
              **September 30,**
                **2007**
              
              **September 30,**
                **2008**
              
              **September 30,**
                **2007**Dividend
                  yield
              
              
              0.0
              %
              
              0.0
              %
              
              0.0
              %
              
              0.0
              %Expected
                  volatility
              
              
              40
              %
              
              150
              %
              
              46
              %
              
              150
              %Risk-free
                  interest rate
              
              
              4.39
              %
              
              4.59
              %
              
              4.43
              %
              
              4.59
              %Expected
                  lives (years)
              
              
              4.3
              
              
              4.5
              
              
              4.4
              
              
              4.6





The
      expected lives of the options represent the estimated period of time until
      exercise or forfeiture and are based on historical experience of similar awards.
      Expected volatility is partially based on the historical volatility of the
      Company’s common stock since the end of the prior fiscal year as well as
      management’s expectations for future volatility. The risk-free interest rate is
      based on the published yield available on U.S. treasury issues with an
      equivalent term remaining equal to the expected life of the option.





The
      following is a summary of the stock option activity for the nine months ended
      September 30, 2008:





**Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**BALANCE,
                December 31, 2007
            
            
            1,644,300
            
            $
            5.07Granted
            
            
            35,000
            
            
            3.19Forfeited
            
            
            (1,036,400
            )
            
            5.80Exercised
            
            
            (325,000
            )
            
            1.40BALANCE,
                September 30, 2008
            
            
            317,900
            
            $
            6.22





***Recently
      Issued Accounting Pronouncements*** -
      In
      April 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
      Position No. 142-3, *Determination
      of the Useful Life of Intangible Assets* (“FSP
      142-3”). The standard requires entities to consider their own historical
      experience in renewing or extending similar arrangements when developing
      assumptions regarding the useful lives of intangible assets and also mandates
      certain related disclosure requirements. FSP 142-3 is effective for fiscal
      years
      beginning after December 15, 2008, with early adoption prohibited. The
      Company is currently evaluating the impact of the pending adoption of FSP 142-3
      on its consolidated financial statements.





All
      other
      new and recently issued, but not yet effective, accounting pronouncements have
      been deemed to be not relevant to the Company and therefore are not expected
      to
      have any impact once adopted.


9


**2.**  **SEGMENT
      INFORMATION**





Prior
      to
      2008, the Company operated as two segments. During late 2007 and the first
      quarter of 2008, management realigned certain production and development
      functions and eliminated redundant administrative functions and now reports
      the
      consolidated business as a single business segment. The Company’s chief
      operating decision maker is its Chief Executive Officer, who reviews financial
      information presented on a consolidated basis. Accordingly, in accordance with
      SFAS No. 131, *Disclosures
      about Segments of an Enterprise and Related Information* ,
      the
      Company has determined that it has a single reporting segment and operating
      unit
      structure, specifically the provision of an on-demand suite of integrated
      business management software services.





During
      2007, the two segments were the Company’s core operations (the “Smart Online
      segment”) and the operations of the Company’s wholly-owned subsidiary Smart
      Commerce (the “Smart Commerce segment”). The Smart Online segment generated
      revenues from the development and distribution of Internet-delivered SaaS small
      business applications through a variety of subscription, integration, and
      syndication channels. The Smart Commerce segment derived its revenues primarily
      from subscriptions to the Company’s multi-channel e-commerce systems, including
      domain name registration and e-mail solutions, e-commerce solutions, website
      design, and website hosting, as well as consulting services. The Company
      included costs that were not allocated to specific segments, such as corporate
      general and administrative expenses and share-based compensation expenses,
      in
      the Smart Online segment.





**3.**  **ASSETS
      & LIABILITIES**





***Accounts
      Receivable, Net***





The
      Company typically invoices its customers on a monthly basis for professional
      services and either upfront or annually for licenses. Management
      evaluates the need for an allowance for doubtful accounts based on specifically
      identified amounts believed to be uncollectible. Management also records an
      additional allowance based on its assessment of the general financial conditions
      affecting the Company’s customer base. If actual collections experience changes,
      revisions to the allowance may be required. Based on these criteria, management
      determined that no allowance for doubtful accounts was required as of December
      31, 2007, and management has recorded an allowance of $81,842 as of September
      30, 2008.





***Contract
      Receivable, Net***





From
      time
      to time, the Company, as part of its negotiated contracts, has granted extended
      payment terms to its strategic partners. As payments become due under the terms
      of the contract, they are invoiced and reclassified as accounts receivable.
      During the second quarter of 2008, the Company entered into a web services
      agreement with a new customer that provided for extended payment terms related
      to both professional services and the grant of a software license. During the
      third quarter of 2008, this customer began experiencing cash flow difficulties
      and slowed its payments to the Company. Based on this, management has recorded
      an allowance for doubtful accounts of $185,033, representing one half of the
      outstanding balance, as it continues to work with the customer to resume
      contractual payments. As of September 30, 2008, the Company has classified
      $25,033 of this net receivable as non-current.





***Prepaid
      Expenses***





In
      July
      2008, the Company entered into a 36-month sublease agreement with Advantis
      Real
      Estate Services Company for approximately 9,837 square feet of office space
      in
      Durham, North Carolina, into which the Company relocated its headquarters in
      September 2008. The agreement included the conveyance of certain furniture
      to
      the Company without a stated value and required a lump-sum, upfront payment
      of
      $500,000 that was made in September 2008. Management has assessed the fair
      market value of the furniture to be approximately $50,000, and this amount
      was
      capitalized and is subject to depreciation in accordance with the Company’s
      fixed asset policies. The remainder of the payment was recorded as prepaid
      expense, with the portion relating to rent for periods beyond the next twelve
      months classified as non-current, and is being amortized to rent expense over
      the term of the lease.


10


***Deferred
      Financing Costs***





To
      assist
      the Company in securing a modification to its line of credit with
      Wachovia Bank, NA (“Wachovia”), Atlas Capital, SA (“Atlas”) provided Wachovia
      with a standby letter of credit. In exchange for Atlas providing Wachovia with
      the modified letter of credit, on January 15, 2007 the Company issued Atlas
      a
      warrant to purchase 444,444 shares of common stock at $2.70 per share. The
      fair
      value of that warrant was $734,303 as measured using the Black-Scholes
      option-pricing model at the time the warrant was issued. This amount was
      recorded as deferred financing costs and was amortized to interest expense
      in
      the amount of $37,657 per month over the remaining period of the modified line
      of credit, which was scheduled to expire in August 2008. In February 2008,
      the
      Wachovia line of credit was replaced by a new line of credit with Paragon
      Commercial Bank (“Paragon”) as described in Note 4, “Notes Payable.” Atlas
      agreed to provide Paragon a new standby letter of credit and the Company agreed
      to amend the Atlas warrant agreement to provide that the warrant is exercisable
      within 30 business days of the termination of the Paragon line of credit or
      if
      the Company is in default under the terms of the line of credit with
      Paragon. As of September 30, 2008, the deferred financing costs were fully
      amortized to interest expense.





***Capitalized
      Software, Net***





SFAS
      No.
      86 requires capitalization of certain software development costs subsequent
      to
      the establishment of technological feasibility, with costs incurred prior to
      this time expensed as research and development. Technological feasibility is
      established when all planning, designing, coding, and testing activities that
      are necessary to establish that the product can be produced to meet its design
      specifications have been completed. Historically, the Company had not developed
      detailed design plans for its SaaS applications, and the costs incurred between
      the completion of a working model of these applications and the point at which
      the products were ready for general release had been insignificant. These
      factors, combined with the historically low revenue generated by the sale of
      the
      applications that do not support the net realizable value of any capitalized
      costs, resulted in the continued expensing of underlying costs as research
      and
      development.





Beginning
      in May 2008, the Company determined that it was strategically desirable to
      develop an industry standard platform and enhance the current SaaS applications.
      A detailed design plan indicated that the product was technologically feasible.
      In July 2008, development commenced, and as of September 30, 2008, $120,191
      in
      associated costs were capitalized in accordance with SFAS No. 86. As this
      platform is still under development, the Company has recognized no amortization
      expense as of September 30, 2008.





***Accrued
      Liabilities***





At
      December 31, 2007, the Company had accrued liabilities totaling $603,338. This
      amount consisted primarily of $204,000 of liability accrued related to the
      development of the Company’s custom accounting application; $250,000 related to
      legal reserves (see Note 7, “Commitments and Contingencies”); $45,308 due a
      customer for overpayment of its account; $30,040 of accrued commissions; and
      $33,733 of convertible note interest payable.





At
      September 30, 2008, accrued liabilities totaled $477,647. This amount consisted
      primarily of $120,666 of liability related to the above-noted development of
      the
      Company’s custom accounting application; $137,500 related to legal reserves (see
      Note 7, “Commitments and Contingencies”); $26,335 for tax-related liabilities
      associated with the vesting of restricted stock; $96,602 of loss estimated
      on a
      long-term customer contract; $18,360 of accrued commissions; and $51,934 of
      convertible note interest payable.





***Deferred
      Revenue***





Deferred
      revenue comprises the following items:





·
            Subscription
                Fees - short-term and long-term portions of cash received related
                to one-
                or two-year subscriptions for domain names and/or email
                accounts





·
            License
                Fees - licensing revenue where customers did not meet all the criteria
                of
                SOP 97-2. Such deferred revenue will be recognized as cash is delivered
                or
                collectibility becomes probable.





The
      components of deferred revenue for the periods indicated were as
      follows:


11





**September 30,**
              **2008**
            
            **December 31,**
              **2007**Subscription
                fees
            
            $
            126,431
            
            $
            197,117License
                fees
            
            
            120,000
            
            
            380,000BALANCE
            
            $
            246,431
            
            $
            577,117Current
                portion
            
            $
            164,459
            
            $
            329,805Non-current
                portion
            
            
            81,972
            
            
            247,312Total
            
            $
            246,431
            
            $
            577,117





**4.**  **NOTES
      PAYABLE**





***Convertible
      Notes***





On
      November 14, 2007, in an initial closing, the Company sold $3.3 million
      aggregate principal amount of secured subordinated convertible notes due
      November 14, 2010 (the “Initial Notes”). In addition, the noteholders committed
      to purchase on a pro rata basis up to $5.2 million aggregate principal of
      secured subordinated notes in future closings upon approval and call by the
      Company’s Board of Directors. On August 12, 2008, the Company exercised its
      option to sell $1.5 million aggregate principal of additional secured
      subordinated notes due November 14, 2010, with substantially the same terms
      and
      conditions as the Initial Notes (the “Additional Notes,” and collectively with
      the Initial Notes, the “notes”). In connection with the sale of the Additional
      Notes, the noteholders holding a majority of the aggregate principal amount
      of
      the notes outstanding agreed to increase the aggregate principal amount of
      secured subordinated convertible notes that they are committed to purchase
      from
      $8.5 million to $15.3 million, of which $4.8 million is currently
      outstanding.





The
      Company is obligated to pay interest on the Initial Notes and the Additional
      Notes at an annualized rate of 8% payable in quarterly installments commencing
      on February 14, 2008 and November 12, 2008, respectively. The Company is not
      permitted to prepay the notes without approval of the holders of at least a
      majority of the principal amount of the notes then outstanding.





On
      the
      earlier of the maturity date of November 14, 2010 or a merger or acquisition
      or
      other transaction pursuant to which existing stockholders of the Company hold
      less than 50% of the surviving entity, or the sale of all or substantially
      all
      of the Company’s assets, or similar transaction, or event of default, each
      noteholder in its sole discretion shall have the option to:





·
            convert
                the principal then outstanding on its notes into shares of the Company’s
                common stock, or





·
            receive
                immediate repayment in cash of the notes, including any accrued and
                unpaid
                interest.




If
      a
      noteholder elects to convert its notes under these circumstances, the conversion
      price of notes:




·
            issued
                in the initial closing on November 14, 2007 shall be $3.05;
                and




·
            issued
                on August 12, 2008 shall be the lower of $3.05 or the average of
                the
                closing bid and asked prices of shares of the Company’s common stock
                quoted in the Over-The-Counter Market Summary (or, if the Company’s shares
                are traded on the Nasdaq Stock Market or another exchange, the closing
                price of shares of the Company’s common stock quoted on such exchange)
                averaged over five trading days prior to the closing date of the
                sale of
                the Additional Notes.





Payment
      of the notes will be automatically accelerated if the Company enters voluntary
      or involuntary bankruptcy or insolvency proceedings.





The
      notes
      and the common stock into which they may be converted have not been registered
      under the Securities Act of 1933, as amended (the “Securities Act”), or the
      securities laws of any other jurisdiction. As a result, offers and sales of
      the
      notes were made pursuant to Regulation D of the Securities Act and only made
      to
      accredited investors that were the Company’s existing stockholders. The
      investors in the Initial Notes include (i) The Blueline Fund, which originally
      recommended Philippe Pouponnot, a former director of the Company, for
      appointment to the Company’s Board of Directors; (ii) Atlas, an affiliate of the
      Company that originally recommended Shlomo Elia, one of the Company’s current
      directors, for appointment to the Board of Directors; (iii) Crystal Management
      Ltd. (“Crystal”), which is owned by Doron Roethler, who subsequently became
      Chairman of the Company’s Board of Directors and serves as the noteholders’ bond
      representative; and (iv) William Furr, who is the father of Thomas Furr, who,
      at
      the time, was one of the Company’s directors and executive officers. The
      investors in the Additional Notes are Atlas and Crystal.


12


In
      addition, if the Company proposes to file a registration statement to register
      any of its common stock under the Securities Act in connection with the public
      offering of such securities solely for cash, subject to certain limitations,
      the
      Company shall give each noteholder who has converted its notes into common
      stock
      the opportunity to include such shares of converted common stock in the
      registration. The Company has agreed to bear the expenses for any of these
      registrations, exclusive of any stock transfer taxes, underwriting discounts,
      and commissions.





On
      November 6, 2007, Canaccord Adams Inc. agreed to waive any rights it held under
      its January 2007 engagement letter with the Company that it may have with
      respect to the convertible note offering, including the right to receive any
      fees in connection with the offering.





***Line
      of Credit***





As
      of
      December 31, 2007, the Company owed $2,052,000 under a line of credit with
      Wachovia. On February 15, 2008, the Company repaid the full outstanding
      principal balance of $2,052,000 and accrued interest of $2,890.





