*Table
            of Contents*





**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 June 30, 2007**





**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.)**








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








**(919)
      765-5000**


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


**_________________**





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





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):





Large
                Accelerated Filero
            Accelerated
                Filero
            Non-accelerated
                Filerx





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





As
      of
      August 10, 2007, there were approximately 17,930,000 shares of the registrant's
      common stock outstanding.







*Table
        of Contents*




**Smart
      Online, Inc.**


**Page
                No.****PART
                I. FINANCIAL INFORMATION****Item
                1.**
            **Financial
                Statements:**Consolidated
                Balance Sheets as of June 30, 2007 (unaudited) andDecember 31, 2006
            2Consolidated
                Statements of Operations (unaudited) for the three and six
                monthsended June 30, 2007 and 2006
            3Consolidated
                Statements of Cash Flows (unaudited) for the three and six
                monthsended June 30, 2007 and 2006
            4Notes
                to Consolidated Financial Statements
                (unaudited)
            5**Item
                2.**
            **Management’s
                Discussion and Analysis of Financial Condition****and Results of Operations**
            14**Item
                3.**
            **Quantitative
                and Qualitative Disclosures About Market
                Risk**
            27**Item
                4.**
            **Controls
                and Procedures**
            27**Item
                4T.**
            **Controls
                and Procedures**
            27**PART
                II. OTHER INFORMATION****Item
                1.**
            **Legal
                Proceedings**
            29**Item
                1A.**
            **Risk
                Factors**
            29**Item
                4**
            **Submission
                of Matters to a Vote of Security
                Holders**
            39**Item
                6.**
            **Exhibits**
            40**Signatures**
            41




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          | 1
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          of Contents*




**PART
      I.****FINANCIAL INFORMATION**




**1.
      Financial Statements**




**SMART
      ONLINE, INC.**


**CONSOLIDATED
      BALANCE SHEETS**




**Assets**
            
            **June
                30,**
              **2007**
              **(unaudited)**
            
            **December
                31,**
              **2006**CURRENT
                ASSETS:Cash
                and Cash Equivalents
            
            $
            3,628,253
            
            $
            326,905Restricted
                Cash (See Note 5)
            
            
            250,000
            
            
            250,000Accounts
                Receivable, Net
            
            
            934,270
            
            
            247,618Prepaid
                Expenses
            
            
            90,929
            
            
            100,967Deferred
                Financing Costs (See Note 5)
            
            
            451,884
            
            
            -Total
                current assets
            
            $
            5,355,336
            
            $
            925,490PROPERTY
                AND EQUIPMENT, Net
            
            $
            179,107
            
            $
            180,360INTANGIBLE
                ASSETS, Net
            
            
            3,250,783
            
            
            3,617,477GOODWILL
            
            
            2,696,642
            
            
            2,696,642OTHER
                ASSETS
            
            
            90,107
            
            
            13,040TOTAL
                ASSETS
            
            $
            11,571,975
            
            $
            7,433,009**Liabilities
                and Stockholders' Equity**CURRENT
                LIABILITIES:Accounts
                Payable
            
            $
            759,584
            
            $
            850,730Accrued
                Registration Rights Penalty
            
            
            244,725
            
            
            465,358Current
                Portion of Notes Payable (See Note 6)
            
            
            1,128,359
            
            
            2,839,631Deferred
                Revenue
            
            
            671,456
            
            
            313,774Accrued
                Liabilities
            
            
            344,665
            
            
            301,266Total
                Current Liabilities
            
            $
            3,148,789
            
            $
            4,770,759LONG-TERM
                LIABILITIES:Long-Term
                Portion of Notes Payable (See Note 6)
            
            $
            2,427,000
            
            $
            825,000Deferred
                Revenue
            
            
            33,473
            
            
            11,252Total
                Long-Term Liabilities
            
            
            2,460,473
            
            
            836,252Total
                Liabilities
            
            $
            5,609,262
            
            $
            5,607,011COMMITMENTS
                AND CONTINGENCIESSTOCKHOLDERS'
                EQUITY:Common
                Stock, $.001 Par Value, 45,000,000 Shares Authorized, Shares Issued
                and
                Outstanding:
              June
                30, 2007 - 17,927,137; December 31, 2006 - 15,379,030
            
            
            17,927
            
            
            15,379Additional
                Paid-in Capital
            
            
            65,818,590
            
            
            59,159,919Accumulated
                Deficit
            
            
            (59,873,804
            )
            
            (57,349,300
            )Total
                Stockholders' Equity
            
            
            5,962,713
            
            
            1,825,998TOTAL
                LIABILITIES AND STOCKHOLDERS' EQUITY
            
            $
            11,571,975
            
            $
            7,433,009






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


Page
          | 2
 *Table
          of Contents*




**SMART
      ONLINE, INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS
      (unaudited)**




**Three
                Months Ended**
            
            **Six
                Months Ended****June
                30, 2007**
            
            **June
                30, 2006**
            **June
                30, 2007**
            
            **June
                30, 2006**REVENUES:Integration
                Fees
            
            $
            5,000
            
            $
            26,667
            
            $
            5,000
            
            $
            176,410Syndication
                Fees
            
            
            15,000
            
            
            57,352
            
            
            30,000
            
            
            126,267Subscription
                Fees (See Note 3)
            
            
            576,600
            
            
            501,093
            
            
            1,209,583
            
            
            1,046,767Professional
                Services Fees
            
            
            317,900
            
            
            232,466
            
            
            606,479
            
            
            464,201License
                Fees
            
            
            280,000
            
            
            -
            
            
            280,000
            
            
            337,500Other
                Revenue
            
            
            9,429
            
            
            18,416
            
            
            15,254
            
            
            40,312Total
                Revenues
            
            $
            $1,203,929
            
            $
            835,994
            
            $
            2,146,316
            
            $
            2,191,457COST
                OF REVENUES
            
            $
            111,489
            
            $
            79,100
            
            $
            187,909
            
            $
            181,204GROSS
                PROFIT
            
            $
            1,092,440
            
            $
            756,894
            
            $
            1,958,407
            
            $
            2,010,253OPERATING
                EXPENSES:General
                and Administrative
            
            
            1,051,314
            
            
            1,638,994
            
            
            2,164,005
            
            
            3,629,098Sales
                and Marketing
            
            
            473,668
            
            
            239,088
            
            
            942,915
            
            
            531,912Research
                and Development
            
            
            685,915
            
            
            392,824
            
            
            1,262,610
            
            
            823,201Total
                Operating Expenses
            
            $
            2,210,897
            
            $
            2,270,906
            
            $
            4,369,530
            
            $
            4,984,211LOSS
                FROM CONTINUING OPERATIONS
            
            
            (1,118,457
            )
            
            (1,514,012
            )
            
            (2,411,123
            )
            
            (2,973,958
            )OTHER
                INCOME (EXPENSE):Interest
                Expense, Net
            
            
            (126,759
            )
            
            (64,643
            )
            
            (261,787
            )
            
            (139,056)Gain
                on Debt Forgiveness
            
            
            -
            
            
            144,351
            
            
            4,600
            
            
            144,351Writeoff
                of Investment
            
            
            -
            
            
            -
            
            
            -
            
            
            (25,000
            )Other
                Income
            
            
            30,478
            
            
            1,562,500
            
            
            143,808
            
            
            1,562,500Total
                Other Income (Expense)
            
            $
            (96,281)
            
            $
            1,642,208
            
            
            (113,379
            )
            
            1,542,795NET
                INCOME/(LOSS) FROM CONTINUING OPERATIONS
            
            
            (1,214,738
            )
            
            128,196
            
            
            (2,524,502
            )
            
            (1,431,163
            )DISCONTINUED
                OPERATIONSLoss
                of Operations of Smart CRM, net of tax
            
            
            -
            
            
            (156,571
            )
            
            -
            
            
            (196,135
            )NET
                LOSS ATTRIBUTED TO COMMON STOCKHOLDERS
            
            $
            (1,214,738
            )
            
            (28,375
            )
            $
            (2,524,502
            )
            $
            (1,627,298
            )NET
                LOSS PER SHARE:Continuing
                OperationsBasic
                and Fully Diluted
            
            $
            (0.07
            )
            $
            0.01
            
            $
            (0.15
            )
            $
            (0.10
            )Discontinued
                OperationsBasic
                and Fully Diluted
            
            $
            -
            
            $
            (0.01
            )
            $
            -
            
            $
            (0.01
            )Net
                Loss Attributed to Common StockholdersBasic
                and Fully Diluted
            
            $
            (0.07
            )
            
            0.00
            
            
            (0.15
            )
            
            (0.11
            )SHARES
                USED IN COMPUTING NET LOSS PER SHAREBasic
            
            
            17,252,639
            
            
            15,096,415
            
            
            16,728,010
            
            
            15,052,205Fully
                Diluted
            
            
            17,252,639
            
            
            15,356,015
            
            
            16,728,010
            
            
            15,052,205






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


Page
          | 3
 *Table
          of Contents*


**SMART
      ONLINE, INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(unaudited)**




**Three
                Months**
              **Ended**
              **June
                30, 2007**
            
            **Six
                Months**
              **Ended**
              **June
                30, 2007**
            
            **Three
                Months**
              **Ended**
              **June
                30, 2006**
            
            **Six
                Months**
              **Ended**
              **June
                30, 2006**CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                Loss
            
            $
            (1,214,738
            )
            $
            (2,524,502
            )
            $
            128,196
            
            $
            (1,431,163
            )Adjustments
                to reconcile Net Loss to Net Cashused
                in Operating Activities:Depreciation
                and Amortization
            
            
            210,652
            
            
            420,418
            
            
            170,237
            
            
            334,207Amortization
                of Deferred Financing Costs
            
            
            112,971
            
            
            207,112
            
            
            -Bad
                Debt Expense
            
            
            -
            
            
            -
            
            
            2,500
            
            
            65,817Takeback
                of Investor Relation Shares
            
            
            -
            
            
            -
            
            
            (1,562,500
            )
            
            (1,562,500
            )Stock
                Option Related Compensation Expense
            
            
            223,285
            
            
            380,018
            
            
            191,550
            
            
            449,014Writeoff
                of Investment
            
            
            -
            
            
            -
            
            
            -
            
            
            25,000Registration
                Rights Penalty
            
            
            -
            
            
            (320,632
            )
            
            121,415
            
            
            229,313Gain
                on Debt Forgiveness
            
            
            -
            
            
            (4,600
            )
            
            (144,351
            )
            
            (144,351
            )Changes
                in Assets and Liabilities:Accounts
                Receivable
            
            
            (650,160
            )
            
            (686,651
            )
            
            385,295
            
            
            53,122Prepaid
                Expenses
            
            
            10,938
            
            
            10,035
            
            
            1,117
            
            
            63,906Other
                Assets
            
            
            -
            
            
            (1,760
            )
            
            (25,000
            )
            
            (24,571
            )Deferred
                Revenue
            
            
            432,027
            
            
            380,476
            
            
            19,286
            
            
            (96,483
            )Accounts
                Payable
            
            
            (75,827
            )
            
            (86,495
            )
            
            291,290
            
            
            540,940Accrued
                and Other Expenses
            
            
            1,090
            
            
            44,312
            
            
            (58,124
            )
            
            35,195Cash
                Flow from Discontinued Operations
            
            
            -
            
            
            -
            
            
            (11,822
            )
            
            109,669Net
                Cash used in Operating Activities
            
            $
            (949,762
            )
            $
            (2,182,269
            )
            $
            (490,911
            )
            $
            (1,352,885
            )CASH
                FLOWS FROM INVESTING ACTIVITIES:Purchases
                of Furniture and Equipment
            
            
            (41,217
            )
            
            (51,976
            )
            
            (4,896
            )
            
            (7,345
            )Purchase
                of Tradename
            
            
            (2,033
            )
            
            (2,033
            )
            
            -
            
            
            -Cash
                Flow from Discontinued Operations
            
            
            -
            
            
            -
            
            
            182,017
            
            
            (146,591
            )Smart
                CRM Advances
            
            
            -
            
            
            -
            
            
            (203,681
            )
            
            56,098Net
                Cash provided by (used in) Investing Activities
            
            $
            (43,250
            )
            $
            (54,009
            )
            $
            (26,560
            )
            $
            (97,838
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Repayments
                on Notes Payable
            
            
            (305,315
            )
            
            (1,559,272
            )
            
            (459,323
            )
            
            (1,006,594
            )Debt
                Borrowings
            
            
            -
            
            
            1,450,000
            
            
            -
            
            
            221,734Restricted
                Cash
            
            
            -
            
            
            -
            
            
            103,301
            
            
            (196,455
            )Issuance
                of Common Stock
            
            
            -
            
            
            5,748,607
            
            
            1,000,000
            
            
            2,022,100Expenses
                Related to Form S-1 Filing
            
            
            (101,709
            )
            
            (101,709
            )
            
            -
            
            
            -Cash
                Flow from Discontinued Operations
            
            
            -
            
            
            -
            
            
            (171,898
            )
            
            (171,898
            )Net
                Cash provided by Financing Activities
            
            $
            (407,024
            )
            $
            5,537,626
            
            $
            472,080
            
            $
            868,887NET
                INCREASE (DECREASE) IN CASHAND
                CASH EQUIVALENTS
            
            $
            (1,400,036
            )
            $
            3,301,348
            
            $
            (45,391
            )
            $
            (581,836
            )CASH
                AND CASH EQUIVALENTS,
              BEGINNING
                OF PERIOD
            
            $
            5,028,289
            
            $
            326,905
            
            $
            898,521
            
            $
            1,434,966CASH
                AND CASH EQUIVALENTS,END
                OF PERIOD
            
            $
            3,628,253
            
            $
            3,628,253
            
            $
            853,130
            
            $
            853,130Supplemental
                Disclosures:Cash
                Paid during the Period for Interest:
            
            $
            109,596
            
            $
            182,866
            
            $
            71,043
            
            $`
            136,279Cash
                Paid for Taxes
            
            
            -
            
            
            -
            
            
            -
            
            
            -






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


Page
            | 4
 *Table
            of Contents*




**Smart
      Online, Inc.**


**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 Internet-delivered Software-as-a-Service
      (“SaaS”) software applications and data resources to help start and run small
      businesses. Subscribers access the Company’s products through the websites of
      its private label syndication partners, including major companies and financial
      institutions, and its portal at www.onebiz.com. Corporate information on the
      Company can be found at www.smartonline.com.





***Basis
      of Presentation*** -
      The
      accompanying balance sheet as of June 30, 2007 and the statements of operations
      and cash flows for the three and six months ended June 30, 2007 and 2006 are
      unaudited. The balance sheet as of December 31, 2006 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 position and
      results of operations, contained in the Company's Annual Report on Form 10-K
      for
      the year ended December 31, 2006 filed with the Securities and Exchange
      Commission (the “SEC”) on March 30, 2007 (the “2006 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 June 30,
      2007, and its results of operations and cash flows for the three months and
      six
      months ended June 30, 2007 and June 30, 2006. The results for the three months
      and six months ended June 30, 2007 are not necessarily indicative of the results
      to be expected for the fiscal year ending December 31, 2007.




The
      Company continues to incur development expenses to enhance and expand its
      products by focusing on establishing its Internet-delivered SaaS applications
      and data resources. All allocable expenses to establish the technical
      feasibility of the software have been recorded as research and development
      expense. The ability of the Company to successfully develop and market its
      products is dependent upon certain factors, including the timing and success
      of
      any new services and products, the progress of research and development efforts,
      results of operations, the status of competitive services and products, and
      the
      timing and success of potential strategic alliances or potential opportunities
      to acquire technologies or assets, any of which may require the Company to
      seek
      additional funding sooner than expected.




***Significant
      Accounting Policies -*** In the
      opinion of the Company's management, the significant accounting policies used
      for the three months and six months ended June 30, 2007 are consistent with
      those used for the years ended December 31, 2006, 2005 and 2004. Accordingly,
      please refer to the 2006 Annual Report for our significant accounting
      policies.





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





***Revenue
      Recognition -*** The
      Company has recently begun to derive revenue from the license of software
      platforms along with the sale of associated maintenance, consulting, and
      application development. The arrangement may include delivery in
      multiple-element arrangements if the customer purchases any combination of
      products and/or services. The Company 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 Smart Online to recognize revenue for delivered elements when
      such
      element has vendor specific objective evidence (“VSOE”) of the fair value of the
      delivered element. If VSOE can not 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. The
      determination of whether the arrangement involved significant development,
      modification or customization could be complex and require the use of
      judgment.