On
      February 20, 2008, the Company entered into a revolving credit arrangement
      with
      Paragon. The line of credit advanced by Paragon is $2.47 million and can be
      used
      for general working capital. Any advances made on the line of credit must be
      paid off no later than February 19, 2009, with monthly payments being applied
      first to accrued interest and then to principal. The interest shall accrue
      on
      the unpaid principal balance at the Wall Street Journal’s published prime rate
      minus one-half percent. The line of credit is secured by an irrevocable standby
      letter of credit in the amount of $2.5 million issued by HSBC Private Bank
      (Suisse) SA with Atlas, a current stockholder and affiliate of the Company,
      as
      account party. This letter of credit expires on February 18, 2010, and the
      Paragon letter of credit is renewable so long as the letter of credit remains
      in
      force. The Company also has agreed with Atlas that in the event of a default
      by
      the Company in the repayment of the line of credit that results in the letter
      of
      credit being drawn, the Company shall reimburse Atlas any sums that Atlas is
      required to pay under such letter of credit. At the sole discretion of the
      Company, 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.





In
      consideration for Atlas providing the Paragon letter of credit, the Company
      agreed to amend the warrant agreement with Atlas to provide that the warrant
      is
      exercisable within 30 business days of the termination of the Paragon line
      of
      credit or if the Company is in default under the terms of the line of
      credit.





As
      of
      September 30, 2008, the Company had notes payable totaling $6,441,117. The
      detail of these notes is as follows:


**Note Description**
              
              **Short-Term**
                **Portion**
              
              **Long-Term**
                **Portion**
              
              **TOTAL**
              
              **Maturity**
              
              **Rate**Paragon
                  Commercial Bank credit line
              
              $
              1,517,929
              
              $
              -
              
              $
              1,517,929
              
              
              Feb
                  ‘09
              
              
              Prime
                  less 0.5
              %Various
                  capital leases
              
              
              25,403
              
              
              34,136
              
              
              59,539
              
              
              Various
              
              
              11-19
              %Insurance
                  premium note
              
              
              63,649
              
              
              -
              
              
              63,649
              
              
              Jul
                  ‘09
              
              
              6.1
              %Convertible
                  notes
              
              
              -
              
              
              4,800,000
              
              
              4,800,000
              
              
              Nov
                  ‘10
              
              
              8.0
              %TOTAL
              
              $
              1,606,981
              
              $
              4,834,136
              
              $
              6,441,117





**5.**  **STOCKHOLDERS’
      EQUITY**




***Common
      Stock***




During
      the nine months ended September 30, 2008, 70,000 shares of restricted stock
      were
      issued. These restricted stock awards included 32,000 shares issued to the
      newly
      appointed Chief Operating Officer. The Chief Operating Officer received an
      additional 3,000 shares of restricted stock that had been previously promised
      to
      him in connection with his initial hiring in an August 2007 offer letter.
      Additionally, in June 2008 certain members
      of the Board of Directors received restricted stock awards that accounted for
      the remaining 35,000 shares of restricted stock issued.


13


During
      the first nine months of 2008 and in conjunction with their termination of
      employment, the Company accelerated vesting with respect to 31,250 shares of
      restricted stock previously issued to the Company’s former Chief Financial
      Officer, former Chief Operating Officer, and former in-house legal counsel.
      The
      Company recorded $92,281 of expense related to the accelerated vesting of these
      shares including $31,500 that had been accrued during the fourth quarter of
      2007. Additionally, net of the accelerated vesting discussed above,
      53,341 ****** shares
      of
      restricted stock were accounted for as forfeited during the first nine months
      of
      2008 due to resignations, terminations, payment of employee tax obligations
      resulting from share vesting, and conversions to stock options. The forfeited
      shares included 15,625 shares issued to the former Chief Operating Officer,
      10,000 shares issued to the former Chief Financial Officer, 7,500 shares issued
      to a former director, 7,500 shares exchanged by a current director for stock
      options, 2,051 shares issued to employees used to satisfy tax obligations,
      and
      10,665 shares issued to former employees.





In
      a
      transaction that closed on February 21, 2007, the Company sold an aggregate
      of
      2,352,941 shares of its common stock to two new investors (the “Investors”). The
      private placement shares were sold at $2.55 per share pursuant to a Securities
      Purchase Agreement (the “SPA”) between the Company and each of the Investors.
      The aggregate gross proceeds to the Company were $6 million, and the Company
      incurred issuance costs of approximately $637,000. Under the SPA, the Company
      issued the Investors warrants for the purchase of an aggregate of 1,176,471
      shares of common stock at an exercise price of $3.00 per share. These warrants
      contain a provision for cashless exercise and must be exercised, if at all,
      by
      February 21, 2010.




The
      Company and each of the Investors also entered into a Registration Rights
      Agreement (the “Investor RRA”) whereby the Company had an obligation to register
      the shares for resale by the Investors by filing a registration statement within
      30 days of the closing of the private placement, and to have the registration
      statement declared effective 60 days after actual filing, or 90 days after
      actual filing if the SEC reviewed the registration statement. If a registration
      statement was not timely filed or declared effective by the date set forth
      in
      the Investor RRA, the Company would have been obligated to pay a cash penalty
      of
      1% of the purchase price on the day after the filing or declaration of
      effectiveness was due, and 0.5% of the purchase price per every 30-day period
      thereafter, to be prorated for partial periods, until the Company fulfilled
      these obligations. Under no circumstances could the aggregate penalty for late
      registration or effectiveness exceed 10% of the aggregate purchase price. Under
      the terms of the Investor RRA, the Company could not offer for sale or sell
      any
      securities until May 22, 2007, subject to certain limited exceptions, unless,
      in
      the opinion of the Company’s counsel, such offer or sale did not jeopardize the
      availability of exemptions from the registration and qualification requirements
      under applicable securities laws with respect to this placement. On March 28,
      2007, the Company entered into an amendment to the Investor RRA with each
      Investor to extend the registration filing obligation date by an additional
      eleven calendar days. On April 3, 2007, the Company filed the registration
      statement within the extended filing obligation period, thereby avoiding the
      first potential penalty. Effective July 2, 2007, the Company entered into
      another amendment to the Investor RRA to extend the registration effectiveness
      obligation date to July 31, 2007. On July 31, 2007, the SEC declared the
      registration statement effective. Accordingly, the Company met all of its
      requirements under the amended Investor RRA and no penalties were
      incurred.





As
      part
      of the commission paid to Canaccord Adams Inc. (“CA”), the Company’s placement
      agent in the transaction described above, CA was issued a warrant to purchase
      35,000 shares of the Company’s common stock at an exercise price of $2.55 per
      share. This warrant contains a provision for cashless exercise and must be
      exercised by February 21, 2012. CA and the Company also entered into a
      Registration Rights Agreement (the “CA RRA”). Under the CA RRA, the shares
      issuable upon exercise of the warrant were required to be included on the same
      registration statement the Company was obligated to file under the Investor
      RRA
      described above, but CA was not entitled to any penalties for late registration
      or effectiveness.





As
      incentive to modify a letter of credit relating to the Wachovia line of
      credit (see Note 4, “Notes Payable”), the Company entered into a Stock
      Purchase Warrant and Agreement (the “Warrant Agreement”) with Atlas on January
      15, 2007. Under the terms of the Warrant Agreement, Atlas received a warrant
      to
      purchase up to 444,444 shares of the Company’s common stock at $2.70 per share
      at the termination of the line of credit or if the Company is in default under
      the terms of the line of credit with Wachovia. In connection with entering
      the
      line of credit with Paragon on February 20, 2008, the Warrant Agreement was
      amended to provide that the warrant is exercisable within 30 business days
      of
      the termination of the Paragon line of credit or if the Company is in default
      under the terms of the line of credit. If the warrant is exercised in full,
      it
      will result in gross proceeds to the Company of approximately
      $1,200,000.


14


On
      March
      29, 2007, the Company issued 55,666 shares of its common stock to certain
      investors as registration penalties for its failure to timely file a
      registration statement covering shares owned by those investors as required
      pursuant to amendments to registration rights agreements between such investors
      and the Company. On July 20, 2007, the Company issued 27,427 additional
      shares as registration penalties to certain investors who did not enter into
      amendments to certain registration rights agreements.





In
      January 2008, the Company issued 28,230 shares of common stock to a consulting
      firm as full payment of the outstanding obligation related to fees accrued
      for
      services rendered in conjunction with the 2005 acquisitions of iMart
      Incorporated and Computility, Inc. At December 31, 2007, these obligations
      were
      included in the current portion of notes payable and in accrued liabilities
      in
      the amounts of $228,359 and $187, respectively.




***Equity
      Compensation Plans***




In
      June
      2007, the Company temporarily limited the issuance of shares of its common
      stock
      reserved under the 2004 Equity Compensation Plan to awards of restricted or
      unrestricted stock and in June 2008 again made options available for grant
      under
      the plan. In January 2008, a former officer of the Company exercised options
      to
      purchase 69,930 shares of the Company’s common stock in a cashless exercise
      whereby the former officer tendered to the Company 38,462 shares of common
      stock
      previously held by the former officer. In June 2008, the same former officer
      exercised options to purchase 180,070 shares of the Company’s common stock in a
      cashless exercise whereby the former officer tendered to the Company 80,469
      shares of the Company’s common stock previously held by the former officer. Also
      in June 2008, a member
      of
      the Board of Directors was granted an option to purchase 20,000 shares of common
      stock under the 2004 Equity Compensation Plan. In September 2008, a member
      of
      the Board of Directors was granted an option to purchase 15,000 shares of common
      stock under the 2004 Equity Compensation Plan in exchange for the forfeiture
      of
      7,500 shares of restricted stock. During the first nine months of
      2008, options
      to purchase 1,036,400 shares of common stock at prices ranging from $1.43 to
      $9.82 were forfeited by former employees, officers, directors, and consultants
      of the Company.





The
      following table summarizes information about stock options outstanding at
      September 30, 2008:





**Currently
                Exercisable****Exercise**
              **Price**
            
            **Number of**
              **Shares**
              **Outstanding**
            
            **Average**
              **Remaining**
              **Contractual**
              **Life (Years)**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            **Number of**
              **Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**From $2.50 to $3.50
            
            
            100,000
            
            
            7.5
            
            $
            3.20
            
            
            66,000
            
            $
            3.19$5.00
            
            
            31,200
            
            
            6.4
            
            $
            5.00
            
            
            21,200
            
            $
            5.00$7.00
            
            
            75,000
            
            
            7.0
            
            $
            7.00
            
            
            75,000
            
            $
            7.00From
                $8.61 to $9.00
            
            
            111,500
            
            
            6.6
            
            $
            8.74
            
            
            63,300
            
            $
            8.72$9.60
            
            
            200
            
            
            7.0
            
            $
            9.60
            
            
            120
            
            $
            9.60





***Dividends***





The
      Company has not paid any cash dividends through September 30, 2008.




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





The
      Company 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 total revenues for their respective time
      periods:


15





Three Months Ended
              September 30, 2008Revenue Type
            
            Revenues
            
            % of Total
              RevenuesCustomer A
            
            
            Subscription
                fees
            
            $
            360,109
            
            
            23
            %Customer
                B
            
            
            Subscription
                fees
            
            
            213,384
            
            
            14
            %Customer
                C
            
            
            Professional
                services
            
            
            465,750
            
            
            29
            %Customer
                D
            
            
            License
                  fees/professional services
            
            
            400,000
            
            
            25
            %Others
            
            
            Various
            
            
            147,125
            
            
            9
            %Total
            
            
            
            
            $
            1,586,368
            
            
            100
            %


Three Months Ended
                September 30, 2007Revenue Type
              
              Revenues
              
              % of Total
                RevenuesCustomer B
              
              
              Subscription
                  fees
              
              $
              425,778
              
              
              30
              %Customer
                  C
              
              
              Professional
                  services
              
              
              327,937
              
              
              23
              %Customer
                  E
              
              
              License
                    fees/professional services
              
              
              218,330
              
              
              15
              %Others
              
              
              Various
              
              
              457,150
              
              
              32
              %Total
              
              
              
              
              $
              1,429,195
              
              
              100
              %
 
 Nine Months Ended
                September 30, 2008Revenue Type
              
              Revenues
              
              % of Total
                RevenuesCustomer A
              
              
              Subscription fees
              
              $
              1,019,600
              
              
              22
              %Customer
                  B
              
              
              Subscription
                  fees
              
              
              882,387
              
              
              19
              %Customer
                  C
              
              
              Professional
                  services
              
              
              1,250,747
              
              
              26
              %Others
              
              
              Various
              
              
              1,582,150
              
              
              33
              %Total
              
              
              
              
              $
              4,734,884
              
              
              100
              %
 
 Nine Months Ended
                September 30, 2007Revenue Type
              
              Revenues
              
              % of Total
                RevenuesCustomer B
              
              
              Subscription
                  fees
              
              $
              1,562,319
              
              
              44
              %Customer
                  C
              
              
              Professional
                  services
              
              
              754,493
              
              
              21
              %Others
              
              
              Various
              
              
              1,258,699
              
              
              35
              %Total
              
              
              
              
              $
              3,575,511
              
              
              100
              %
  As
        of
        September 30, 2008, two customers accounted for 63% and 21% of net receivables,
        respectively. ****** As
        of
        December 31, 2007, the Company had three customers that accounted for 42%,
        28%
        and 17% of net receivables, respectively.


16


**7.** **COMMITMENTS
      AND CONTINGENCIES**





Please
      refer to Part I, Item 3 of the Company’s Annual Report on Form 10-K for the
      fiscal year ended December 31, 2007 and Part II, Item 1 of the Company’s
      Quarterly Report on Form 10-Q for the quarterly period ended September 30,
      2008
      for a description of material legal proceedings, including the proceedings
      discussed below.





The
      Company is subject to claims and suits that arise from time to time in the
      ordinary course of business.





In
      August
      2005, the Company entered into a software assignment and development agreement
      with the developer of a customized accounting software application. In
      connection with this agreement, the developer would be paid up to $512,500
      and
      issued up to 32,395 shares of the Company’s common stock based upon the
      developer attaining certain milestones. As of September 30, 2008, the
      Company had paid $470,834 and issued 3,473 shares of common stock related
      to this obligation.





On
      October 18, 2007, Robyn L. Gooden filed a purported class action lawsuit in
      the
      United States District Court for the Middle District of North Carolina naming
      the Company, certain of its current and former officers and directors, Maxim
      Group, LLC, and Jesup & Lamont Securities Corp. as defendants. The lawsuit
      was filed on behalf of all persons other than the defendants who purchased
      the
      Company’s securities from May 2, 2005 through September 28, 2007 and were
      damaged. The complaint asserts violations of federal securities laws, including
      violations of Section 10(b) of the Securities Exchange Act of 1934, as
      amended, and Rule 10b-5. The complaint asserts that the defendants made material
      and misleading statements with the intent to mislead the investing public and
      conspired in a fraudulent scheme to manipulate trading in the Company’s stock,
      allegedly causing plaintiffs to purchase the stock at an inflated price. The
      complaint requests certification of the plaintiff as class representative and
      seeks, among other relief, unspecified compensatory damages including interest,
      plus reasonable costs and expenses including counsel fees and expert fees.
      On
      June 24, 2008, the court entered an order appointing a lead plaintiff for the
      class action. On
      September 8, 2008, the plaintiff filed an amended complaint which added
      additional defendants who had served as directors or officers of the Company
      during the class period as well the Company’s independent auditor.