The
      amount of revenue to be recognized from development and consulting services
      is
      typically based on the amount of work performed within a given period. This
      is
      typically based on estimates involving total costs to complete and the stage
      of
      completion. The assumptions and estimates made to determine such figures may
      affect the timing of revenue recognition. Changes in estimates of progress
      to
      completion and costs to complete are accounted for as cumulative catch-up
      adjustments.


Page
          | 5
 *Table
          of Contents*


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, and


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 required judgment and the amount and timing of revenue
      recognition could change if different assessments had been made. In addition,
      payment terms may vary and could be collectible over several months, but not
      greater than one year.




***Fiscal
      Year -*** The
      Company's fiscal year ends December 31. References to fiscal 2006, for example,
      refer to the fiscal year ending December 31, 2006.




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





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





***Advertising
      Costs*** -
      The
      Company expenses all advertising costs as they are incurred. The amounts charged
      to expense during the second quarter of 2007 and 2006 were $12,095 and $395,
      respectively. The amounts charged to sales and marketing expense during the
      first six months of 2007 and 2006 were $15,669 and $42,315, respectively. There
      were no barter advertising expenses for the three months ending June 30, 2007
      and June 30, 2006 respectively, and $0 and $37,915 for the six months ended
      June
      30, 2007 and June 30, 2006, respectively.





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





***Stock-Based
      Compensation -*** In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS
      No. 123 (revised 2004), *Share-Based Payment* (“SFAS
      No. 123R”), which replaces SFAS No. 123, *Accounting for Stock-Based Compensation* (“SFAS
      No. 123”), and supersedes Accounting Principles Board (“APB”) Opinion No.
      25, *Accounting for Stock Issued to Employees* (“APB
      No. 25”). SFAS No. 123R requires all share-based payments, including grants of
      employee stock options, to be recognized in the financial statements based
      on
      their fair values. Under SFAS No. 123R, public companies are required to measure
      the costs of services received in exchange for stock options and similar awards
      based on the grant date fair value of the awards and recognize this cost in
      the
      income statement over the period during which an award recipient is permitted
      to
      provide service in exchange for the award. The pro forma disclosures previously
      permitted under SFAS No. 123 are no longer an alternative to financial statement
      recognition.





The
      Company maintains stock-based compensation arrangements under which employees,
      consultants and directors may be awarded grants of stock options and restricted
      stock. Effective January 1, 2006, the Company adopted SFAS No. 123R using
      the Modified Prospective Approach. Under the Modified Prospective Approach,
      the
      amount of compensation cost recognized includes: (i) compensation cost for
      all share-based payments granted prior to, but not yet vested as of,
      January 1, 2006, based on the grant date fair value estimated in accordance
      with the provisions of SFAS No. 123 and (ii) compensation cost for all
      share-based payments that


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will
      be
      granted subsequent to January 1, 2006, based on the grant date fair value
      estimated in accordance with the provisions of SFAS No. 123R. Upon
      adoption, the Company recognizes the stock-based compensation of previously
      granted share-based options and new share-based options under the straight-line
      method over the requisite service period. Total stock-based compensation expense
      recognized under SFAS No. 123R was approximately $223,285 and $380,018 for
      the three months and six months ended June 30, 2007, respectively.
      No stock-based compensation was capitalized in the consolidated financial
      statements.





The
      fair
      value of option grants under the Company's 2004 Equity Compensation Plan and
      other stock option issuances during the three months and six months ended June
      30, 2007 and June 30, 2006 was estimated using the Black-Scholes option-pricing
      model with the following weighted-average assumptions:




**Three
                Months Ended**
            
            
            **Six
                Months Ended****June
                30,****2007**
            
            
            **June
                30,****2006**
            
            
            **June
                30,****2007**
            
            
            **June
                30,****2006**Dividend
                yield
            
            
            0.0
            %
            
            0.
                00
            %
            
            0.0
            %
            
            0.
                00
            %Expected
                volatility
            
            
            150
            %
            
            140
            %
            
            150
            %
            
            150
            %Risk
                free interest rate
            
            
            4.92
            %
            
            5.11
            %
            
            4.92
            %
            
            5.11
            %Expected
                lives (years)
            
            
            5
            
            
            5
            
            
            5
            
            
            5




The
      expected term of the options represents the estimated period of time until
      exercise or forfeiture and is based on historical experience of similar awards.
      Expected volatility is based on the historical volatility of the Company’s
      common stock over a period of time. 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.





Compensation
      expense is recognized only for option grants expected to vest. The Company
      estimates forfeitures at the date of grant based on historical experience and
      future expectation.





The
      following is a summary of the stock option activity for the six months ended
      June 30, 2007:




**Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**BALANCE,
                December 31, 2006
            
            
            2,360,100
            
            $
            5.33Granted
            
            
            20,000
            
            $
            2.80Forfeited
            
            
            158,300
            
            $
            4.42Exercised
            
            
            20,000
            
            $
            1.30BALANCE,
                June 30, 2007
            
            
            2,201,800
            
            $
            4.10





**Recently
      Issued Accounting Pronouncements**





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* (“SFAS
      No. 157”). SFAS No. 157 defines fair value, establishes a framework for
      measuring fair value in U.S. GAAP, and expands disclosures about fair value
      measurements. SFAS No. 157 applies under other accounting pronouncements that
      require or permit fair value measurements, the FASB having previously concluded
      in those accounting pronouncements that fair value is a relevant measurement
      attribute. Accordingly, SFAS No. 157 does not require any new fair value
      measurements. However, for some entities, the application of SFAS No. 157 will
      change current practices. SFAS No. 157 is effective for financial statements
      for
      fiscal years beginning after November 15, 2007. Earlier application is permitted
      provided that the reporting entity has not yet issued financial statements
      for
      that fiscal year. Management does not believe that the adoption of SFAS No.
      157
      will have a material impact on the Company's results of operations or financial
      condition once adopted.





In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities - Including
      an
      amendment of FASB Statement No. 115* (“SFAS
      No. 159”). SFAS No. 159 provides companies with an option to measure, at
      specified election dates, many financial instruments and certain other items
      at
      fair value that are not currently measured at fair value. A company that adopts
      SFAS No. 159 will report unrealized gains and losses on items for which the
      fair
      value option has been elected in earnings at each subsequent reporting date.
      SFAS No. 159 also establishes presentation and disclosure requirements designed
      to facilitate comparisons between entities that choose different measurement
      attributes for similar types of assets and liabilities. SFAS


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No.
      159
      is effective for fiscal years beginning after November 15, 2007. Management
      does
      not believe that the adoption of SFAS No. 159 will have a material impact on
      the
      Company's results of operations or financial condition once
      adopted.




**2.  
      PRESENTATION OF SUBSIDIARIES**





As
      more
      fully detailed in the 2006 Annual Report, the Company completed two acquisitions
      in October 2005. On October 4, 2005, the Company purchased substantially all
      of
      the assets of Computility, Inc., or Computility. In consideration for the
      purchased assets, the Company issued the seller 484,213 shares of the Company's
      common stock and assumed certain liabilities of Computility totaling
      approximately $1.9 million.  The shares were valued at $7.30 per share,
      which was the median trading price on the acquisition date. The total purchase
      price, including liabilities assumed, was approximately $5.8 million including
      approximately $228,000 of acquisition fees. We
      operated this business under the name Smart CRM, Inc. (d/b/a Computility),
      or
      Smart CRM.





On
      October 18, 2005, the Company completed its purchase of all of the capital
      stock
      of iMart Incorporated, or iMart, a Michigan based company providing
      multi-channel electronic commerce systems. The Company issued to iMart's
      stockholders 205,767 shares of its common stock and agreed to pay iMart's
      stockholders approximately $3,462,000 in cash installments. This amount was
      payable in four equal payments of $432,866 on the first business day of each
      of
      January 2006, April 2006, July 2006 and October 2006. The final installment
      payment of approximately $1.7 million was payable in January 2007. As of January
      2007, the entire purchase price was paid in full. The shares were valued at
      $8.825 per share, which was the median trading price on the acquisition date.
      The total purchase price for all of the outstanding iMart shares was
      approximately $5.3 million including approximately $339,000 of acquisition
      fees. We
      operate this subsidiary as Smart
      Commerce, Inc. (d/b/a iMart), or Smart Commerce .





Upon
      the
      Company's successful integration of the sales force automation and customer
      relationship management (“SFA/CRM”) application into its OneBiz SM platform, management deemed the remaining operations of Smart CRM, specifically
      consulting and network management, to be non-strategic to ongoing operations.
      On
      September 29, 2006, the Company, Smart CRM and Alliance Technologies, Inc.
      ("Alliance") executed and delivered an Asset Purchase Agreement pursuant to
      which Alliance acquired substantially all of the assets of Smart CRM. In
      accordance with SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets* ,
      the
      Company has reported the operating results for Smart CRM as discontinued
      operations. For the three months and six months ended June 30, 2006, the revenue
      associated with the discontinued operations were $494,328 and $1,034,534
      respectively. For the three months and six months ended June 30, 2006, the
      net
      loss associated with the discontinued operations were $156,571 and $196,135,
      respectively. Because the sale had been completed in 2006, the 2007 periods
      contain no results of discontinued operations.





**3.
      SUBSCRIPTION REVENUE**





Effective
      January 1, 2007, a major customer executed a letter of clarification which
      more
      definitively defined the roles and responsibilities of each party. Individual
      Business Owners (“IBOs”) associated with this customer are provided e-commerce,
      domain name and email services. In exchange for marketing these services to
      its
      IBOs, the customer is paid a marketing fee. At the inception of the business
      relationship, it was agreed that the customer would collect the gross service
      fee from the IBO; the customer would retain its marketing fee and remit the
      net
      remaining cash. Because the roles and responsibilities of each party were
      vaguely defined in the past, revenue was recorded only on the net cash received.
      Following the execution of the letter of clarification and in accordance with
      Emerging Issues Task Force (“EITF”) 99-19, *Reporting
      Revenue Gross as a Principal versus Net as an Agent,* this
      revenue is now recorded as the gross amount paid by the IBO and a sales and
      marketing expense for the marketing services rendered by the customer.
      Ultimately, the effect on net income is nil; however, subscription revenue
      and
      sales and marketing expense are effectively and appropriately grossed up.
      Because the new accounting method was triggered by a clarification to the
      existing agreement and not by a change from one accepted accounting method
      to
      another, the 2006 subscription revenue was not retroactively adjusted as would
      be required by Statement of Financial Accounting Standard (“SFAS”) No.
      154, *Accounting Changes and Error Corrections - a replacement of APB Opinion No.
      20
      and FASB Statement No. 3* .
      For the
      three months and six months ended June 30, 2007, this accounting method resulted
      in approximately $227,000 and $488,000, respectively, of additional subscription
      revenue and a corresponding charge to sales and marketing expense.




**4.  
      INDUSTRY SEGMENT INFORMATION**





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





Smart
      Commerce revenue is generally composed of subscription fees, professional
      services fees and licensing fees related to domain name subscriptions,
      e-commerce or networking consulting or networking maintenance
      agreements.


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          | 8
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The
      Smart
      Online segment generates revenue from the development and distribution of
      internet-delivered SaaS small business applications through a variety of
      subscription, licensing, integration and syndication channels.





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





The
      following table shows the Company's financial results by reportable segment
      for
      the three months ended June 30, 2007:





Smart
              Online,
              Inc.
            
            Smart
              Commerce,
              Inc.
            
            ConsolidatedREVENUES:Integration
                Fees
            
            $
            5,000
            
            $
            -
            
            $
            5,000Syndication
                Fees
            
            
            15,000
            
            
            -
            
            
            15,000Subscription
                Fees
            
            
            14,142
            
            
            562,458
            
            
            576,600Professional
                Services Fees
            
            
            -
            
            
            317,900
            
            
            317,900License
                Fees
            
            
            280,000
            
            
            -
            
            
            280,000Other
                Revenues
            
            
            5,486
            
            
            3,943
            
            
            9,429Total
                Revenues
            
            $
            319,628
            
            $
            884,301
            
            $
            1,203,929COST
                OF REVENUES
            
            $
            35,746
            
            $
            75,743
            
            $
            111,489OPERATING
                EXPENSES
            
            $
            1,476,554$1,522,754
            
            $
            688,143
            
            $
            2,210,897OPERATING
                INCOME (LOSS)
            
            $
            (1,238,872
            )
            $
            120,415
            
            $
            (1,118,457
            )OTHER
                INCOME (EXPENSE)
            
            $
            (62,689
            )
            $
            (33,592
            )
            $
            (96,281
            )NET
                INCOME/(LOSS) BEFORE INCOME TAXES
            
            $
            (1,301,561
            )
            $
            86,823
            
            $
            (1,214,738
            )TOTAL
                ASSETS
            
            $
            8,010,665
            
            $
            3,561,310
            
            $
            11,571,975





The
      following table shows the Company's financial results by reportable segment
      for
      the six months ended June 30, 2007:





Smart
              Online,
              Inc.
            
            Smart
              Commerce,
              Inc.
            
            ConsolidatedREVENUES:Integration
                Fees
            
            $
            5,000
            
            $
            -
            
            $
            5,000Syndication
                Fees
            
            
            30,000
            
            
            -
            
            
            30,000Subscription
                Fees
            
            
            27,533
            
            
            1,182,050
            
            
            1,209,583Professional
                Services Fees
            
            
            -
            
            
            606,479
            
            
            606,479License
                Fees
            
            
            280,000
            
            
            -
            
            
            280,000Other
                Revenues
            
            
            5,686
            
            
            9,568
            
            
            15,254Total
                Revenues
            
            $
            3348,219
            
            $
            1,798,097
            
            $
            2,146,316COST
                OF REVENUES
            
            $
            48,776
            
            $
            139,133
            
            $
            187,909OPERATING
                EXPENSES
            
            $
            2,986,145
            
            $
            1,383,385
            
            $
            4,369,530OPERATING
                INCOME (LOSS)
            
            $
            (2,686,702
            )
            $
            275,579
            
            $
            (2,411,123
            )OTHER
                INCOME (EXPENSE)
            
            $
            (41,682
            )
            $
            (71,697
            )
            $
            (113,379
            )NET
                INCOME/(LOSS) BEFORE INCOME TAXES
            
            $
            (2,728,384
            )
            $
            203,882
            
            $
            (2,524,502
            )TOTAL
                ASSETS
            
            $
            8,010,665
            
            $
            3,561,310
            
            $
            11,571,975




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**5.  
      CURRENT ASSETS**





***Accounts
      Receivable, Net***





The
      Company evaluates the need for an allowance for doubtful accounts based on
      specifically identified amounts that management believes to be uncollectible.
      Management also records an additional allowance based on management's assessment
      of the general financial conditions affecting its customer base. If actual
      collections experience changes, revisions to the allowance may be required.
      Based on these criteria, management has recorded an allowance for doubtful
      accounts of approximately $65,000 and $65,000 as of June 30, 2007 and December
      31, 2006, respectively.





***Restricted
      Cash***





Under
      the
      terms of a promissory note between Smart Commerce and Fifth Third Bank, $250,000
      on deposit at Fifth Third Bank serves as loan collateral and is restricted.
      Such
      restricted cash is scheduled to be released from the restrictions in three
      equal
      installments of approximately $83,000, on June 30, 2007, December 31, 2007
      and
      June 30, 2008, if the Company meets certain debt covenants regarding operating
      metrics for Smart Commerce. Those
      operating metrics relate to Smart Commerce’s actual results of operations as
      compared to certain projections provided to Fifth Third at the inception of
      the
      loan. Meeting or failing to meet those metrics relate only to the release of
      cash as described above. Failure to meet these metrics does not, however, result
      in an acceleration of the debt. Fifth
      Third Bank is currently evaluating the June 30, 2007 results to make a
      determination regarding the scheduled cash release.