During
      April 2008, the Company received approximately $95,000 in insurance
      reimbursement for previously disputed legal expenses primarily related to
      previously disclosed SEC matters. During August 2008, the Company and the
      insurance carrier agreed that the carrier would reimburse it $300,000 for
      previously disputed legal expenses primarily related to its previously disclosed
      SEC matters. The reimbursement covered all disputed Company expenses prior
      to
      September 11, 2007 as well as certain enumerated invoices in dispute for the
      balance of 2007, and it was received by the Company. Because the
      outcome of the dispute was unclear, the Company expensed all legal costs with
      respect to the SEC matters and the Company’s 2006 internal investigation as
      incurred. For the nine months ended September 30, 2008, both reimbursements
      have
      been recorded in the consolidated statements of operations as a gain on legal
      settlements.





On
      July
      14, 2008, the Company filed a civil action against a former employee in the
      General Court of Justice, Superior Court Division, Durham County, North
      Carolina. The complaint alleged that the former employee embezzled funds from
      the Company in the amount of $105,600 and asserted claims for conversion and
      unfair trade practices. The lawsuit sought recovery for the embezzled funds,
      plus punitive damages or treble damages, interest, and attorneys’ fees. On
      August
      25, 2008, the Company obtained a judgment against the former employee in the
      amount of $105,599.94, trebled to $316,799.82 pursuant to the North Carolina
      Unfair and Deceptive Trade Practice Statute, plus interest at 8% from the date
      of filing the complaint, and all court costs and reasonable attorneys’ fees
      existing as of the date of the judgment and as may accrue from time to time
      until the judgment is paid in full. The Company is in the process of attempting
      to collect on the judgment.





At
      this
      time, the Company is not able to determine the likely outcome of the Company’s
      current pending legal matters, nor can it estimate its potential financial
      exposure. Management has made an initial estimate based upon its knowledge,
      experience, and input from legal counsel, and the Company has accrued
      approximately $137,500 of legal reserves. Such reserves will be adjusted in
      future periods as more information becomes available. If an unfavorable
      resolution of any of these matters occurs, the Company’s business, results of
      operations, and financial condition could be materially adversely
      affected.


17


**8.**  **SUBSEQUENT
      EVENTS**





*Convertible
      Note Financing.* On
      November 12, 2008, the Company notified all current noteholders that it has
      exercised its option to sell $1.5 million aggregate principal of additional
      secured subordinated notes due November 14, 2010 (the “New Notes”) with
      substantially the same terms and conditions as the outstanding notes, as
      described in Note 4, “Notes Payable,” above, in a closing to occur on or before
      December 31, 2008. The Company will be obligated to pay interest on the New
      Notes at an annualized rate of 8% payable in quarterly installments commencing
      three months after the closing date. The Company plans to use the proceeds
      to
      meet ongoing working capital and capital spending requirements.





**Item
      2.**   **Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations**





*Information
      set forth in this Quarterly Report on Form 10-Q contains various forward-looking
      statements within the meaning of Section 27A of the Securities Act of 1933,
      or
      the Securities Act, and Section 21E of the Securities Exchange Act of 1934,
      or
      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 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 “expect,” “anticipate,” “project,”
“intend,” “plan,” “estimate,” variations of such words, and similar expressions
      also are 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 under Part II, Item 1A,
“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 software products and services targeted to small businesses
      that are delivered via a Software-as-a-Service, or SaaS, model. We also provide
      website consulting services, primarily in the e-commerce retail industry. We
      reach small businesses primarily through arrangements with channel partners
      that
      private-label our software applications and market them to their customer bases
      through their corporate websites. We believe these relationships provide a
      cost-
      and time-efficient way to market to a diverse and fragmented yet very sizeable
      small business sector.




Prior
      to
      2008, we operated our company as two segments. During late 2007 and the first
      quarter of 2008, management realigned certain production and development
      functions and eliminated redundant administrative functions and now reports
      the
      consolidated business as a single business segment. During 2007, the two
      segments were our core operations, or the Smart Online segment, and the
      operations of our wholly-owned subsidiary Smart Commerce, Inc., or the Smart
      Commerce segment. The Smart Online segment generated revenues from the
      development and distribution of Internet-delivered SaaS small business
      applications through a variety of channels. The Smart Commerce segment derived
      its revenues primarily from subscriptions to our multi-channel e-commerce
      systems, including registration and e-mail solutions, e-commerce solutions,
      and
      website design; as well as website hosting and consulting services. We included
      costs that were not allocated to specific segments, such as corporate general
      and administrative expenses and share-based compensation expenses, in the Smart
      Online segment. We
      continue to evaluate the factors that will form the basis of our segmentation
      going forward.





During
      2007, we began providing software solutions and services to sizeable small
      business markets dealing with regulatory demands that could not be met
      adequately by existing low-cost and easy-to-use software solutions. These
      efforts have led to the launch of software solutions for partners in the food
      safety, multi-level marketing, and real estate industries. We are continuing
      to
      target other segments in the small business industry that may require such
      regulatory-focused software solutions and services and to market our experience
      with developing software solutions and services to meet these
      needs.


18


In
      the
      second half of 2007, we commenced an overall evaluation of our business model
      as
      well as our current technologies, the outcome of which was the decision to
      develop a core industry standard platform for small business with
      an architecture designed to integrate with a virtually unlimited
      number of other applications, services, and existing infrastructures.
      These applications would include not only our own small
      business applications, which we are currently optimizing, but
      also other applications we expect to arise from collaborative
      partnerships with third-party developers and service providers. In addition,
      we
      identified emerging market opportunities in the small business segment to
      leverage social networking and community-building. We are currently
      refining and integrating these capabilities into the core platform to be
      readily available in a “plug-and-play” fashion to meet any anticipated customer
      need or desire. We believe that this platform and associated applications will
      provide opportunities for new sources of revenue, including an increase in
      our
      subscription fees. Because the platform is designed to follow industry standard
      protocol, we also believe that the customization efforts and associated timeline
      previously necessary to meet a particular customer’s requirements will diminish
      significantly, allowing us to shorten the sale-to-revenue cycle. ****** As
      we
      near completion of the development of our industry standard platform, we are
      shifting our focus from development toward the sales and marketing of the new
      platform in the fourth quarter of 2008.





**Sources
      of Revenue**





We
      derive
      revenues from the following sources:





·
            Subscription
                fees  – monthly fees charged to customers for access to our SaaS
                applications




·
            License
                fees  – fees charged for perpetual or term licensing of platforms or
                applications




·
            Professional
                service fees  – fees related to consulting services, some of which
                complement our other products and
                applications




·
            Other
                revenues  – revenues generated from non-core activities such as
                syndication and integration fees; original equipment manufacturer,
                or OEM,
                contracts; and miscellaneous other
                revenues




Our
      current primary focus is to target those established companies that have both
      a
      substantial base of small business customers as well as a recognizable and
      trusted brand name in specific market segments. Our goal is to enter into
      partnerships with these established companies whereby they private-label our
      products and offer them to their small business customers. We believe the
      combination of the magnitude of their customer bases and their trusted brand
      names and recognition will help drive our subscription volume.





Subscription
      fees primarily consist of sales of subscriptions through private-label marketing
      partners to end users. We typically have a revenue share arrangement with these
      private-label marketing partners in order to encourage them to market our
      products and services to their customers. We make subscription sales either
      on a
      subscription or on a “for fee” basis. Applications for which subscriptions are
      available vary from our own portal to the websites of our partners.
      Subscriptions are generally payable on a monthly basis and are typically paid
      via credit card of the individual end user or the aggregating entity. We are
      focusing our efforts on enlisting new channel partners as well as diversifying
      with vertical intermediaries in various industries.





License
      fees consist of perpetual or term license agreements for the use of the Smart
      Online platform, the Smart Commerce platform, or any of our
      applications.





We
      generate professional service fees from our consulting services. For example,
      a
      partner may request that we re-design its website to better accommodate our
      products or to improve its own website traffic. We typically bill professional
      service fees on a time and material basis. Hosting and maintenance fees are
      generated as the services are provided.





Other
      revenues primarily consist of non-core revenue sources such as syndication
      and
      integration fees, miscellaneous web services, and OEM revenue generated through
      sales of our applications bundled with products offered by other
      manufacturers.





**Cost
      of Revenues**





Cost
      of
      revenues primarily is composed of salaries associated with maintaining and
      supporting integration and syndication partners, the cost of domain name and
      email registrations, and the cost of external hosting facilities associated
      with
      maintaining and supporting our partners and end user customers.


19


**Operating
      Expenses**





For
      the
      balance of 2008, we expect our primary business initiatives to include
      increasing subscription fee revenue, making organizational improvements,
      concentrating our development efforts on enhancements and customization of
      our
      platforms and applications, and shifting our strategic focus to the sales and
      marketing of our products.




*General
      and Administrative* .
      General
      and administrative expenses consist of salaries and related expenses for
      executive, finance and accounting, legal, human resources, and information
      technology personnel; professional fees; depreciation and amortization expenses;
      insurance; and other corporate expenses, including facilities costs. We
      anticipate general and administrative expenses will increase as we incur
      additional professional fees and insurance costs related to the growth of our
      business and our operations as a public company. We expect to continue to incur
      material costs in 2008 related to the civil and criminal complaints filed in
      September 2007, described in detail in Part I, Item 3, “Legal Proceedings,” in
      our Annual Report on Form 10-K for the year ended December 31, 2007 and Part
      II,
      Item 1, “Legal Proceedings,” in this report and the Quarterly Reports on Form
      10-Q for the quarterly periods ended March 31, 2008 and June 30,
      2008.





*Sales
      and Marketing* .
      Historically, we spent limited funds on marketing, advertising, and public
      relations, particularly due to our business model of partnering with established
      companies with extensive small business customer bases. In June 2008, we engaged
      a public relations firm and, as a result, our public relations expenses
      increased in the third quarter and will continue to do so during the fourth
      quarter of 2008. As we implement our sales and marketing strategy to take our
      enhanced products to market, we also expect associated costs to increase in
      the
      balance of 2008 due to targeting new partnerships, development of channel
      partner enablement programs, additional sales and marketing personnel, and
      the
      various percentages of revenues we may be required to pay to future partners
      as
      marketing fees.





*Research
      and Development* . Statement
      of Financial Accounting Standard (“SFAS”) No. 86, *Accounting
      for the Costs of Computer Software to Be Sold, Leased, or Otherwise
      Marketed* ,
      or SFAS
      No. 86, requires capitalization of certain software development costs subsequent
      to the establishment of technological feasibility, with costs incurred prior
      to
      this time expensed as research and development. Technological feasibility is
      established when all planning, designing, coding, and testing activities that
      are necessary to establish that the product can be produced to meet its design
      specifications have been completed. Historically, we had not developed detailed
      design plans for our SaaS applications, and the costs incurred between the
      completion of a working model of these applications and the point at which
      the
      products were ready for general release had been insignificant. These factors,
      combined with the historically low revenue generated by the sale of the
      applications that do not support the net realizable value of any capitalized
      costs, resulted in the continued expensing of underlying costs as research
      and
      development.





Beginning
      in May 2008, we determined that it was strategically desirable to develop an
      industry standard platform and enhance our current SaaS applications. A detailed
      design plan indicated that the product was technologically feasible. In July
      2008, development commenced, and all related costs from this point in time
      are
      being capitalized in accordance with SFAS No. 86. Because
      of our scalable and secure multi-user 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 incur
      relatively low development costs as compared to traditional enterprise software
      business models. As we complete the core development of our new applications
      during the balance of 2008, we expect that future research and development
      expenses will decrease in both absolute and relative dollars as we continue
      to
      capitalize costs associated with the new platform and reduce our personnel
      to a
      core group focused on enhancements and custom development work for
      customers.





*Stock-Based
      Expenses* .
      Our
      operating expenses include stock-based expenses related to options, restricted
      stock awards, and warrants issued to employees and non-employees. These charges
      have been significant and are reflected in our historical financial results.
      Effective January 1, 2006, we adopted SFAS No. 123 (revised
      2004), *Share-Based
      Payment* ,  which
      resulted and will continue to result in material costs on a prospective basis
      as
      long as a significant number of options are outstanding. In June 2007, we
      limited the issuance of awards under our 2004 Equity Compensation Plan, or
      the
      2004 Plan, to awards of restricted or unrestricted stock. In June 2008, we
      made
      options available for grant under the 2004 Plan once again, primarily due to
      the
      adverse ****** tax
      consequences to recipients of restricted stock upon the lapsing of
      restrictions.


20


**Critical
      Accounting Policies and Estimates**





Our
      discussion and analysis of financial condition and results of operations are
      based upon our consolidated financial statements, which we 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 reevaluate 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 Annual Report on Form 10-K for the year ended
      December 31, 2007.





We
      derive
      revenue primarily from subscription fees charged to customers accessing our
      SaaS
      applications; the perpetual or term licensing of software platforms or
      applications; and professional services, consisting of consulting, development,
      hosting, and maintenance services. These arrangements may include delivery
      in
      multiple-element arrangements if the customer purchases a combination of
      products and/or services. Because we license, sell, lease, or otherwise market
      computer software, we use the residual method pursuant to American Institute
      of
      Certified Public Accountants Statement of Position 97-2, *Software Revenue Recognition* ,
      or SOP
      97-2, as amended. This method allows us to recognize revenue for a delivered
      element when such element has vendor specific objective evidence, or VSOE,
      of
      the fair value of the delivered element. If we cannot determine or maintain
      VSOE
      for an element, it could impact revenues as all or a portion of the revenue
      from
      the multiple-element arrangement may need to be deferred.





If
      multiple-element arrangements involve significant development, modification,
      or
      customization or if it we determine that certain elements are essential to
      the
      functionality of other elements within the arrangement, we defer revenue until
      all elements necessary to the functionality of the customer is provided. The
      determination of whether the arrangement involves significant development,
      modification, or customization could be complex and require the use of judgment
      by our management.





Under
      SOP
      97-2, provided the arrangement does not require significant development,
      modification, or customization, we recognize revenue when all of the following
      criteria have been met:





1.
            persuasive
                evidence of an arrangement exists





2.
            delivery
                has occurred





3.
            the
                fee is fixed or determinable





4.
            collectibility
                is probable





If
      at the
      inception of an arrangement the fee is not fixed or determinable, we defer
      revenue until the arrangement fee becomes due and payable. If we deem
      collectibility not probable, we defer revenue until we receive payment or
      collection becomes probable, whichever is earlier. The determination of whether
      fees are collectible requires the judgment of our management, and the amount
      and
      timing of revenue recognition may change if different assessments are
      made.





Under
      the
      provisions of Emerging Issues Task Force Issue No. 00-21, *Revenue
      Arrangements with Multiple Deliverables* ,
      we
      account for consulting, website design fees, and application development services separately from the license of associated software
      platforms when these services have value to the customer and there is objective
      and reliable evidence of fair value of each deliverable. When accounted for
      separately, revenues are recognized as the services are rendered for time and
      material contracts, and when milestones are achieved and accepted by the
      customer for fixed-price or long-term contracts. The majority of our consulting
      service contracts are on a time and material basis and are typically billed
      monthly based upon standard professional service rates.


21


Application
      development services are typically fixed price and of a longer term. As such,
      we
      account for these services as long-term construction contracts that require
      revenue recognition to be based on estimates involving total costs to complete
      and the stage of completion. The assumptions and estimates made to determine
      the
      total costs and stage of completion may affect the timing of revenue
      recognition, with changes in estimates of progress to completion and costs
      to
      complete accounted for as cumulative catch-up adjustments. If the criteria
      for
      revenue recognition on construction-type contracts are not met, we capitalize
      the associated costs of such projects and include them in costs in excess of
      billings on the balance sheet until such time that revenue recognition is
      permitted.





Subscription
      fees primarily consist of sales of subscriptions through private-label marketing
      partners to end users. We typically have a revenue share arrangement with these
      private-label marketing partners in order to encourage them to market our
      products and services to their customers. Subscriptions are generally payable
      on
      a monthly basis and are typically paid via credit card of the individual end
      user or the aggregating entity. Any payments received in advance of the
      subscription period are accrued as deferred revenue and amortized over the
      subscription period.





Because
      our customers generally do not have the contractual right to take possession
      of
      the software we license or market at any time, we recognize revenue on hosting
      and maintenance fees as the services are provided in accordance with Emerging
      Issues Task Force Issue No. 00-3, *Application
      of AICPA Statement of Position 97-2 to Arrangements That Include the Right
      to
      Use Software Stored on Another Entity’s Hardware* .





We
      are
      currently facing legal actions from stockholders that relate to the charges
      filed against our former Chief Executive Officer described in Part II, Item
      1,
“Legal Proceedings,” in this report. At this time, we are not able to determine
      the likely outcome of our currently pending legal matters, nor can we estimate
      our potential financial exposure. Management has made an initial estimate based
      upon its knowledge, experience, and input from legal counsel, and we have
      accrued approximately $137,500 of legal reserves. Such reserves will be adjusted
      in future periods as more information becomes available.





**Overview
      of Results of Operations for the Three Months Ended September 30, 2008 and
      September 30, 2007**





Total
      revenues were $1,586,000 for the three months ended September 30, 2008 compared
      to $1,429,000 for the same period in 2007, representing an increase of $157,000,
      or 11%. Gross profit increased $102,000, or 8%, to $1,363,000 from $1,261,000.
      Operating expenses increased $227,000, or 9%, to $2,897,000 from $2,670,000.
      Net
      loss decreased $171,000, or 11%, to $1,392,000 from $1,563,000.





The
      following table sets forth our consolidated statements of operations data
      expressed as a percentage of revenues for the periods indicated:





**Three Months Ended**
              **September 30,**
              **2008**
            
            **Three Months Ended**
              **September 30,**
              **2007**REVENUES:Subscription
                fees
            
            
            41
            %
            
            58
            %Professional
                service fees
            
            
            39
            %
            
            26
            %License
                fees
            
            
            18
            %
            
            14
            %Other
                revenue
            
            
            2
            %
            
            2
            %Total
                revenues
            
            
            100
            %
            
            100
            %COST
                OF REVENUES
            
            
            14
            %
            
            12
            %GROSS
                PROFIT
            
            
            86
            %
            
            88
            %OPERATING
                EXPENSES:General
                and administrative
            
            
            79
            %
            
            98
            %Sales
                and marketing
            
            
            45
            %
            
            44
            %Research
                and development
            
            
            59
            %
            
            45
            %Total
                operating expenses
            
            
            183
            %
            
            187
            %LOSS
                FROM OPERATIONS
            
            
            (97
            )%
            
            (99
            )%OTHER
                INCOME (EXPENSE):Interest
                expense, net
            
            
            (9
            )%
            
            (10
            )%Legal
                reserve and debt forgiveness, net
            
            
            0
            %
            
            (2
            )%Gain
                on legal settlements, net
            
            
            18
            %
            
            0
            %Other
                income
            
            
            0
            %
            
            2
            %Total
                other income (expense)
            
            
            9
            %
            
            (10
            )%NET
                LOSS
            
            
            (88
            )%
            
            (109
            )%


22


**Comparison
      of the Results of Operations for the Three Months Ended September 30, 2008
      and
      September 30, 2007**





**Revenues.** Total
      revenues for the three months ended September 30, 2008 were $1,586,000 compared
      to $1,429,000 for the same period in 2007, representing an increase of $157,000,
      or 11%. This overall increase in revenues was primarily attributable to
      increases in professional service fees and license fees, offset in part by
      a
      decrease in subscription fees.





*Subscription
      Fees* -
      Subscription fees for the three months ended September 30, 2008 were $643,000
      compared to $831,000 for the same period in 2007, representing a decrease of
      $188,000, or 23%. This decrease is primarily due to a 65% decline in active
      subscribers to whom we provide e-commerce, domain name, and email services
      for
      use as members of one of our primary customers, a direct-selling organization.
      The customer instituted an initiative in early 2008 to bring these services
      in-house, and we have experienced a steady migration from our platform each
      month.





*Professional
      Service Fees* -
      Professional service fees for the three months ended September 30, 2008 were
      $621,000 compared to $378,000 for the same period in 2007, representing an
      increase of $243,000, or 64%. This increase is primarily due to a number of
      website infrastructure upgrade projects completed in the third quarter of 2008
      for a significant e-commerce retail customer. Because new customers typically
      contract for significant upfront professional services, professional service
      fees generally increase in advance of the associated subscription revenues.
      Professional service fees accounted for approximately 39% of third quarter
      2008
      revenues as compared to approximately 26% for third quarter 2007. We expect
      professional service fees will continue to represent a greater portion of total
      revenues for fiscal 2008 as compared to fiscal 2007.





*License
      Fees* -
      License
      fees for the three months ended September 30, 2008 were $291,000 compared to
      $200,000 for the same period in 2007, representing an increase of $91,000,
      or
      46%. This increase is primarily the result of recognition in September 2008
      of a
      perpetual license that had previously been classified as deferred revenue in
      prior periods because not all criteria of SOP 97-2 had been met.





*Other
      Revenue* -
      Other
      revenue for the three months ended September 30, 2008 totaled $31,000 compared
      to $20,000 for the same period in 2007. This revenue is generated from non-core
      activities. We expect these revenue streams to continue to be insignificant
      in
      the future as we continue our strategy of focusing on the growth of our
      subscription and license revenues.





**Cost
      of Revenues**





Cost
      of
      revenues for the three months ended September 30, 2008 was $224,000 compared
      to
      $168,000 for the same period in 2007, representing an increase of $56,000,
      or
      33%. This increase is primarily due to more domain name registrations and credit
      card processing fees resulting from a higher turnover rate of members of our
      direct-selling organization customers, as well as our introduction of business
      card printing services to these members beginning in early
      2008.


23


**Operating
      Expenses**





Operating
      expenses for the three months ended September 30, 2008 were $2,897,000 compared
      to $2,670,000 for the same period in 2007, representing an increase of $227,000,
      or 9%. This increase was primarily attributable to increases in sales and
      marketing and research and development expenses, offset in part by a decrease
      in
      general and administrative expenses.




*General
      and Administrative* -
      General
      and administrative expenses for the three months ended September 30, 2008 were
      $1,246,000 compared to $1,398,000 for the same period in 2007, representing
      a
      decrease of $152,000, or 11%. This decrease is primarily due to a $108,000
      reduction in salaries resulting from the termination or reassignment of several
      employees in connection with restructuring efforts, a $113,000 reduction in
      stock-based compensation expense resulting from our decision in June 2007 (which
      was later reversed) to limit future stock option grants, a reduction in outside
      consulting services ****** of
      $84,000, a reduction in franchise taxes of $17,000, a reduction in Board member
      compensation of $13,000 as a result of our current Chairman of the Board not
      accepting cash consideration for his services, and $69,000 in
      non-recurring ****** legal
      costs associated with the Securities and Exchange Commission, or SEC, action
      filed against us in September 2007. These reductions were offset in part by
      increases of $47,000 in outside accounting and recruiting fees as we
      transitioned to our permanent Chief Financial Officer and bad debt expense
      of
      $222,000 recorded in the third quarter of 2008. We anticipate that general
      and
      administrative expenses will continue to decrease in the fourth quarter of
      2008
      as our legal and professional fees are reduced. In addition, on July 1, 2008,
      our management initiated a restructuring program aimed at realigning certain
      production and development functions as well as eliminating redundant
      administrative functions. The objective was to reduce operating and
      administrative expenses in fiscal 2008 by consolidating significant operations
      in our Durham, North Carolina headquarters location. The program included
      severance of our employees located in Grand Rapids, Michigan and was completed
      in the third quarter of 2008 at an approximate cost of $55,000. We also
      anticipate that general and administrative expenses will decrease in the fourth
      quarter of 2008 as a result of these actions.





*Sales
      and Marketing* -
      Sales
      and marketing expenses for the three months ended September 30, 2008 were
      $710,000 compared to $635,000 for the same period in 2007, representing an
      increase of $75,000, or 12%. This increase is primarily attributable to $58,000
      in increased wages resulting from additional sales and marketing personnel
      added
      during 2008, including new Vice President of Sales and Sr. Director of Marketing
      positions in the third quarter of 2008, as we began to shift our strategy from
      the development of a new platform to the sales and marketing of that platform.
      The increase was also attributable to $25,000 in public relations expenses
      resulting from the addition of a firm on retainer. We expect sales and marketing
      expenses to increase substantially in the fourth quarter of 2008 as we shift
      our
      focus from development to selling and marketing activities.





*Research
      and Development* -
      Research and development expenses for the three months ended September 30,
      2008
      were $941,000 compared to $637,000 for the same period in 2007, representing
      an
      increase of $304,000, or 48%. This increase is primarily due to a $186,000
      increase in outside contractors (net of such costs included in capitalized
      software on our balance sheet) engaged to assist in a backlog of development
      projects, a $30,000 increase in employee development methodology training,
      a
      $97,000 estimated loss on a long-term customer contract recorded in the third
      quarter of 2008, and a net increase of $7,000 in development wages and related
      payroll expenses (net of such costs included in capitalized software on our
      balance sheet) as we added new ****** employees
      in North Carolina in preparation for the restructuring of our Michigan
      operations in July 2008, as discussed above. We expect research and development
      expenses to decrease in the fourth quarter of 2008 as our focus moves to the
      marketing and sale of our newly enhanced products and as a relatively larger
      percentage of our costs are capitalized in accordance with SFAS No.
      86.





**Other
      Income (Expense)**





We
      incurred net interest expense of $151,000 for the three months ended September
      30, 2008 compared to net interest expense of $139,000 for the same period in
      2007, representing an increase of $12,000, or 9%. Interest expense totaled
      $179,000 and $178,000 and interest income totaled $28,000 and $35,000 during
      the
      third quarters of 2008 and 2007, respectively. During the three months ended
      September 30, 2008, we carried a higher balance on our line of credit with
      Paragon Commercial Bank, or Paragon, but this increase in interest was offset
      in
      part by completion of the amortization of the stock purchase warrant and
      agreement with Atlas as described in Note 5, “Stockholders’ Equity,” to the
      consolidated financial statements in this report. Interest income during the
      third quarter of 2008 was primarily attributable to interest accrued on the
      note
      receivable with a customer; however, it is lower than the same quarter in 2007
      due to the higher level of money market interest earned on the cash proceeds
      of
      the February 2007 private placement also described in Note 5, “Stockholders’
Equity,” to the consolidated financial statements in this
      report.


24





**Overview
        of Results of Operations for the Nine Months Ended September 30, 2008 and
        September 30, 2007**
 
 Total
        revenues were $4,735,000 for the nine months ended September 30, 2008 compared
        to $3,576,000 for the same period in 2007, representing an increase of
        $1,159,000, or 32%. Gross profit increased $878,000, or 27%, to $4,098,000
        from
        $3,220,000. Operating expenses increased $1,468,000, or 21%, to $8,508,000
        from
        $7,040,000. Net loss increased $438,000, or 11%, to $4,525,000 from
        $4,087,000.
 
 The
        following table sets forth our consolidated statements of operations data
        expressed as a percentage of revenues for the periods indicated:
 
 **Nine Months Ended**
                **September 30,**
                **2008**
              
              **Nine Months Ended**
                **September 30,**
                **2007**REVENUES:Subscription
                  fees
              
              
              45
              %
              
              57
              %Professional
                  service fees
              
              
              45
              %
              
              28
              %License
                  fees
              
              
              8
              %
              
              1
              %Other
                  revenue
              
              
              2
              %
              
              14
              %Total
                  revenues
              
              
              100
              %
              
              100
              %COST
                  OF REVENUES
              
              
              13
              %
              
              10
              %GROSS
                  PROFIT
              
              
              87
              %
              
              90
              %OPERATING
                  EXPENSES:General
                  and administrative
              
              
              81
              %
              
              100
              %Sales
                  and marketing
              
              
              45
              %
              
              44
              %Research
                  and development
              
              
              54
              %
              
              53
              %Total
                  operating expenses
              
              
              180
              %
              
              197
              %LOSS
                  FROM OPERATIONS
              
              
              (93
              )%
              
              (107
              )%OTHER
                  INCOME (EXPENSE):Interest
                  expense, net
              
              
              (11
              )%
              
              (11
              )%Legal
                  reserve and debt forgiveness, net
              
              
              0
              %
              
              (1
              )%Gain
                  on legal settlements, net
              
              
              8
              %
              
              0
              %Other
                  income
              
              
              0
              %
              
              5
              %Total
                  other income (expense)
              
              
              (3
              )%
              
              (7
              )%NET
                  LOSS
              
              
              (96
              )%
              
              (114
              )%
 
 **Comparison
        of the Results of Operations for the Nine Months Ended September 30, 2008
        and
        September 30, 2007**
 
 **Revenues.** Total
        revenues for the nine months ended September 30, 2008 were $4,735,000 compared
        to $3,576,000 for the same period in 2007, representing an increase of
        $1,159,000, or 32%. This overall increase in revenues was primarily attributable
        to an increase in professional service fees.
 