***Deferred
      Financing Costs***





In
      order
      to secure a modification to a line of credit with Wachovia Bank, NA, or
      Wachovia, (see Note 6 - Notes Payable), Atlas Capital, S.A., or Atlas, provided
      the Company with a modified letter of credit. In exchange for the modified
      letter of credit, the Company issued Atlas a warrant to purchase 444,444 shares
      of common stock at $2.70 per share (see Note 7 - Stockholders' Equity). The
      fair
      value of that warrant using the Black-Scholes model was $734,303 as measured
      at
      the time the warrant was issued. Such amount was recorded as deferred financing
      costs and will be amortized to interest expense in the amount of $37,657 per
      month over the remaining period of the modified line of credit, which is
      scheduled to expire in August 2008. As of June 30, 2007, the deferred financing
      costs that will be amortized to interest expense over the next twelve months,
      or
      $451,884, were classified as current assets with the remaining $75,307
      classified as non-current and included in other assets.





**6.
      NOTES PAYABLE**





As
      of
      June 30, 2007, the Company had notes payable totaling $3,555,359. The detail
      of
      these notes is as follows:





Note
                Description
            
            Short-Term
              Portion
            
            Long-Term
              Portion
            
            TOTAL
            
            Maturity
            
            RateWachovia
                Credit Line
            
            
            -
            
            $
            2,052,000
            
            $
            2,052,000
            
            
            Aug
                `08
            
            
            Libor
                + 0.9
            %Fifth
                Third Loan
            
            $
            900,000
            
            
            375,000
            
            
            1,275,000
            
            
            Nov
                `08
            
            
            Prime
                + 1.5
            %Acquisition
                Fee (iMart)
            
            $
            209,177
            
            
            -
            
            
            209,177
            
            
            Oct
                ‘07
            
            
            8
            %Acquisition
                Fee (Computility)
            
            
            19,182
            
            
            -
            
            
            19,182
            
            
            Mar
                ‘07
            
            
            8
            %TOTAL
            
            $
            1,128,359
            
            $
            2,427,000
            
            $
            3,555,359





On
      January 24, 2007, the Company entered into an amendment to its line of credit
      with Wachovia. The amendment resulted in an increase in the line of credit
      from
      $1.3 million to $2.5 million. The pay-off date for the line of credit was also
      extended from August 1, 2007 to August 1, 2008. Interest accrues on the unpaid
      principal balance at the LIBOR Market Index Rate plus 0.9%. The line of credit
      is secured by the Company's deposit account at Wachovia and an irrevocable
      standby letter of credit in the amount of $2,500,000 issued by HSBC Private
      Bank
      (Suisse) S.A. with Atlas as account party. As of June 30, 2007, the Company
      has
      drawn down approximately $2.1 million on the line of credit.




**7.
      STOCKHOLDERS' EQUITY**




***Common
      Stock and Warrants***




In
      the
      second quarter of 2007, a total of 55,000 shares of restricted stock were issued
      to the Company’s independent directors in accordance with the Company’s board
      compensation policy. The restrictions on such shares lapse over the subsequent
      four quarters


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          | 10
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provided
      that the director remains on the board of directors. In addition, a total of
      49,500 shares of restricted stock were issued to three employees, one of whom
      is
      an officer. One-third of these restricted shares vested upon grant with the
      remaining shares to vest over the next two years provided the employee remains
      employed by the Company.





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
      has
      incurred issuance costs of approximately $637,000 as of June 30, 2007. 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 has 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 reviews the registration statement. If a registration
      statement is not timely filed or declared effective by the date set forth in
      the
      Investor RRA, the Company is obligated to pay a cash penalty of 1% of the
      purchase price on the day after the filing or declaration of effectiveness
      is
      due, and 0.5% of the purchase price per every 30-day period thereafter, to
      be
      prorated for partial periods, until the Company fulfills these obligations.
      Under no circumstances can the aggregate penalty for late registration or
      effectiveness exceed 10% of the aggregate purchase price. Under the terms of
      the
      Investor RRA, the Company cannot 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 does 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.





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 must be included on the same registration
      statement the Company is obligated to file under the Investor RRA described
      above, but CA is 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 6 - 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. If the warrant is exercised
      in
      full, it will result in gross proceeds to the Company of approximately
      $1,200,000.





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.





***Equity
      Compensation Plans***




The
      Company maintains three equity compensation plans. In the second quarter of
      2007, a total of 55,000 shares of restricted stock were issued to the Company’s
      independent directors in accordance with the Company’s board compensation
      policy. The restrictions on such shares lapse over the following four quarters
      provided that the director remains on the board of directors. In addition,
      a
      total of 49,500 shares of restricted stock were issued to three employees,
      one
      of whom is an officer. One-third of these restricted shares vested upon grant
      with the remaining shares to vest over the next two years provided the employee
      remains employed by the Company.





On
      April
      11, 2007, the Company entered into a stock option agreement for the purchase
      up
      to 20,000 shares of the Company’s common stock at an exercise price of $2.80 per
      share with an independent member of the Company’s Board of Directors. Under the
      terms of the option agreement, this option vests in equal quarterly increments
      on February 16, 2007, May 16, 2007, August 16, 2007, and November 16, 2007
      if
      this director is serving as a member of the Company’s Board of Directors on such
      dates. These dates were selected so that all shares will have vested by the
      first anniversary of this directors appointment to the Board. In the event
      of a
      change of control or reorganization of the Company (both as defined in the
      option agreement), the option vests as to all shares on the date of such
      event.





In
      June
      2007, the Company limited the issuance of shares of its common stock reserved
      under its 2004 Equity Compensation Plan (the


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“2004
      Plan”) to awards of restricted or unrestricted stock. Also in June 2007, the
      non-interested members of the Company’s Board of Directors approved an offer for
      holders of outstanding options with an exercise price of $2.50 per share or
      greater, including such options held by the Company’s named executive
      officers and directors, to exchange the outstanding options for a certain number
      of shares of restricted stock. In this offer, the Company intends to divide
      the
      outstanding options into classes based on the exercise price and the remaining
      expected life of the option and to use the Black-Scholes valuation model in
      its
      determination of the exchange ratios for the several classes of eligible
      options. The Company targets using exchange ratios such that the
      eligible options surrendered for cancellation would exceed the number of shares
      of restricted stock that would be received in exchange for such options. The
      exchange offer has not commenced and will not commence until certain actions
      are
      taken by the Company, including the filing of a tender offer statement and
      offer
      to exchange on Schedule TO to be filed with the SEC.





The
      following table summarizes information about stock options outstanding at June
      30, 2007:




**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
                $1.30 to $1.43
            
            575,000
            
            1.5
            
            $
                1.41
            
            575,000
            
            $
                1.41From
                $2.50 to $3.50
            
            432,500
            
            7.2
            
            $
                3.34
            
            287,624
            
            $
                3.42$5.00
            
            211,600
            
            8
            
            $
                5.00
            
            136,600
            
            $
                5.00$7.00
            
            150,000
            
            8.3
            
            $
                7.00
            
            50,000
            
            $
                7.00From
                $8.61 to $9.00
            
            571,500
            
            8.2
            
            $
                8.71
            
            120,300
            
            $
                8.72From
                $9.60 to $9.82
            
            261,200
            
            1.0
            
            $
                9.82
            
            160,240
            
            $
                9.82




***Dividends***





The
      Company has not paid any cash dividends through June 30, 2007.





**8.
      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:




Three
                Months Ended
              June
                30, 2007Revenues
            
            %
                of Total
              RevenuesCustomer
                E
            
            
            Professional
                Services
            
            $
            244,478
            
            
            20
            %Customer
                F
            
            
            Subscription
            
            $
            336,295
            
            
            28
            %Customer
                C
            
            
            License
                Fees
            
            $
            280,000
            
            
            23
            %Others
            
            
            Various
            
            $
            343,156
            
            
            29
            %Total
            
            
            
            
            $
            1,203,929
            
            
            100
            %








Three
                Months Ended
              June
                30, 2006Revenues
            
            %
                of Total
              RevenuesCustomer
                F
            
            
            Subscription
            
            $
            491,463
            
            
            59
            %Others
            
            
            Various
            
            $
            344,531
            
            
            41
            %Total
            
            
            
            
            $
            835,994
            
            
            100
            %




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          | 12
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Six
                Months Ended
              June
                30, 2007Revenues
            
            %
                of Total
              RevenuesCustomer
                E
            
            
            Professional
                Services
            
            $
            426,555
            
            
            20
            %Customer
                F
            
            
            Subscription
            
            $
            648,279
            
            
            30
            %Customer
                C
            
            
            License
                Fees
            
            $
            280,000
            
            
            13
            %Others
            
            
            Various
            
            $
            791,482
            
            
            37
            %Total
            
            
            
            
            $
            2,146,316
            
            
            100
            %




Six
                Months Ended
              June
                30, 2006Revenues
            
            %
                of Total
              RevenuesCustomer
                E
            
            
            Professional
                Services
            
            $
            662,283
            
            
            30
            %Customer
                F
            
            
            Subscription
            
            $
            1,013,273
            
            
            46
            %Others
            
            
            Various
            
            $
            515,901
            
            
            24
            %Total
            
            
            
            
            $
            2,191,457
            
            
            100
            %





**9.
      COMMITMENTS AND CONTINGENCIES**





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 June 30, 2007, the Company
      has paid $366,667 and issued 3,473 shares of common stock related to this
      obligation.





On
      January 17, 2006, the SEC temporarily suspended the trading of the Company's
      securities. In its “Order of Suspension of Trading,” the SEC stated that the
      reason for the suspension was a lack of current and accurate information
      concerning the Company's securities because of possible manipulative conduct
      occurring in the market for its stock. By its terms, that suspension ended
      on
      January 30, 2006 at 11:59 p.m. EST. Simultaneously with the suspension, the
      SEC
      advised the Company that the SEC was conducting a non-public investigation.
      As
      of June 30, 2007, the SEC has not provided the Company with any communication
      indicating that its investigation has concluded or that the Company or any
      of
      its officers or directors had engaged in any criminal or fraudulent conduct
      with
      respect to the Company.





**10.
      SUBSEQUENT EVENTS**





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. If
      the
      registration statement was not declared effective by July 31, 2007, the Company
      was obligated to pay the penalty set forth in Note 7 - “Stockholder’s
      Equity,”
      above, with the prorated portion to be calculated beginning on July 3,
      2007, the effectiveness obligation date under the Investor RRA. The registration
      statement filed by the Company was declared effective by the SEC on July 31,
      2007, and the Company avoided any obligation to pay the potential
      penalty.





On
      July
      20, 2007, the Company issued 27,427 shares in satisfaction of late registration
      penalty obligations to certain investors who did not enter into amendments
      to
      certain registration rights agreements. These penalties were incurred as a
      result of the Company’s failure to timely file a registration statement
      including certain shares owned by these investors pursuant to registration
      rights agreements between these investors and the Company.





On
      July
      30, 2007, certain of the Company’s affiliates have also entered into lock-up
      agreements covering a portion of their shares (the “Lock-Up Agreements”). These
      agreements restrict the sale of 1,296,623 shares of the Company’s common stock.
      Under the terms of these Lock-Up Agreements, these affiliates cannot sell,
      pledge, grant or otherwise transfer the shares subject to the agreement for
      one
      year following July 31, 2007. After one year, 2.5% of these shares per quarter
      are released from these restrictions on a pro rata basis among these affiliates.
      All remaining shares will be released from the Lock-Up Agreements on July 31,
      2009. These Lock-Up Agreements will otherwise terminate at the following times:
      (A) if the Registration Statement on Form S-1 filed by the Company and declared
      effective on July 31, 2007 (the “Registration Statement”) is terminated, the
      earlier of (i) the date of termination if no shares were sold, or (ii) the
      date
      any proceeds received from public investors are placed in the mail for return;
      (B) the date the Company’s common stock is listed on a national securities
      exchange, or (C) 30 days following the date the persons signing these Lock-Up
      Agreements are no longer affiliates.


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On
      April
      3, 2007, the Company originally filed the Registration Statement. As indicated
      above, the Registration Statement was declared effective by the SEC on July
      31,
      2007. A total of 8,707,051 shares of common stock were included on the
      Registration Statement.





**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
      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 foreign currency exchange rate and interest rate
      fluctuations on our business, the potential impact of current litigation or
      any
      future litigation, the potential availability of tax assets in the future and
      related matters, and the sufficiency of our capital resources, all of which
      are
      based on current expectations, estimates, and forecasts, and the beliefs and
      assumptions of our management. Words such as “expect,” “anticipate,” “project,”
“intend,” “plan,” “estimate,” variations of such words, and similar expressions
      are also intended to identify such forward-looking statements. These
      forward-looking statements are subject to risks, uncertainties and assumptions
      that are difficult to predict. Therefore, actual results may differ materially
      and adversely from those expressed in any forward-looking statements. Readers
      are directed to risks and uncertainties identified below, under “Risk Factors”
and elsewhere in this report, for factors that may cause actual results to
      be
      different than those expressed in these forward-looking statements. Except
      as
      required by law, we undertake no obligation to revise or update publicly any
      forward-looking statements for any reason.*





**Overview**





We
      develop and market Internet-delivered Software-as-a-Service, or SaaS, software
      applications and data resources for small businesses. We reach small businesses
      through syndication arrangements with other companies that private label our
      software applications through their corporate web sites and our own website
      at
      www.onebiz.com. Our syndication relationships provide a cost and time effective
      way to market our products and services to the small business sector. We also
      provide solutions to companies developing customized IT applications through
      the
      licensing of our platforms.




We
      currently operate Smart Online in two segments. Those segments are 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 generates revenues from the development and distribution of
      internet-delivered SaaS small business applications through a variety of
      subscription, licensing, integration and syndication channels. The Smart
      Commerce segment generally generates revenue from subscription fees and
      professional services fees related to domain name subscriptions and e-commerce,
      networking consulting or network maintenance agreements. We include costs such
      as corporate general and administrative expenses and share-based compensation
      expenses that are not allocated to specific segments in the Smart Online
      segment.





**Sources
      of Revenue**





We
      derive
      revenues from the following sources:





·
            Subscription
                fees - monthly fees charged to end-users for access to our SaaS
                applications.




·
            License
                fees - fees charged for licensing of platforms or applications. Licenses
                may be perpetual or for a specific
                term.




·
            Integration
                fees - fees charged to partners to integrate their products into
                our
                syndication platform.




·
            Syndication
                fees




o
            fees
                charged to syndication partners to create a customized private-label
                site.




o
            barter
                revenue derived from syndication agreements with media
                companies.




·
            Professional
                services fees - fees related to consulting services which complement
                our
                other products and applications.




·
            Other
                revenues - revenues generated from non-core activities such as sales
                of
                shrink-wrapped products, original equipment manufacturer, or OEM,
                contracts and miscellaneous other
                revenues.




Our
      current primary focus is to target established companies that have both a
      substantial base of small business customers as well as a recognizable and
      trusted brand name. We are also seeking to establish partnerships with smaller
      companies catering to the small business customer base that we view as more
      ready to adopt new technologies. Our goal is to enter into partnerships with
      these companies whereby they private label our products and offer them to their
      base of small business customers. We believe the


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combination
      of the magnitude of their customer bases and their trusted brand names and
      recognition will help drive our subscription volume. In addition, we are also
      targeting larger or developing enterprises that are developing a customized
      application delivery system or IT solution that might utilize our
      OneBiz SM or iDSA
      platforms as a solution. Such enterprises might wish to use our platform(s)
      as
      the framework into which they will plug their own or other third-party
      application, or they might wish to use all or some of our existing applications.
      Such solutions generally would generate licensing and subscription revenue
      for
      us if the customer desires that our applications be made a part of their
      solution.





Subscription
      revenues consist of sales of subscriptions directly to end-users, or to others
      for distribution to end-users, hosting and maintenance fees, and e-commerce
      website design fees. Subscription sales are made either on a subscription or
      on
      a “for fee” basis. Subscriptions, which include access to most of our offerings,
      are payable in advance on a monthly basis and are typically paid via credit
      card
      of the individual end-user or the aggregating entity. We offer new subscribers
      a
      limited free use period and notify such free users that we will terminate access
      it they fail to become paid subscribers within a certain period of time. We
      expect lower net subscription fees from subscribers at the private label
      syndication websites of our partners than from our main portal since our
      syndication agreements require us to share revenue generated from syndication
      sites with each respective partner. In the first half of 2007, 98% of our
      subscription revenue was generated by our Smart Commerce segment, and the
      remaining 2% by our Smart Online segment. As of June 30, 2007, we had an
      aggregate of approximately 10,800 subscribers: approximately 10,300 through
      our
      Smart Commerce segment and approximately 500 through our Smart Online
      segment.