 *Subscription
        Fees* –
        Subscription fees for the nine months ended September 30, 2008 were $2,133,000
        compared to $2,040,000 for the same period in 2007, representing an increase
        of
        $93,000, or 5%. This increase was due to new partnerships under which we
        began
        recognizing revenue in the second half of 2007.
  25
 
 *Professional
        Service Fees* -
        Professional service fees for the nine months ended September 30, 2008 were
        $2,130,000 compared to $985,000 for the same period in 2007, representing
        an
        increase of $1,145,000, or 116%. This
        increase was due to existing customers requesting additional project consulting
        services for their web initiatives as well as $465,000 associated with the
        recognition of consulting revenue from new customers added in fiscal 2008.
        Professional service fees accounted for approximately 45% of revenue for
        the
        first nine months of 2008 as compared to approximately 28% for the first
        nine
        months of 2007. We expect professional service fees will continue to represent
        a
        greater portion of total revenues for fiscal 2008 as compared to fiscal
        2007.
 
 *License
        Fees* -
        License
        fees for the nine months ended September 30, 2008 were $395,000 compared
        to
        $480,000 for the same period in 2007, representing a decrease of $85,000,
        or
        18%. The license revenue for the first nine months of 2008 was primarily
        related
        to a single license agreement signed during 2007 under which $100,000 of
        the fee
        was collected during the first quarter of 2008, but for which the revenue
        was
        deferred at December 31, 2007 in accordance with the provisions of SOP 97-2;
        the
        ratable recognition of $30,000 of a term license that commenced in June 2008;
        and the recognition of $280,000 in September 2008 relating to a perpetual
        license. The license revenue for the first nine months of 2007 related to
        a
        single perpetual license agreement entered into during the second quarter
        of
        2007.
 
 *Other
        Revenue* -
        Other
        revenue for the nine months ended September 30, 2008 totaled $77,000 compared
        to
        $71,000 for the same period in 2007. This revenue is generated from non-core
        activities. We expect these revenue streams to continue to be insignificant
        in
        the future as we continue our strategy of focusing on the growth of our
        subscription and license revenues.
 
 **Cost
        of Revenues**
 
 Cost
        of
        revenues for the nine months ended September 30, 2008 was $636,000 compared
        to
        $356,000 for the same period in 2007, representing an increase of $280,000,
        or
        79%. This increase was primarily the result of incremental costs incurred
        in
        connection with supporting several new customers acquired in the latter part
        of
        2007 and first part of 2008 as well as a higher turnover rate of members
        of
        existing direct-selling organization customers. These incremental costs include
        additional call center personnel salaries and related payroll expenses of
        $100,000, hosting costs of $61,000, and credit card processing of $33,000.
        In
        addition, we incurred costs of $45,000 as a result of the introduction of
        business card printing services to direct-selling organization members in
        early
        2008.
 
 **Operating
        Expenses**
 
 Operating
        expenses for the nine months ended September 30, 2008 were $8,508,000 compared
        to $7,040,000 for the same period in 2007, representing an increase of
        $1,468,000, or 21%. This increase was primarily attributable to increases
        in
        sales and marketing and research and development expenses.
 
 *General
        and Administrative* -
        General
        and administrative expenses for the nine months ended September 30, 2008
        were
        $3,823,000 compared to $3,567,000 for the same period in 2007, representing
        an
        increase of $256,000, or 7%. This increase is primarily attributable to an
        increase in legal costs of $246,000 as we performed a review of our corporate
        and customer agreements, strengthened our internal controls and review
        procedures related to the legal function, and incurred fees in connection
        with
        the legal proceedings brought during the third quarter of 2007 against us,
        our
        former Chief Executive Officer, and a former employee. We also incurred higher
        professional services, contract labor costs, and recruiting fees in the first
        nine months of 2008 totaling $171,000 as a result of our engagement of a
        contract Interim Chief Financial Officer during our search for a new full-time
        Chief Financial Officer. In addition, during 2007 we began granting restricted
        stock, but failed to report certain taxes in connection with the vesting
        of
        restricted stock. We accrued $55,000 during the second quarter of 2008 to
        cover
        the estimated tax obligations and fees. We self-reported to the Internal
        Revenue
        Service regarding this matter and have implemented procedures to ensure full
        tax
        compliance going forward. These increases were partially offset by a $233,000
        decrease in stock-based compensation expense resulting from our decision
        in June
        2007 (which was later reversed) to limit future stock option grants.
 
 *Sales
        and Marketing* -
        Sales
        and marketing expenses for the nine months ended September 30, 2008 were
        $2,137,000 compared to $1,564,000 for the same period in 2007, representing
        an
        increase of $573,000, or 37%. This increase is primarily attributable to
        $291,000 in expense associated with new revenue sharing arrangements added
        in
        the latter part of 2007, $44,000 in increased wages resulting from additional
        sales and marketing personnel added during the first nine months of 2008,
        increased sales commissions of $99,000, and $60,000 in public relations
        expenses.
  26
 
 *Research
        and Development* -
        Research and development expenses for the nine months ended September 30,
        2008
        were $2,547,000 compared to $1,909,000 for the same period in 2007, representing
        an increase of $638,000, or 33%. This increase is primarily due to increased
        personnel expenses as we added developers during the last quarter of 2007
        and
        first nine months of 2008 to enhance and customize our platforms and
        applications and to launch additional private-label sites.
 
 **Other
        Income (Expense)**
 
 We
        incurred net interest expense of $520,000 for the nine months ended September
        30, 2008 compared to net interest expense of $401,000 for the same period
        in
        2007, representing an increase of $119,000, or 30%. Interest expense totaled
        $562,000 and $524,000 and interest income totaled $42,000 and $123,000 during
        the first nine months of 2008 and 2007, respectively. Interest expense increased
        as a direct result of increased indebtedness under lines of credit and $3.3
        million and $1.5 million of secured subordinated convertible notes bearing
        interest at 8% per annum issued in November 2007 and August 2008, respectively.
        The decrease in interest income is due to lower cash balances in the first
        nine
        months of 2008 as the cash proceeds raised in the February 2007 private
        placement described in Note 5, “Stockholders’ Equity,” to the consolidated
        financial statements in this report were depleted in operations.
 
 During
        the first nine months of 2008, we recognized $404,000 in other income, including
        a $395,000 gain on legal settlements with our insurance carrier as described
        in
        Note 7, “Commitments and Contingencies,” to the consolidated financial
        statements in this report.
 
 **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
        third quarter of 2008 primarily due to continued substantial uncertainty
        based
        on objective evidence regarding our ability to realize our deferred tax assets,
        thereby warranting a full valuation allowance in our financial statements.
        We
        have approximately $47,000,000 in net operating loss carryforwards, which
        may be
        utilized to offset future taxable income.
 
 **Liquidity
        and Capital Resources**
 
 At
        September 30, 2008, our principal sources of liquidity were cash and cash
        equivalents totaling $31,000 and current accounts receivable of $483,000.
        As of
        November 10, 2008, our principal sources of liquidity were cash and cash
        equivalents totaling approximately $45,000 and accounts receivable of
        approximately $305,000. As of September 30, 2008, we had drawn approximately
        $1.52 million on our $2.47 million line of credit with Paragon, leaving
        approximately $950,000 available under the line of credit for our operations.
        As
        of November 10, 2008, we had drawn approximately $2.15 million on the Paragon
        line of credit, leaving approximately $320,000 available under the line of
        credit for our operations, and we expect to continue to draw down on this
        line
        of credit as needed for working capital purposes. During the third quarter
        of
        2008, management established automated sweeps among its accounts at Paragon
        whereby all available cash at the end of each day is used to pay down the
        line
        of credit with Paragon, the purpose of which is to reduce our interest expense.
        This line of credit expires in February 2009 but is renewable if the underlying
        irrevocable standby letter of credit remains in force. This letter of credit
        is
        currently scheduled to expire in February 2010. As of November 10, 2008,
        we also
        have the ability to call up to approximately $10.5 million of additional
        funding
        from our convertible noteholders and, on November 12, 2008, we notified the
        convertible noteholders that we have exercised our option to sell $1.5 million
        aggregate principal of additional secured subordinated notes in a closing
        to
        occur on or before December 31, 2008, as described below under “Recent
        Developments.”
 
 During
        the quarter ended September 30, 2008, our working capital deficit increased
        by
        approximately $2,701,000 to approximately $1,814,000 compared to a working
        capital surplus of $887,000 at December 31, 2007. As described more fully
        below,
        the working capital deficit at September 30, 2008 is primarily attributable
        to
        negative cash flows from operations, including a $120,000 increase in accounts
        receivable, a $148,000 increase in notes receivable, and a $544,000
        increase in prepaid expenses during the first nine months of 2008.
  27
 
 **Cash
        Flow from Operations** .
        Cash
        used in operations for the nine months ended September 30, 2008 totaled
        $3,980,000, up from $3,319,000 for the same period in 2007. This increase
        is
        primarily due to the prepayment of 36 months of rent at our new
        headquarter ****** facilities,
        a decrease in deferred revenue, and a general increase in cash operating
        costs.
 
 **Cash
        Flow from Investing Activities** .
        Cash
        used in investing activities for the nine months ended September 30, 2008
        totaled $400,000, up from $89,000 for the same period in 2007. This increase
        is
        primarily due to the acquisition of furniture and upgrade of computer equipment
        in connection with our relocation to new headquarter facilities, as well
        as the
        capitalization of software costs related to our new platform.
 
 **Cash
        Flow from Financing Activities** .
        Cash
        provided by financing activities for the nine months ended September 30,
        2008
        totaled $937,000, down from $5,309,000 for the same period in 2007. This
        decrease is primarily due to cash raised in 2007 from the issuance of common
        stock as described below, a portion of which was used to reduce debt borrowings.
        In the first nine months of 2008, the Company again relied upon debt borrowings
        to help fund operations.
 
 *Equity
        Financing* .
        In a
        transaction that closed on February 21, 2007, we sold an aggregate of 2,352,941
        shares of our common stock to two new investors, or the Investors. The private
        placement shares were sold at $2.55 per share pursuant to a Securities Purchase
        Agreement, or the SPA, between us and each of the Investors. The aggregate
        gross
        proceeds to us were $6 million, and we incurred issuance costs of approximately
        $637,000. ****** Under
        the
        SPA, the Investors were issued warrants for the purchase of an aggregate
        of
        1,176,471 shares of common stock at an exercise price of $3.00 per share.
        These
        warrants contain a provision for cashless exercise and must be exercised,
        if at
        all, by February 21, 2010.
 
 *Debt
        Financing.* On
        February 15, 2008, we repaid the full outstanding principal balance of
        $2,052,000 and accrued interest of $2,890 outstanding under our revolving
        credit
        arrangement with Wachovia Bank, NA, or Wachovia. The line of credit advanced
        by
        Wachovia was $2.5 million to be used for general working capital purposes.
        Any
        advances made on the line of credit were to be paid off no later than August
        1,
        2008. The line of credit was secured by our deposit account at Wachovia and
        the
        irrevocable standby letter of credit issued by HSBC Private Bank (Suisse)
        SA, or
        HSBC, with Atlas Capital, SA, or Atlas, a current stockholder and affiliate,
        both of which were released by Wachovia.
 
 On
        February 20, 2008, we entered into a revolving credit arrangement with Paragon
        that is subject to annual renewal subject to mutual approval. The line of
        credit
        advanced by Paragon is $2.47 million and can be used for general working
        capital. Any advances made on the line of credit must be paid off no later
        than
        February 19, 2009, subject to extension due to renewal, with monthly payments
        being applied first to accrued interest and then to principal. The interest
        shall accrue on the unpaid principal balance at the Wall Street Journal’s
        published prime rate minus one half percent. As of September 30, 2008, the
        line
        of credit was secured by an irrevocable standby letter of credit in the amount
        of $2.5 million issued by HSBC with Atlas as account party, expiring February
        18, 2010. We also have agreed with Atlas that in the event of our default
        in the
        repayment of the line of credit that results in the letter of credit being
        drawn, we will reimburse Atlas any sums that Atlas is required to pay under
        such
        letter of credit. At our sole discretion, these payments may be made in cash
        or
        by issuing shares of our common stock at a set per share price of $2.50.
 
 This
        line
        of credit replaces our line of credit with Wachovia. As an incentive for
        the
        letter of credit from Atlas to secure the Wachovia line of credit, we had
        entered into a stock purchase warrant and agreement with Atlas. Under the
        terms
        of the agreement, Atlas received a warrant to purchase up to 444,444 shares
        of
        our common stock at $2.70 per share within 30 business days of the termination
        of the Wachovia line of credit or if we are in default under the terms of
        the
        line of credit with Wachovia. In consideration for Atlas providing the Paragon
        letter of credit, we agreed to amend the agreement to provide that the warrant
        is exercisable within 30 business days of the termination of the Paragon
        line of
        credit or if we are in default under the terms of the line of credit with
        Paragon.
 
 On
        November 14, 2007, in an initial closing, we sold $3.3 million aggregate
        principal amount of secured subordinated convertible notes due November 14,
        2010, or the initial notes. In addition, the noteholders committed to purchase
        on a pro rata basis up to $5.2 million aggregate principal of secured
        subordinated notes in future closings upon approval and call by our Board
        of
        Directors. On August 12, 2008, we exercised our option to sell $1.5 million
        aggregate principal of additional secured subordinated notes due November
        14,
        2010, or the additional notes, and together with the initial notes, the notes,
        with substantially the same terms and conditions as the initial notes. In
        connection with the sale of the additional notes, the noteholders holding
        a
        majority of the aggregate principal amount of the notes outstanding agreed
        to
        increase the aggregate principal amount of secured subordinated convertible
        notes that they are committed to purchase from $8.5 million to $15.3 million,
        of
        which $4.8 million is currently outstanding.
  28
 
 We
        are
        obligated to pay interest on the initial notes and the additional notes at
        an
        annualized rate of 8% payable in quarterly installments commencing on February
        14, 2008 and November 12, 2008, respectively. We are not permitted to prepay
        the
        notes without approval of the holders of at least a majority of the principal
        amount of the notes then outstanding.
 