Recently,
      we began charging our partners a fee for a license to our platforms, where
      we
      used to include such a license in exchange for only subscription revenue share
      and syndication fees, if any. Licensing revenue consists of perpetual or term
      license agreements for the use of the Smart Online OneBiz platform, the Smart
      Commerce iDSA platform, or any of our applications. Perpetual license revenue
      is
      typically recorded in the period the license is sold and meets the requirements
      of American Institute of Certified Public Accountants Statement of Position
      97-2, *Software
      Revenue Recognition* ;
      specifically, that there is evidence of an arrangement, the product has been
      delivered, the fee is fixed and determinable and collection is reasonably
      assured. The revenue associated with term licenses is typically recorded over
      the period of the license. In the first half of 2007, 100% of our licensing
      revenue was generated by our Smart Online segment.





When
      appropriate, we charge our partners a fee for private-labeling our website
      in
      their own customized interface (i.e., in the “look and feel” of our partners'
      sites). This fee is based on the extent of the modifications required as well
      as
      the revenue sharing ratio that has been negotiated between us and our partner.
      If a fee is charged for the production of the website and the modifications,
      it
      is recorded as syndication revenue.





In
      certain instances, we have integrated products offered by other companies into
      our products or websites. This is a means for the integration partner to
      generate additional traffic to its own website or revenue for its own product
      while expanding the range of our products and services. Such revenue is recorded
      as integration revenue. Our integration contracts also provide for us to receive
      a percentage of revenue generated by our partner. Such revenues have been
      immaterial.





Both
      syndication and integration fees are recognized on a monthly basis over the
      life
      of the contract, although a significant portion of integration fees is received
      upfront. Our contracts and support contracts are generally non-cancelable,
      though customers typically have the right to terminate their contracts for
      cause
      if we fail to perform. We generally invoice our paying syndication or
      integration customers in annual or monthly installments and typical payment
      terms provide that our customers pay us within 30 days of invoice. Amounts
      that
      have been invoiced are recorded as accounts receivable and in deferred
      revenue or revenue depending on whether the appropriate revenue recognition
      criteria have been met. In general, we collect our billings in advance of the
      service period. As we have shifted our focus toward driving subscription
      revenue, which we deem to have the greatest potential for future revenue growth,
      we have seen a decrease in syndication and integration revenue through the
      first
      half of 2007 and we expect this decrease to continue through the remaining
      fiscal year. In the first half of 2007, 100% of our syndication and integration
      revenue was generated by our Smart Online segment.





Professional
      services fees are fees generated from consulting services often directly
      associated with other projects that will generate subscription revenue. For
      example, a partner may request that we re-design its website to better
      accommodate our products or to improve its own website traffic. Such fees are
      typically billed on a time and material basis and are recognized as revenue
      when
      these services are performed and the customer is invoiced. In the first half
      of
      2007, 100% of our professional services revenue was generated by our Smart
      Commerce segment.





Other
      revenues consist primarily of non-core revenue sources such as traditional
      shrink-wrap software sales and miscellaneous web services. It also includes
      OEM
      revenue generated through sales of our applications bundled with products
      offered by manufacturers such as Dell, Gateway and CompUSA. Revenues from OEM
      arrangements are reported and paid to us on a quarterly basis. In the first
      half
      of 2007, 63% of our other revenues was generated by our Smart Online and the
      remaining 37% was generated by our Smart Commerce segment.




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          | 15
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**Cost
      of Revenues**




Cost
      of
      revenues is primarily composed of salaries associated with maintaining and
      supporting integration and syndication partners and
      the
      cost of external hosting facilities associated with maintaining and supporting
      integration and syndication partners. Historically, we do not capitalize any
      costs associated with the development of our products and platforms. Statement
      of Financial Accounting Standards, or 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. Based on our product
      development process, technological feasibility is established upon completion
      of
      a working model. Costs related to software development incurred between
      completion of the working model and the point at which the product is ready
      for
      general release have been insignificant.





**Operating
      Expenses**





In
      previous years, our efforts have been primarily focused on basic product
      development and integration. In the fourth quarter of 2006, we shifted our
      focus
      toward driving subscription revenue while concentrating our development efforts
      on enhancements and customization of our proprietary platforms. In the early
      part of 2007, we also began to focus on licensing our platform products. As
      of
      August 13, 2007, we had 61 employees. Most employees perform multiple
      functions.





*Research
      and Development* .
      Historically, we have not capitalized any costs associated with the development
      of our products and platforms. SFAS No. 86 requires capitalization of certain
      software development costs subsequent to the establishment of technological
      feasibility. Because any such costs that would be capitalized following the
      establishment of technological feasibility would immediately be written off
      due
      to uncertain realizability, all such costs have been recorded as research and
      development costs and expensed as incurred. Because of our proprietary, 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 have relatively low
      research and development expenses as compared to traditional enterprise software
      business models. We expect that in the future, research and development expenses
      will increase substantially in absolute dollars but decrease as a percentage
      of
      total revenue as we hire additional personnel in both segments to enhance and
      customize our platforms and applications.





*Sales
      and Marketing* .
      Historically, we have spent limited funds on marketing, advertising, and public
      relations. Our business model of partnering with established companies with
      extensive small business customer bases allows us to leverage the marketing
      dollars spent by our partners rather than requiring us to incur such costs.
      We
      do not conduct any significant direct marketing or advertising programs. Our
      sales and marketing costs are expected to increase significantly in 2007 due
      to
      the addition of several sales persons. As we begin to grow the number of
      subscribers to our products, we expect sales and marketing expense to increase
      due to the percentages of revenue we may be required to pay to partners as
      marketing fees.





*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, and other corporate expenses, including
      facilities costs. We anticipate general and administrative expenses will
      increase as we add personnel and incur additional professional fees and
      insurance costs related to the growth of our business and to our operations
      as a
      public company. Non-recurring general and administrative expenses increased
      significantly in 2006 as a result of the suspension of trading of our securities
      by the Securities and Exchange Commission, or the SEC, the related SEC
      investigation, and the internal investigation of matters relating to that
      suspension. Our expenses related to these matters have decreased to an
      immaterial amount in the fourth quarter of 2006 and first half of 2007. We
      expect to incur additional material costs in 2007 as we take the necessary
      steps
      to comply with Section 404 of the Sarbanes-Oxley Act of 2002.





*Stock-Based
      Expenses* .
      Our
      operating expenses include stock-based expenses related to options and warrants
      issued to employees and non-employees. These charges have been significant
      and
      are reflected in our historical financial results. Effective January 1, 2006,
      we
      adopted SFAS No. 123 (revised 2004), *Share-Based Payment* ,
      or SFAS
      No. 123R, which has resulted and will continue to result in material costs
      on a
      prospective basis as long as a significant number of options are outstanding.
      In
      addition, in June 2007, we limited the issuance of awards under our 2004 Equity
      Compensation Plan (the “2004 Plan”) to awards of restricted or unrestricted
      stock, and do not anticipate any further stock option awards to be granted
      under
      the 2004 Plan.




**Critical
      Accounting Policies and Estimates**





Our
      discussion and analysis of financial condition and results of operations is
      based upon our consolidated financial statements, which have been prepared
      in
      accordance with accounting principles generally accepted in the United States.
      The preparation of these financial statements requires us to make estimates
      and
      judgments that affect the reported amounts of assets, liabilities, revenues
      and
      expenses, and related disclosures of contingent assets and liabilities.
“Critical accounting policies and estimates” are defined as those most important
      to the financial statement presentation and that require the most difficult,
      subjective, or complex judgments. We base our estimates on historical experience
      and on various other factors that we believe to be reasonable under the
      circumstances, the results of which form the basis for making judgments about
      the carrying value of assets and liabilities that are not readily apparent
      from
      other sources. Under different assumptions and/or conditions, actual results
      of
      operations may materially differ. We periodically re-evaluate our critical
      accounting policies and estimates, including those related to revenue
      recognition, provision for doubtful


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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, 2006.





Effective
      January 1, 2007, a major customer executed a letter of clarification which
      more
      definitively defined the roles and responsibilities of each party. Individual
      Business Owners, or IBOs, associated with this customer are provided e-commerce,
      domain name and email services. In exchange for marketing these services to
      its
      IBOs, the customer is paid a marketing fee. At the inception of the business
      relationship, it was agreed that the customer would collect the gross service
      fee from the IBO; the customer would retain its marketing fee and remit the
      net
      remaining cash. Because the roles and responsibilities of each party were
      vaguely defined in the past, revenue was recorded only on the net cash received.
      Following the execution of the letter of clarification and in accordance with
      Emerging Issues Task Force, or EITF, 99-19, *Reporting
      Revenue Gross as a Principal versus Net as an Agent* ,
      this
      revenue is now recorded as the gross amount paid by the IBO and a sales and
      marketing expense for the marketing services rendered by the customer.
      Ultimately, the effect on net income is nil; however, subscription revenue
      and
      sales and marketing expense are effectively and appropriately grossed up.
      Because the new accounting method was triggered by a clarification to the
      existing agreement and not by a change from one accepted accounting method
      to
      another, the 2006 subscription revenue was not retroactively adjusted as would
      be required by SFAS No. 154, *Accounting Changes and Error Corrections - a replacement of APB Opinion No.
      20
      and FASB Statement No. 3* ,
      or SFAS
      No. 154. For the three months and six months ended June 30, 2007, this
      accounting method resulted in approximately $227,000 and $488,000, respectively,
      of additional subscription revenue and a corresponding charge to sales and
      marketing expense.





The
      Company has recently begun to derive revenue from the license of software
      platforms along with the sale of associated maintenance, consulting, and
      application development. The arrangement may include delivery in
      multiple-element arrangements if the customer purchases any combination of
      products and/or services. The Company uses the residual method pursuant to
      American Institute of Certified Public Accountants, or the AICPA, Statement
      of
      Position 97-2, Software Revenue Recognition, or SOP 97-2, as amended. This
      method allows Smart Online to recognize revenue for delivered elements when
      such
      element has vendor specific objective evidence, or VSOE, of the fair value
      of
      the delivered element. If VSOE can not 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. The
      determination of whether the arrangement involved significant development,
      modification or customization could be complex and require the use of
      judgment.





The
      amount of revenue to be recognized from development and consulting services
      is
      typically based on the amount of work performed within a given period. This
      is
      typically based on estimates involving total costs to complete and the stage
      of
      completion. The assumptions and estimates made to determine such figures may
      affect the timing of revenue recognition. Changes in estimates of progress
      to
      completion and costs to complete are accounted for as cumulative catch-up
      adjustments.





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, and


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 and the amount and timing of revenue
      recognition could change if different assessments had been made. In addition,
      payment terms may vary and could be collectible over several months, but not
      greater than one year.


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          | 17
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          of Contents*


**Overview
      of Results of Operations for the Three Months Ended June 30, 2007 and June
      30,
      2006**





**Three
                Months Ended**
              **June
                30, 2007**
            
            **Three
                Months Ended**
              **June
                30, 2006**REVENUES:Integration
                Fees
            
            $
            5,000
            
            $
            26,667Syndication
                Fees
            
            
            15,000
            
            
            57,352Subscription
                Fees
            
            
            576,600
            
            
            501,093Professional
                Services Fees
            
            
            317,900
            
            
            232,466License
                Fees
            
            
            280,000
            
            
            -Other
                Revenue
            
            
            9,429
            
            
            18,416Total
                Revenues
            
            
            1,203,929
            
            
            835,994COST
                OF REVENUES
            
            
            111,489
            
            
            79,100GROSS
                PROFIT
            
            
            1,092,440
            
            
            756,894OPERATING
                EXPENSES:General
                and Administrative
            
            
            1,051,314
            
            
            1,638,994Sales
                and Marketing
            
            
            473,668
            
            
            239,088Research
                and Development
            
            
            685,915
            
            
            392,824Total
                Operating Expenses
            
            
            2,210,897
            
            
            2,270,906LOSS
                FROM CONTINUING OPERATIONS
            
            
            (1,118,457
            )
            
            (1,514,012
            )OTHER
                INCOME (EXPENSE):Interest
                Expense, Net
            
            
            (126,759
            )
            
            (64,643
            )Gain
                on Debt Forgiveness
            
            
            -
            
            
            144,351Other
                Income
            
            
            30,478
            
            
            1,562,500Total
                Other Income (Expense)
            
            
            (96,281
            )
            
            1,642,208NET
                INCOME (LOSS) FROM CONTINUING OPERATIONS
            
            
            (1,214,738
            )
            
            128,196DISCONTINUED
                OPERATIONSLoss
                of Operations of Smart CRM, net of tax
            
            
            -
            
            
            (156,571
            )NET
                LOSSNet
                loss attributed to common stockholders
            
            $
            (1,214,738
            )
            $
            (28,375
            )NET
                LOSS PER SHARE:Continuing
                OperationsBasic
                and Fully Diluted
            
            $
            (0.07
            )
            
            0.01Discontinued
                OperationsBasic
                and Fully Diluted
            
            $
            -
            
            
            (0.01
            )Net
                Loss Attributed to Common StockholdersBasic
                and Fully Diluted
            
            $
            (0.07
            )
            
            0.00SHARES
                USED IN COMPUTING NET LOSS PER SHAREBasic
            
            
            17,252,639
            
            
            15,096,415Fully
                Diluted
            
            
            17,252,639
            
            
            15,356,015





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            | 18
 *Table
            of Contents*




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




**Three
                Months**
              **Ended**
              **June
                30,**
              **2007**
            
            **Three
                Months Ended**
              **June
                30,**
              **2006**REVENUES:Integration
                fees
            
            
            0
            %
            
            3
            %Syndication
                fees
            
            
            1
            %
            
            7
            %Subscription
                fees
            
            
            49
            %
            
            60
            %Professional
                services fees
            
            
            26
            %
            
            28
            %License
                Fees
            
            
            23
            %
            
            0
            %Other
                revenues
            
            
            1
            %
            
            2
            %Total
                revenues
            
            
            100
            %
            
            100
            %COST
                OF REVENUES
            
            
            9
            %
            
            9
            %GROSS
                PROFIT
            
            
            91
            %
            
            91
            %OPERATING
                EXPENSES:General
                and administrative
            
            
            87
            %
            
            196
            %Sales
                and marketing
            
            
            39
            %
            
            29
            %Research
                and Development
            
            
            57
            %
            
            47
            %Total
                operating expenses
            
            
            183
            %
            
            272
            %LOSS
                FROM OPERATIONS
            
            
            (92
            %)
            
            (181
            %)OTHER
                INCOME (EXPENSE):Interest
                income (expense), net
            
            
            (11
            %)
            
            (8
            %)Other
                income
            
            
            3
            %
            
            187
            %Writeoff
                of investment
            
            
            0
            %
            
            0
            %Gain
                on debt forgiveness
            
            
            0
            %
            
            17
            %DISCONTINUED
                OPERATIONSLoss
                of Operations of Smart CRM, net of tax
            
            
            0
            %
            
            (19
            %)NET
                INCOME(LOSS)
            
            
            (100
            %)
            
            (4
            %)0




**Overview
      of Results of Operations of the Three Months Ended June 30,
      2007**





Total
      revenues were $1,204,000 for the second quarter of 2007 compared to $836,000
      for
      the second quarter of 2006, representing an increase of $368,000, or 44%. Gross
      profit increased $335,000 or 44% to $1,092,000 from $757,000. Operating expenses
      decreased $60,000 or 3% to $2,211,000 from $2,271,000. Loss from continuing
      operations narrowed to $1,118,000 from $1,514,000, a decrease of $396,000 or
      26%, while net loss from continuing operations widened by $1,343,000 from a
      gain
      of $128,000 to a loss of $1,215,000. Net loss attributed to common stockholders
      for the three months ended June 30, 2007 increased $1,186,000 to $1,215,000
      from
      $28,000. The net loss for the three months ended June 30, 2006 included other
      non-cash income of $1,562,500 related to the takeback of certain investor
      relation shares.





**Comparison
      of the Results of Operations for the Three Months Ended June 30, 2007 and June
      30, 2006**





**Revenue.** Total
      revenues were $1,204,000 for the second quarter of 2007 compared to $836,000
      for
      the second quarter of 2006


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          | 19
 *Table
          of Contents*


representing
      an increase of $368,000 or 44%. This increase is primarily attributable to
      increases in revenue from license fees of $280,000, subscription fees of $76,000
      and professional fees of $86,000, which were offset by decreases in integration
      revenue of $22,000 and other revenues of $9,000.





Revenues
      from license fees increased to $280,000 for the second quarter of 2007 from
      $0
      for the second quarter of 2006, and represented 23% of our consolidated revenue
      for the second quarter of 2007. This increase is attributable to there being
      one
      platform license sale in our Smart Online segment in the second quarter of
      2007
      as compared to none for the same period in 2006.





Subscription
      revenues increased $76,000, or 15%, to $577,000 for the second quarter of 2007
      from $501,000 for the second quarter of 2006. This increase was due to
      approximately $227,000 of additional revenue recorded in the three months ended
      June 30, 2007 due to our adoption of gross revenue reporting. As discussed
      above, certain subscription revenues that were recorded net for the three months
      ended June 30, 2006 were recorded as gross for the three months ended June
      30,
      2007. Because the new accounting method was triggered by a clarification to
      an
      existing agreement and not by a change from one accepted accounting method
      to
      another, the 2006 subscription revenues were not retroactively adjusted as
      would
      be required by SFAS No. 154. Therefore, subscription revenues for the three
      months ended June 30, 2007 are not recorded in the same manner as subscription
      revenues for the three months ended June 30, 2006. ****** Had
      revenue from this customer been recognized net (making it comparable to the
      three months ended June 30, 2006), subscription revenues for the three months
      ended June 30, 2007 would have been approximately $349,000 as compared to
      approximately $501,000 in the same period of 2006. The decrease of approximately
      $152,000, or 30%, is related to the decrease in volume related to the 2006
      restructuring of a major customer of the Smart Commerce segment which has been
      partially offset by the addition of new customers from new partners.





Revenues
      from professional services fees, all of which are derived from our Smart
      Commerce segment, increased $86,000, or 37%, to $318,000 for the second quarter
      of 2007 from $232,000 for the second quarter of 2006. This increase was
      attributable to the addition of one new customer as well as additional services
      being provided to one existing customer.





Integration
      revenues decreased $22,000, or 81%, to $5,000 for the second quarter of 2007
      as
      compared to $27,000 for the same period in 2006. The 2007 and 2006 periods
      also
      included $0 and $5,000 of revenue derived from barter transactions,
      respectively. Almost all integration contract revenue was recognized by the
      end
      of 2006 and no new integration agreements have been entered at this time. As
      we
      have shifted our focus to growing subscription and license revenue, we have
      not
      sought any new or additional integration partners.





Syndication
      revenues decreased $42,000, or 74%, to $15,000 for the second quarter of 2007
      as
      compared to $57,000 for the same period in 2006. In the past, we have sought
      and
      received syndication fees as part of our contracts with partners to set up
      private label websites. Currently, as part of our efforts to increase the number
      of subscribers to our services through these partnerships, we are no longer
      seeking contracts which include such syndication fees and are focusing on
      increasing subscription revenues from end subscribers. The $15,000 of recognized
      syndication revenues in the second quarter of 2007 relates to a monthly hosting
      fee in the amount of $5,000 from one syndication partner.





Other
      revenue decreased $9,000, or 50%, to $9,000 for the second quarter of 2007
      as
      compared to $18,000 for the same period in 2006. This revenue is generated
      from
      non-core activities such as sales of shrink-wrapped products, OEM contracts
      and
      miscellaneous other revenues.





**Cost
      of Revenues**





Cost
      of
      revenues increased $32,000, or 41%, to $111,000 in the second quarter of 2007
      from $79,000 in the second quarter 2006, primarily as a result of increased
      hosting costs at our Smart Commerce segment related to hosting for additional
      customers, which resulted in an increase in cost of revenues of approximately
      $30,000.





**Operating
      Expenses**





Operating
      expenses decreased $60,000, or 3%, to $2,211,000 for the second quarter of
      2007
      from $2,271,000 during the second quarter of 2006. This decrease was primarily
      due to a decrease in general and administrative expenses of approximately
      $588,000. This decrease was offset by an increase in sales and marketing
      expenses of approximately $235,000 and an increase in research and development
      expenses of approximately $293,000.




*General
      and Administrative* -
      General and administrative expenses decreased by $588,000, or 36%,
      to $1,051,000 for the second quarter of 2007 from $1,639,000 in the same
      quarter of 2006. This decrease was primarily due to a reduction of $393,000
      in
      legal fees as the second quarter of 2006, which included legal expense related
      to the SEC matter and our own internal investigation. Compensation expense
      required by SFAS No. 123R decreased $32,000 from the prior period as there
      have
      been minimal options granted from the second quarter of 2006 through the end
      of
      the second quarter of 2007, and the number of expirations exceeded
      the


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          | 20
 *Table
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grants.
      In addition, wage expense in the Smart Online segment decreased $20,000 from
      the
      prior period as certain officers agreed to have their salaries reduced for
      a
      limited period, registration right penalties decreased $121,000 as we
      reached agreements with certain stockholders regarding penalties in the first
      half of 2007, and the amount of interest associated with the iMart Incorporated,
      or iMart, purchase price agreement decreased in the amount of $50,000 as the
      purchase price was paid in full during the first quarter of 2007. Travel expense
      decreased $17,000 and rent expense decreased $15,000 in the Smart Online
      segment.





We
      are
      currently disputing our insurance carrier's refusal to cover certain legal
      expenses related to the SEC matter. We contend that these legal expenses should
      be reimbursed by our insurance carrier. Because the outcome of this dispute
      is
      unclear, we have expensed all legal costs incurred and we will account for
      any
      insurance reimbursement, should there be any, in the period such amounts are
      reimbursed.





*Sales
      and Marketing* - Sales
      and marketing expense increased to $474,000 in the second quarter of 2007 from
      $239,000 in the second quarter of 2006, an increase of $235,000, or
      98%. ****** As
      detailed in the Revenue section above, in the Smart Commerce segment, there
      was
      approximately $227,000 of additional revenue recorded in the three months ended
      June 30, 2007 due to our adoption of gross revenue reporting. A corresponding
      increase in sales and marketing expense of $227,000 was recorded in association
      with the new gross accounting method.





*Research
      and Development* -
      Research and development expense increased to $686,000 in the second quarter
      of
      2007 from $393,000 in the second quarter of 2006, an increase of approximately
      $293,000, or 75%. This increase primarily is due to increased expenses from
      the
      Smart Online segment, including increases of $116,000 in consulting expense
      for
      our accounting application, $105,000 for wages for additional staffing, and
      moving expenses of $6,000 associated with the relocation of employees from
      the
      Smart Commerce segment’s out of state office. In addition, the Smart Commerce
      segment incurred approximately $55,000 of additional wages with the hiring
      of
      new research and development personnel to implement new partnership signings.
      We
      expect research and development expenses to increase during the last half of
      2007 as a result of anticipated hiring of additional research and development
      personnel for both the Smart Online and Smart Commerce segments to enhance
      and
      customize our platforms and applications.





**Other
      Income (Expense)**





We
      incurred net interest expense of $127,000 during the second quarter of 2007
      and
      $65,000 of net interest expense during the second quarter of 2006. Interest
      expense increased as a direct result of the notes payable related to the iMart
      and Computility, Inc., or Computility, acquisitions, including notes related
      to
      non-compete agreements. Additionally, interest expense of approximately $32,000
      was incurred during the second quarter of 2007 on our revolving line of credit
      with Wachovia Bank, NA, or Wachovia. Second quarter 2007 interest income
      totaling $55,000 was earned on money market account deposits compared to $2,000
      earned for the same period in 2006. The second quarter 2007 interest income
      increase was attributable to the interest earned on the cash proceeds of the
      February 2007 private placement described in Note 7, “Stockholders’ Equity,” to
      the consolidated financial statements in this report.





We
      realized a gain of $0 during the second quarter of 2007 from negotiated and
      contractual releases of outstanding liabilities compared to $144,000 gain from
      debt forgiveness in the second quarter of 2006.





One
      of
      the assets purchased as part of the iMart acquisition was a $25,000 investment
      in a privately held company that was a customer of iMart's. Management
      determined that it is likely that such investment is currently worthless, so
      the
      entire $25,000 investment had been written off in the second quarter of 2006.
      Also in the second quarter of 2006, we reserved 100% of the approximately
      $65,000 of the accounts receivable due from that customer. We did not have
      similar expenses in the second quarter of 2007.


Page
          | 21
 *Table
          of Contents*




**Overview
      of Results of Operation for the Six Months Ended June 30, 2007 and
      2006**





**Six
                Months Ended**
              **June
                30, 2007**
            
            **Six
                Months Ended**
              **June
                30, 2006**REVENUES:Integration
                Fees
            
            $
            5,000
            
            $
            176,410Syndication
                Fees
            
            
            30,000
            
            
            126,267Subscription
                Fees
            
            
            1,209,583
            
            
            1,046,767Professional
                Services Fees
            
            
            606,479
            
            
            464,201License
                Fees
            
            
            280,000
            
            
            337,500Other
                Revenue
            
            
            15,254
            
            
            40,312Total
                Revenues
            
            
            2,146,316
            
            
            2,191,457COST
                OF REVENUES
            
            
            187,909
            
            
            181,204GROSS
                PROFIT
            
            
            1,958,407
            
            
            2,010,253OPERATING
                EXPENSES:General
                and Administrative
            
            
            2,164,005
            
            
            3,629,098Sales
                and Marketing
            
            
            942,915
            
            
            531,912Research
                and Development
            
            
            1,262,610
            
            
            823,201Total
                Operating Expenses
            
            
            4,369,530
            
            
            4,984,211LOSS
                FROM CONTINUING OPERATIONS
            
            
            (2,411,123
            )
            
            (2,973,958
            )OTHER
                INCOME (EXPENSE):Interest
                Expense, Net
            
            
            (261,787
            )
            
            (139,056
            )Gain
                on Debt Forgiveness
            
            
            4,600
            
            
            144,351Writeoff
                of Investment
            
            
            -
            
            
            (25,000
            )Other
                Income
            
            
            143,808
            
            
            1,562,500Total
                Other Income (Expense)
            
            
            (113,379
            )
            
            1,542,795NET
                LOSS FROM CONTINUING OPERATIONS
            
            
            (2,524,502
            )
            
            (1,431,163
            )DISCONTINUED
                OPERATIONSLoss
                of Operations of Smart CRM, net of tax
            
            
            -
            
            
            (196,135
            )NET
                LOSSNet
                loss attributed to common stockholders
            
            $
            (2,524,502
            )
            $
            (1,627,298
            )NET
                LOSS PER SHARE:Continuing
                OperationsBasic
                and Fully Diluted
            
            $
            (0.15
            )
            
            (0.10
            )Discontinued
                OperationsBasic
                and Fully Diluted
            
            $
            -
            
            
            (0.01
            )Net
                Loss Attributed to Common StockholdersBasic
                and Fully Diluted
            
            $
            (0.15
            )
            
            (0.11
            )SHARES
                USED IN COMPUTING NET LOSS PER SHAREBasic
                and Fully Diluted
            
            
            16,728,010
            
            
            15,052,205





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          | 22
 *Table
          of Contents*


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




**Six
                Months**
              **Ended**
              **June
                30,**
              **2007**
            
            **Six
                Months Ended**
              **June
                30,**
              **2006**REVENUES:Integration
                fees
            
            
            0
            %
            
            8
            %Syndication
                fees
            
            
            1
            %
            
            6
            %Subscription
                fees
            
            
            57
            %
            
            48
            %Professional
                services fees
            
            
            28
            %
            
            21
            %License
                fees
            
            
            13
            %
            
            15
            %Other
                revenues
            
            
            1
            %
            
            2
            %Total
                revenues
            
            
            100
            %
            
            100
            %COST
                OF REVENUES
            
            
            9
            %
            
            8
            %GROSS
                PROFIT
            
            
            91
            %
            
            92
            %OPERATING
                EXPENSES:General
                and administrative
            
            
            101
            %
            
            166
            %Sales
                and marketing
            
            
            44
            %
            
            24
            %Development
            
            
            59
            %
            
            38
            %Total
                operating expenses
            
            
            204
            %
            
            228
            %LOSS
                FROM OPERATIONS
            
            
            (113
            %)
            
            (136
            %)OTHER
                INCOME (EXPENSE):Interest
                income (expense), net
            
            
            (12
            %)
            
            (6
            %)Other
                income
            
            
            6
            %
            
            71
            %Writeoff
                of investment
            
            
            0
            %
            
            (1
            %)Gain
                on debt forgiveness
            
            
            0
            %
            
            7
            %DISCONTINUED
                OPERATIONSLoss
                of Operations of Smart CRM, net of tax
            
            
            0
            %
            
            (9
            %)NET
                INCOME(Loss)
            
            
            (119
            %)
            
            (74
            %)





**Overview
      of Results of Operations for the Six Months Ended June 30,
      2007**





Total
      revenues were $2,146,000 for the six months ended June 30, 2007 compared to
      $2,191,000 for the six months ended June 30, 2006, representing a decrease
      of
      $45,000, or 2%. Gross profit decreased $52,000, or 3%, to $1,958,000 from
      $2,010,000. Operating expenses decreased $614,000 or 12% to $4,370,000 from
      $4,984,000. Loss from continuing operations narrowed by $563,000, or 19%, to
      $2,411,000 from $2,974,000 while net loss from continuing operations widened
      by
      $1,094,000, or 76%, to $2,525,000 from $1,431,000. Net loss attributable to
      common stockholders for the six months ended June 30, 2007 increased $898,000,
      or 55%, to $2,525,000 from $1,627,000. The net loss for the six months ended
      June 30, 2006 included other non-cash income of $1,562,500 related to the
      takeback of certain investor relation shares.




**Comparison
      of the Results of Operations for the Six Months Ended June 30, 2007 and June
      30,
      2006**


Page
          | 23
 *Table
          of Contents*


**Revenue.** Total
      revenues were $2,146,000 for the first half 2007 compared to $2,191,000 for
      the
      first half of 2006, representing a decrease of $45,000, or 2%. This decrease
      is
      primarily attributable to decreases in integration revenue of $171,000,
      syndication revenue of $96,000, license fees of 58,000, and other revenues
      of
      $25,000, which were offset by increases in subscription fees of $163,000 and
      professional services fees of $142,000.





Revenues
      from license fees decreased by $58,000, or 17%, to $280,000 for the first half
      of 2007 from $338,000 for the first half of 2006, representing 15% of our
      consolidated revenue for the second half of 2007. This decrease is attributable
      to there being one smaller platform license sale (from the Smart Online segment)
      in the first half of 2007 as compared to one license sale (in the Smart Commerce
      segment) for the same period in 2006. ******





Subscription
      revenues increased $163,000, or 16%, to $1,210,000 for the six months ended
      June
      30, 2007 from $1,047,000 for the six months ended June 30, 2006. This increase
      was due to approximately $488,000 of additional revenue recorded in the six
      months ended June 30, 2007 due to our adoption of gross revenue reporting offset
      by a decrease of approximately $326,000 related to the restructuring at one
      of
      our customers. As discussed above, certain subscription revenues that were
      recorded net for the six months ended June 30, 2006 were recorded gross for
      the
      six months ended June 30, 2007. Because the new accounting method was triggered
      by a clarification to an existing agreement and not by a change from one
      accepted accounting method to another, the 2006 subscription revenues were
      not
      retroactively adjusted as would be required by SFAS No. 154 *.* Therefore, subscription revenues for the six months ended June 30, 2007 are
      not
      recorded in the same manner as subscription revenues for the six months ended
      June 30, 2006. Had revenue from this customer been recognized net (making it
      comparable to the six months ended June 30, 2006), subscription revenues for
      the
      six months ended June 30, 2007 would have been approximately $721,000 as
      compared to approximately $1,047,000 in the same period of 2006. The decrease
      of
      approximately $326,000, or 31%, is related to the decrease in volume related
      to
      the 2006 restructuring of a major customer, which has been partially offset
      by
      the addition of new customers from new partners.