 On
        the
        earlier of the maturity date of November 14, 2010 or a merger or acquisition
        or
        other transaction pursuant to which our existing stockholders hold less than
        50%
        of the surviving entity, or the sale of all or substantially all of our assets,
        or similar transaction, or event of default, each noteholder in its sole
        discretion shall have the option to:
 
 ·
              convert
                  the principal then outstanding on its notes into shares of our
                  common
                  stock, or
 
 ·
              receive
                  immediate repayment in cash of the notes, including any accrued
                  and unpaid
                  interest.
  If
        a
        noteholder elects to convert its notes under these circumstances, the conversion
        price of notes:
  ·
              issued
                  in the initial closing on November 14, 2007 shall be $3.05;
                  and
  ·
              issued
                  on August 12, 2008 shall be the lower of $3.05 or the average of
                  the
                  closing bid and asked prices of shares of our common stock quoted
                  in the
                  Over-The-Counter Market Summary (or, if our shares are traded on
                  the
                  Nasdaq Stock Market or another exchange, the closing price of shares
                  of
                  our common stock quoted on such exchange) averaged over five trading
                  days
                  prior to the closing date of the sale of the additional notes.
 
 Payment
        of the notes will be automatically accelerated if we enter voluntary or
        involuntary bankruptcy or insolvency proceedings.
 
 The
        notes
        and the common stock into which they may be converted have not been registered
        under the Securities Act or the securities laws of any other jurisdiction.
        As a
        result, offers and sales of the notes were made pursuant to Regulation D
        of the
        Securities Act and only made to accredited investors that were our existing
        stockholders. The investors in the initial notes include (i) The Blueline
        Fund,
        or Blueline, which originally recommended Philippe Pouponnot, one of our
        former
        directors, for appointment to the Board of Directors; (ii) Atlas, an affiliate
        that originally recommended Shlomo Elia, one of our current directors, for
        appointment to the Board of Directors; (iii) Crystal Management Ltd., which
        is
        owned by Doron Roethler, who subsequently became Chairman of our Board of
        Directors and serves as the noteholders’ bond representative; and (iv) William
        Furr, who is the father of Thomas Furr, who, at the time, was one of our
        directors and executive officers. The investors in the additional notes are
        Atlas and Crystal Management Ltd.
 
 In
        addition, if we propose to file a registration statement to register any
        of its
        common stock under the Securities Act in connection with the public offering
        of
        such securities solely for cash, subject to certain limitations, we must
        give
        each noteholder who has converted its notes into common stock the opportunity
        to
        include such shares of converted common stock in the registration. We have
        agreed to bear the expenses for any of these registrations, exclusive of
        any
        stock transfer taxes, underwriting discounts, and commissions.
 
 On
        November 6, 2007, Canaccord Adams Inc. agreed to waive any rights it held
        under
        its January 2007 engagement letter with us that it may have with respect
        to the
        convertible note offering, including the right to receive any fees in connection
        with the offering.
 
 We
        have
        not yet achieved positive cash flows from operations, and our main sources
        of
        funds for our operations are the sale of securities in private placements,
        the
        sale of additional convertible notes, and bank lines of credit. We must continue
        to rely on these sources until we are able to generate sufficient revenue
        to
        fund our operations. We believe that anticipated cash flows from operations,
        funds available from our existing line of credit, and additional issuances
        of
        notes, together with cash on hand, will provide sufficient funds to finance
        our
        operations at least for the next 12 to 18 months, depending on our ability
        to
        achieve strategic goals outlined in our annual operating budget approved
        by our
        Board of Directors. Changes in our operating plans, lower than anticipated
        sales, increased expenses, or other events may cause us to seek additional
        equity or debt financing in future periods. There can be no guarantee that
        financing will be available on acceptable terms or at all. Additional equity
        financing could be dilutive to the holders of our common stock, and additional
        debt financing, if available, could impose greater cash payment obligations
        and
        more covenants and operating restrictions.
  29
 
 **Recent
        Developments**
 
 As
        more
        fully described elsewhere in this report, on November 12, 2008 we notified
        all
        current noteholders that we have exercised our option to sell $1.5 million
        aggregate principal of additional secured subordinated notes due November
        14,
        2010, or the new notes, with substantially the same terms and conditions
        as the
        outstanding notes in a closing to
        occur
        on or before December 31, 2008 .
        We will
        be obligated to pay interest on the new notes at an annualized rate of 8%
        payable in quarterly installments commencing three months after the closing
        date, and we will not be permitted to prepay the new notes without approval
        of
        the holders of at least a majority of the aggregate principal amount of the
        notes then outstanding. We plan to use the proceeds to meet ongoing working
        capital and capital spending requirements.
 
 **Item
        3.**  **Quantitative
        and Qualitative Disclosures About Market Risk**
  Not
        applicable.
 
 **Item
        4.** **Controls
        and Procedures**
 
 Not
        applicable.
 
 **Item
        4T.** **Controls
        and Procedures**
 
 We
        maintain disclosure controls and procedures (as defined in Rules 13a-15(e)
        and
        15d-15(e) under the Exchange Act) that are designed to provide reasonable
        assurances that information required to be disclosed by us in the reports
        that
        we file or submit under the Exchange Act is recorded, processed, summarized
        and
        reported, within the time periods specified in the SEC’s rules and forms, and
        that such information is accumulated and communicated to management, including
        our Chief Executive Officer and Chief Financial Officer, as appropriate,
        to
        allow timely decisions regarding required disclosure. In designing and
        evaluating the disclosure controls and procedures, management recognized
        that
        disclosure controls and procedures, no matter how well designed and operated,
        can provide only reasonable assurances of achieving the desired control
        objectives, as ours are designed to do, and management necessarily was required
        to apply its judgment in evaluating the cost-benefit relationship of possible
        controls and procedures.
 
 Our
        management, with the participation of our Chief Executive Officer and Chief
        Financial Officer, has evaluated the effectiveness of our disclosure controls
        and procedures as of the end of the period covered by this Quarterly Report
        on
        Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief
        Financial Officer concluded that, as of the end of the period covered by
        this
        Quarterly Report on Form 10-Q, our disclosure controls and procedures were
        effective to ensure that information required to be disclosed by us in the
        reports we file under the Exchange Act is recorded, processed, summarized
        and
        reported within the time periods specified in the SEC’s rules and
        forms.
 
 We
        have
        made the following changes to our internal controls over financial reporting
        during the third quarter of fiscal 2008 that have materially affected, or
        are
        reasonably likely to materially affect, our internal control over financial
        reporting :
 
 ·
              hired
                  a new permanent Chief Financial
                  Officer;
 
 ·
              implemented
                  dual-control security on all cash transfers with our bank and established
                  maximums that could be initiated by our Controller, with any transfer
                  in
                  excess of such maximums requiring initiation by one of our
                  officers;
 
 ·
              restricted
                  check signing authority to our
                  officers;
 
 ·
              modified
                  permission rights in our accounting software to ensure transactions
                  could
                  not be modified or deleted after
                  posting;
  30
 
 ·
              implemented
                  a structured vendor invoice approval process with multiple levels
                  of
                  approval required before the expense can be entered into our accounting
                  system;
 
 ·
              engaged
                  an outside firm to conduct an ethics training course for all members
                  of
                  management;
 
 ·
              with
                  respect to our previously-identified controls regarding period
                  closing,
                  refined our internal checklist to ensure that all period closing
                  procedures are recorded properly and completely, and that the financial
                  statements are reviewed and approved by our Chief Financial Officer;
                  and
 
 ·
              with
                  respect to our controls regarding stock option and restricted stock
                  expense, implemented a process to track the vesting of restricted
                  stock
                  issued to employees and introduced a policy to allow the netting
                  of shares
                  as payment of the resulting employee tax obligation so that such
                  taxes are
                  paid timely to governmental
                  agencies.
 
 During
        the fourth quarter of 2008, we are developing a new general ledger chart
        of
        accounts to more closely align our 2009 budget with actual results and to
        assign
        accountability for expenses by department. We are also working on the testing
        and remediation phases of our compliance initiative with respect to the
        Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley. As part of our ongoing efforts
        to
        improve our internal control over financial reporting, our new Chief Financial
        Officer is continuing to evaluate certain financial and accounting functions.
        As
        we previously disclosed in our Annual Report on Form 10-K for the year ended
        December 31, 2007, we have identified five critical control areas for
        improvement in fiscal 2008. As discussed above, we have adopted controls
        related
        to period closing and stock option and restricted stock expense. We expect
        to
        make several additional changes to our internal control over financial reporting
        during the remainder of fiscal 2008, including full adoption of the remaining
        previously-identified controls relating to accrual analysis and journal entries,
        the adoption of which would be critical and material to our internal control
        environment.
 
 **PART
        II – OTHER INFORMATION**
 
 **Item
        1.** **Legal
        Proceedings**
 
 Please
        refer to Part I, Item 3 of our Annual Report on Form 10-K for the fiscal
        year ended December 31, 2007 and Part II, Item 1 of our Quarterly Reports
        on
        Form 10-Q for the quarterly periods ended March 31, 2008 and June 30, 2008
        for a
        description of material legal proceedings, including the proceedings discussed
        below.
 
 On
        July
        14, 2008, we filed a civil action against a former employee in the General
        Court
        of Justice, Superior Court Division, Durham County, North Carolina. The
        complaint alleged that the former employee embezzled funds from us in the
        amount
        of $105,600 and asserted claims for conversion and unfair trade practices.
        The
        lawsuit sought recovery for the embezzled funds, plus punitive damages or
        treble
        damages, interest, and attorneys’ fees. On August 25, 2008, we obtained a
        judgment against the former employee in the amount of $105,599.94, trebled
        to
        $316,799.82 pursuant to the North Carolina Unfair and Deceptive Trade Practice
        Statute, plus interest at 8% from the date of filing the complaint, and all
        court costs and reasonable attorneys’ fees existing as of the date of the
        judgment and as may accrue from time to time until the judgment is paid in
        full.
        We are in the process of attempting to collect on the judgment.
 
 On
        October 18, 2007, Robyn L. Gooden filed a purported class action lawsuit
        in the
        United States District Court for the Middle District of North Carolina naming
        us, certain of our current and former officers and directors, Maxim Group,
        LLC,
        and Jesup & Lamont Securities Corp. as defendants. The lawsuit was filed on
        behalf of all persons other than the defendants who purchased our securities
        from May 2, 2005 through September 28, 2007 and were damaged. The complaint
        asserts violations of federal securities laws, including violations of
        Section 10(b) of the Exchange Act and Rule 10b-5. The complaint asserts
        that the defendants made material and misleading statements with the intent
        to
        mislead the investing public and conspired in a fraudulent scheme to manipulate
        trading in the our stock, allegedly causing plaintiffs to purchase the stock
        at
        an inflated price. The complaint requests certification of the plaintiff
        as
        class representative and seeks, among other relief, unspecified compensatory
        damages including interest, plus reasonable costs and expenses including
        counsel
        fees and expert fees. On June 24, 2008, the court entered an order appointing
        a
        lead plaintiff for the class action. On September 8, 2008, the plaintiff
        filed
        an amended complaint which added additional defendants who had served as
        our
        directors or officers during the class period as well as our independent
        auditor.
  31
 
 At
        this
        time, we are not able to determine the likely outcome of our currently pending
        legal matters, nor can we estimate our potential financial exposure. Our
        management has made an initial estimate based upon its knowledge, experience
        and
        input from legal counsel, and we have accrued approximately $137,500 of legal
        reserves. Such reserves will be adjusted in future periods as more information
        becomes available. If an unfavorable resolution of any of these matters occurs,
        our business, results of operations, and financial condition could be materially
        adversely affected.
 
 **Item
        1A.** **Risk
        Factors**
 
 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, you should pay particular attention
        to
        the descriptions of risks and uncertainties described below and in other
        sections of this document and our other filings. These risks and uncertainties
        are not the only ones we face. Additional risks and uncertainties not presently
        known to us, which 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 operations could be materially and adversely
        affected.
 
 **Historically,
        we have operated at a loss, and we continue to do so.** ******
 
 We
        have
        had recurring losses from operations and continue to have negative cash flows.
        If we do not become cash flow positive through additional financing or growth,
        we may have to cease operations and liquidate our business. Our
        working capital, including our line of credit with Paragon, February 2007
        equity
        financing transaction, and convertible note financings, should fund our
        operations for the next 12 to 18 months. As of November 10, 2008, we have
        approximately $320,000 available on our revolving line of credit and
        approximately $10.5 million available through our convertible note financing.
        On
        November 12, 2008, we notified our convertible noteholders that we have
        exercised our option to sell $1.5 million aggregate principal of additional
        secured subordinated notes in a closing to occur on or before December 31,
        2008.
        Factors such as 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, the timing and success of potential strategic
        alliances or potential opportunities to acquire technologies or assets, the
        charges filed against a former officer and a former employee filed by the
        SEC
        and the United States Attorney General, and the pending shareholder class
        action
        lawsuit may require us to seek additional funding sooner than we expect.
        If we
        fail to raise sufficient financing, we will not be able to implement our
        business plan and may not be able to sustain our business.
 
 **Current
        economic uncertainties in the global economy could adversely impact our growth,
        results of operations, and our ability to forecast future
        business.**
 
 In
        2008,
        there has been a downturn in the global economy, slower economic activity,
        decreased consumer confidence, reduced corporate profits and capital spending,
        adverse business conditions, and liquidity concerns. These conditions make
        it
        difficult for our customers and us to accurately forecast and plan future
        business activities, and they could cause our customers to slow or defer
        spending on our products and services, which would delay and lengthen sales
        cycles, or change their willingness to enter into longer-term licensing and
        support arrangements with us. Furthermore, during challenging economic times
        our
        customers may face issues gaining timely access to sufficient credit, which
        could result in an impairment of their ability to make timely payments to
        us. If
        that were to occur, we may be required to increase our allowance for doubtful
        accounts and our results would be negatively impacted.
 
 We
        cannot
        predict the timing, strength, or duration of any economic slowdown or subsequent
        economic recovery. If the downturn in the general economy or markets in which
        we
        operate persists or worsens from present levels, our business, financial
        condition, and results of operations could be materially and adversely
        affected.
 
 **Our
        business is dependent upon the development and market acceptance of our
        applications.**
  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 deliver
        timely 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. Our business could be harmed if we fail to achieve the improved
        performance that customers want with respect to our current and future product
        offerings. There can be no assurance that our products will achieve widespread
        market penetration or that we will derive significant revenues from the sale
        or
        licensing of our platforms or applications.
  32
 
 **We
        have not yet demonstrated that we have a successful business model.**
 
 We
        have
        invested significantly in infrastructure, operations, and strategic
        relationships to support our SaaS delivery model, which represents 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. 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 this business model may
        become
        ineffective due to forces beyond our control that we do not currently
        anticipate. Although we currently have various agreements and continue to
        enter
        into new agreements, our success depends in part on the ultimate success
        of our
        syndication ****** partners
        and referral partners and their ability to market our products and services
        successfully. Our partners are not obligated to provide potential customers
        to
        us and may have difficulty retaining customers within certain markets that
        we
        serve. 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.
 