Revenues
      from professional services fees, all of which are derived from our Smart
      Commerce segment, increased to $606,000 for the six months ended June 30, 2007
      from $464,000 for the six months ended June 30, 2006. This increase was
      attributable to the addition of one new customer as well as additional services
      being provided to one existing customer.





Integration
      revenues decreased $171,000, or 97%, to $5,000 for the six months ended June
      30,
      2007 as compared to $176,000 for the same period in 2006. The 2007 and 2006
      periods also included $0 and $5,000 of revenue derived from barter transactions,
      respectively. Almost all integration contract revenue was recognized by the
      end
      of 2006 and no new integration agreements have been entered at this time. As
      we
      have shifted our focus to growing subscription revenue, we have not sought
      any
      new or additional integration partners.





Syndication
      revenues decreased $96,000, or 76%, to $30,000 for the six months ended June
      30,
      2007 as compared to $126,000 for the same period in 2006. In the past, we have
      sought and received syndication fees as part of our contracts with partners
      to
      set up private label websites. Currently, as part of our efforts to increase
      the
      number of subscribers to our services through these partnerships, we are no
      longer seeking contracts which include such revenues and are focusing on
      increasing subscription revenues. The $30,000 of recognized syndication revenues
      in the six months ended June 30, 2007 relates to a monthly hosting fee in the
      amount of $5,000 from one syndication partner.





Other
      revenue was approximately $15,000 for the six months ended June 30, 2007 as
      compared to $40,000 for the comparable period in 2006. Other revenue relates
      primarily to smaller OEM contracts and other miscellaneous
      revenues.





**Cost
      of Revenues**





Cost
      of
      revenues increased $7,000, or 4%, to $188,000 in the six months ended June
      30,
      2007, from $181,000 in the comparable period in 2006, primarily as a result
      of
      increased hosting costs at our Smart Commerce segment related to hosting for
      additional customers, which resulted in an increase in cost of revenues of
      approximately $30,000. The majority of this increase was offset by an overall
      reduction of personnel at the Smart Commerce segment.





**Operating
      Expenses**





Operating
      expenses decreased $614,000, or 12%, to $4,370,000 for the six months ended
      June
      30, 2007 from $4,984,000 for the six months ended June 30, 2006. This decrease
      was primarily due to a decrease in general and administrative expenses of
      approximately $1,465,000. This decrease was offset by an increase in sales
      and
      marketing expenses of approximately $411,000 and an increase in research and
      development expenses of approximately $440,000.




*General
      and Administrative* -
      General and administrative expenses decreased by $1,465,000 or 40%
      to $2,164,000 for the six months ended June 30, 2007 from $3,629,000 in the
      same period of 2006. This decrease was primarily due to a reduction of $869,000
      in legal fees as the six months ended June 30, 2006 included legal expense
      related to the SEC matter and our own internal investigation. Compensation
      expense required by SFAS No. 123R decreased $115,000 from the prior period
      as
      there have been minimal options


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granted
      from the six months ended June 30, 2006 through the end of the six months ended
      June 30, 2007, and the number of expirations exceeded the grants. General and
      administrative wage expense decreased $83,000 from the prior period related
      to
      the elimination of non-essential positions. Registration right penalties
      decreased $206,000 as certain stockholders settled in the six months ended
      June
      30, 2007 and no additional penalties were accrued for those individuals.
      Accounting expense was reduced by approximately $124,000 in the first half
      of
      2007 as compared to the same period in 2006 through the hiring of a full-time
      Chief Financial Officer and the elimination of using outside firms to provide
      those services. In the six months ended June 30, 2006, general and
      administrative expenses also included $51,000 for market research on our
      securities and $23,000 for recruiting our current Chief Financial Officer,
      and
      we did not have similar expenses in the six months ended June 30,
      2007.





We
      are
      currently disputing our insurance carrier's refusal to cover certain legal
      expenses related to the SEC matter. We contend that these legal expenses should
      be reimbursed by our insurance carrier. Because the outcome of this dispute
      is
      unclear, we have expensed all legal costs incurred and we will account for
      any
      insurance reimbursement, should there be any, in the period such amounts are
      reimbursed.





*Sales
      and Marketing* - Sales
      and marketing expense was $943,000 for the six months ended June 30, 2007 from
      $532,000 in the six months ended June 30, 2006, an increase of $411,000, or
      77%. ****** As
      detailed in the Revenue section above, due to our adoption of gross revenue
      reporting, for the six months ended June 30, 2007, we recorded approximately
      $488,000 of additional revenue and an equivalent increase in sales and marketing
      expense. This increase was offset by several decreases in sales and marketing
      expense in the Smart Online segment, including a $38,000 reduction in barter
      advertising expense and a $50,000 decrease in revenue share expense, as we
      paid
      our partners a fee in the six months ended June 30, 2006 for a syndication
      contract and had no similar expense in the six months ended June 30,
      2007.





Generally,
      we expect we will have to increase sales and marketing expenses before we can
      substantially increase our revenue from sales of subscriptions. We have
      increased investment in sales and marketing by increasing the number of direct
      sales personnel and increasing penetration within our existing customer base,
      expanding our domestic selling and marketing activities, building brand
      awareness and participating in additional marketing programs, and we are
      planning to continue to increase these investments.





*Research
      and Development* -
      Research and development expense increased to $1,263,000 in the six months
      ended
      June 30, 2007 from $823,000 in the six months ended June 30, 2006, an increase
      of approximately $440,000, or 53%. This increase is due to several factors
      in
      the Smart Online segment, including increases of $226,000 in consulting expense
      for our accounting application and an increase of $122,000 for wages for
      additional staffing. At our Smart Commerce segment, our research and development
      wages increased by approximately $100,000 and our consulting expense increased
      by approximately $31,000 related to additional staff and support required to
      accommodate our new customers.





**Other
      Income (Expense)**





We
      incurred net interest expense of $262,000 during the six months ended June
      30,
      2007 and $139,000 of net interest expense during the six months ended June
      30,
      2006. Interest expense increased as a direct result of approximately $207,000
      of
      interest expense related to the amortization of deferred financing costs of
      the
      warrants issued to Atlas Capital, S.A., or Atlas. Additionally, interest expense
      of approximately $59,000 was incurred during the six months ended June 30,
      2007
      on our revolving line of credit with Wachovia and $77,000 of interest expense
      related to the Smart Commerce loan with Fifth Third Bank. Interest income for
      our Smart Online segment totaling $80,000 was earned on money market account
      deposits compared to $5,000 earned for the same period in 2006. The first half
      of 2007 interest income increase was attributable to the interest earned on
      the
      cash proceeds of the February 2007 private placement described in Note 7,
“Stockholders’ Equity,” to the consolidated financial statements in this report
      under Item 2, Unregistered Sales of Equity Securities and Use of
      Proceeds.





We
      realized a gain of $5,000 during the six months ended June 30, 2007 from
      negotiated and contractual releases of outstanding liabilities as compared
      to
      $144,000 in the six months ended June 30, 2006.





One
      of
      the assets purchased as part of the iMart acquisition was a $25,000 investment
      in a privately held company that was a customer of iMart's. Management
      determined that it is likely that such investment is currently worthless, so
      the
      entire $25,000 investment had been written off in the six months ended June
      30,
      2006. Also in the six months ended June 30, 2006, we reserved for 100% of the
      approximately $65,000 of the accounts receivable due from that customer. We
      did
      not have similar expenses in the six months ended June 30, 2007.





**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
      second quarter of 2007 primarily due to continued substantial uncertainty
      regarding our ability to realize our deferred tax assets. Based upon available
      objective evidence, there has been sufficient uncertainty regarding the ability
      to realize our deferred tax assets, which warrants a full valuation allowance
      in
      our financial statements. We have approximately


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$35,000,000
      in net operating loss carryforwards, which may be utilized to offset future
      taxable income.





**Liquidity
      and Capital Resources**





At
      June
      30, 2007, our principal sources of liquidity were unrestricted cash and cash
      equivalents totaling $3,628,000 and accounts receivable of $934,000. As of
      August 10, 2007, our principal sources of liquidity were cash and cash
      equivalents totaling approximately $3,727,000 and accounts receivable of
      approximately $812,000. ****** However,
      $250,000 of our cash is restricted under the loan agreement with Fifth Third
      Bank. Such restricted cash is scheduled to be released from the restrictions
      in
      three equal installments of approximately $83,000, on June 30, 2007, December
      31, 2007 and June 30, 2008, if we meet certain debt covenants regarding
      operating metrics for Smart Commerce. Those operating metrics relate to Smart
      Commerce’s actual results of operations as compared to certain projections
      provided to Fifth Third Bank at the inception of the loan. Meeting or failing
      to
      meet those metrics relate only to the release of cash as described above.
      Failure to meet these metrics does not, however, result in an acceleration
      of
      the debt. Fifth Third Bank is currently evaluating the June 30, 2007 results
      to
      make a determination regarding the scheduled cash release. As of June 30, 2007,
      we have drawn approximately $2.1 million of our $2.5 million line of credit,
      leaving approximately $400,000 available for our operations.





At
      June
      30, 2007, we had working capital of approximately $2.2 million.





**Cash
      Flow from Operations** .
      Cash
      flows used in operations for the six months ended June 30, 2007 totaled
      $2,182,000, up from $1,353,000 for the six months ended June 30, 2006. This
      increase was primarily due to increased accounts receivable as well as the
      loss
      of cash flow from discontinued operations.





**Cash
      Flow from Financing Activity** .
      For the
      six months ended June 30, 2007, we generated a total of $5,538,000 net cash
      from
      our financing activities, up from $869,000 for the six months ended June 30,
      2006. This net cash was generated through both equity and debt financing, as
      described below.





*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 were $6 million, and we incurred issuance costs of approximately
      $637,000 as of July 30, 2007. These costs were higher than the $585,000
      originally anticipated due to state securities law filing requirements along
      with the associated legal fees. 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 by February 21, 2010.





*Debt
      Financing.* On
      November 9, 2006, Smart Commerce entered into a loan agreement with Fifth Third
      Bank. Under the terms of this agreement, Smart Commerce borrowed $1.8 million
      to
      be repaid in 24 monthly installments of $75,000 plus interest beginning in
      December 2006. The interest rate is prime plus 1.5% as periodically determined
      by Fifth Third Bank. The loan is secured by all of the assets of Smart Commerce,
      including a cash security account of $250,000 and all of Smart Commerce's
      intellectual property. Such restricted cash is scheduled to be released from
      the
      restrictions in three equal installments of approximately $83,000, on June
      30,
      2007, December 31, 2007 and June 30, 2008, if certain debt covenants regarding
      operating metrics for Smart Commerce are met. Those operating metrics relate
      to
      Smart Commerce’s actual results of operations as compared to certain projections
      provided to Fifth Third Bank at the inception of the loan. Meeting or failing
      to
      meet those metrics relate only to the release of cash as described above.
      Failure to meet these metrics does not, however, result in an acceleration
      of
      the debt. Fifth Third Bank is currently evaluating the June 30, 2007 results
      to
      make a determination regarding the scheduled cash release. As of August 10,
      2007, our outstanding principal balance on this debt was approximately
      $1,200,000.





On
      November 14, 2006, we entered into a revolving credit arrangement with Wachovia,
      or the line of credit, for $1.3 million which can be used for general working
      capital. Any advances made on the line of credit were to be paid off no later
      than August 1, 2007, with monthly payments of accrued interest on any
      outstanding balance commencing on December 1, 2006. Interest accrues on the
      unpaid principal balance at the LIBOR Market Index Rate plus 0.9%. On January
      24, 2007, we entered into an amendment to the line of credit. The amendment
      resulted in an increase in the line of credit from $1.3 million to $2.5 million.
      The pay-off date was also extended from August 1, 2007 to August 1, 2008. The
      line of credit is secured by our deposit account at Wachovia and an irrevocable
      standby letter of credit in the amount of $2,500,000 issued by HSBC Private
      Bank
      (Suisse) S.A. with Atlas as account party. Atlas and we have separately agreed
      that in the event of a default by us in the repayment of the line of credit
      that
      results in the letter of credit being drawn, we shall reimburse Atlas any sums
      that Atlas is required to pay. 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. As of August 10, 2007, we have drawn down approximately $2.1 million
      on the line of credit.





We
      have
      not yet achieved positive cash flows from operations, and our main sources
      of
      funds for our operations have been the sale of securities in private placements
      and the Wachovia line 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


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existing
      line of credit, together with cash on hand, will provide sufficient funds to
      finance our operations at least for the next 11 months. Changes in our operating
      plans, lower than anticipated sales, increased expenses, or other events may
      cause us to need 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. We
      have
      no current plans to seek any such additional financing.





**3.****QUANTITATIVE
      AND QUALITATIVE**


**DISCLOSURES
      ABOUT MARKET RISK**




***Interest
      rate sensitivity***





We
      had
      unrestricted cash and cash equivalents totaling $327,000, $1,435,000, and
      $173,000 at December 31, 2006, 2005, and 2004, respectively. At June 30,
      2007, our unrestricted cash was $3,628,000. These amounts were invested
      primarily in demand deposit accounts and money market funds. The cash and cash
      equivalents are held for working capital purposes. We do not enter into
      investments for trading or speculative purposes. Due to the short-term nature
      of
      these investments, we believe that we do not have any material exposure to
      changes in the fair value of our investment portfolio as a result of changes
      in
      interest rates. Declines in interest rates, however, will reduce future
      investment income.





Two
      debt
      instruments have variable interest rates: one is prime + 1.5% and the other
      is
      LIBOR + .9% (See Note 6, “Notes Payable,” to the consolidated financial
      statements). At June 30, 2007, the outstanding principal balance on these loans
      was $1,275,000 and $2,052,000, respectively. Due to the relatively short term
      of
      these debt instruments combined with the relative stability of interest rates,
      we do not expect interest rate or market volatility will have a material effect
      on our cash flows.




**4.
      CONTROLS AND PROCEDURES**





Not
      applicable.




**4T. CONTROLS
      AND PROCEDURES**





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




Based
      on
      their evaluation, our Chief Executive Officer and Chief Financial Officer
      concluded that, as of the end of the period covered by this Quarterly Report,
      our disclosure controls and procedures were not effective because of significant
      deficiencies in our internal control over financial reporting that we are in
      the
      process of remediating. Management first identified and reported on these
      significant deficiencies and related changes to our internal controls under
      Item
      9A of Part II of our Annual Report on Form 10-K for the fiscal year ending
      December 31, 2005, and provided an update regarding the implementation of the
      new internal controls in our 2006 Annual Report. While management believes
      those
      controls effectively mitigate those significant deficiencies, we have not
      completed our testing of all of these control changes and therefore cannot
      conclude on their effectiveness. See “Changes in Internal Control Over Financial
      Reporting” below for a more detailed description of the status of these internal
      control changes.




**Changes
      to Internal Control Over Financial Reporting**





There
      have been no changes in our internal control over financial reporting that
      occurred during the second quarter of fiscal 2007 that have materially affected,
      or are reasonably likely to materially affect, our internal control over
      financial reporting.




As
      described in our Annual Report on Form 10-K for the fiscal year ending December
      31, 2005, filed with the SEC on July 11, 2006, or the 2005 Annual Report, and
      as
      updated in our Annual Report on Form 10-K for the fiscayl year ending December
      31, 2006, filed with the SEC on March 30, 2007, we have continued to test
      internal controls added in response to the final findings of our Audit
      Committee’s investigation related to the SEC’s suspension of trading of our
      common stock in January 2006. In July 2006, the Audit


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Committee
      concluded that: (i) our Chief Executive Officer should have disclosed and sought
      approval from the Board of Directors before entering into certain transactions
      and arrangements, including personal loans; (ii) there was inadequate diligence
      by management and the Board of Directors regarding third parties with which
      we
      contracted, including outside investor relations vendors, some of which were
      registered brokers; (iii) management and our directors lacked sufficient
      knowledge regarding rules and regulations with respect to dealings between
      registered brokers and public companies, (iv) we lack clear policies regarding
      the limits on the Chief Executive Officer’s authority to enter into business
      transactions and agreements without Board approval; (v) there has been
      inadequate legal and accounting review of material contracts; (vi) there has
      been inadequate training and understanding of SEC disclosure requirements;
      (vii)
      there was an unintentional violation of our Securities Trading Policy by one
      of
      our directors as previously reported in our public filings; (viii) we have
      inadequate processes for determination of independence of Board members; and
      (ix) there has been a failure to communicate and stress the importance of
      controls and procedures throughout our organization. The Audit Committee
      investigation concluded that these deficiencies primarily resulted from our
      transition from a private company to a publicly reporting company and
      insufficient preparation for, focus on, and experience with compliance
      requirements for a publicly reporting company




As
      a
      result of the findings of the Audit Committee investigation, we made the
      following changes to our internal controls:





1.
            Mr.
                Jeffrey LeRose was appointed to the position of non-executive Chairman
                of
                the Board of Directors to separate the leadership of the Board of
                Directors from the management of the Company, replacing Mr. Michael
                Nouri,
                who remained as President, Chief Executive Officer, and a member
                of the
                Board




2.
            Mr.
                Nouri has repaid all amounts outstanding to several noteholders,
                including
                Berkley Financial Services through sales of shares of our common
                stock
                from Mr. Nouri's personal holdings.




3.
            Our
                Chief Financial Officer has been involved in communications with
                investment professionals, including analysts, brokers and potential
                institutional investors.




4.
            Our
                Chief Financial Officer has been given direct reporting responsibility
                to
                the Audit Committee with respect to any such
                communications.




5.
            Three
                additional, non-management directors have been appointed to our Board
                of
                Directors, two of whom qualify as “independent” under Item 407(a) of
                Regulation S-K. One of these “independent” directors also qualifies as an
                “audit committee financial expert” under Item 407(d)(5)(ii) of Regulation
                S-K and is serving as the Chairman of the Audit
                Committee.




6.
            Our
                outside counsel has provided periodic educational training for management
                and directors by outside legal counsel and other appropriate professional
                advisors.




7.
            We
                have adopted a revised Securities Trading
                Policy.




8.
            Controls
                have been implemented regarding the review and approval of material
                contracts by our Chief Financial Officer, Corporate Counsel, and
                where
                appropriate, our outside counsel and Board of Directors, including
                the
                creation of a contract checklist to be completed by our Chief Financial
                Officer and Corporate Counsel for each material
                agreement.




9.
            We
                have instituted a program requiring written confirmation of compliance
                with our Code of Ethics and Conflicts of Interest Policy on a quarterly
                basis from all members of management and the Board of
                Directors.




10.
            We
                entered into a contract with Ethical Advocates, Inc. for confidential
                and
                anonymous incident reporting.




11.
            Multiple
                control systems have been put in place to review checks paid to officers
                and directors in excess of $2,500.




12.
            We
                now have three members of our Board who are members of the National
                Association of Corporate Directors
                (“NACD”).




Of
      the
      changes to our internal controls listed above, we continue to test the changes
      numbered 6, 7 and 9 for their effectiveness. All of the other changes have
      been
      tested and found effective as of the end of the second quarter of fiscal 2007.
      We recognize that “tone at the top” is a key element to an organization’s
      control environment and are focused and committed to providing the correct
      tone
      and structure within the company. We cannot assure you that we will not in
      the
      future identify further deficiencies in our controls. However, we plan to
      continue to review and make any necessary changes to the overall design of
      our
      control environment in order to enhance our corporate governance and reporting
      practices.


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**II. 
OTHER
      INFORMATION**




**1.  LEGAL
      PROCEEDINGS**





During
      the three months ended June 30, 2007, there were no material developments in
      the
      legal proceedings previously reported in our 2006 Annual Report. Please refer
      to
      Part I, Item 3 of our 2006 Annual Report for additional
      information.




**1A.
      RISK FACTORS**





The
      following is a description of what we consider our key challenges and
      risks.





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.




We
      have
      organized these factors into the following categories below:





·
            Our
                Financial Condition





·
            Our
                Products and Operations




·
            Our
                Market, Customers and Partners





·
            Our
                Officers, Directors, Employees and
                Stockholders




·
            Regulatory
                Matters that Affect Our Business





·
            Matters
                Related to the Market For Our
                Securities




**Risks
      Associated with Our Financial Condition**





**(1)**  **We
      have had recurring losses from operations since inception and continue to have
      negative cashflows. If we do not rectify these deficiencies through additional
      financing or growth, we may have to cease operations and liquidate our
      business.**





Through
      June 30, 2007, we have lost an aggregate of approximately $59.9 million since
      inception on August 10, 1993. During the quarters ended June 30, 2007 and 2006,
      we incurred a net loss of approximately $1,200,000 and $28,000, respectively.
      At
      June 30, 2007, we had $2.6 million of working capital. Our working capital,
      including our line of credit and recent financing transaction for $6 million,
      is
      not sufficient to fund our operations beyond July 2008, unless we substantially
      increase our revenue, limit expenses or raise substantial additional financing.
      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, and
      the
      suspension of trading of shares of our common stock by the SEC, and the
      resulting drop in share price, trading volume and liquidity, 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; we may have
      to
      liquidate our business.





**(2)**  **Any
      issuance of shares of our common stock in the future could have a dilutive
      effect on your investment.**





We
      may
      issue shares of our common stock in the future for a variety of reasons. For
      example, under the terms of the stock purchase warrant and agreement we entered
      into with Atlas in January 2007, 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 Wachovia. 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. In addition, we may raise funds
      in the future by issuing additional shares of common stock or other
      securities.


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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.
      You may experience dilution in the value of your shares as a
      result.





**(3)**  **In
      the future, we may enter into certain debt financing transactions with third
      parties that could adversely affect our financial health.**





We
      currently have a secured loan arrangement from Fifth Third Bank. Under the
      terms
      of this agreement, Smart Commerce borrowed $1.8 million to be repaid in 24
      monthly installments of $75,000 plus interest beginning in December 2006. The
      interest rate is prime plus 1.5% as periodically determined by Fifth Third
      Bank.
      The loan is secured by all of the assets of Smart Commerce and all of Smart
      Commerce's intellectual property. The loan is guaranteed by us and such guaranty
      is secured by all the common stock of Smart Commerce.





We
      also
      have a revolving line of credit from Wachovia. This line of credit is $2.5
      million, and as of August 10, 2007, we have drawn down approximately $2.1
      million. Any advances made on the line of credit must be repaid no later than
      August 1, 2008, with monthly payments of accrued interest only commencing on
      December 1, 2006 on any outstanding balance. The interest shall accrue on the
      unpaid principal balance at the LIBOR Market Index Rate plus 0.9%. The line
      of
      credit is secured by our deposit account at Wachovia and an irrevocable standby
      letter of credit in the amount of $2.5 million issued by HSBC Private Bank
      (Suisse) S.A. with Atlas as account party.





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




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





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





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





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





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





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




**Risks
      Associated with Our Products and Operations**





**(4)**  **Our
      business is dependent upon the development and market acceptance of our
      applications, including the acceptance of using some of our applications to
      conduct business. Our business models and operating plans have changed as a
      result of forces beyond our control. Consequently, we have not yet demonstrated
      that we have a successful business model or operating
      plan.**





We
      continually revise our business models and operating plans as a result of
      changes in our market, the expectations of customers and the behavior of
      competitors. Today, we anticipate that our future financial performance and
      revenue growth will depend, in large part, upon our Internet-based SaaS business
      model and the results of our sales efforts to reach agreements with syndication
      partners with small business customer bases, but this business model may become
      ineffective due to forces beyond our control that we do not currently
      anticipate. In 2007, we have entered into agreements with five new partners.
      However, we have not yet demonstrated that we have a successful business model
      or operating plan. Our evolving business model makes our business operations
      and
      prospects difficult to evaluate. There can be no assurance that our revised
      business model will allow us to capture significant future market potential.
      Investors in our securities should consider all the risks and uncertainties
      that
      are commonly encountered by companies in this stage of operations under our
      current business model, particularly companies, such as ours, that are in
      emerging and rapidly evolving markets.


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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. There can be no assurance that we will be able to successfully
      develop new services or products, or to introduce in a timely manner and gain
      acceptance of our new services or products in the marketplace.





Our
      business could be harmed if we fail to achieve the improved performance that
      customers want with respect to our current and future 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 of our
      applications.




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





**(5)**  **We
      may consider strategic divestiture, acquisition or investment opportunities
      in
      the future. We face risks associated with any such
      opportunity.**





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





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





·
            diversion
                of financial and managerial resources from existing
                operations;





·
            reduction
                of available cash;





·
            risk
                of entering new markets;





·
            potential
                write-offs of acquired assets;





·
            potential
                loss of key employees;





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





·
            delays
                in customer purchases due to
                uncertainty.




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





**(6)**  **We
      entered into a debt financing transaction in order to make certain installment
      payments under our agreement in the iMart acquisition. Failure to comply with
      the provisions of this loan agreement could have a material adverse effect
      on
      us.**





When
      we
      purchased iMart in October 2005, we committed to make installment payments
      of
      approximately $3,462,000 and non-competition payments to two key employees
      of
      $780,000. Prior to the loan agreement described below, the cash flow we received
      from the business we purchased from iMart was insufficient to cover any of
      the
      installment payments we have been required to make, and we have had to fund
      the
      difference. We amended the lock box agreement related to the acquisition in
      January 2007, terminating the iMart shareholders' security interest in the
      amounts in the lock box account, and agreed to pay the installment payments
      and


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          | 31
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noncompetition
      payments in three non-equal installments by February 2007, which have been
      paid
      in full.





We
      entered into a loan agreement with Fifth Third Bank in order to finance a
      portion of the payments to the iMart shareholders. Under the terms of this
      agreement, Smart Commerce borrowed $1.8 million to be repaid in 24 monthly
      installments of $75,000 plus interest. The interest rate is prime plus 1.5%
      as
      periodically determined by Fifth Third Bank. Currently and at closing, the
      prime
      rate was 8.25%. The loan is secured by all of the assets of Smart Commerce,
      including a security account of $250,000 and all of Smart Commerce's
      intellectual property. The loan is guaranteed by us, and such guaranty is
      secured by all the common stock of Smart Commerce. If an event of default occurs
      and remains uncured, then the lender could foreclose on the assets securing
      the
      loan. If that were to occur, it would have a substantial adverse effect on
      our
      business. Making the payments on the loan used to finance part of these payments
      may drain our financial resources or cause other material harm to our business
      if the lender forecloses on the secured assets.





**(7)**  **We
      rely on third-party software that may be difficult to repair should errors
      or
      failures occur. Such an error or failure, or the process undertaken by us to
      correct such an error or failure, could disrupt our services and harm our
      business.**





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




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




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





**(8)**  **The
      structure of our subscription model makes it difficult to predict the rate
      of
      customer subscription renewals or the impact non-renewals will have on our
      revenue or operating results.**





Our
      small
      business customers do not sign long-term contracts. Our customers have no
      obligation to renew their subscriptions for our services after the expiration
      of
      their initial subscription period and, in fact, customers have often elected
      not
      to do so. In addition, our customers may renew for a lower-priced edition of
      our
      services or for fewer users. Many of our customers utilize our services without
      charge. 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. Most of our subscribers are in our Smart
      Commerce segment. Since the first quarter of 2006, the number of subscribers
      to
      our software products in our Smart Online segment has declined. We are not
      certain what caused this decline. Some customers had indicated they had
      difficulty accessing our software applications on our website. Consequently,
      we
      redesigned our website and product bundling to address this problem. As of
      July
      2007, the decline in the number of subscribers has continued, but has been
      offset by an increase in the number of subscribers to our Smart Commerce
      segment. However, 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.





**(9)**  **We
      depend on corporate partners to market our products through their web sites
      under relatively short-term agreements in order to increase subscription fees
      and grow revenue. Failure of our partners' marketing efforts or termination
      of
      these agreements could harm our business.**





Subscription
      fees represented approximately 40% of total revenues in the second quarter
      of
      2007 compared to 60% of total revenues in the second quarter of 2006. With
      the
      launch of our new applications and the acquisition of iMart, subscription fees
      represent a significant percentage of our total revenues and our future
      financial performance and revenue growth depends, in large part, upon the growth
      in customer demand for our outsourced services delivery models. We depend on
      our
      syndication partners and referral relationships to offer our products and
      services to a larger customer base than we can reach through direct sales or
      other marketing efforts. Although we recently entered into agreements with
      five
      new partners and a marketing referral agreement. 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. 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


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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.





**(10)**  **Our
      future growth is substantially dependent on customer demand for our subscription
      services delivery models. Failure to increase this revenue could harm our
      business.**





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. There can be no assurance that we will be able to maintain
      positive gross margins in our subscription services delivery models in future
      periods. If our subscription services business does not grow sufficiently,
      we
      could fail to meet expectations for our results of operations, which could
      harm
      our business.




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





**(11)**  **There
      are risks associated with international operations, which may become a bigger
      part of our business in the future.**





We
      currently do not generate revenue from international operations. Although we
      signed an agreement with a company in January 2007 to market our products and
      services in a foreign country, this agreement has not yet generated any revenue
      for us. We are currently evaluating whether and how to expand into additional
      international markets. If we continue to develop our international operations,
      these operations will be subject to risks associated with selling abroad. These
      international operations are subject to a number of difficulties and special
      costs, including:




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





·
            laws
                and business practices favoring local
                competitors;





·
            uncertain
                regulation of electronic commerce;





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




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





·
            import
                and export restrictions and
                tariffs;




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





·
            difficulties
                staffing and managing foreign
                operations;




·
            political
                and economic instability.




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




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


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the
      important differences and customize our product to address the
      differences.




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




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





**(12)**  **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
      success depends significantly on the continued services of our executive
      management personnel. Losing any of our officers could seriously harm our
      business. Competition for executives is intense. If we had to replace any of
      our
      officers, we would not be able to replace the significant amount of knowledge
      that they have about our operations. All of our executive team work at the
      same
      location, which could make us vulnerable to loss of our entire management team
      in the event of a natural or other disaster. We do not maintain key man
      insurance policies on any of our employees.




**(13)**  **Officers,
      directors and principal stockholders control us. This might lead them to make
      decisions that do not benefit the interests of minority
      stockholders.**





Our
      officers, directors and principal stockholders beneficially own or control
      approximately 53% of our outstanding common stock. As a result, these persons,
      acting together, will have the ability to control substantially all matters
      submitted to our stockholders for approval (including the election and removal
      of directors and any merger, consolidation or sale of all or substantially
      all
      of our assets) and to control our management and affairs. Accordingly, this
      concentration of ownership may have the effect of delaying, deferring or
      preventing a change in control of us, impeding a merger, consolidation, takeover
      or other business combination involving us or discouraging a potential 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.




**Regulatory
      Risks**





**(14)**  **Compliance
      with regulations governing public company corporate governance and reporting
      is
      uncertain and expensive.**





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





**(15)**  **Remediation
      of deficiencies in our internal control over financial reporting is uncertain
      and may be expensive.**





By
      the
      end of fiscal 2007, we are required to comply with Sarbanes-Oxley requirements
      involving management's assessment of our internal control over financial
      reporting, and our independent accountant's audit of our internal control over
      financial reporting is required for fiscal 2008. In March 2006, we retained
      a new Chief Financial Officer. His review of our internal control over financial
      reporting to date and the final findings of our Audit Committee investigation
      have identified several deficiencies in our internal control over financial
      reporting. In July 2006, the Audit Committee concluded that: (i) our Chief
      Executive Officer should have disclosed and sought approval from the Board
      of
      Directors before entering into certain transactions and arrangements, including
      personal loans; (ii) there was inadequate diligence by management and the Board
      of Directors regarding third parties with which we contracted, including outside
      investor relations vendors, some of which were registered brokers; (iii)
      management and our directors lacked sufficient knowledge regarding rules and
      regulations with respect to dealings between registered brokers and public
      companies, (iv) we lack clear policies regarding the limits


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on
      the
      Chief Executive Officer's authority to enter into business transactions and
      agreements without Board approval; (v) there has been inadequate legal and
      accounting review of material contracts; (vi) there has been inadequate training
      and understanding of SEC disclosure requirements; (vii) there was an
      unintentional violation of our Securities Trading Policy by one of our directors
      as previously reported in our public filings; (viii) we have inadequate
      processes for determination of independence of Board members; and (ix) there
      has
      been a failure to communicate and stress the importance of controls and
      procedures throughout our organization. The Audit Committee investigation
      concluded that these deficiencies primarily resulted from our transition from
      a
      private company to a publicly reporting company and insufficient preparation
      for, focus on, and experience with compliance requirements for a publicly
      reporting company. We reported the changes to our internal controls related
      to
      the Audit Committee's findings in our Annual Report on Form 10-K for the fiscal
      year ended December 31, 2005, filed with the SEC on July 11, 2006, as updated
      in
      our Annual Report on Form 10-K for the fiscal year ended December 31, 2006,
      filed with the SEC on March 30, 2007.