 In
        addition, our end users currently do not sign long-term contracts. They have
        no
        obligation to renew their subscriptions for our services after the expiration
        of
        their initial subscription period and, in fact, they have often elected not
        to
        do so. Our end users also may renew for a lower-priced edition of our services
        or for fewer users. These factors make it difficult to 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 capability to
        continue their operations and spending levels. 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.
 
 **The
        SEC action against us, the SEC and criminal actions brought against certain
        former employees, and related stockholder and other lawsuits have damaged
        our
        business, and they could damage our business in the future.**
 
 The
        lawsuit filed against us by the SEC, the SEC and criminal actions filed against
        a former officer and a former employee, the class action lawsuit filed against
        us and certain current and former officers, directors, and employees, and
        the
        lawsuit filed by a former executive officer against us, all as described
        in our
        Annual Report on Form 10-K for the year ended December 31, 2007, have harmed
        our
        business in many ways, and may cause further harm in the future. Since the
        initiation of these actions, our ability to raise financing from new investors
        on favorable terms has suffered due to the lack of liquidity of our stock,
        the
        questions raised by these actions, and the resulting drop in the price of
        our
        common stock. As a result, we may not raise sufficient financing, if necessary,
        in the future.
 
 Legal
        and
        other fees related to these actions have also reduced our available cash.
        We
        make no assurance that we will not continue to experience additional harm
        as a
        result of these matters. The time spent by our management team and directors
        dealing with issues related to these actions detracts from the time they
        spend
        on our operations, including strategy development and implementation. These
        actions also have harmed our reputation in the business community, jeopardized
        our relationships with vendors and customers, and decreased our ability to
        attract qualified personnel, especially given the media coverage of these
        events.
  33
 
 In
        addition, we face uncertainty regarding amounts that we may have to pay as
        indemnification to certain current and former officers, directors, and employees
        under our Bylaws and Delaware law with respect to these actions, and we may
        not
        recover all of these amounts from our directors and officers liability insurance
        policy carrier. Our Bylaws and Delaware law generally require us to indemnify,
        and in certain circumstances advance legal expenses to, current and former
        officers and directors against claims arising out of such person’s status or
        activities as our officer or director, unless such person (i) did not act
        in
        good faith and in a manner the person reasonably believed to be in or not
        opposed to our best interests or (ii) had reasonable cause to believe his
        conduct was unlawful. As of November 10, 2008, there are SEC and criminal
        actions pending against a former executive officer and a former employee
        who
        have requested that we indemnify them and advance expenses incurred by them
        in
        the defense of those actions. Also, a stockholder class action lawsuit has
        been
        filed against us and certain of our current ****** and
        former officers, directors, and employees. The SEC, criminal, and stockholder
        actions are more fully described in Part I, Item 3, “Legal Proceedings,” in our
        Annual Report on Form 10-K for the year ended December 31, 2007 and Part
        II,
        Item 1, “Legal Proceedings,” in this report and the Quarterly Reports on Form
        10-Q for the quarterly periods ended March 31, 2008 and June 30, 2008.
 
 Generally,
        we are required to advance defense expenses prior to any final adjudication
        of
        an individual’s culpability. The expense of indemnifying our current and former
        directors, officers, and employees for their defense or related expenses
        in
        connection with the current actions may be significant. Our Bylaws require
        that
        any director, officer, employee, or agent requesting advancement of expenses
        enter into an undertaking with us to repay any amounts advanced unless it
        is
        ultimately determined that such person is entitled to be indemnified for
        the
        expenses incurred. This provides us with an opportunity, depending upon the
        final outcome of the matters and the Board’s subsequent determination of such
        person’s right to indemnity, to seek to recover amounts advanced by us. However,
        we may not be able to recover any amounts advanced if the person to whom
        the
        advancement was made lacks the financial resources to repay the amounts that
        have been advanced. If we are unable to recover the amounts advanced, or
        can do
        so only at great expense, our operations may be substantially harmed as a
        result
        of loss of capital.
 
 Although
        we have purchased insurance that may cover these obligations, we can offer
        no
        assurances that all of the amounts that may be expended by us will be recovered
        under our insurance policy. It is possible that we may have an obligation
        to
        indemnify our current and former officers and directors under the terms of
        our
        Bylaws and Delaware law, but that there may be insufficient coverage for
        these
        payments under the terms of our insurance policy. Therefore, we face the
        risk of
        making substantial payments related to the defense of these actions, which
        could
        significantly reduce amounts available to fund working capital, capital
        expenditures, and other general corporate objectives.
 
 In
        addition, our insurance policy provides that, under certain conditions, our
        insurer may have the right to seek recovery of any amounts it paid to the
        individual insureds or us. As of November 10, 2008, we do not know and can
        offer
        no assurances about whether these conditions will apply or whether the insurance
        carrier will change its position regarding coverage related to the current
        actions. Therefore, we can offer no assurances that our insurer will not
        seek to
        recover any amounts paid under its policy from the individual insureds or
        us. If
        such recovery is sought, then we may have to expend considerable financial
        resources in defending and potentially settling or otherwise resolving such
        a
        claim, which could substantially reduce the amount of capital available to
        fund
        our operations.
 
 **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.**
 
 Our
        executive management team has undergone significant changes during late 2007
        and
        the first nine months of 2008. Our success depends significantly on the
        continued services of our executive management personnel and attracting
        additional qualified personnel. Losing any of our officers could seriously
        harm
        our business. Competition for executives is intense. Although we have resolved
        the SEC charges filed against us, we may not be able to attract highly qualified
        candidates to serve on our executive management team. If we had to replace
        any
        of our officers, we would not be able to replace the significant amount of
        knowledge that they may have about our operations. If we cannot attract and
        retain qualified personnel and integrate new members of our executive management
        team effectively into our business, then our business and financial results
        may
        suffer. In addition, 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 any
        of our employees.
  34
 
 **Failure
        to comply with the provisions of our debt financing arrangements could have
        a
        material adverse effect on us.**
 
 Our
        revolving line of credit from Paragon is secured by an irrevocable standby
        letter of credit issued by HSBC, with Atlas as account party. Our secured
        subordinated convertible notes are secured by a first-priority lien on all
        of
        our unencumbered assets.
 
 If
        an
        event of default occurs under our debt financing arrangements and remains
        uncured, then the lender could foreclose on the assets securing the debt.
        If
        that were to occur, it would have a substantial adverse effect on our business.
        In addition, making the principal and interest payments on these debt
        arrangements may drain our financial resources or cause other material harm
        to
        our business.
 
 **Compliance
        with regulations governing public company corporate governance and reporting
        is
        uncertain and expensive.**
 
 As
        a
        public company, we have incurred and will continue to incur significant legal,
        accounting, and other expenses that we did not incur as a private company.
        We
        incur costs associated with our public company reporting requirements and
        with
        corporate governance and disclosure requirements, including requirements
        under
        Sarbanes-Oxley and new rules implemented by the SEC and the Financial Industry
        Regulatory Authority, or FINRA. We expect these rules and regulations to
        increase our legal and financial compliance costs and to make some activities
        more time-consuming and costly.
 
 For
        fiscal 2009, we will be required to comply with the requirements of Section
        404
        of Sarbanes-Oxley involving our independent accountant’s audit of our internal
        control over financial reporting. To comply with these requirements, we are
        evaluating and testing our internal controls, and where necessary, taking
        remedial actions, to allow our independent auditors to attest to our internal
        control over financial reporting. As a result, we have incurred and will
        continue to incur expenses and diversion of management’s time and attention from
        the daily operations of the business, which may increase our operating expenses
        and impair our ability to achieve profitability.
 
 We
        have
        identified several significant deficiencies in our internal control over
        financial reporting. We are working to remediate these identified significant
        deficiencies, and we cannot give any assurances that all significant
        deficiencies or material weaknesses have been identified or that additional
        significant deficiencies or material weaknesses will not be identified in
        the
        future in connection with our compliance with the provisions of Section 404
        of
        Sarbanes-Oxley. The existence of one or more material weaknesses would preclude
        a conclusion by management that we maintained effective internal control
        over
        financial reporting.
 
 Our
        former Chief Financial Officer resigned at the end of the first quarter of
        2008,
        resulting in our loss of his financial expertise and knowledge of our history
        and past transactions. We engaged an outside accounting consultant and an
        Interim Chief Financial Officer, each with a level of accounting knowledge,
        experience, and training in the application of generally accepted accounting
        principles commensurate with our financial reporting requirements to assist
        us
        during the transition period between permanent Chief Financial Officers.
        We
        appointed a new Chief Financial Officer on July 15, 2008 who has restructured
        our financial and accounting functions to address concerns regarding segregation
        of duties and expense approval processes.
 
 There
        can
        be no assurance that we will be able to maintain our schedule to complete
        all
        assessment and testing of our internal controls in a timely manner. Further,
        we
        cannot be certain that our testing of internal controls and resulting
        remediation actions will yield adequate internal control over financial
        reporting as required by Section 404 of Sarbanes-Oxley. If we are not able
        to
        implement the requirements of Section 404 in a timely manner or with adequate
        compliance, there could be an adverse reaction in the financial markets due
        to a
        loss of confidence in the reliability of our financial statements, which
        could
        adversely affect the market price of our common stock.
 
 **Officers,
        directors, and principal stockholders control us. This might lead them to
        make
        decisions that do not align with the interests of minority
        stockholders.**
 
 Our
        officers, directors, and principal stockholders beneficially own or control
        a
        large percentage of our outstanding common stock. Certain of these principal
        stockholders hold warrants and convertible notes, which may be exercised
        or
        converted into additional shares of our common stock under certain conditions.
        The convertible noteholders have designated a bond representative to act
        as
        their agent. We have agreed that the bond representative shall be granted
        access
        to our facilities and personnel during normal business hours, shall have
        the
        right to attend all meetings of our Board of Directors and its committees,
        and
        to receive all materials provided to our Board of Directors or any committee
        of
        our Board. In addition, so long as the notes are outstanding, we have agreed
        that we will not take certain material corporate actions without approval
        of the
        bond representative. The Chairman of our Board of Directors currently is
        serving
        as the bond representative.
  35
 
 Our
        officers, directors, and principal stockholders, acting together, would 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 acquirer 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.
 
 **Our
        failure to properly report certain taxes in connection with the vesting of
        restricted stock could result in tax penalties and interest from the Internal
        Revenue Service and state tax authorities.**
 
 During
        2007, we began granting restricted stock, but failed to properly report certain
        taxes in connection with the vesting of restricted stock. We accrued $55,000
        during the second quarter of 2008 to cover the estimated tax obligations
        and
        fees. We self-reported to the Internal Revenue Service regarding this
        matter ****** and
        paid
        estimated taxes and penalties of $28,655 in the third quarter of 2008, with
        additional costs associated with this event expected in the fourth quarter
        of
        2008. In addition, we are subject to a settlement offer in compromise order
        with
        the Internal Revenue Service regarding past tax obligations and could be
        subject
        to significant past penalties related to this order depending upon the Internal
        Revenue Service’s view of our approach to handling the current matter. Any such
        additional tax penalties could materially and adversely impact our financial
        condition and results of operations.
 
 **Any
        issuance of shares of our common stock in the future could have a dilutive
        effect on the value of our existing stockholders’ shares.**
 
 We
        may
        issue shares of our common stock in the future for a variety of reasons.
        For
        example, under the terms of our stock purchase warrant and agreement with
        Atlas,
        it may elect to purchase up to 444,444 shares of our common stock at $2.70
        per
        share upon termination of, or if we are in breach under the terms of, our
        line
        of credit with Paragon. In connection with our private financing in February
        2007, we issued warrants to the investors to purchase an additional 1,176,471
        shares of our common stock at $3.00 per share and a warrant to our placement
        agent in that transaction to purchase 35,000 shares of our common stock at
        $2.55
        per share. Upon maturity of their convertible notes, our noteholders may
        elect
        to convert all, a part of, or none of their notes into shares of our common
        stock at variable conversion prices. In addition, we may raise funds in the
        future by issuing additional shares of common stock or other
        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.
        Depending on the share price we are able to obtain, we may have to sell a
        significant number of shares in order to raise the necessary amount of capital.
        Our stockholders may experience dilution in the value of their shares as
        a
        result.
 
 **Shares
        eligible for public sale could adversely affect our stock
        price.**
 
 Future
        sales of substantial amounts of our shares in the public market, or the
        appearance that a large number of our shares are available for sale, could
        adversely affect market prices prevailing from time to time and could impair
        our
        ability to raise capital through the sale of our securities. At August 8,
        2008,
        18,325,606 shares of our common stock were issued and outstanding and a
        significant number of shares may be issued upon the exercise of outstanding
        options, warrants, and convertible notes.
 
 Our
        stock
        historically has been very thinly traded. The average daily trading volume
        for
        our common stock between January 2008 and September 2008 was approximately
        34,852 shares per day. The number of shares that could be sold during this
        period was restrained by previous contractual and other legal limitations
        imposed on some of our shares that are no longer applicable. This means that
        market supply may increase more than market demand for our shares. Many
        companies experience a decrease in the market price of their shares when
        such
        events occur.
 
 We
        cannot
        predict if future sales of our common stock, or the availability of our common
        stock held for sale, will materially and adversely affect the market price
        for
        our common stock or our ability to raise capital by offering equity or other
        securities. Our stock price may decline if the resale of shares under Rule
        144,
        in addition to the resale of registered shares, at any time in the future
        exceeds the market demand for our stock.
  36
 
 **Our
        stock price is likely to be highly volatile and may
        decline.**
 
 The
        trading prices of the securities of technology companies have been highly
        volatile. Accordingly, the trading price of our common stock has been and
        is
        likely to continue to be subject to wide fluctuations. Further, our common
        stock
        has a limited trading history. Factors affecting the trading price of our
        common
        stock generally include the risk factors described in this report.
 
 In
        addition, the stock market from time to time has experienced extreme price
        and
        volume fluctuations that have affected the trading prices of many emerging
        growth companies. Such fluctuations have often been unrelated or
        disproportionate to the operating performance of these companies. These broad
        trading fluctuations could adversely affect the trading price of our common
        stock.
 
 Further,
        securities class action litigation has often been brought against companies
        that
        experience periods of volatility in the market prices of their securities.
        A
        securities class action was filed against us in October 2007 as more fully
        described in Part II, Item 1, “Legal Proceedings,” in this report. This
        securities class action litigation could result in substantial costs and
        a
        diversion of our management’s attention and resources. We may determine, like
        many defendants in such lawsuits, that it is in our best interest to settle
        the
        lawsuit, even if we believe that the plaintiffs’ claims have no merit, to avoid
        the cost and distraction of continued litigation. Any liability we incur
        in
        connection with this or any other potential lawsuit could materially harm
        our
        business and financial position and, even if we defend ourselves successfully,
        there is a risk that management’s distraction in dealing with this type of
        lawsuit could harm our results.
 