While
      we
      have made some progress on this remediation effort, we continue to work on
      addressing all the issues raised in these findings. Although we believe our
      on-going review and testing of our internal control over financial reporting
      will enable us to be compliant with these requirements, we have identified
      some
      deficiencies and may identify others that we may not be able to remediate and
      test by the end of fiscal 2007.





If
      we
      cannot assess our internal controls over financial reporting as effective,
      it
      may affect our management's assessment of our internal control environment
      as it
      will be disclosed in our Annual Report on Form 10-K for fiscal 2007 and our
      stock price could decline.





**(16)**  **The
      SEC suspension of trading of our securities has damaged our business, and it
      could damage our business in the future.**





The
      suspension of trading by the SEC has harmed our business in many ways, and
      may
      cause further harm in the future. Prior to our re-entry onto the Over the
      Counter Bulletin Board, or the OTC-BB, for quotation, our ability to raise
      financing on favorable terms to us and our existing stockholders suffered due
      to
      the lack of liquidity of our stock, the questions raised by the SEC's action,
      and the resulting drop in the price of our common stock. As a result, we did
      not
      raise sufficient financing to make the sales and marketing investments we felt
      were needed in 2006 to substantially increase revenue. Legal and other fees
      related to the SEC's action also reduced our cash flow, which jeopardized our
      ability to make the installment payments required by the agreements to acquire
      iMart. We completed a private placement financing for $6 million in February
      2007; however we make no assurance that we will not continue to experience
      additional harm as a result of the SEC matter. The time spent by our management
      team and directors dealing with issues related to the SEC action also detracted
      from the time they spent on our operations, including strategy development
      and
      implementation. Finally, an important part of our business plan is to enter
      into
      private label syndication agreements with large companies. The SEC's action
      and
      related matters have caused us to be a less attractive partner for large
      companies and to lose important opportunities. The SEC's action and related
      matters may cause other problems in our operations.




**Risks
      Associated with the Market for Our Securities**





**(17)**  **If
      securities analysts do not publish research or reports about our business or
      if
      they downgrade our stock, the price of our stock could
      decline.**





The
      trading market for our common stock relies in part on the research and reports
      that industry or financial analysts publish about us or our business. Because
      our stock is currently quoted on the OTC-BB rather than traded on a national
      exchange, analysts may not be interested in conducting research or publishing
      reports on us. If we do not succeed in attracting analysts to report about
      our
      company, most investors will not know about us even if we are successful in
      implementing our business plan. We do not control these analysts. There are
      many
      large, well established publicly traded companies active in our industry and
      market, which may mean it will be less likely that we receive widespread analyst
      coverage. Furthermore, if one or more of the analysts who do cover us downgrade
      our stock, our stock price would likely decline rapidly. If one or more of
      these
      analysts cease coverage of our company, we could lose visibility in the market,
      which in turn could cause our stock price to decline.





**(18)**  **Our
      revenues and operating results may fluctuate in future periods and we may fail
      to meet expectations of investors and public market analysts, which could cause
      the price of our common stock to decline.**





Our
      revenues and operating results may fluctuate significantly from quarter to
      quarter. If quarterly revenues or operating results fall below the expectations
      of investors or public market analysts, the price of our common stock could
      decline substantially. Factors that might cause quarterly fluctuations in our
      operating results include:




·
            the
                evolving demand for our services and
                software;





·
            spending
                decisions by our customers and prospective
                customers;




·
            our
                ability to manage expenses;




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          | 35
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·
            the
                timing of product releases;




·
            changes
                in our pricing policies or those of our
                competitors;





·
            the
                timing of execution of contracts;





·
            changes
                in the mix of our services and software
                offerings;





·
            the
                mix of sales channels through which our services and software are
                sold;




·
            costs
                of developing product enhancements;





·
            global
                economic and political conditions;




·
            our
                ability to retain and increase sales to existing customers, attract
                new
                customers and satisfy our customers'
                requirements;





·
            subscription
                renewal rates for our service;




·
            the
                rate of expansion and effectiveness of our sales
                force;





·
            the
                length of the sales cycle for our
                service;




·
            new
                product and service introductions by our
                competitors;





·
            technical
                difficulties or interruptions in our
                service;




·
            regulatory
                compliance costs;





·
            integration
                of acquisitions; and




·
            extraordinary
                expenses such as litigation or other dispute-related settlement
                payments.




In
      addition, due to a slowdown in the general economy and general uncertainty
      of
      the current geopolitical environment, an existing or potential customer may
      reassess or reduce its planned technology and Internet-related investments
      and
      defer purchasing decisions. Further delays or reductions in business spending
      for technology could have a material adverse effect on our revenues and
      operating results.





**(19)**  **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 include:





·
            variations
                in our actual and anticipated operating
                results;





·
            the
                volatility inherent in stock prices within the emerging sector in
                which we
                conduct business;




·
            announcements
                of technological innovations, new services or service enhancements,
                strategic alliances or significant agreements by us or by our
                competitors;





·
            recruitment
                or departure of key personnel;




·
            changes
                in the estimates of our operating results or changes in recommendations
                by
                any securities analysts that elect to follow our common
                stock;





·
            market
                conditions in our industry, the industries of our customers and the
                economy as a whole; and


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·
            the
                volume of trading in our common stock, including sales of substantial
                amounts of common stock issued upon the exercise of outstanding options
                and warrants.





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.
      Securities class action litigation could result in substantial costs and a
      diversion of our management's attention and resources. If such a suit is brought
      against us, we may determine, like many defendants in such lawsuits, that it
      is
      in our best interests to settle such a 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 any 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.





**(20)**  **Shares
      eligible for public sale could adversely affect our stock
      price.**





Certain
      holders of shares of our common stock signed agreements that prohibit resales
      of
      our common stock. If substantial numbers of shares are resold as lock-up periods
      expire, the market price of our common stock is likely to decrease
      substantially.




At
      August
      10, 2007, 17,927,137 shares of our common stock were issued and outstanding
      and
      3,857,715 shares may be issued pursuant to the exercise of warrants and options.
      During May 2005, we registered on Form S-8 5,000,000 shares of our common stock
      for issuance to our officers, directors and consultants under the 2004 Plan,
      of
      which at August 10, 2007, 156,000 shares were outstanding and 1,376,200 shares
      are subject to outstanding stock options of the 5,000,000 shares reserved for
      issuance under such plan. In June 2007, we limited the issuance of shares of
      our
      common stock reserved under the 2004 Plan to awards of shares of restricted
      and
      unrestricted common stock. Also in June 2007, our Board of Directors approved
      an
      offer for holders of outstanding options with an exercise price of $2.50 per
      share or greater to exchange the outstanding options for a certain number of
      shares of restricted stock. We target that the restriction on these shares
      of
      stock would lapse in four equal, quarterly increments over the year following
      the acceptance of the exchange offer. The exchange offer has not commenced
      and
      will not commence until certain actions are taken by us, including a filing
      of a
      tender offer statement and offer to exchange on Scheduled TO with the SEC.
      This
      quarterly report on Form 10-Q is not an offer or solicitation of an offer to
      sell or exchange any outstanding options. The remaining outstanding shares
      of
      our common stock are restricted and may be sold in the public market only if
      they qualify for an exemption from registration under Rules 144 or 701
      promulgated under the Securities Act of 1933.




We
      entered into agreements that limit the number of shares that may be sold during
      specific time periods, or Dribble Out Agreements, with all of the investors
      who
      purchased shares of our stock from us in private placements during 2005 and
      2006, a total of approximately 2,497,000 shares. Under these Dribble Out
      Agreements, sales of shares are limited to 25% during a rolling 30-day period.
      Such limitations terminate six months after the effective date of the
      registration statement registering these shares. Almost all of these shares
      are
      registered on our Registration Statement on Form S-1 (Registration No.
      333-141853), or the Registration Statement, which was declared effective by
      the
      SEC as of July 31, 2007.





Certain
      of our affiliates have also entered into other Lock-Up Agreements covering
      a
      portion of their shares. These agreements restrict the sale of 1,296,623 shares
      of our common stock. Under the terms of these Lock-Up Agreements, these officers
      cannot sell, pledge, grant or otherwise transfer the shares subject to the
      agreement for one year following July 31, 2007. After one year, 2.5% of these
      shares per quarter are released from these restrictions on a pro rata basis
      among these affiliates. All remaining shares will be released from the Lock-Up
      Agreements on July 31, 2009. These Lock-Up Agreements will otherwise terminate
      at the following times: (A) if the Registration Statement is terminated, the
      earlier of (i) the date of termination if no shares were sold, or (ii) the
      date
      any proceeds received from public investors are placed in the mail for return;
      (B) the date our common stock is listed on a national securities exchange,
      or
      (C) 30 days following the date the persons signing these Lock-Up Agreements
      are
      no longer affiliates.





Our
      stock
      is very thinly traded. The average daily trading volume for our common stock
      between November 2006 and July 2007 was approximately 14,900 shares per day.
      The
      number of shares that could be sold during this period was restrained by Dribble
      Out Agreements, Lock-Up Agreements, and other contractual limitations imposed
      on
      some of our shares, while there was no similar contractual restraint on the
      number of buyers of our common stock. This means that market supply may increase
      more than market demand for our shares when lock-up and dribble-out periods
      expire. 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 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


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demand
      for our stock.





Future
      sales of substantial amounts of our shares in the public market could adversely
      affect market prices prevailing from time to time and could impair our ability
      to raise capital through the sale of our equity securities.





**(21)**  **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, which:


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·
            contains
                a description of the nature and level of risk in the market for penny
                stocks in both public offerings and secondary
                trading;




·
            contains
                a description of the broker's or dealer's duties to the customer
                and of
                the rights and remedies available to the customer with respect to
                a
                violation of such duties or other
                requirements;




·
            contains
                a brief, clear, narrative description of a dealer market, including
“bid”
                and “ask” prices for penny stocks and the significance of the spread
                between the bid and ask price;




·
            contains
                a toll-free telephone number for inquiries on disciplinary
                actions;




·
            defines
                significant terms in the disclosure document or in the conduct of
                trading
                penny stocks; and





·
            contains
                such other information and is in such form (including language, type,
                size, and format) as the SEC
                requires.




The
      broker-dealer also must provide the customer, prior to effecting any transaction
      in a penny stock, with:




·
            bid
                and ask quotations for the penny
                stock;





·
            the
                compensation of the broker-dealer and its salesperson in the
                transaction;




·
            the
                number of shares to which such bid and ask prices apply, or other
                comparable information relating to the depth and liquidity of the
                market
                for such stock; and





·
            monthly
                account statements showing the market value of each penny stock held
                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.




**4.
      SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS**




Our
      Annual Meeting of Stockholders was held on June 20, 2007. The following matters
      were submitted to a vote of the stockholders with the results shown below:




(a)
            Election
                of seven directors, each elected to serve until the later of the
                next
                Annual Meeting of Stockholders or until such time as his successor
                has
                been duly elected and qualified.





Name
            
            Votes
                For
            
            Votes WithheldDennis
                Michael Nouri
            
            11,099,412
            
            24,400Thomas
                P. Furr
            
            11,099,412
            
            24,400Jeffrey
                W. LeRose
            
            10,340,194
            
            783,618Shlomo
                Elia
            
            11,109,612
            
            14,200Philippe
                Pouponnot
            
            11,109,612
            
            14,200C.
                James Meese, Jr.
            
            10,340,194
            
            783,618David
                E. Colburn
            
            10,340,194
            
            783,618




(b)
            Ratification
                of the appointment of Sherb & Co., LLP as independent auditors for the
                fiscal year ended December 31, 2007.


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**Votes
                For**
            
            **Votes Against**
            
            **Abstained**11,123,612
            
            200
            
            0





The
      matters listed above are described in detail in our definitive proxy statement
      dated June 4, 2007 for the Annual Meeting of Stockholders held on June 20,
      2007.




**6.  EXHIBITS**




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




Exhibit
                No.
            Description3.1
            Third
                Amended and Restated Bylaws (incorporated herein by reference to
                Exhibit
                3.1 to our Current Report on Form 8-K, as filed with the SEC on May
                31,
                2007)10.1
            Form
                of Restricted Stock Agreement (Non-Employee Director) under Smart
                Online,
                Inc.'s 2004 Equity Compensation Plan (incorporated herein by reference
                to
                Exhibit 10.1 to our Current Report on Form 8-K, as filed with the
                SEC on
                May 31, 2007)10.2
            Form
                of Executive Officer Compensation Agreement, dated April 25, 2007,
                by and
                between Smart Online, Inc. and certain of its executive officers
                (incorporated herein by reference to Exhibit 10.53 to Amendment No.
                1 to
                our Registration Statement on Form S-1 (Registration No. 333-141853),
                as
                filed with the SEC on June 15, 2007)10.3
            Form
                of Amendment to Registration Rights Agreement, dated March 26, 2007,
                by
                and between Smart Online, Inc. and each of Magnetar Capital Master
                Fund,
                Ltd. and Herald Investment Management Limited on behalf of Herald
                Investment Trust PLC (incorporated herein by reference to Exhibit
                10.54 to
                Amendment No. 3 to our Registration Statement on Form S-1 (Registration
                No. 333-141853), as filed with the SEC on July 31, 2007)31.1
            Certification
                of Chief Executive Officer Pursuant to Rule 13a-14(a) as Adopted
                Pursuant
                to Section 302 of the Sarbanes-Oxley Act of 200231.2
            Certification
                of Chief Financial Officer Pursuant to Rule 13a-14(a) as Adopted
                Pursuant
                to Section 302 of the Sarbanes-Oxley Act of 200232.1
            Certification
                of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
                Adopted
                Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit
                is
                being furnished pursuant to Section 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 Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350,
                as
                Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                This
                exhibit is being furnished pursuant to Section 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.








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**SIGNATURES**





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





Dated:
      August 14, 2007




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




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Exhibit
      Table




Exhibit
                No.
            Description3.1
            Third
                Amended and Restated Bylaws (incorporated herein by reference to
                Exhibit
                3.1 to our Current Report on Form 8-K, as filed with the SEC on May
                31,
                2007)10.1
            Form
                of Restricted Stock Agreement (Non-Employee Director) under Smart
                Online,
                Inc.'s 2004 Equity Compensation Plan (incorporated herein by reference
                to
                Exhibit 10.1 to our Current Report on Form 8-K, as filed with the
                SEC on
                May 31, 2007)10.2
            Form
                of Executive Officer Compensation Agreement, dated April 25, 2007,
                by and
                between Smart Online, Inc. and certain of its executive officers
                (incorporated herein by reference to Exhibit 10.53 to Amendment No.
                1 to
                our Registration Statement on Form S-1 (Registration No. 333-141853),
                as
                filed with the SEC on June 15, 2007)10.3
            Form
                of Amendment to Registration Rights Agreement, dated March 26, 2007,
                by
                and between Smart Online, Inc. and each of Magnetar Capital Master
                Fund,
                Ltd. and Herald Investment Management Limited on behalf of Herald
                Investment Trust PLC (incorporated herein by reference to Exhibit
                10.54 to
                Amendment No. 3 to our Registration Statement on Form S-1 (Registration
                No. 333-141853), as filed with the SEC on July 31, 2007)31.1
            Certification
                of Chief Executive Officer Pursuant to Rule 13a-14(a) as Adopted
                Pursuant
                to Section 302 of the Sarbanes-Oxley Act of 200231.2
            Certification
                of Chief Financial Officer Pursuant to Rule 13a-14(a) as Adopted
                Pursuant
                to Section 302 of the Sarbanes-Oxley Act of 200232.1
            Certification
                of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
                Adopted
                Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit
                is
                being furnished pursuant to Section 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 Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350,
                as
                Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                This
                exhibit is being furnished pursuant to Section 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.






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