 **Our
        securities may be subject to “penny stock” rules, which could adversely affect
        our stock price and make it more difficult for our stockholders to resell
        their
        stock.**
 
 The
        SEC
        has adopted rules that regulate broker-dealer practices in connection with
        transactions in penny stocks. Penny stocks are generally equity securities
        with
        a price of less than $5.00 per share (other than securities registered on
        certain national securities exchanges or quotation systems, provided that
        reports with respect to transactions in such securities are provided by the
        exchange or quotation system pursuant to an effective transaction reporting
        plan
        approved by the SEC).
 
 The
        penny
        stock rules require a broker-dealer, prior to a transaction in a penny stock
        not
        otherwise exempt from those rules, to deliver a standardized risk disclosure
        document prescribed by the SEC and certain other information related to the
        penny stock, the broker-dealer’s compensation in the transaction, and the other
        penny stocks in the customer’s account.
 
 In
        addition, the penny stock rules require that, prior to a transaction in a
        penny
        stock not otherwise exempt from those rules, the broker-dealer must make
        a
        special written determination that the penny stock is a suitable investment
        for
        the purchaser and receive the purchaser’s written acknowledgment of the receipt
        of a risk disclosure statement, a written agreement related to transactions
        involving penny stocks, and a signed and dated copy of a written suitability
        statement. These disclosure requirements could have the effect of reducing
        the
        trading activity in the secondary market for our stock because it will be
        subject to these penny stock rules. Therefore, stockholders may have difficulty
        selling those securities.
 
 **If
        we fail to evaluate, implement, and integrate strategic opportunities
        successfully, our business may suffer.**
 
 From
        time
        to time we evaluate strategic opportunities available to us for product,
        technology, or business acquisitions or dispositions. If we choose to make
        acquisitions or dispositions, we face certain risks, such as failure of an
        acquired business to meet our performance expectations, diversion of management
        attention, retention of existing customers of our current and acquired business,
        and difficulty in integrating or separating a business’s operations, personnel,
        and financial and operating systems. We may not be able to successfully address
        these risks or any other problems that arise from our previous or future
        acquisitions or dispositions. Any failure to successfully evaluate strategic
        opportunities and address risks or other problems that arise related to any
        acquisition or disposition could adversely affect our business, results of
        operations, and financial condition.
  37
 
 **Item
        2.** **Unregistered
        Sales of Equity Securities and Use of Proceeds**
 
 Except
        as
        previously disclosed in our Quarterly Report on Form 10-Q for the quarterly
        period ended June 30, 2008, there were no sales of unregistered securities
        during the third quarter of fiscal 2008.
 
 The
        following table lists all repurchases during the third quarter of fiscal
        2008 of
        any of our securities registered under Section 12 of the Exchange Act by or
        on behalf of us or any affiliated purchaser.
 
 **Issuer
        Purchases of Equity Securities**
  **Period**
              
              **Total**
                **Number of**
                **Shares**
                **Purchased**
              
              **Average**
                **Price**
                **Paid Per**
                **Share**
              
              **Total Number of**
                **Shares Purchased as**
                **Part of Publicly**
                **Announced Plans or**
                **Programs**
              
              **Maximum**
                **Number of**
                **Shares That May**
                **Yet Be Purchased**
                **Under the Plans or**
                **Programs**July
                  1 – July 31, 2008
              
              
              -
              
              $
              -
              
              
              -
              
              
              -August
                  1 – August 31, 2008
              
              
              -
              
              $
              -
              
              
              -
              
              
              -September
                  1 – September 30, 2008
              
              
              9,551
              (1)
              $
              3.25
              (2)
              
              -
              
              
              -Total
              
              
              9,551
              
              $
              3.25
              
              
              -
              
              
              -
 
 (1)
              Includes
                  2,051 shares repurchased in connection with tax withholding obligations
                  under the 2004 Plan and 7,500 shares of restricted stock forfeited
                  by one
                  of our directors in exchange for the grant of a stock option to
                  purchase
                  15,000 shares of common stock at an exercise price of $3.25 per
                  share.(2)
              Represents
                  the average price paid per share for the 2,051 shares repurchased
                  in
                  connection with tax withholding obligations under the 2004 Plan
                  and does
                  not reflect the grant of a stock option to purchase 15,000 shares
                  at an
                  exercise price of $3.25 per share in exchange for the forfeiture
                  of 7,500
                  shares of restricted stock by one of our directors.
 
 **Item
        5.** **Other
        Information**
 
 In
        connection with our increased focus on sales and marketing, on November 10,
        2008, Neile King’s position was changed from Chief Operating Officer to Vice
        President of Sales and Marketing. Mr. King will oversee our sales and marketing
        function, and the operational functions will report directly to David Colburn,
        our President and Chief Executive Officer.
 
 On
        November 12, 2008, we notified all of our current convertible noteholders
        that
        we have exercised our option to sell $1.5 million aggregate principal of
        additional secured subordinated notes due November 14, 2010, or the new notes,
        with substantially the same terms and conditions as the initial notes sold
        on
        November 14, 2007 and the additional notes sold on August 12, 2008, in a
        closing
        to occur on or before December 31, 2008. We will be obligated to pay interest
        on
        the new notes at an annualized rate of 8% payable in quarterly installments
        commencing three months after the closing date. All other terms and conditions
        of the new notes will be the same as the terms and conditions of the additional
        notes sold on August 12, 2008, described below.
 
 We
        are
        not permitted to prepay the additional notes without approval of the holders
        of
        at least a majority of the principal amount of the notes then
        outstanding.
 
 On
        the
        earlier of the maturity date of November 14, 2010 or a merger or acquisition
        or
        other transaction pursuant to which our existing stockholders hold less than
        50%
        of the surviving entity, or the sale of all or substantially all of our assets,
        or similar transaction, or event of default, each noteholder in its sole
        discretion shall have the option to:
 
 ·
              convert
                  the principal then outstanding on its notes into shares of our
                  common
                  stock, or
 ·
              receive
                  immediate repayment in cash of the notes, including any accrued
                  and unpaid
                  interest.
  38
 
 If
        a
        noteholder elects to convert its notes under these circumstances, the conversion
        price of additional notes will be the lower of:
  ·
              $3.05;
                  and
 ·
              the
                  average of the closing bid and asked prices of shares of our common
                  stock
                  quoted in the Over-The-Counter Market Summary (or, if ours shares
                  are
                  traded on the Nasdaq Stock Market or another exchange, the closing
                  price
                  of shares of our common stock quoted on such exchange) averaged
                  over five
                  trading days prior to the closing date of the sale of the additional
                  notes.
 
 Upon
        the
        following events of default and at any time during the continuance of such
        an
        event of default, the noteholders have the right, with the consent of the
        agent
        appointed for such noteholders, to accelerate payment on their
        notes:
 
 ·
              failure
                  to pay any amounts when due;
 ·
              non-performance
                  of any material covenant that remains uncured for 15
                  days;
 ·
              any
                  of our representations and warranties prove to have been false
                  or
                  misleading in any material respect when
                  made;
 ·
              one
                  or more judgments, decrees, or orders (excluding settlement orders)
                  for
                  the payment of money in the aggregate of $1,000,000 or more is
                  entered
                  against us or a subsidiary and is not discharged or stayed for
                  a period of
                  60 days; or
 ·
              default
                  by us or a subsidiary under any agreement related to indebtedness
                  resulting in the acceleration of more than $500,000 of
                  indebtedness.
 
 In
        addition, payment of the notes will be automatically accelerated if we enter
        voluntary or involuntary bankruptcy or insolvency proceedings.
 
 The
        notes
        are secured by a first-priority lien on all of our unencumbered
        assets.
 
 The
        additional notes and the common stock into which they may be converted have
        not
        been registered under the Securities Act or the securities laws of any other
        jurisdiction. As a result, offers and sales of the additional notes were
        made
        pursuant to Regulation D of the Securities Act and only made to accredited
        investors that were our existing stockholders. Unless and until they are
        registered, the additional notes and the common stock into which they may
        be
        converted may not be offered or sold except pursuant to an exemption from,
        or in
        a transaction not subject to, the registration requirements of the Securities
        Act or applicable securities laws of other jurisdictions.
 
 If
        notes
        are converted into our common stock and a demand for registration of the
        shares
        of common stock is made by a holder of a majority of the converted common
        stock,
        we have agreed, subject to certain limitations, to use our best efforts to
        file
        a registration statement with the SEC:
 
 ·
              within
                  180 days of such demand if:
 o
              we
                  are eligible to use Form S-1,and
 o
              the
                  demand is made with respect to at least 40% of the converted common
                  stock
                  then outstanding (or a lesser percentage if the anticipated aggregate
                  offering price, net of selling expenses, would exceed $5
                  million);
                  and
 ·
              within
                  90 days of such demand if:
 o
              we
                  are eligible to use Form S-3, and
 o
              the
                  demand is made with respect to at least 30% of the converted common
                  stock
                  then outstanding and the anticipated aggregate offering price,
                  net of
                  selling expenses, would exceed $2
                  million.
 
 In
        addition, if we propose to file a registration statement to register any
        of our
        common stock under the Securities Act in connection with the public offering
        of
        such securities solely for cash, subject to certain limitations, we shall
        give
        each noteholder who has converted its notes into common stock the opportunity
        to
        include such shares of converted common stock in the registration. We have
        agreed to bear the expenses for any of these registrations, exclusive of
        any
        stock transfer taxes, underwriting discounts, and commissions.
 
 The
        noteholders have designated Doron Roethler, our Chairman of the Board of
        Directors, as bond representative to act as their agent. We have agreed that
        the
        bond representative and his representatives shall be granted access to our
        facilities and personnel during normal business hours, shall have the right
        to
        have his representative attend all meetings of our Board of Directors and
        its
        committees, and to receive all materials provided to the Board of Directors
        or
        any committee of the Board of Directors. We have agreed to pay all reasonable
        travel and lodging expenses of the bond representative related to his access
        to
        our facilities and attendance at Board of Directors meetings. In addition,
        so
        long as the notes are outstanding, we have agreed that we will not take any
        of
        the following actions without approval of the bond
        representative:
  39
 
 ·
              make
                  any loan or advance to, or own any stock or other securities of,
                  any
                  subsidiary or other corporation, partnership, or other entity unless
                  it is
                  wholly owned by us, except that we may own securities of 1-800-Pharmacy,
                  Inc. pursuant to an agreement we have with it without obtaining
                  the bond
                  representative’s consent;
 
 ·
              make
                  any loan or advance to any person, except advances and similar
                  expenditures in the ordinary course of business or under the terms
                  of an
                  employee stock or option plan approved by our Board of Directors;
 
 ·
              guarantee
                  any indebtedness except for our trade accounts or those of a subsidiary
                  arising in the ordinary course of business;
 
 ·
              make
                  any investment other than investments in prime commercial paper,
                  money
                  market funds, certificates of deposit in any United States bank
                  having a
                  net worth in excess of $100,000,000 or obligations issued or guaranteed
                  by
                  the United States of America, in each case having a maturity not
                  in excess
                  of two years;
 
 ·
              incur
                  any aggregate indebtedness in excess of $25,000, other than trade
                  credit
                  incurred in the ordinary course of business;
 
 ·
              increase
                  or approve the compensation of our named executive officers, including
                  benefits, bonuses, and issuances of equity compensation;
 
 ·
              change
                  our principal business, enter new lines of business, or exit the
                  current
                  line of business;
 
 ·
              sell,
                  transfer, exclusively license, pledge, or encumber technology or
                  intellectual property;
 
 ·
              create
                  or authorize the creation of or issue any other security convertible
                  into
                  or exercisable for any equity security, other than issuances to
                  employees
                  pursuant to equity compensation plans approved by our Board of
                  Directors;
 
 ·
              purchase
                  or redeem or pay any dividend on any capital stock, other than
                  stock
                  repurchased from former employees or consultants in connection
                  with the
                  cessation of their employment/services, at the lower of fair market
                  value
                  or cost; or
 
 ·
              increase
                  the number of shares authorized for issuance to officers, directors,
                  employees, consultants, and advisors pursuant to equity incentive
                  plans or
                  arrangements.
  We
        plan
        to use the proceeds to meet ongoing working capital and capital spending
        requirements.
 
 **Item
        6.**   **Exhibits**
 
 The
        following exhibits are being filed herewith and are numbered in accordance
        with
        Item 601 of Regulation S-K:
 
 Exhibit
                  No.
              
              Description4.1
              
              First
                  Amendment to Convertible Secured Subordinated Note Purchase Agreement,
                  dated August 12, 2008, by and among Smart Online, Inc. and certain
                  investors10.1
              
              Sublease
                  Agreement, dated July 30, 2008, between Advantis Real Estate Services
                  Company and Smart Online, Inc. (asterisks located within the exhibit
                  denote information which has been deleted pursuant to a request
                  for
                  confidential treatment filed with the Securities and Exchange
                  Commission)31.1
              
              Certification
                  of Principal Executive Officer Pursuant to Rule 13a-14(a) as Adopted
                  Pursuant to Section 302 of the Sarbanes-Oxley Act of
                  200231.2
              
              Certification
                  of Principal Financial Officer Pursuant to Rule 13a-14(a) as Adopted
                  Pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002
  40
  32.1
              
              Certification
                  of Principal 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 906 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 Principal Financial 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 906 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.
  41
  **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.
 
 **Smart
                  Online, Inc.**/s/
                  David E. ColburnDavid
                  E. ColburnDate:
                  November 12, 2008
              Principal
                  Executive Officer/s/
                  Timothy L. KristTimothy
                  L. KristPrincipal
                  Financial Officer andDate:
                  November 12, 2008
              Principal
                  Accounting Officer
  42
  **EXHIBIT
        INDEX**
 
 Exhibit
                  No.
              
              Description4.1
              
              First
                  Amendment to Convertible Secured Subordinated Note Purchase Agreement,
                  dated August 12, 2008, by and among Smart Online, Inc. and certain
                  investors10.1
              
              Sublease
                  Agreement, dated July 30, 2008, between Advantis Real Estate Services
                  Company and Smart Online, Inc. (asterisks located within the exhibit
                  denote information which has been deleted pursuant to a request
                  for
                  confidential treatment filed with the Securities and Exchange
                  Commission)31.1
              
              Certification
                  of Principal Executive Officer Pursuant to Rule 13a-14(a) as Adopted
                  Pursuant to Section 302 of the Sarbanes-Oxley Act of
                  200231.2
              
              Certification
                  of Principal Financial Officer Pursuant to Rule 13a-14(a) as Adopted
                  Pursuant to Section 302 of the Sarbanes-Oxley Act of
                  200232.1
              
              Certification
                  of Principal 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 906 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 Principal Financial 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 906 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.
  43